HOPE BANCORP INC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Hope Bancorp, Inc.

Hope Bancorp, Inc. (“Hope Bancorp” on a parent-only basis and the “Company” on a consolidated basis), headquartered in Los Angeles, California, is the holding company for Bank of Hope (the “Bank”). At September 30, 2024, the Bank had 48 branches andnine loan production offices in California, New York, Texas, Washington, Illinois, New Jersey, Virginia, Georgia, Alabama, Colorado and Oregon, as well a representative office in Seoul, South Korea. The Company is a corporation organized under the laws of the state of Delaware and a bank holding company registered under the Bank Holding Company Act of 1956, as amended.

On March 28, 2024, the Bank entered into a Purchase and Assumption Agreement with PromiseOne Bank, a Georgia state bank, to sell the deposits, other liabilities and certain physical assets of the Bank’stwo branches located in Virginia (Annandale and Centreville). The transaction was completed on October 1, 2024.

On April 26, 2024, the Company entered into a merger agreement with Territorial Bancorp Inc. (“Territorial”), headquartered in Honolulu, Hawaii. Under the terms of the merger agreement, assuming the transaction is consummated, Territorial will merge with and into the Company, immediately followed by the merger of Territorial’s subsidiary bank, Territorial Savings Bank, with and into the Company’s subsidiary bank, Bank of Hope. If the transaction is completed, Territorial shareholders will receive a fixed exchange ratio of 0.8048 shares of the Company’s common stock in exchange for each share of Territorial common stock they own. Based on the closing price of the Company’s common stock on April 26, 2024, this represented a value of $8.82 per share of Territorial common stock, although the actual value will be determined upon the completion of the merger. Following the completion of the pending transaction, the legacy Territorial franchise in Hawaii will continue to do business under the Territorial brand, as a trade name of Bank of Hope.

2. Basis of Presentation

The consolidated financial statements included herein have been prepared without an audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”), except for the Consolidated Statement of Financial Condition at December 31, 2023, which was from the audited financial statements included in the Company’s 2023 Annual Report on Form 10-K. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such SEC rules and regulations.

The consolidated financial statements include the accounts of Hope Bancorp and its wholly owned subsidiaries, principally the Bank. All intercompany transactions and balances have been eliminated in consolidation. The Company has made all adjustments, that, in the opinion of management, are necessary to fairly present the Company’s financial position at September 30, 2024 and December 31, 2023, and the results of operations for the three and nine months ended September 30, 2024 and 2023. Certain reclassifications have been made to prior period amounts to conform to the current year presentation. The results of operations for the interim periods are not necessarily indicative of results to be anticipated for the full year.

The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates.

These unaudited consolidated financial statements should be read along with the audited consolidated financial statements and accompanying notes included in the Company’s 2023 Annual Report on Form 10-K.

Significant Accounting Policies

The Company’s accounting policies are described in Note 1—“Summary of Significant Accounting Policies”, of its audited consolidated financial statements included in its 2023 Annual Report Form 10-K. Significant changes to accounting policies from those disclosed in the Company’s audited consolidated financial statements included in its 2023 Annual Report Form 10-K are presented below.

The allowance for unfunded commitments is recognized as a liability (other liabilities in the Consolidated Statements of Financial Condition), with adjustments to the allowance for unfunded commitments recognized through provision for credit losses in the Consolidated Statements of Income.

Adopted Accounting Policies

In 2024, the Company adopted ASU 2023-02 - “Investments-Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method”. During the third quarter of 2024, the Company made an adjustment related to the adoption of ASU 2023-02 and recorded $15.1 million in the derecognition of delayed contribution liabilities related to the Company’s investments in affordable housing partnerships, as balance sheet adjustments. In addition, the Company recorded adjustments to equity including a $1.1 million adjustment to retained earnings net of a $472 thousand reduction to account for deferred tax assets.

Recently Issued Accounting Pronouncements Not Yet Adopted

There were no recently issued accounting pronouncements not yet adopted that are expected to have a material impact on the Company’s consolidated financial statements.

3. Earnings Per Share (“EPS”)

Earnings per share are computed by dividing net income by the weighted average number of common shares outstanding for the period. Basic EPS does not reflect the possibility of dilution that could result from the issuance of additional shares of common stock upon exercise or conversion of outstanding equity awards or convertible notes. Diluted EPS reflects the potential dilution that could occur if stock options, convertible notes, employee stock purchase program (“ESPP”) shares, or other contracts to issue common stock were exercised or converted to common stock that would then share in earnings. For the three months ended September 30, 2024 and 2023, stock options and restricted share awards of 430,728 and 1,049,495 shares of common stock, respectively, were excluded in computing diluted earnings per common share because they were anti-dilutive. For the nine months ended September 30, 2024 and 2023, stock options and restricted share awards of 611,573 and 1,189,286 shares of common stock, respectively, were excluded in computing diluted earnings per common share because they were anti-dilutive.

