California BanCorp - Annual Report: 2021 (Form 10-K)

☐	ANNUAL REPORT PURSUANT TO SECTION 13 OF 15(d) OR THE SECURITIES EXCHANGE ACT OF 1934

California		82-1751097
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

Common Stock, No Par Value		CALB		NASDAQ Global Select Market
(Title of class)		(Trading Symbol)		(Name of exchange on which registered)

Large accelerated filer		☐		Accelerated filer		☐
Non-accelerated filer		☐		Smaller reporting company		☒
				Emerging growth company		☒

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Part I
Item 1.		Business			6
Item 1A.		Risk Factors			22
Item 1B.		Unresolved Staff Comments			36
Item 2.		Properties			36
Item 3.		Legal Proceedings			36
Item 4.		Mine Safety Disclosures			36
Part II
Item 5.		Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			37
Item 6.		Reserved			37
Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			37
Item 7A.		Quantitative and Qualitative Disclosures about Market Risk			50
Item 8.		Financial Statements and Supplementary Data			51
Item 9.		Changes in and Disagreements with Accountants on Accounting Financial Disclosures			91
Item 9A.		Controls and Procedures			91
Item 9B.		Other Information			91
Item 9C.		Disclosure Regarding Foreign Jurisdictions that Prevent Inspections			91
Part III
Item 10.		Directors, Executive Officers and Corporate Governance			92
Item 11.		Executive Compensation			92
Item 12.		Security Ownership of Certain Beneficial Owners and Management, and Related Stockholder Matters			92
Item 13.		Certain Relationships and Related Transactions, and Director Independence			92
Item 14.		Principal Accountant Fees and Services			92
Part IV
Item 15.		Exhibits and Financial Statement Schedules			93
Item 16.		Form 10-K Summary			94
Signatures					95

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the impact of the COVID-19 epidemic on our business, employees, customers and the local, national and global economy;

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business and economic conditions nationally, regionally and in our target markets, particularly in the greater San Francisco Bay Area and other areas in which we operate;

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concentration of our loan portfolio in commercial and industrial loans, which loans may be dependent on the borrower’s cash flows for repayment and, to some extent, the local and regional economy;

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concentration of our loan portfolio in real estate loans and changes in the prices, values and sales volumes of commercial and residential real estate;

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the concentration of our business activities within the geographic areas of Northern California;

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credit and lending risks associated with our commercial real estate, commercial and industrial, and construction and development portfolios;

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disruptions to the credit and financial markets, either nationally or globally;

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increased competition in the banking industry, nationally, regionally or locally;

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our ability to execute our business strategy to achieve profitable growth;

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the dependence of our operating model on our ability to attract and retain experienced and talented bankers in each of our markets;

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risks that our cost of funding could increase, in the event we are unable to continue to attract stable, low-cost deposits and/or reduce our cost of deposits;

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our ability to improve our operating efficiency;

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failure to keep pace with technological change or difficulties when implementing new technologies;

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our ability to attract and maintain business banking relationships with well-qualified businesses, real estate developers and investors with proven track records in our market areas;

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our ability to attract sufficient loans that meet prudent credit standards, including in our commercial and industrial and owner-occupied commercial real estate loan categories;

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failure to maintain adequate liquidity and regulatory capital and comply with evolving federal and state banking regulations;

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inability of our risk management framework to effectively mitigate risks, such as credit risk, interest rate risk, liquidity risk, price risk, compliance risk, operational risk, strategic risk and reputational risk;

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our ability to develop new, and grow our existing, streams of noninterest income;

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our dependence on our management team and our ability to motivate and retain our management team;

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risks related to any future acquisitions, including failure to realize anticipated benefits from future acquisitions;

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system failures, data security breaches, including as a result of cyber-attacks, or failures to prevent breaches of our network security;

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data processing system failures and errors;

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our heavy reliance on communications and information systems to conduct business and reliance on third parties and affiliates to provide key components of business structure, any disruptions of which could interrupt operations or increase the costs of doing business;

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fraudulent and negligent acts by our customers, employees or vendors;

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our financial reporting controls and procedures’ ability to prevent or detect all errors or fraud;

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our ability to maintain expenses in line with current projections;

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fluctuations in the market value of the securities held in our securities portfolio;

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the adequacy of our reserves (including the allowance for loan and lease losses and the appropriateness of our methodology for calculating such reserves);

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increased loan losses or impairment of goodwill and other intangibles;

