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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2023

OR

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

For the transition period from ________ to ________

Commission File Number 001-40379

FIVE STAR BANCORP

(Exact name of Registrant as specified in its charter)

California						75-3100966
(State or other jurisdiction of incorporation or organization)						(IRS Employer Identification No.)

3100 Zinfandel Drive, Suite 100 Rancho Cordova, CA 95670

(Address of principal executive office) (Zip Code)

Registrant’s telephone number, including area code: (916) 626-5000

Securities registered pursuant to 12(b) of the Act:

Title of each class			Trading symbol			Name of each exchange on which registered
Common stock, no par value per share			FSBC			The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer			o			Accelerated filer			o
Non-accelerated Filer			x			Smaller reporting company			x
Emerging growth company			x

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

As of August 4, 2023, there were 17,257,357 shares of the registrant’s common stock, no par value, outstanding.

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Table of Contents

TABLE OF CONTENTS

FIVE STAR BANCORP AND SUBSIDIARY

Quarterly Report on Form 10-Q

June 30, 2023

PART I			FINANCIAL INFORMATION			1
ITEM 1.			Financial Statements (unaudited)			1
			Consolidated Balance Sheets			1
			Consolidated Statements of Income			2
			Consolidated Statements of Comprehensive Income			3
			Consolidated Statements of Shareholders’ Equity			4
			Consolidated Statements of Cash Flows			6
			Notes to Consolidated Financial Statements (unaudited)			7
ITEM 2.			Management’s Discussion and Analysis of Financial Condition and Results of Operations			30
ITEM 3.			Quantitative and Qualitative Disclosure About Market Risk			68
ITEM 4.			Controls and Procedures			68
PART II			OTHER INFORMATION			69
ITEM 1.			Legal Proceedings			69
ITEM 1A.			Risk Factors			69
ITEM 2.			Unregistered Sales of Equity Securities and Use of Proceeds			69
ITEM 3.			Defaults Upon Senior Securities			69
ITEM 4.			Mine Safety Disclosures			69
ITEM 5.			Other Information			69
ITEM 6.			Exhibits			70
SIGNATURES						71

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Table of Contents

PART I FINANCIAL INFORMATION

ITEM 1. Financial Statements

FIVE STAR BANCORP AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except share amounts)						June 30, 2023						December 31, 2022
ASSETS
Cash and due from financial institutions						$	28,568					$	32,561
Interest-bearing deposits in banks						271,555						227,430
Cash and cash equivalents						300,123						259,991
Time deposits in banks						7,343						9,849
Securities available-for-sale, at fair value						110,794						115,988
Securities held-to-maturity, at amortized cost (fair value of $3,208 and $3,432 at June 30, 2023 and December 31, 2022, respectively)						3,486						3,756
Loans held for sale						8,559						9,416
Loans held for investment						2,927,411						2,791,326
Allowance for credit losses - loans						(33,984)						(28,389)
Loans held for investment, net of allowance for credit losses						2,893,427						2,762,937
FHLB stock						15,000						10,890
Operating leases, right-of-use asset, net						5,032						3,981
Premises and equipment, net						1,599						1,605
Bank-owned life insurance						16,897						14,669
Interest receivable and other assets						40,441						34,077
Total assets						$	3,402,701					$	3,227,159
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Non-interest-bearing						$	833,707					$	971,246
Interest-bearing						2,096,032						1,810,758
Total deposits						2,929,739						2,782,004
Borrowings:
FHLB advances						100,000						100,000
Subordinated debt, net						73,677						73,606
Operating lease liability						5,275						4,243
Interest payable and other liabilities						24,870						14,481
Total liabilities						3,133,561						2,974,334
Commitments and contingencies (Note 8)
Shareholders’ equity
Preferred stock, no par value; 10,000,000 shares authorized; zero issued and outstanding at June 30, 2023 and December 31, 2022						—						—
Common stock, no par value; 100,000,000 shares authorized; 17,257,357 shares issued and outstanding at June 30, 2023; 17,241,926 shares issued and outstanding at December 31, 2022						220,021						219,543
Retained earnings						62,095						46,736
Accumulated other comprehensive loss, net						(12,976)						(13,454)
Total shareholders’ equity						269,140						252,825
Total liabilities and shareholders’ equity						$	3,402,701					$	3,227,159

See accompanying notes to the unaudited consolidated financial statements.

1

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FIVE STAR BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

						Three Months Ended June 30,												Six Months Ended June 30,
(in thousands, except per share amounts)						2023						2022						2023						2022
Interest and fee income:
Loans, including fees						$	39,929					$	24,879					$	77,423					$	46,991
Taxable securities						463						423						929						813
Nontaxable securities						183						179						367						356
Interest-bearing deposits in other banks						2,218						518						4,385						710
Total interest and fee income						42,793						25,999						83,104						48,870
Interest expense:
Deposits						13,969						1,021						23,347						1,566
FHLB advances						84						5						708						5
Subordinated debt						1,162						444						2,323						887
Total interest expense						15,215						1,470						26,378						2,458
Net interest income						27,578						24,529						56,726						46,412
Provision for credit losses						1,250						2,250						2,150						3,200
Net interest income after provision for credit losses						26,328						22,279						54,576						43,212
Non-interest income:
Service charges on deposit accounts						135						130						252						238
Net gain on sale of securities available-for-sale						—						—						—						5
Gain on sale of loans						641						831						1,239						1,749
Loan-related fees						389						757						697						1,353
FHLB stock dividends						189						99						382						201
Earnings on BOLI						126						101						228						191
Other						1,340						41						1,393						386
Total non-interest income						2,820						1,959						4,191						4,123
Non-interest expense:
Salaries and employee benefits						6,421						5,553						13,039						11,228
Occupancy and equipment						551						513						1,074						1,033
Data processing and software						1,013						739						1,885						1,455
FDIC insurance						410						245						812						410
Professional services						586						568						1,217						1,122
Advertising and promotional						733						484						1,151						828
Loan-related expenses						324						389						579						667
Other operating expenses						1,941						1,714						3,340						3,037
Total non-interest expense						11,979						10,205						23,097						19,780
Income before provision for income taxes						17,169						14,033						35,670						27,555
Provision for income taxes						4,440						4,080						9,780						7,740
Net income						$	12,729					$	9,953					$	25,890					$	19,815
Basic earnings per common share						$	0.74					$	0.58					$	1.51					$	1.15
Diluted earnings per common share						$	0.74					$	0.58					$	1.51					$	1.15