The Company previously issued $217.5 million in convertible senior notes maturing on May 15, 2038, of which $444 thousand remained outstanding at September 30, 2024. The convertible notes can be converted into the Company’s shares of common stock at an initial rate of 45.0760 shares per $1,000 principal amount of the notes (See Note 10—“Convertible Notes and Subordinated Debentures” for additional information regarding convertible notes issued). Under the required if-converted method for calculating dilutive EPS for convertible instruments, the denominator of the diluted EPS calculation is adjusted to reflect the full number of common shares issuable upon conversion, while the numerator is adjusted to add back after-tax interest expense for the period. For the three and nine months ended September 30, 2024 and 2023, shares related to the convertible notes issued were not included in the Company’s diluted EPS calculation. In accordance with the terms of the convertible notes and settlement options available to the Company, no shares would have been delivered to investors of the convertible notes based on the Company’s common stock price during the three and nine months ended September 30, 2024 and 2023, as the conversion price exceeded the market price of the Company’s stock.

The following tables present computations of basic and diluted EPS for the three and nine months ended September 30, 2024 and 2023.

4. Equity Investments

Equity investments with readily determinable fair values at September 30, 2024 and December 31, 2023, consisted of mutual funds in the amounts of $4.5 million and $4.4 million, respectively, and were included in “Equity investments” on the Consolidated Statements of Financial Condition.

The changes in fair value for equity investments with readily determinable fair values for the three and nine months ended September 30, 2024 and 2023, were recorded in other noninterest income and fees as summarized in the table below:

At September 30, 2024 and December 31, 2023, the Company also had equity investments without readily determinable fair values, which are carried at cost less any determined impairment. The balance of these investments is adjusted for changes in subsequent observable prices. At September 30, 2024, the total balance of equity investments without readily determinable fair values included in “Equity investments” on the Consolidated Statements of Financial Condition was $35.5 million, consisting of $370 thousand in correspondent bank stock, $1.0 million in Community Development Financial Institutions (“CDFI”) investments, and $34.1 million in Community Reinvestment Act (“CRA”) investments. At December 31, 2023, the total balance of equity investments without readily determinable fair values was $39.4 million, consisting of $370 thousand in correspondent bank stock, $1.0 million in CDFI investments, and $38.0 million in CRA investments.

The Company hadno impairments or subsequent observable price changes for equity investments without readily determinable fair values for the three and nine months ended September 30, 2024 and 2023.

5. Investment Securities

The following is a summary of investment securities as of the dates indicated:

The Company has elected to exclude accrued interest from the amortized cost of its investment debt securities. Accrued interest receivable for investment debt securities at September 30, 2024 and December 31, 2023, totaled $7.5 million and $11.0 million, respectively.

At September 30, 2024 and December 31, 2023, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.

The table below summarizes the proceeds from and gains and losses on the sales and calls of investment securities AFS, for the periods presented below.

At September 30, 2024 and December 31, 2023, $167.9 million and $200.2 million in unrealized losses on investment securities AFS, net of taxes, respectively, were included in accumulated other comprehensive loss.

The following table presents a breakdown of interest income recorded for investment securities that are taxable and nontaxable.

The amortized cost and estimated fair value of investment securities at September 30, 2024, by contractual maturity, are presented in the table below. Collateralized mortgage obligations, mortgage-backed securities, and asset-backed securities are presented by final maturity. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.

Securities with carrying values of approximately $223.7 million and $1.70 billion at September 30, 2024 and December 31, 2023, respectively, were pledged to secure public deposits, for various borrowings, and for other purposes as required or permitted by law. The decrease was primarily due to securities were no longer being pledged at the Bank Term Funding Program (“BTFP”) as of September 30, 2024, as the BTFP ceased extending new advances in March 2024.

The following tables show the Company’s investments’ gross unrealized losses and estimated fair values, aggregated by investment category and the length of time that the individual securities have been in a continuous unrealized loss position as of the dates indicated. The length of time that the individual securities have been in a continuous unrealized loss position is not a factor in determining credit impairment with the adoption of current expected credit losses (“CECL”).

The Company had agency securities, collateralized mortgage obligations, mortgage-backed, corporate, and municipal securities classified as AFS that were in a continuous loss position for twelve months or longer at September 30, 2024. The agency securities, collateralized mortgage obligations, and mortgage-backed securities were investments in U.S. Government agency and U.S. Government sponsored enterprises and have high credit ratings (“AA” grade or better). The interest on asset-backed, corporate, and municipal securities that were in an unrealized loss position has been paid as agreed, and the Company believes this will continue in the future and that the securities will be paid in full as scheduled. The market value declines for these securities were primarily due to movements in interest rates and are not reflective of management’s expectations of the Company’s ability to fully recover any unrealized losses, which may be at maturity. With the adoption of CECL, the length of time that the fair value of investment securities has been less than amortized cost is not considered when assessing for credit impairment.