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an inability to raise necessary capital to fund our growth strategy, operations, or to meet increased minimum regulatory capital levels;

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the sufficiency of our capital, including sources of such capital and the extent to which capital may be used or required;

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interest rate changes and their impact on our financial condition and results of operations;

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the institution and outcome of litigation and other legal proceeding to which we become subject;

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changes in our accounting standards;

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the impact of recent and future legislative and regulatory changes;

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examinations by our regulatory authorities, including the possibility that the regulatory authorities may, among other things, require us to increase our allowance for loan losses, or write-down assets, or otherwise impose restrictions or conditions on our operations, including, but not limited to, our ability to acquire or be acquired;

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governmental monetary and fiscal policies;

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changes in the scope and cost of Federal Deposit Insurance Corporation insurance and other insurance coverage; and

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other factors and risks described under the “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections herein.

Our market areas cover primarily the greater San Francisco Bay Area and Sacramento. Our branch and loan production offices are located in three contiguous counties in the San Francisco Bay Area: Alameda, Contra Costa and Santa Clara; and Sacramento County. The economic base of this market area is heavily dependent on small and businesses, providing us with a market rich in potential customers.

The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer most types of financial services, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems.

Some of our competitors, such as fintech lenders, have fewer regulatory constraints and may have lower cost structures. In addition, some of our competitors have assets, capital and lending limits greater than that of the Bank, have greater access to capital markets and offer a broader range of products and services than the Bank. These institutions may have the ability to offer lower rates on loans and higher rates on deposits than we can offer. Some of these institutions offer services, such as international banking, which we do not directly offer, except for a limited suite of services such as international wires and currency exchange.

We provide a range of commercial lending services, including commercial and industrial loans, commercial real estate loans, and residential and commercial construction and development loans. Our specialty commercial lending niches include dental and veterinary lending, commercial contractors, asset-based lending, commercial and residential construction and emerging businesses. Our customers are generally small to

Under California law, our ability to make aggregate secured and unsecured is limited to 25% and 15%, respectively, of unimpaired capital and surplus. At December 31, 2021, the Bank’s limit on aggregate secured was $50.8 million and unsecured borrower was $30.5 million. At December 31 2021, the Bank’s highest aggregate balance of secured was $20.9 million and the highest aggregate balance of unsecured borrower was $19.1 million. The Bank’s legal lending limit will increase or decrease as the Bank’s level of capital increases or decreases. In addition, the Bank has established internal loan limits, which are lower than the legal lending limits for a California bank. Our board of directors will adjust the internal lending limit as deemed necessary to continue to mitigate risk and serve the Bank’s customers. We are also able to sell participations in our larger loans to other financial institutions, which allow us to manage the risk involved in these loans and to meet the lending needs of our customers requiring extensions of credit in excess of these limits.

We provide a mix of variable and fixed rate commercial and industrial loans. We extend commercial business loans for working capital, accounts receivable and inventory financing and other business purposes. Generally, short-term loans have maturities ranging from 12 months to 3 years, and “term loans” have maturities ranging from 5 to 10 years. Loans are generally intended to finance current transactions and typically provide for periodic principal payments, with interest payable monthly. Repayment of commercial loans depends substantially on the borrower’s underlying business, financial condition and cash flows, as well as the sufficiency of the collateral. Compared to real estate, the collateral may be more difficult to monitor, evaluate and sell. Where the borrower is a corporation, partnership or other entity, we typically require personal guarantees from significant equity holders. Our maximum ratio for commercial and industrial loans is dependent on the collateral.

We attempt to reduce risk associated with construction and development loans by obtaining personal guarantees and by keeping the maximum ratio at or below depending on the project type with a maximum ratio of 80%. Many of our loans will include interest reserves built into the loan commitment. Generally, for owner occupied commercial construction loans, we will require periodic cash payments for interest from the borrower’s cash flow. As of December 31 2021, construction and development loans made up approximately $43.2 million or 3% of our loan portfolio.

Our commercial real estate loans generally have terms of 10 years or less, although payments may be structured on a longer amortization basis. We evaluate each borrower on an individual basis and attempt to determine their business risks and credit profile. We attempt to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied industrial, office, and retail buildings where the ratio, established by independent appraisals, generally does not exceed 70% of cost or appraised value. We also generally require that a borrower’s cash flow exceed 130% of monthly debt service obligations. In order to ensure secondary sources of payment and liquidity to support a loan request, we typically review all of the personal financial statements of the principal owners and require their personal guarantees. Commercial real estate loans are generally viewed as having more risk of default than residential real estate loans. They are also typically larger than residential real estate loans and depend on cash flows from the owner’s business or the property to service the debt. Because our loan portfolio contains a number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in our levels of nonperforming assets.

