RBB Bancorp

ANALYSIS OF RESULTS OF OPERATIONS

Financial Performance

Average Balance Sheet, Interest and Yield/Rate Analysis

The principal component of our earnings is net interest income, which is the difference between the interest and fees earned on loans, cash and investments (interest-earning assets) and the interest paid on deposits and borrowed funds (interest-bearing liabilities). Net interest margin is net interest income as a percentage of average interest-earning assets for the period. The level of interest rates and the volume and mix of interest-earning assets and interest-bearing liabilities impact net interest income and net interest margin. The net interest spread is the yield on average interest-earning assets minus the cost of average interest-bearing liabilities. Net interest margin and net interest spread are included on a tax equivalent (“TE”) basis by adjusting interest income utilizing the federal statutory tax rate of 21% for 2024 and 2023. Our net interest income, interest spread, and net interest margin are sensitive to general business and economic conditions. These conditions include short-term and long-term interest rates, inflation, monetary supply, and the strength of the international, national and state economies, in general, and more specifically, the local economies in which we conduct business. Our ability to manage net interest income during changing interest rate environments will have a significant impact on our overall performance. We manage net interest income through affecting changes in the mix of interest-earning assets as well as the mix of interest-bearing liabilities, changes in the level of interest-bearing liabilities in proportion to interest-earning assets, and in the growth and maturity of earning assets. For additional information see “Capital Resources and Liquidity Management” and Part I, Item 3.* "Quantitative and Qualitative Disclosures about Market Risk*" included in this Report.

The following tables present average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the periods presented. The average balances are daily averages and, for loans, include both performing and nonperforming balances. Interest income on loans includes the effects of discount accretion and net deferred loan origination fees and costs accounted for as yield adjustments.

The following table summarizes the extent to which changes in (1) interest rates and (2) volume of average interest-earning assets and average interest-bearing liabilities affected our net interest income for the periods presented. The total change for each category of interest-earning assets and interest-bearing liabilities is segmented into changes attributable to variations in volume and yield/rate. Changes that are not solely due to either volume or yield/rate are allocated proportionally based on the absolute value of the change related to average volume and average yield/rate.

Net Interest Income/Average Balance Sheet

Net interest income was $24.5 million for the third quarter of 2024, compared to $24.0 million for the second quarter of 2024. The $580,000 increase was due to an increase in interest income of $1.5 million offset by an increase in interest expense of $959,000. The increase in interest income was due mostly to higher interest income on loans held for investment (“HFI”) of $2.0 million, partially offset by lower interest income on investment securities of $504,000. The increase in loan interest income was mostly due to higher average loans HFI of $54.4 million combined with a 9 basis point increase in the HFI loan yield. The decrease in investment income was attributed to lower average balances and a lower portfolio yield as proceeds from maturing short-term commercial paper were invested into loans and interest-earning cash. The increase in interest expense was due to higher average interest-bearing deposits of $42.3 million in the third quarter of 2024.

Net interest margin ("NIM") was 2.68% for the third quarter of 2024, an increase of 1 basis point from 2.67% for the second quarter of 2024. The increase was due to a 5 basis point increase in the yield on average interest-earning assets, partially offset by a 3 basis point increase in the overall cost of funds. The yield on average interest-earning assets increased to 5.94% for the third quarter of 2024 from 5.89% for the second quarter of 2024 due mainly to a 9 basis point increase in the yield on average loans HFI to 6.13% for the third quarter of 2024. The increase in the loan yield was largely attributed to nonaccrual loan activity in the current and prior quarter, including both the recapture of interest income for fully paid off nonaccrual loans and reversals of interest income for loans migrating to nonaccrual status. Such activity increased the third quarter loan yield by 1 basis point and decreased the second quarter loan yield by 7 basis points. Average loans represented 84% of average interest-earning assets in the third quarter of 2024, unchanged from the second quarter of 2024.

The overall cost of funds increased to 3.57% in the third quarter of 2024 from 3.54% in the second quarter of 2024 due to a higher average cost of interest-bearing deposits in the third quarter of 2024 as compared to the second quarter of 2024. The overall funding mix remained relatively unchanged from the second quarter of 2024 as the ratio of average noninterest-bearing deposits to average total funding sources remained relatively unchanged at 16% for the third and second quarters of 2024. The all-in spot rate for total deposits was 3.53% at September 30, 2024.