83.7% of the Company’s investment portfolio at September 30, 2024, consisted of securities that were issued by U.S. Government agency and U.S. Government sponsored enterprises. Although a government guarantee exists on securities issued by U.S. Government sponsored agencies, these entities are not legally backed by the full faith and credit of the federal government, and the current support is subject to a cap as part of the Housing and Economic Recovery Act of 2008. Nonetheless, at this time the Company does not foresee any set of circumstances in which the government would not fund its commitments on these investments as the issuers are an integral part of the U.S. housing market in providing liquidity and stability. Therefore, the Company concluded that a zero allowance approach for these investments was appropriate. The Company also hadfive asset-backed securities, six corporate securities, and 44 municipal bonds in unrealized loss positions at September 30, 2024. The Company performed an assessment of investments in unrealized loss positions for credit impairment and concluded thatno allowance for credit losses was required at September 30, 2024.

Allowance for Credit Losses on Securities Available for Sale—The Company evaluates investment securities AFS in unrealized loss positions for impairment related to credit losses on at least a quarterly basis. Investment securities AFS in unrealized loss positions are first assessed as to whether the Company intends to sell, or if it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. If one of the criteria is met, the security’s amortized cost basis is written down to fair value through earnings. For securities that do not meet these criteria, the Company evaluates whether the decline in fair value resulted from credit losses or other factors. In evaluating whether a credit loss exists, the Company has set up an initial quantitative filter for impairment triggers. Once the quantitative filter has been triggered, a security is placed on a watch list and an additional assessment is performed to identify whether a credit impairment exists. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security and the issuer, among other factors. If this assessment indicates that a credit loss exists, the Company compares the present value of cash flows expected to be collected from the security with the amortized cost basis. If the present value of cash flows expected to be collected is less than the amortized cost basis for the security, a credit loss exists and an allowance for credit losses is recorded, limited to the amount that the fair value of the security is less than its amortized cost basis. Unrealized losses that have not been recorded through an allowance for credit losses are recognized in other comprehensive income, net of applicable taxes. The Company didnot have an allowance for credit losses on investment securities AFS at September 30, 2024 and December 31, 2023.

Allowance for Credit Losses on Securities Held to Maturity—For each major HTM debt security type, the allowance for credit losses is estimated collectively for groups of securities with similar risk characteristics. For securities that do not share similar risk characteristics, the losses are estimated individually. Debt securities that are issued by a U.S. government agency or government-sponsored enterprises are highly rated by major rating agencies, and have a long history of no credit losses. Therefore, the Company applies a zero credit loss assumption on these investments. Any expected credit loss is recorded through the allowance for credit losses on investment securities HTM and deducted from the amortized cost basis of the security, so that the balance sheet reflects the net amount the Company expects to collect. At September 30, 2024, all of the Company’s investment securities HTM were issued by a U.S. government agency or government-sponsored enterprises. The Company didnot have an allowance for credit losses on investment securities HTM at September 30, 2024 and December 31, 2023.

6. Loans Receivable and Allowance for Credit Losses

The following is a summary of loans receivable by segment:

Loans receivable is stated at the amount of unpaid principal, adjusted for net deferred fees and costs, premiums and discounts, and purchase accounting fair value adjustments. The Company had net deferred fees of $1.3 million and $6.1 million at September 30, 2024 and December 31, 2023, respectively.

The loan portfolio consists offour segments: CRE loans, C&I loans, residential mortgage loans, and consumer and other loans. CRE loans are extended for the purchase and refinance of commercial real estate and are generally secured by first deeds of trust and collateralized by multifamily residential or commercial properties. C&I loans are loans provided to businesses for various purposes such as working capital, purchasing inventory, debt refinancing, business acquisitions, international trade finance activities, and other business-related financing needs. CRE and C&I loans also include Small Business Administration (“SBA”) loans. Residential mortgage loans are extended for personal, family, or household use and are secured by a first mortgage or deed of trust. Consumer and other loans consist of home equity, credit card, and other personal loans.

The Company had loans receivable of $13.62 billion at September 30, 2024, a decrease of $235.6 million, or 1.7%, from December 31, 2023. The decrease in loans receivable during the nine months ended September 30, 2024, was due to the decline in C&I and CRE loans, partially offset by the growth in residential mortgage loans. During the nine months ended September 30, 2024, loan payoffs, paydowns and sales exceeded new origination volume, reflecting, in part, an elevated pace of payoffs in a high interest rate environment.

The Company had $25.7 million in loans held for sale at September 30, 2024, compared with $3.4 million at December 31, 2023. Loans held for sale at September 30, 2024, consisted of $2.0 million in residential mortgage loans and $23.7 million in C&I loans, net of valuation allowance of $1.6 million. Loans held for sale are not included in the loans receivable table presented above.

The tables below detail the activity in the allowance for credit losses (“ACL”) by portfolio segment for the three and nine months ended September 30, 2024 and 2023.

The following tables break out the allowance for credit losses and loan balance by measurement methodology at September 30, 2024 and December 31, 2023:

At September 30, 2024 and December 31, 2023, reserves for unfunded loan commitments recorded in other liabilities were $2.8 million and $3.8 million, respectively. For the three and nine months ended September 30, 2024, the Company recorded an addition to reserves for unfunded commitments of $280 thousand and a reduction to reserves for unfunded commitments of $1.0 million, respectively. For the three and nine months ended September 30, 2023, the Company recorded additions to reserves for unfunded commitments totaling $62 thousand and $1.8 million, respectively.