We offer U.S. Small Business Administration, or SBA, loans for qualifying businesses for loan amounts up to $5 million. The Bank primarily extends SBA loans known as SBA 7(a) loans and SBA 504 loans. SBA 7(a) loans are typically extended for working capital needs, purchase of inventory, purchase of machinery and equipment, debt refinance, business acquisitions, financing or to purchase or construct owner-occupied commercial

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provide a ready source of balance sheet liquidity, ensuring adequate availability of funds to meet fluctuations in loan demand, deposit balances and other changes in balance sheet volumes and composition;

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serve as a means for diversification of our assets with respect to credit quality, maturity and other attributes;

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serve as a tool for modifying our interest rate risk profile pursuant to our established policies; and

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provide collateral to secure local governmental agency and business deposits.

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a requirement to have only two years of audited financial statements and only two years of related management’s discussion and analysis of financial condition and results of operations;

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exemption from the auditor attestation requirement in the assessment of the emerging growth company’s internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002;

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reduced disclosure about the emerging growth company’s executive compensation arrangements; and

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no non-binding advisory votes on executive compensation or golden parachute arrangements.

		Adequately Capitalized				Well Capitalized				Well Capitalized With Buffer
Leverage Ratio			4.00	%			5.00	%			5.00	%
Common Equity Tier I Capital Ratio			4.50	%			6.50	%			7.00	%
Tier I Capital Ratio			6.00	%			8.00	%			8.50	%
Total Capital Ratio			8.00	%			10.00	%			10.50	%

. The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before:

. Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act of 1978, as amended, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control exists if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Under the Federal Reserve’s regulations, control may be presumed to exist if a person or company acquires more than 5% but less than 25%, of any class of voting securities of a bank holding company, depending on the circumstances as set forth in the regulations, and the regulations also provide a procedure for challenging presumptions of control.

. The Bank Holding Company Act generally prohibits a bank holding company from engaging in activities other than banking, managing or controlling banks or other permissible subsidiaries, and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those determined by the Federal Reserve to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The Gramm-Leach-Bliley Act expanded the permissible activities of a bank holding company that qualifies as a financial holding company to engage in activities that are financial in nature or incidental or complementary to financial activities. Those activities include, among others, certain insurance, advisory and securities activities. The Company has not elected to be financial holding company and we have no plans to do so.

. Under the Federal Deposit Insurance Act (the “FDIA”) federal banking agencies are required to take “prompt corrective action” should an insured depository institution fail to meet certain capital adequacy standards. In the event an institution becomes “undercapitalized,” it must submit a capital restoration plan, which must be guaranteed by each company “having control of” the undercapitalized institution. For purposes of this statute, the Company controls the Bank. The FDIA grants greater powers to bank regulators in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior Federal Reserve approval of proposed distributions, or might be required to consent to a merger or to divest the troubled institution or other affiliates. See “Regulation of the Bank — Prompt Corrective Action” below

. The Company’s ability to pay dividends to its shareholders is limited by both general corporate law and the regulations and policies of the Federal Reserve applicable to bank holding companies. It is the Federal Reserve’s policy that a bank holding company should generally pay dividends on common stock only out of income available over the past year, and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition, and current Federal Reserve policy further calls for a bank holding company to consult with the Federal Reserve before repurchasing shares during a quarter in an amount that exceeds its earnings for the quarter. It is also the Federal Reserve’s policy that a bank holding company should not maintain dividend levels that undermine its ability to be a source of strength to its banking subsidiaries. The Federal Reserve has indicated that bank holding companies should carefully review their dividend policy and has discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong.

The primary source of capital for the Company’s payment of any dividend or its repurchase of stock is expected to be the Bank, through the payment of dividends or management fees to the Company. The ability of the Bank to pay cash dividends or fees to the Company is limited by law and regulation, as described in “,” below.

The Community Reinvestment Act requires that the federal banking agencies evaluate the record of each financial institution in meeting the credit needs of its local community, including and moderate-income neighborhoods. If the Bank fails to adequately comply with the Community Reinvestment Act, the FDIC could impose remedial requirements and limitations on the Bank. In addition, the federal banking agencies must consider an institution’s Community Reinvestment Act compliance in evaluating applications for mergers, acquisitions, and to establish branches. Additionally, the Bank must publicly disclose the terms of various Community Reinvestment agreements.