Net interest income was $24.5 million for the third quarter of 2024, compared to $27.6 million for the third quarter of 2023. The $3.0 million decrease in net interest income was primarily due to higher interest expense of $1.9 million and lower interest income of $1.1 million. The increase in interest expense was due to higher average rates paid on interest-bearing deposits, a lower percentage of noninterest-bearing deposits offset by lower average subordinated debt. In the fourth quarter of 2023, we redeemed $55.0 million of subordinated debt, which lowered interest expense by $899,000. Interest expense on deposits increased $2.8 million to $27.7 million for the third quarter of 2024 from $25.0 million for the third quarter of 2023. The increase in interest expense on deposits was primarily due to the increase in the average rates paid on interest-bearing deposits, partially offset by a $67.9 million decrease in average interest-bearing deposits. Average noninterest-bearing deposits decreased $43.3 million to $528.1 million in the third quarter of 2024 from $571.4 million in the third quarter of 2023. Average noninterest-bearing deposits as a percentage of total average deposits was 17.3% for the third quarter of 2024 compared to 18.1% for the third quarter of 2023.

The decrease in interest income was primarily due to lower average interest earning asset balances as compared to the same quarter last year, partially offset by higher yields on loans and interest earning deposits in other financial institutions. Average loans represented 84% of average interest-earning assets in the third quarter of 2024 compared to 83% in the third quarter of 2023. The decrease in interest income was comprised of lower interest income on investment securities of $1.1 million and lower interest income on loans HFI of $301,000, partially offset by higher interest income on interest-earning deposits in other financial institutions of $195,000. The decrease in investment income was due to a $70.5 million decrease in average AFS securities combined with a lower average yield of 4.13% for the 2024 period from 4.50% for the 2023 period. The decrease in loans HFI interest income was primarily due to an $87.0 million decrease in average outstanding loan balances due to strategic loans sales and moderated loan production to improve the risk profile of the loan portfolio and strengthen overall on-balance sheet liquidity in response to market conditions during 2023.

NIM was 2.68% for the third quarter of 2024, a decrease of 19 basis points from 2.87% for the third quarter of 2023. The decrease was primarily due to a 39 basis point increase in the overall cost of funds, partially offset by a 16 basis point increase in the yield on interest earnings assets to 5.94% for the third quarter of 2024 from 5.78% for the third quarter of 2023. The increase in the yield on interest earning assets was due mainly to a 14 basis point increase in the yield on loans HFI to 6.13% for the third quarter of 2024 compared to 5.99% for the third quarter of 2023. The cost of interest-bearing deposits increased 56 basis points due to increased market rates including the Federal Reserve raising the target Federal Funds Rate during 2023 and peer bank deposit competition. The Federal Funds Rate averaged 5.26% during the third quarter of 2024, unchanged from the same period in 2023.

Interest and fees on loans HFI for the third quarter of 2024 were $47.3 million compared to $47.6 million for the third quarter of 2023. The $301,000 decrease was primarily due to an $87.0 million decrease in the average outstanding balance of loans HFI. The decrease in the average loan balance was primarily due to strategic loans sales and moderated loan production to improve the risk profile of the loan portfolio and strengthen overall on-balance sheet liquidity in response to market conditions during 2023. For the three months ended September 30, 2024 and 2023, the yield on loans HFI was 6.13% and 5.99%.

Interest expense on deposits increased to $27.7 million for the third quarter of 2024 as compared to $25.0 million for the third quarter of 2023. The $2.8 million increase in interest expense on deposits was primarily due to the increase in the average rates paid on interest-bearing deposits, partially offset by a $67.9 million decrease in average interest-bearing deposits. Average noninterest-bearing deposits decreased $43.3 million to $528.1 million in the third quarter of 2024 from $571.4 million in the third quarter of 2023. Average noninterest-bearing deposits as a percentage of total average deposits was 17.3% for the third quarter of 2024 compared to 18.1% for the third quarter of 2023.

Net interest income was $73.5 million for the nine months ended September 30, 2024, compared to $93.7 million for the nine months ended September 30, 2023. The $20.2 million decrease in net interest income was primarily due to higher interest expense of $16.0 million and lower interest income of $4.2 million. The increase in interest expense was due to higher average rates paid on interest-bearing deposits, and a change in the mix of total deposits.