Generally, loans are placed on nonaccrual status if principal and/or interest payments become 90 days or more past due, and/or management deems the collectability of the principal and/or interest to be in question, as well as when required by regulatory requirements. Loans to customers whose financial conditions have deteriorated are considered for nonaccrual status whether or not the loan is 90 days or more past due. Generally, payments received on nonaccrual loans are recorded as principal reductions. Loans are returned to accrual status only when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. The Company does not recognize interest income while loans are on nonaccrual status.

The tables below represent the amortized cost of nonaccrual loans, as well as loans past due 90 or more days and still on accrual status, by loan segment and broken out by loans with a recorded ACL and those without a recorded ACL, at September 30, 2024 and December 31, 2023.

(1) Total nonaccrual loans exclude the guaranteed portion of SBA loans that are in liquidation totaling $13.1 million and $11.4 million, at September 30, 2024 and December 31, 2023, respectively.

The following table presents the amortized cost of collateral-dependent loans at September 30, 2024 and December 31, 2023:

Collateral on loans is a significant portion of what secures collateral-dependent loans and significant changes to the fair value of the collateral can potentially impact ACL. During the nine months ended September 30, 2024, the Company did not have any significant changes to the extent to which collateral secured its collateral-dependent loans, due to general deterioration or from other factors. Real estate collateral securing CRE and C&I loans consisted of commercial real estate properties including hotel/motel, building, office, gas station/carwash, residential mortgage, restaurant and land properties. Loans secured by other collateral are secured by assets of the underlying businesses of the borrowers or borrowers net worth.

Accrued interest receivable on loans totaled $43.1 million at September 30, 2024, and $49.3 million at December 31, 2023. The Company has elected to exclude accrued interest receivable in its estimates of expected credit losses because the Company writes off uncollectible accrued interest receivable in a timely manner. The Company considers writing off accrued interest amounts once the amounts become 90 days past due to be considered within a timely manner. The Company has elected to write off accrued interest receivable by reversing interest income. The following table presents interest income reversals, due to loans being placed on nonaccrual status, by loan segment for the three and nine months ended September 30, 2024 and 2023:

The following table presents the amortized cost of past due loans, including nonaccrual loans past due 30 or more days, by the number of days past due at September 30, 2024 and December 31, 2023, by loan segment:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt, including, but not limited to, current financial information, historical payment experience, credit documentation, public information, and current economic trends. Homogeneous loans (i.e., home mortgage loans, home equity lines of credit, overdraft loans, express business loans, and automobile loans) are not risk rated and credit risk is analyzed largely by the number of days past due. This analysis is performed at least on a quarterly basis.

The definitions for risk ratings are as follows:

•Pass: Loans that meet a preponderance or more of the Company’s underwriting criteria and evidence an acceptable level of risk.

•Special Mention: Loans that have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

•Substandard: Loans that are inadequately protected by the current net worth and paying capacity of the borrower or by the collateral pledged, if any. Loans in this classification have a well-defined weakness or weaknesses that jeopardize the repayment of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

•Doubtful: Loans that have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or repayment in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

The following table presents the amortized cost basis of loans receivable by segment, risk rating, and year of origination, renewal, or major modification at September 30, 2024 and December 31, 2023.

For the three and nine months ended September 30, 2024 and the twelve months ended December 31, 2023, there wereno revolving loans converted to term loans.

The Company may reclassify loans held for investment to loans held for sale in the event that the Company plans to sell loans that were originated with the intent to hold to maturity. Loans transferred from held for investment to held for sale are carried at the lower of cost or fair value. The breakdown of loans by segment that were reclassified from held for investment to held for sale for the three and nine months ended September 30, 2024 and 2023, is presented in the following table:

The Company calculates its ACL by estimating expected credit losses on a collective basis for loans that share similar risk characteristics. Loans that do not share similar risk characteristics with other loans are evaluated for credit losses on an individual basis. The Company differentiates its loan segments based on shared risk characteristics for which allowance for credit losses is measured on a collective basis.

The Company uses a combination of a modeled and non-modeled approach that incorporates current and future economic conditions to estimate lifetime expected losses on a collective basis. The Company uses Probability of Default (“PD”), Loss Given Default (“LGD”), and Exposure at Default (“EAD”) methodologies with quantitative factors and qualitative considerations in the calculation of the allowance for credit losses for collectively assessed loans. The Company uses a reasonable and supportable period oftwo years, at which point loss assumptions revert back to historical loss information by means of aone-year reversion period. Included in the quantitative portion of the ACL analysis are inputs such as borrowers’ net operating income, debt coverage ratios, real estate collateral values, as well as factors that are more subjective or require management’s judgment, including key macroeconomic variables from Moody’s forecast scenarios such as GDP, unemployment rates, interest rates, and CRE prices. These key inputs are utilized in the Company’s models to develop PD and LGD assumptions used in the calculation of estimated quantitative losses.