The Gramm-Leach-Bliley Act (the “GLBA”) and the implementing regulations issued by federal regulatory agencies require financial institutions (including banks, insurance agencies, and broker/dealers) to adopt policies and procedures regarding the disclosure of nonpublic personal information about their customers to third parties. In general, financial institutions are required to explain to customers their policies and procedures regarding the disclosure of such nonpublic personal information and, unless otherwise required or permitted by law, financial institutions are prohibited from disclosing such information except as provided in their policies and procedures. Specifically, the GLBA established certain information security guidelines that require each financial institution, under the supervision and ongoing oversight of its board of directors or an appropriate committee thereof, to develop, implement, and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against anticipated threats or hazards to the security or integrity of such information, and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.

The ongoing pandemic, including the emergence and impact of the Delta and Omicron variants, has caused significant disruptions in the United States economy, which could in turn disrupt the business, activities,

and operations of our customers, as well as our business and operations. Moreover, the pandemic has caused significant disruption in the financial markets both globally and in the United States. The spread of may result in a significant decrease in business and/or cause our customers to be unable to meet existing payment or other obligations to us, particularly in the event of a spread of or related variant in our market area.

There continue to be broad concerns and uncertainty related to the potential effects of the outbreak. If the pandemic has an adverse effect on (i) customer deposits, (ii) the ability of our borrowers to satisfy their obligations to us, (iii) the demand for our loans or our other products and services, (iv) other aspects of our business operations, or (v) on financial markets, real estate markets, or economic growth, this could, depending on the extent of the decline in customer deposits or loan defaults, materially and adversely affect our liquidity, financial condition and the results of operations.

We are continuing to monitor the pandemic, including the emergence and impact of the Delta and Omicron variants, and its economic effects and related risks. However, the rapid development and fluidity of the situation precludes any specific prediction as to its ultimate impact on the Company. The potential continued impact of and its impact on the economy heightens the risk associated with many of the following risk factors described in this report, such as those related to loan losses and our reliance on our executives and third-party service providers, for example.

We maintain an allowance for loan losses to provide a reserve for loan defaults and There is no precise method of predicting loans losses. We regularly evaluate and conduct an analysis to determine the probable and estimable losses inherent in our loan portfolio and the adequacy of our allowance for loan losses. This evaluation requires us to make a number of estimates and judgments regarding the financial condition and creditworthiness of a significant number of our borrowers, the value and sufficiency of the collateral securing our loans, economic conditions and other factors, all of which are difficult to assess and may change over time.

In addition, the FASB has issued a new accounting standard for establishing allowances for loan and lease losses referred to as the Current Expected Credit Loss (“CECL”). CECL will replace the current approach under GAAP, which generally considers only past events and current conditions, with a forward-looking methodology that reflects the expected credit losses over the lives of financial assets, starting when such assets are first originated or acquired. We are required to adopt the CECL standard on January 1, 2023. The CECL standard will require us to record, at the time of origination, credit losses expected throughout the life of the asset portfolio on loans and securities, as opposed to the current practice of recording losses when it is probable that a loss event has occurred. We are currently evaluating the impact the CECL standard will have on our accounting and regulatory capital position. The adoption of the CECL standard will materially affect how we determine allowance for loan losses and could require us to significantly increase the allowance at the time of adoption and possibly on an basis. Moreover, the CECL standard may create more volatility in the level of allowance for loan losses. If we are required to materially increase the level of our allowance for loan losses for any reason, such increase could have an adverse effect on our business, financial condition, and results of operations.

Most of our commercial business and commercial real estate loans are made to small to businesses. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities, and may have a heightened vulnerability to economic conditions and greater customer concentration risk. If general economic conditions in the markets in which we operate negatively impact this customer segment, our results of operations and financial condition and the value of our common stock may be adversely affected. Moreover, a portion of these loans have been made by us in recent years and the borrowers may not have experienced a complete business or economic cycle. The deterioration of our borrowers’ businesses may hinder their ability to repay their loans with us, which could have a material adverse effect on our financial condition and results of operations.