The increase in interest expense was due to higher average interest-bearing deposits, higher average rates paid on such deposits and the impact of a lower percentage of noninterest-bearing deposits, offset by lower average long-term debt. In the fourth quarter of 2023, we redeemed $55 million of subordinated debt, which lowered interest expense by $2.7 million. Interest expense on deposits increased $19.7 million to $82.3 million for the nine months ended September 30, 2024 from $62.6 million for the nine months ended September 30, 2023. The increase in interest expense on deposits was primarily due to a 98 basis point increase in the cost of interest-bearing deposits due to increases in market rates and peer competition combined with a $46.5 million increase in average interest-bearing deposit balances. Average interest-bearing deposits increased, in part, to help offset a decrease in noninterest-bearing deposits as customers looked to higher yielding deposit products in response to higher market interest rates. Average noninterest-bearing deposits decreased $96.2 million to $528.6 million for the first nine months of 2024 from $624.8 million for the first nine months of 2023. Average noninterest-bearing deposits as a percentage of total average deposits was 17.3% for the first nine months of 2024 compared to 20.1% for the first nine months of 2023.

The decrease in interest income was primarily due to a change in the mix of average interest-earning assets including lower average loan balances as compared to the same period last year. Average loans represented 83% of average interest-earning assets in the first nine months of 2024 compared to 86% in the first nine months of 2023. Interest and fees on loans HFI for the nine months ended September 30, 2024 was $138.1 million compared to $148.4 million for the nine months ended September 30, 2023. The $10.3 million decrease was primarily due to a $222.7 million decrease in the average outstanding loan balances due to strategic loans sales and moderated loan production described above combined with a relatively unchanged yield on loans HFI year over year.

NIM was 2.68% for the nine months ended September 30, 2024, a decrease of 63 basis points from 3.31% for the nine months ended September 30, 2023. The decrease was primarily due to a 75 basis point increase in the total cost of funds, partially offset by a 4 basis point increase in the yield on interest-earning assets. The cost of interest-bearing deposits increased 98 basis points due to increased market rates including the Federal Reserve raising the target Federal Funds Rate 100 basis points between January 1, 2023 and July 31, 2023, and peer bank deposit competition. The weighted average Federal Funds Rate was 5.31% for the first nine months of 2024 compared to 4.92% for the first nine months of 2023.

Provision for Credit Losses

We recorded a $3.3 million provision for credit losses for the third quarter of 2024 compared to a $557,000 provision for credit losses for the second quarter of 2024. The third quarter provision increased due to a number of factors including (i) higher specific reserves on nonperforming loans of $2.5 million; (ii) net charge-offs of $1.2 million; and (iii) higher nonperforming and criticized loans, offset in part by modest improvements in the underlying economic conditions as of September 30, 2024. The increase in specific reserves and net charge-offs for the third quarter of 2024 was due to a decrease in the estimated fair value of collateral-dependent loans. Charge-offs in the third quarter of 2024 were related to one C&D loan and one CRE loan, which were written-down to their estimated fair value, less selling costs. The outlook for economic conditions including factors such as the interest rate environment and the forecast for GDP and unemployment rates have continued to generally improve in the third quarter of 2024, as compared to the second quarter of 2024.

We recorded a provision for credit losses of $3.3 million for the third quarter of 2024 compared to a $1.4 million provision for the third quarter of 2023. The third quarter provision increased primarily due to higher specific reserves of $2.5 million and the impact of higher nonperforming and criticized loans, offset in part by the impact of modest improvements in the underlying economic conditions. The increase in specific reserves for the third quarter of 2024 was due to a decrease in the estimated fair value of collateral-dependent loans. There were $1.2 million in net loan charge-offs in the third quarter of 2024, as compared to $2.2 million in net loan charge-offs in the third quarter of 2023. The outlook for economic conditions, including factors such as the interest rate environment and the forecast for GDP and unemployment rates have continued to generally improve in the third quarter of 2024, as compared to the same quarter of 2023.

We recorded a provision for credit losses of $3.9 million for the nine months ended September 30, 2024 compared to a $3.8 million provision for the nine months ended September 30, 2023. The provision for credit losses for the first nine months of 2024 included a provision for loan losses of $3.7 million and a provision for unfunded commitments of $139,000 compared to a provision for loan losses of $4.3 million, partially offset by a reversal of provision for unfunded commitments of $504,000 for the first nine months of 2023. The $579,000 decrease in the provision for loan losses year over year is due to the impact of an improvement in the outlook for economic conditions and interest rate environment, partially offset by higher charge-offs combined with higher specific reserves and higher levels of nonperforming and criticized loans as compared to the same period last year. During 2024, net loan charge-offs totaled $1.9 million and specific reserves have increased $2.4 million as compared to $2.9 million in charge-offs and no specific reserves for the nine months ended September 30, 2023.