The ACL for the Company’s construction, credit card, and certain consumer loans is calculated based on a non-modeled approach that utilizes historical loss rates to estimate losses. A non-modeled approach was chosen for these loans as fewer data points exist, which could result in high levels of estimated loss volatility under a modeled approach. In the aggregate, non-modeled loans represented less than 2% of the Company’s total loan portfolio at September 30, 2024.

The Company’s Economic Forecast Committee (“EFC”) reviews economic forecast scenarios that are incorporated in the Company’s ACL. The EFC reviews multiple scenarios provided to the Company by an independent third party and chooses a single scenario that best aligns with management’s expectation of future economic conditions. At September 30, 2024, the Company utilized the September 2024 consensus economic forecast scenario from Moody’s, as it best aligned with management’s expectations of future conditions. The forecast projected GDP growth of 2.6% in 2024, 1.8% for 2025, and 1.9% for 2026, with unemployment projected to be 4.1% for 2024, 4.2% for 2025, and 4.1% in 2026. CRE prices in the consensus scenario were expected to decrease initially, with the CRE price index declining -3.4% for 2024, before rebounding +6.8% for 2025 and +7.4% in 2026. The Company also utilized Moody’s December 2023 consensus economic forecast for the calculation of the December 31, 2023 ACL.

In order to quantify the credit risk impact of other trends and changes within the loan portfolio, the Company utilizes qualitative adjustments to the modeled and non-modeled estimated loss approaches. The parameters for making adjustments are established under a Credit Risk Matrix that provides different possible scenarios for each of the factors below. The Credit Risk Matrix and the possible scenarios enable the Bank to qualitatively adjust the Loss Migration Ratio by as much as 25 basis points for each loan type pool. This matrix considers the following seven factors, which are patterned after the guidelines provided under the Interagency Policy Statement on the Allowance for Credit Losses, updated to reflect the adoption of CECL:

•Changes in lending policies and procedures, including underwriting standards and collection, charge off, and recovery practices;

•Changes in the nature and volume of the loan portfolio;

•Changes in the experience, ability, and depth of lending management and staff;

•Changes in the trends of the volume and severity of past due loans, classified loans, nonaccrual loans, and other loan modifications;

•Changes in the quality of the loan review system and the degree of oversight by the management and the Board of Directors;

•The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and

•The effect of external factors, such as competition, legal requirements, and regulatory requirements on the level of estimated losses in the loan portfolio.

For loans that do not share similar risk characteristics such as nonaccrual loans above $1.0 million, the Company evaluates these loans on an individual basis in accordance with ASC 326. Such nonaccrual loans are considered to have different risk profiles than performing loans and are therefore evaluated individually. The Company elected to collectively assess nonaccrual loans with balances below $1.0 million along with the performing and accrual loans, in order to reduce the operational burden of individually assessing small nonaccrual loans with immaterial balances. For individually assessed loans, the ACL is measured using either 1) the present value of future cash flows discounted at the loan’s effective interest rate; 2) the loan’s observable market price; or 3) the fair value of the collateral, if the loan is collateral-dependent. For the collateral-dependent loans, the Company obtains a new appraisal to determine the fair value of collateral. The appraisals are based on an “as-is” valuation. To ensure that appraised values remain current, the Company either obtains updated appraisals every twelve months from a qualified independent appraiser or an internal evaluation of the collateral is performed by qualified personnel. If the third-party market data indicates that the value of the collateral property has declined since the most recent valuation date, management adjusts the value of the property downward to reflect current market conditions. If the fair value of the collateral is less than the amortized balance of the loan, the Company recognizes an ACL with a corresponding charge to the provision for credit loss on loans.

The Company maintains a separate ACL for its off-balance-sheet unfunded loan commitments. The Company uses an estimated funding rate to allocate an allowance to undrawn exposures. This funding rate is used as a credit conversion factor to capture how much undrawn lines of credit can potentially become drawn at any point. The funding rate is determined based on a look-back period of eight quarters. Credit loss is not estimated for off-balance-sheet credit exposures that are unconditionally cancellable by the Company.

Loan Modifications to Borrowers Experiencing Financial Difficulty

In January 2023, the Company adopted ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): TDR and Vintage Disclosures (“ASU 2022-02”), which eliminated the accounting guidance for TDR while enhancing disclosure requirements for certain loan refinancing and restructurings by creditors when a borrower is experiencing financial difficulty. The Company applied this guidance on a modified retrospective transition method, which resulted in a positive cumulative effect adjustment to retained earnings of $287 thousand, net of tax. Subsequent to the adoption of ASU 2022-02, the new guidance is applied uniformly to the Company’s entire loan portfolio when estimating expected credit losses.

A summary of loans modified to borrowers experiencing financial difficulty for the period presented, disaggregated by loan class and type of modification, is shown in the tables below.

The following tables describe the financial effect of the loan modifications made to borrowers experiencing financial difficulty for the periods presented:

The Company closely monitors the performance of the loans that are modified to borrowers experiencing financial difficulty to understand the effectiveness of its modification efforts. All loans that have been modified within the previous 12 months to borrowers experiencing financial difficulty were current at September 30, 2024 and 2023.