Commercial real estate, commercial and industrial and construction and land development based lending usually involve higher credit risks than family residential real estate lending. As of December 31, 2021 the following loan types accounted for the stated percentages of our loan portfolio: commercial real estate (both owner-occupied and occupied) 51%; commercial and industrial 34%; and construction and land 3%. These types of loans also involve larger loan balances to a single borrower or groups of related borrowers. These higher credit risks are further heightened when the loans are concentrated in a small number of larger borrowers leading to relationship exposure. As of December 31, 2021, we had 29 relationships with over $10 million of outstanding borrowings with us. While we are not dependent on any of these relationships and while none of these large relationships have directly impacted our allowance for loan losses, a deterioration of any of these large credits could require us to increase our allowance for loan losses or result in significant losses to us.

occupied commercial real estate loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers’ ability to repay their loans depends on successful development of their properties, in addition to the factors affecting residential real estate borrowers. These loans also involve greater risk because they generally are not fully amortizing over the loan period, but have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or sell the underlying property in a timely manner.

Risk of loss on a construction and development loan depends largely upon whether our initial estimate of the property’s value at completion of construction or development equals or exceeds the cost of the property construction or development (including interest), the availability of permanent financing and the builder’s ability to ultimately sell the property. During the construction or development phase, a number of factors can result in delays and cost overruns. If estimates of value are inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan or by seizure of collateral.

Banking regulators are giving commercial real estate lending greater scrutiny, and may require banks with higher levels of commercial real estate loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital levels as a result of commercial real estate lending growth and exposures. Therefore, we could be required to raise additional capital or restrict our future growth as a result of our higher level of commercial real estate loans.

We conduct our banking operations primarily in Northern California. Many of our competitors offer the same, or a wider variety of, banking services within our market areas. These competitors include banks with nationwide operations, regional banks and community banks. In many instances these national and regional banks have greater resources than we do and some community banks may have stronger ties in local markets than we do, which may put us at a competitive disadvantage. We also face competition from many other types of financial institutions, including savings and loan institutions, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In addition, a number of financial institutions have opened production offices, or otherwise solicit deposits and loans, in our market areas. Increased competition in our markets may result in reduced loans and deposits, as well as reduced net interest margin and profitability. Ultimately, we may not be able to compete successfully against current and future competitors. If we are unable to attract and retain banking clients, we may be unable to continue to grow our loan and deposit portfolios, and our business, financial condition and results of operations may be adversely affected.

If short-term interest rates remain at their historically low levels for a prolonged period, and assuming longer term interest rates fall further, we could experience net interest margin compression as our interest earning assets would continue to downward while our interest-bearing liability rates could fail to decline in tandem. Such an occurrence would have a material adverse effect on our net interest income and our results of operations.

Liquidity is essential to our business. We rely on our ability to generate deposits and effectively manage the repayment and maturity schedules of our loans and investment securities, respectively, to ensure that we have adequate liquidity to fund our operations. An inability to raise funds through deposits, borrowings, the sale of our investment securities, Federal Home Loan Bank (‘FHLB”) advances, the sale of loans, and other sources could have a substantial negative effect on our liquidity. Our most important source of funds consists of deposits. Deposit balances can decrease when customers perceive alternative investments as providing a better risk/return tradeoff. If our customers move money out of bank deposits and into other investments, we would lose a relatively source of funds, increasing our funding costs and reducing our net interest income and net income.

Computer phishing and other disruptions could also jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure. Information security risks have generally increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties. Our operations rely on the secure processing, transmission and storage of confidential information in our computer systems and networks. In addition, to access our products and services, our customers may use devices that are beyond our control systems. Although we believe we have robust information security procedures and controls, our technologies, systems, networks, and our customers’ devices may become the target of cyber-attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of the Bank’s or our customers’ confidential, proprietary and other information, or otherwise disrupt the Bank’s or our customers’ or other third parties’ business operations. As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities.

The Bank is under continuous threat of loss due to hacking and cyber-attacks especially as we continue to expand customer capabilities to utilize internet and other remote channels to transact business. Two of the most significant cyber-attack risks that we face are and loss of sensitive customer data. Loss from

A significant portion of our loan portfolio is secured by real estate. In the course of our business, we may foreclose and take title to real estate and could be subject to environmental liabilities with respect to these properties. We may be held liable to a government entity or to third parties for property damage, personal injury, investigation and costs incurred by these parties in connection with environmental contamination, or may be required to clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation and remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. These costs and claims could adversely affect our business, results of operations and prospects.