Noninterest Income

The following table sets forth the major components of our noninterest income for the periods presented:

Noninterest income for the third quarter of 2024 was $5.7 million, an increase of $2.3 million from $3.5 million in the second quarter of 2024. This increase was mostly due to a $2.8 million recovery of a fully charged off loan, which had been acquired in a bank acquisition (included in other income), partially offset by lower net gain on other real estate owned ("OREO") of $292,000.

Noninterest income increased $3.0 million to $5.7 million for the third quarter of 2024 from $2.8 million for the same quarter in the prior year. This increase was mostly due to the $2.8 million recovery of a fully charged off loan as previously described, and higher gain on sale of loans of $235,000, partially offset by lower net gain on OREO of $190,000.

Noninterest income increased $5.0 million to $12.6 million for the nine months ended September 30, 2024, compared to $7.6 million for the same period in the prior year. The increase was mostly due to the $2.8 million recovery of a fully charged off loan as previously described, higher gain on sale of loans of $952,000 and higher gain on OREO of $826,000.

The following table presents information on loan servicing income for the periods indicated:

During the three and nine months ended September 30, 2024 and 2023, we serviced SFR mortgage loans for other financial institutions, Federal Home Loan Mortgage Corporation ("FHLMC"), and Federal National Mortgage Association ("FNMA").

The following table presents loans serviced for others as of the dates indicated:

The following table presents information on loans sold and gain on sale of loans for the periods indicated:

Noninterest Expense

The following table sets forth major components of our noninterest expense for the periods presented:

Noninterest expense for the third quarter of 2024 was $17.4 million, an increase of $297,000 compared to $17.1 million for the second quarter of 2024. This increase was due to higher salaries and employee benefits expense of $475,000 due in part to higher loan production and higher other expenses of $304,000 due to higher loan related expense. These increases were partially offset by lower insurance and regulatory assessments of $323,000 and lower legal and professional expenses of $302,000, the latter being due to reimbursed legal costs from nonaccrual loan payoffs.

Noninterest expense for the third quarter of 2024 was $17.4 million, an increase of $545,000 compared to $16.9 million for the third quarter of 2023. This increase was due to higher salaries and employee benefits expense of $264,000 due in part to higher loan production and higher other expenses of $369,000 due to higher loan related expense.

*Nine Months Ended September 30, 2024 Compared to Nine Months Ended September 30, 2023 *

Noninterest expense for the nine months ended September 30, 2024 was $51.5 million, a decrease of $2.8 million compared to $54.3 million for the nine months ended September 30, 2023. This decrease was due to lower legal and professional expenses of $3.8 million due to a previously disclosed internal investigation that has been subsequently resolved and lower external auditor fees, partially offset by higher insurance and regulatory assessments of $578,000 mostly due to a higher FDIC assessment associated with the consent order issued in October 2023 and subsequently terminated in August 2024. These decreases were partially offset by higher salaries and employee benefits expense of $533,000 due in part to higher loan production.

Income Tax Expense

We recorded an income tax provision of $2.6 million and $2.5 million, reflecting an effective tax rate of 26.9% and 25.9%, for the three months ended September 30, 2024 and June 30, 2024. The effective tax rate is lower than the statutory rate of 31% mostly due to utilizing a higher level of tax credits, including the benefits from Low-Income Housing Tax Credit ("LIHTC") investments and commitments to purchase Federal transferable tax credits.

We recorded an income tax provision of $2.6 million and $3.6 million, reflecting an effective tax rate of 26.9% and 29.9%, for the three months ended September 30, 2024 and 2023. The decrease in the effective tax rate in the third quarter of 2024 was due in part to utilizing a higher level of tax credits.

We recorded an income tax provision of $8.3 million and $12.8 million, reflecting an effective tax rate of 27.2% and 29.6%, for the nine months ended September 30, 2024 and 2023. The decrease in the effective tax rate for the first nine months of 2024 was due in part to utilizing a higher level of tax credits.

The higher level of tax credits was due to LIHTCs representing a higher portion of our pre-tax net income and the addition of new tax credits related mostly to commitments to purchase Federal transferable tax credits made available under the Inflation Reduction Act of 2023.