There wereno loan modifications to borrowers experiencing financial difficulty that had payment defaults during the three and nine months ended September 30, 2024 and 2023, and that were modified in the 12 months prior to default.

7. Leases

The Company’s operating leases are real estate leases of bank branch locations, loan production offices, and office spaces with remaining lease terms ranging from 1 to 9 years at September 30, 2024. Certain lease arrangements contain extension options, which are typically around 5 years. As these extension options are not generally considered reasonably certain of exercise, they are not included in the lease term.

The table below summarizes supplemental balance sheet information related to operating leases:

The Company uses its incremental borrowing rate to present value lease payments in order to recognize a ROU asset and the related lease liability. The Company calculates its incremental borrowing rate by adding a spread to the FHLB borrowing interest rate at a given period. During the nine months ended September 30, 2024, the Company extended seven leases and didnot enter into any new lease contracts. Lease extension terms ranged from three toseven years and the Company reassessed the ROU assets and lease liabilities related to these leases.

The Company wrote off $93 thousand in operating ROU assets resulting from the branch consolidation ofone location during the nine months ended September 30, 2023. There wasno impairment on operating ROU assets during the same period of 2024.

The table below summarizes the Company’s net operating lease cost:

Rent expense for the three and nine months ended September 30, 2024, was $4.3 million and $12.7 million, respectively. Rent expense for the three and nine months ended September 30, 2023, was $4.5 million and $13.6 million, respectively.

The table below summarizes other information related to the Company’s operating leases:

The table below summarizes the maturity of remaining lease liabilities:

At September 30, 2024, the Company hadno operating lease commitments that had not yet commenced. On October 1, 2024, the Company soldtwo of its branches located in Virginia (Annandale and Centreville) to PromiseOne Bank, a Georgia state bank. As part of the transaction, PromiseOne Bank took over the Company’s lease liabilities related to the branch locations sold.

The Company did not have any finance leases at September 30, 2024 and December 31, 2023.

8. Deposits

Total deposits of $14.73 billion at September 30, 2024, were down $24.3 million, or 0.2%, from $14.75 billion at December 31, 2023.

The aggregate amount of time deposits in denominations of more than $250 thousand at September 30, 2024 and December 31, 2023, was $2.68 billion and $2.24 billion, respectively. Included in time deposits of more than $250 thousand was $300.0 million in California State Treasurer’s deposits at September 30, 2024 and December 31, 2023. The California State Treasurer’s deposits are subject to withdrawal based on the State’s periodic evaluations. The Company is required to pledge eligible collateral of at least 110% of outstanding deposits. At September 30, 2024 and December 31, 2023, securities with fair values of approximately $214.7 million and $218.7 million, respectively, and a $150.0 million letter of credit issued by the FHLB, were pledged as collateral for the California State Treasurer’s deposits.

Brokered deposits at September 30, 2024 and December 31, 2023, totaled $1.01 billion and $1.54 billion, respectively. Brokered deposits at September 30, 2024, consisted of $278.3 million in money market and NOW accounts and $733.7 million in time deposit accounts. Brokered deposits at December 31, 2023, consisted of $164.1 million in money market and NOW accounts and $1.37 billion in time deposit accounts.

The aggregate amount of unplanned overdrafts of demand deposits that were reclassified as loans was $2.7 million and $2.0 million at September 30, 2024 and December 31, 2023, respectively.

The following is a breakdown of the Company’s deposits at September 30, 2024 and December 31, 2023:

On March 28, 2024, the Bank entered into a Purchase and Assumption Agreement with PromiseOne Bank, a Georgia state bank, to sell the deposits, other liabilities, and certain physical assets of the Bank’stwo branches located in Virginia. The sale of the branches was completed on October 1, 2024 and as part of this transaction a total of $128.1 million in deposits was transferred to PromiseOne Bank.

9. Borrowings

At September 30, 2024, borrowings totaled $100.0 million, compared with $1.80 billion at December 31, 2023. All of the Company’s borrowings at September 30, 2024 and December 31, 2023, had maturities of less than 12 months. The tables below summarize the Company’s borrowing lines at September 30, 2024 and December 31, 2023:

The Company maintains a line of credit with the FHLB of San Francisco as a secondary source of funds. The borrowing capacity with the FHLB is limited to the lower of either 25% of the Bank’s total assets or the Bank’s collateral capacity. The terms of this credit facility require the Company to pledge eligible collateral with the FHLB equal to at least 100% of outstanding advances. At September 30, 2024 and December 31, 2023, loans with a carrying amount of $7.73 billion and $7.60 billion were pledged at the FHLB for outstanding advances and remaining borrowing capacity, respectively. At September 30, 2024, other than FHLB stock, no securities were pledged as collateral to the FHLB. The purchase of FHLB stock is a prerequisite to become a member of the FHLB system, and the Company is required to own a certain amount of FHLB stock based on total asset size and outstanding borrowings.