We are an emerging growth company. Under the JOBS Act, emerging growth companies can take advantage of certain exemptions from various reporting requirements that are applicable to other public companies including, without limitation, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, exemptions from the requirements of holding a advisory shareholder vote on executive compensation and golden parachute payments, exemption from the requirement of auditor attestation in the assessment of our internal control over financial reporting and exemption from any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit partner rotation or a supplement to the auditor’s report providing additional information about our audit and the financial statements (auditor discussion and analysis). As a result of the foregoing, the information that we provide shareholders may be different than what is available with respect to other public companies.

Bank regulatory agencies, including the Federal Reserve, the FDIC and the DFPI, periodically conduct examinations of our business, including our compliance with laws and regulations. If, as a result of an examination, an agency were to determine that the financial, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of any of our operations had become unsatisfactory, or violates any law or regulation, such agency may take certain remedial or enforcement actions it deems appropriate to correct any deficiency. Remedial or enforcement actions include the power to enjoin “unsafe or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced against a bank, to direct an increase in the bank’s capital, to restrict the bank’s growth, to assess civil monetary penalties against a bank’s officers or directors, and to remove officers and directors. The CFPB also has authority to take enforcement actions, including desist orders or civil monetary penalties, if it finds that we offer consumer financial products and services in violation of federal consumer financial protection laws.

Many factors could cause our stock price to fluctuate substantially in the future. These factors include but are not limited to: actual or anticipated variations in earnings, changes in analysts’ recommendations or projections, our announcement of developments related to our businesses, operations and stock performance of other companies deemed to be peers, new technology used or services offered by traditional and competitors, news reports of trends, irrational exuberance on the part of investors, new or expected changes to federal banking regulations, our limited number of shares and shareholders, and other issues related to the financial services industry. Our stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to our performance. General market declines or market volatility in the future, especially in the financial institutions sector, could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices. Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Moreover, in the past, securities class action lawsuits have been instituted against some companies following periods of volatility in the market price of its securities. We could in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert management’s attention and resources from our normal business.

For information on the statutory and regulatory limitations on the ability of the Company to pay dividends to shareholder and on the Bank to pay dividends to the Company see “Item 1 — Business — Supervision and Regulation—Regulation of the Company” and “Item 1 Business—Supervision and Regulation—Regulation of the Bank.”

that is recorded to expense. Loans are charged against the reserve when management believes with certainty that the loan balance will not be collectible. Any cash received on previously amounts is recorded as a recovery to the reserve. The Company formally and establishes the appropriate level of the allowance for loan losses on a quarterly basis.

The allowance for loan losses consists of specific and general reserves. The specific reserve relates to loans that are individually classified as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings (TDRs) and also classified as impaired. When a loan is considered to be impaired, the amount of impairment is measured based on the fair value of the collateral (less costs to sell) if the loan is collateral dependent, or on the present value of expected future cash flows or values that are observable on the secondary market if the loan is not collateral dependent. The general reserve relates to all loans. In determining the general reserve, management applies quantitative and qualitative factors to each segment of the loan portfolio. Quantitative factors primarily include the Company’s historical delinquency and loss experience. For segments of the loan portfolio where the Company has no significant prior loss experience, management uses quantifiable observable industry data to determine the amount of potential loss to include in the reserve. Qualitative factors supplement the quantitative factors applied to each segment of the loan portfolio and include: levels of and trends in delinquencies and impaired loans (including TDRs); levels of and trends in charge-offs and recoveries; migration of loans to the classification of special mention, substandard, or doubtful; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentration. While management uses the best information available to make its evaluation, future adjustments to the allowance for loan losses may be necessary if there are significant changes in economic or other conditions that affect the current risk profile of the loan portfolio.

Since early 2020, the pandemic has caused a substantial disruption to the economy, as well as a heightened level of uncertainty about the scope and longevity of its impact. In response to the pandemic, we have implemented a multi-pronged approach to address the challenges caused by the effects of this pandemic. Our approach includes ensuring the safety of our employees and the communities that we serve and developing new and temporarily revised programs that are responsive to the needs of our loan and deposit customers. As we continue to closely monitor developments, we remain focused on our ability to navigate these challenging conditions and the underlying strength and stability of our Company. For information regarding the specific business impact to the Company regarding see Note 2 of the consolidated financial statements, which are included elsewhere in this Report.

Some of the financial measures discussed in this Report are considered financial measures. In accordance with SEC rules, we classify a financial measure as being a financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, from the most directly comparable measure calculated and presented in accordance with generally accepted accounting principles.

The following tables reflect the details of the financial measures the Company included in this Report. We believe that these financial measures provide useful information to management and investors that is supplementary to our statements of financial condition, results of income and cash flows computed in accordance with GAAP. However, we acknowledge that our financial measures have limitations. As such, you should not view these disclosures as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to financial measures that other banking companies use. Other banking companies may use names similar to those we use for the financial measures we disclose, but may calculate them differently. You should understand how we and other companies each calculate their financial measures when making comparisons.

For the years ended December 31, 2021 and 2020, net income was $13.4 million and $4.3 million, respectively. The increase of $9.1 million, or 211%, was primarily attributable to an increase in net interest income of $9.8 million and a decrease in the provision for credit losses of $4.9 million, partially offset by an increase in expense of $2.6 million and an increase in income tax expense of $3.2 million.

		Twelve months ended December 31,
		2021												2020
		Average Balance				Yields or Rates				Interest Income/ Expense				Average Balance				Yields or Rates				Interest Income/ Expense
ASSETS
Interest earning assets:
Loans (1)		$	1,368,960				4.29	%		$	58,677			$	1,219,324				4.22	%		$	51,401
Federal funds sold			450,898				0.13	%			587				371,476				0.18	%			685
Investment securities			71,376				2.84	%			2,029				38,815				2.40	%			933
Total interest earning assets			1,891,234				3.24	%			61,293				1,629,615				3.25	%			53,019
Noninterest-earning assets:
Cash and due from banks			17,642												20,810
All other assets (2)			60,008												62,991
TOTAL		$	1,968,884											$	1,713,416
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing liabilities:
Deposits:
Demand		$	35,623				0.11	%		$	38			$	28,559				0.13	%		$	36
Money market and savings			705,621				0.51	%			3,627				547,592				0.88	%			4,795
Time			175,240				0.43	%			753				165,630				0.91	%			1,510
Other			139,011				1.54	%			2,145				249,474				0.71	%			1,761
Total interest-bearing liabilities			1,055,495				0.62	%			6,563				991,255				0.82	%			8,102
Noninterest-bearing liabilities:
Demand deposits			747,868												566,783
Accrued expenses and other liabilities			21,363												21,843
Shareholders’ equity			144,158												133,535
TOTAL		$	1,968,884											$	1,713,416
Net interest income and margin (3)							2.89	%		$	54,730								2.76	%		$	44,917

(1)	Nonperforming loans are included in average loan balances. No adjustment has been made for these loans in the calculation of yields. Interest income on loans includes amortization of net deferred loan fees of $3.4 million and $1.6 million, respectively.

(2)	Other noninterest-earning assets includes the allowance for loan losses of $13.9 million and $12.3 million, respectively.

(3)	Net interest margin is net interest income divided by total interest-earning assets.

We made provisions for loan losses of $4,000 and $4.9 million for the years ended December 31, 2021 and 2020, respectively. We recorded net loan charge-offs of $34,000 in the year ended December 31, 2021 compared to net loan charge-offs of $1.9 million during the same period of 2020. During the year ended December 31, 2020, the Company a legacy commercial loan that had been on nonaccrual status since the second quarter of 2019. The allowance for loan loss as a percent of outstanding loans was 1.02% at December 31, 2021 and 1.03% at December 31, 2020. The reserve percentage excluding PPP loans, which are guaranteed by the SBA, was 1.08% at December 31, 2021 compared to 1.33% at December 31, 2020 (see discussion in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Measures”). The decrease in the reserve percentage excluding PPP loans was primarily due to improving general macroeconomic impacts related to See further discussion of the Provision for Loan Losses and Allowance for Loan losses in “Financial Condition – Allowance for Loan Losses”.

Noninterest income increased by $161,000 or 4% for the year ended December 31, 2021 compared to the same period of 2020. The increase in income from the prior year was primarily the result of an increase in service charges and loan related fees.

During the year ended December 31, 2021, expenses increased by $2.6 million or 7% to $40.4 million compared to $37.8 million in the same period of 2020.

Excluding the capitalized loan origination costs that are included in salaries and benefits, expense was $46.0 million for the twelve months ended December 31, 2021 and $45.7 million for the same period in 2020 which reflects the Company’s continued focus on managing expenses and leveraging the recent investment in infrastructure to support the continued growth of the Company.