As a member of the FRB system, the Bank may also borrow from the FRB discount window. The maximum amount that the Bank may borrow from the FRB’s discount window is up to 99% of the fair market value of the qualifying loans and securities that are pledged. At September 30, 2024, the outstanding principal balance of the qualifying loans pledged at the FRB discount window was $573.8 million. There wereno investment securities pledged at the discount window at September 30, 2024.

The Company availed itself of the BTFP, which was created in March 2023 to enhance banking system liquidity by allowing institutions to pledge certain securities at par value and borrow at a rate of ten basis points over the one-year overnight index swap rate. The BTFP was available to federally insured depository institutions in the U.S., with advances having a term of up to one year with no prepayment penalties. In 2023, the BTFP was available to federally insured depository institutions in the U.S. at a fixed rate of ten basis points over the one-year overnight index swap rate, but in 2024, the interest rate was no lower than the interest rate on reserve balances in effect on the day the loan is made. The Company’s outstanding borrowings at December 31, 2023 were not subject to the new rate. The BTFP ceased extending new advances in March 2024. All outstanding borrowings from the BTFP were paid off as of September 30, 2024.

The Company also maintains unsecured federal funds borrowing lines with other banks. There wereno borrowings outstanding from other banks at September 30, 2024 and December 31, 2023.

10. Convertible Notes and Subordinated Debentures

Convertible Notes

In 2018, the Company issued $217.5 million aggregate principal amount of 2.00% convertible senior notes maturing on May 15, 2038, in a private offering to qualified institutional buyers under Rule 144A of the Securities Act of 1933. The convertible notes are not capital instruments but can be converted into shares of the Company’s common stock at an initial rate of 45.0760 shares per $1,000 principal amount of the notes (equivalent to an initial conversion price of approximately $22.18 per share of common stock, which represented a premium of 22.50% to the closing stock price on the date of the pricing of the notes). Holders of the convertible notes have the option to convert all or a portion of the notes at any time on or after February 15, 2023. The convertible notes can be called by the Company, in part or in whole, on or after May 20, 2023, for 100% of the principal amount in cash. Holders of the convertible notes have the option to put the notes back to the Company on May 15, 2028, or May 15, 2033, for 100% of the principal amount in cash. The convertible notes can be settled in cash, stock, or a combination of stock and cash at the option of the Company.

On May 15, 2023, most holders of the Company’s convertible notes elected to exercise their optional put right and the Company paid off $197.1 million principal amount of notes in cash. During 2023, the Company also repurchased its notes in the aggregate principal amount of $19.9 million and recorded a gain on debt extinguishment of $405 thousand. The repurchased notes were immediately cancelled subsequent to the repurchase. These repurchases are separate from the optional put and were made through a third-party broker. No notes were repurchased or paid off in the nine months ended September 30, 2024.

The carrying value of the convertible notes at September 30, 2024 and December 31, 2023, was $444 thousand. The capitalized issuance costs were fully amortized at both September 30, 2024 and December 31, 2023.

Interest expense on the convertible notes for the three and nine months ended September 30, 2024, totaled $2 thousand and $6 thousand, respectively. Interest expense on the convertible notes for the three and nine months ended September 30, 2023, totaled $2 thousand and $1.9 million, respectively.

Subordinated Debentures

At September 30, 2024, the Company hadnine wholly owned subsidiary grantor trusts that had issued $126.0 million of pooled trust preferred securities. Trust preferred securities accrue and pay distributions periodically at specified annual rates as provided in the indentures. The trusts used the net proceeds from the offering to purchase a like amount of subordinated debentures. The subordinated debentures are the sole assets of the trusts. The Company’s obligations under the subordinated debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the trusts. The trust preferred securities are mandatorily redeemable upon the maturity of the subordinated debentures, or upon earlier redemption as provided in the indentures. The Company has the right to redeem the subordinated debentures in whole (but not in part) on a quarterly basis at a redemption price specified in the indentures plus any accrued but unpaid interest to the redemption date. The Company also has a right to defer consecutive payments of interest on the subordinated debentures for up tofive years.

The following table is a summary of trust preferred securities and subordinated debentures at September 30, 2024:

The carrying value of the subordinated debentures at September 30, 2024 and December 31, 2023, was $108.8 million and $107.8 million, respectively. At September 30, 2024 and December 31, 2023, acquired subordinated debentures had remaining discounts of $21.1 million and $22.1 million, respectively. The carrying balance of subordinated debentures is net of remaining discounts and includes common trust securities.

The Company’s investment in the common trust securities of the issuer trusts was $3.9 million at September 30, 2024 and December 31, 2023, and is included in other assets. Although the subordinated debentures issued by the trusts are not included as a component of stockholders’ equity in the Consolidated Statements of Financial Condition, the debt is treated as capital for regulatory purposes. The Company’s trust preferred security debt issuances (less common trust securities) are includable in Tier 1 capital up to a maximum of 25% of capital on an aggregate basis as they were grandfathered in under BASEL III. Any amount that exceeds 25% qualifies as Tier 2 capital.

11. Derivative Financial Instruments

As part of the Company’s overall interest rate risk management, the Company enters into derivative instruments, including interest rate swaps, collars, caps, floors, foreign exchange contracts, risk participation agreements and mortgage banking derivatives. The notional amount does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual agreements. Derivative instruments are recognized on the balance sheet at their fair value and are not reported on a net basis.