The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) and the revised interagency guidance issued in April 2020, “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working With Customers Affected by the Coronavirus (Revised)”, provide banks the option to temporarily suspend certain requirements under GAAP related to Troubled Debt Restructurings (“TDRs”) for a limited time to account for the effects of As a result, the Company does not recognize eligible loan modifications as TDRs. Additionally, loans qualifying for these modifications will not be required to be reported as delinquent, nonaccrual, impaired or criticized solely as a result of a loan modification. However, management continues to evaluate these loans for performance criteria separate from their respective loan modification status.

See “Part I – Financial Information, Notes to Consolidated Financial Statements, Footnote 2 – Business Impact of for additional discussion of loan modifications that have occurred under the CARES Act.

Our allowance is established through charges to the provision for loan losses. Loans, or portions of loans, deemed to be uncollectible are charged against the allowance. Recoveries of previously amounts are credited to our allowance for loan losses. The allowance is decreased by the reversal of prior provisions when the total allowance balance is deemed excessive for the risks inherent in the portfolio. The allowance for loan losses balance is neither indicative of the specific amounts of future charge-offs that may occur, nor is it an indicator of any future loss trends.

Our provision of $4,000 for the year ended December 31, 2021 reflects a decrease to qualitative assessments from the potential impact of the pandemic combined with modest loan growth, primarily in real estate other. As of December 31, 2021, our most direct potential exposure to the environment related to our dental practice acquisition loans, which are part of commercial loans, and we believe our actions to offer payment deferments and government guaranteed loans provides significant mitigation of risk in that segment. In addition, our assessment broadly anticipates that the most severe and direct impacts from the environment would manifest in consumer credit card and installment portfolios; segments of commercial loans related to consumer services; and real estate in heavily impacted segments such as retail strip malls, hospitality and restaurants.

Our investment portfolio is comprised of debt securities. We use two classifications for our investment portfolio: (AFS) and (HTM). Securities that we have the positive intent and ability to hold to maturity are classified as securities” and reported at amortized cost. Securities not classified as securities are classified as “investment securities and reported at fair value.

At December 31, 2020, we had no investments.

Our investments provide a source of liquidity as they can be pledged to support borrowed funds or can be liquidated to generate cash proceeds. The investment portfolio is also a significant resource to us in managing interest rate risk, as the maturity and interest rate characteristics of this asset class can be readily changed to match changes in the loan and deposit portfolios. The majority of our investment portfolio is comprised of mortgage-backed securities (MBSs) that are either issued or guaranteed by U.S. government agencies or government-sponsored enterprises (GSEs) and corporate bonds.

Our primary source of funding is deposits from our core banking relationships. The majority of the Bank’s deposits are transaction accounts or money market accounts that are payable on demand. A small number of customers represent a large portion of the Bank’s deposits, as evidenced by the fact that approximately 20% of deposits were represented by the 10 largest depositors as of December 31, 2021. We strive to manage our liquidity in a manner that enables us to meet expected and unexpected liquidity needs under both normal and adverse conditions. The Bank maintains significant sheet and liquidity sources, including a marketable securities portfolio and borrowing capacity through various secured and unsecured sources.

We measure our interest rate sensitivity through the use of a simulation model. The model incorporates the contractual cash flows and characteristics from each financial instrument, as well as certain management assumptions. The model also captures the estimated impacts of optionality and duration and their expected change due to changes in interest rates and the shape of the yield curve. We manage our interest rate risk through established policies and procedures. We measure both the potential short term change in earnings and the long term change in market value of equity on a quarterly basis. Both measurements use immediate rate shocks that assume parallel shifts in interest rates up and down the yield curve in 100 basis point increments. There are eight scenarios comprised of rate changes up or down to 400 basis points. We have established policy thresholds for each of these eight scenarios. In the current interest rate environment, however, we do not consider a decrease in interest rates that is greater than 25 basis points. The impact on earnings for one year and the change in market value of equity are limited to a change of no more than (7.5)% for rate changes of 100 basis points, no more than (15.0)% for changes of 200 basis points, no more than (20.0)% for rate changes of 300 basis points, and no more than (25.0)% for rate change of 400 basis points. The objective of these various simulation scenarios is to optimize the risk/reward equation for our future earnings and capital. Based upon the results of these various simulations and evaluations, we are positioned to be moderately asset sensitive, with earnings increasing in a rising rate environment.