The tables below present the fair value of the Company’s derivative financial instruments at September 30, 2024 and December 31, 2023. The Company’s derivative assets and derivative liabilities are located within “Other assets” and “Other liabilities,” respectively, on the Company’s Consolidated Statements of Financial Condition.

(1) The fair values of centrally-cleared derivative contracts are presented net of settled-to-market margin.

(1) The fair values of centrally-cleared derivative contracts are presented net of settled-to-market margin.

Derivatives designated as cash flow hedges

The Company’s interest rate contracts designated as cash flow hedges were determined to be fully effective during the periods presented and were hedged to financial instruments tied to term SOFR and Federal Funds Rate. The aggregate fair value of the cash flow hedges are recorded in assets or liabilities on the Consolidated Statements of Financial Condition, with changes in fair value recorded in other comprehensive income on the Consolidated Statements of Comprehensive Income. The gain or loss on derivatives is recorded in accumulated other comprehensive income (“AOCI”) and is subsequently reclassified into interest income and interest expense in the period, during which the hedged forecasted transaction affects earnings. Amounts reported in AOCI related to interest rate agreements will be reclassified to interest income and interest expense as interest payments are received or paid on the Company’s derivatives. The Company expects the hedges to remain fully effective throughout the remaining terms. The Company expects to reclassify, during the next 12 months, approximately $3.4 million, net of taxes, from AOCI as an increase to net interest income, net of a decrease of $2.3 million from terminated swaps.

During 2024, the Company terminated $400.0 million in notional value of forward-starting received fixed swaps set to mature through July 2027. The swaps were designated as cash flow hedges on the changes in cash flows associated with certain variable rate loans. The termination of the swaps was performed to reduce prolonged exposure to higher interest rates. Prior to the termination of the swaps, the change in value of the swaps was recorded through accumulated other comprehensive income. The unamortized fair value adjustments on terminated forward-starting received fixed swaps was $6.4 million in pre-tax losses in AOCI at September 30, 2024, which will be amortized as a reduction to net interest income over an expected period of 2.8 years.

The table below presents the gains (losses) on derivative instruments designated as cash flow hedges, that were reclassified from AOCI into earnings for the periods indicated:

Total cash held as collateral for interest rate contracts designated as cash flow hedges was $0 at September 30, 2024, and $22.9 million at December 31, 2023.

Derivatives not designated as hedges

The Company’s derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers.

The Company offers a loan hedging program to certain loan customers. Through this program, the Company originates a variable rate loan with the customer. The Company and the customer will then enter into a fixed interest rate swap. Simultaneously, an identical offsetting swap is entered into by the Company with a correspondent bank. These “back-to-back” swap arrangements are intended to offset each other and allow the Company to book a variable rate loan, while providing the customer with a contract for fixed interest payments. In these arrangements, the Company’s net cash flow is equal to the interest income received from the variable rate loan originated with the customer. These customer interest rate contracts are not designated as hedging instruments and are recorded at fair value in other assets and other liabilities. The change in fair value is recognized in the Consolidated Statements of Income as other income and fees.

The Company offers foreign exchange contracts to customers to purchase and/or sell foreign currencies at set rates in the future. The foreign exchange contracts allow customers to hedge the foreign exchange rate risk of their deposits and loans denominated in foreign currencies. In conjunction with this, the Company also enters into offsetting back-to-back contracts with institutional counterparties to hedge the Company’s foreign exchange rate risk. The Company also enters into certain foreign exchange contracts with institutional counterparties, including non-deliverable forward contracts, to manage its foreign exchange rate risk. These foreign exchange contracts are not designated as hedging instruments and are recorded at fair value in other assets and other liabilities. During the three and nine months ended September 30, 2024, the changes in fair value on foreign exchange contracts were losses of $706 thousand and $72 thousand, respectively, and were recognized in the Consolidated Statements of Income as other income and fees. During the three and nine months ended September 30, 2023, the changes in fair value on foreign exchange contracts were gains of $96 thousand and $105 thousand, respectively, and were recognized in the Consolidated Statements of Income as other income and fees.

At September 30, 2024, the Company had risk participation agreements with an outside counterparty for interest rate swaps related to loans in which it is a participant. The risk participation agreements provide credit protection to the financial institution should the borrowers fail to perform on their interest rate derivative contracts. Risk participation agreements are credit derivatives not designated as hedges. Credit derivatives are not speculative and are not used to manage interest rate risk in assets or liabilities. Changes in the fair value of credit derivatives are recognized directly in earnings. The fee received, less the estimate of the loss for credit exposure, is recognized in earnings at the time of the transaction.

The Company enters into various stand-alone mortgage-banking derivatives in order to hedge the risk associated with the fluctuation of interest rates. Changes in fair value are recorded as mortgage banking revenue. Residential mortgage loans funded with interest rate lock commitments and forward commitments for the future delivery of mortgage loans to third party investors are considered derivatives.