See accompanying notes to unaudited consolidated financial statements.

2

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FIVE STAR BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

						Three Months Ended June 30,												Six Months Ended June 30,
(in thousands)						2023						2022						2023						2022
Net income						$	12,729					$	9,953					$	25,890					$	19,815
Unrealized (loss) gain on securities:
Net unrealized holding (loss) gain on securities available-for-sale during the period						(1,462)						(7,849)						679						(17,287)
Reclassification adjustment for net realized gains included in net income						—						—						—						(5)
Income tax (benefit) expense related to items of other comprehensive income						(432)						(2,320)						201						(5,111)
Other comprehensive (loss) income						(1,030)						(5,529)						478						(12,181)
Total comprehensive income						$	11,699					$	4,424					$	26,368					$	7,634

See accompanying notes to the unaudited consolidated financial statements.

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FIVE STAR BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the Three Months Ended June 30, 2023 and 2022

(Unaudited)

						Common Stock												Retained Earnings						Accumulated Other Comprehensive Income (Loss)						Total Shareholders’ Equity
(in thousands, except per share amounts)						Shares						Amount
Balance at March 31, 2022						17,246,199						$	218,721					$	19,558					$	(7,218)					$	231,061
Net income						—						—						9,953						—						9,953
Other comprehensive loss						—						—						—						(5,529)						(5,529)
Stock issued under stock award plans, net						1,438						—						—						—						—
Stock compensation expense						—						302						—						—						302
Stock forfeitures						(1,654)						—						—						—						—
Cash dividends paid ($0.15 per share)						—						—						(2,587)						—						(2,587)
Balance at June 30, 2022						17,245,983						$	219,023					$	26,924					$	(12,747)					$	233,200
Balance at March 31, 2023						17,258,904						$	219,785					$	52,817					$	(11,946)					$	260,656
Net income						—						—						12,729						—						12,729
Other comprehensive loss						—						—						—						(1,030)						(1,030)
Stock compensation expense						—						236						—						—						236
Stock forfeitures						(1,547)						—						—						—						—
Cash dividends paid ($0.20 per share)						—						—						(3,451)						—						(3,451)
Balance at June 30, 2023						17,257,357						$	220,021					$	62,095					$	(12,976)					$	269,140

See accompanying notes to the unaudited consolidated financial statements.

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FIVE STAR BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the Six Months Ended June 30, 2023 and 2022

(Unaudited)

						Common Stock												Retained Earnings						Accumulated Other Comprehensive Income (Loss)						Total Shareholders’ Equity
(in thousands, except per share amounts)						Shares						Amount
Balance at December 31, 2021						17,224,848						$	218,444					$	17,168					$	(566)					$	235,046
Cumulative effect of adoption of ASC 842 on retained earnings						—						—						68						—						68
Net income						—						—						19,815						—						19,815
Other comprehensive loss						—						—						—						(12,181)						(12,181)
Stock issued under stock award plans						23,639						—						—						—						—
Stock compensation expense						—						579						—						—						579
Stock forfeitures						(2,504)						—						—						—						—
Cash dividends paid ($0.75 per share)						—						—						(10,127)						—						(10,127)
Balance at June 30, 2022						17,245,983						$	219,023					$	26,924					$	(12,747)					$	233,200
Balance at December 31, 2022						17,241,926						$	219,543					$	46,736					$	(13,454)					$	252,825
Cumulative effect of adoption of ASC 326 on retained earnings						—						—						(4,491)						—						(4,491)
Net income						—						—						25,890						—						25,890
Other comprehensive income						—						—						—						478						478
Stock issued under stock award plans						16,978						—						—						—						—
Stock compensation expense						—						478						—						—						478
Stock forfeitures						(1,547)						—						—						—						—
Cash dividends paid ($0.35 per share)						—						—						(6,040)						—						(6,040)
Balance at June 30, 2023						17,257,357						$	220,021					$	62,095					$	(12,976)					$	269,140

See accompanying notes to unaudited consolidated financial statements.

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FIVE STAR BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

						Six Months Ended June 30,
(in thousands)						2023						2022
Cash flows from operating activities:
Net income						$	25,890					$	19,815
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses						2,150						3,200
Depreciation and amortization						824						812
Amortization of deferred loan fees and costs						270						158
Amortization of premiums and discounts on securities						612						659
Amortization of subordinated debt issuance costs						71						34
Stock compensation expense						478						579
Earnings on BOLI						(228)						(191)
Deferred tax provision						70						—
Loans originated for sale						(32,126)						(36,964)
Gain on sale of loans						(1,239)						(1,749)
Proceeds from sale of loans						24,806						25,728
Net gain on sale of securities available-for-sale						—						(5)
Decrease in operating lease liability						(482)						(482)
Cost method of investment-related gain						(1,274)						—
Net changes in:
Interest receivable and other assets						(3,478)						(1,557)
Interest payable and other liabilities						9,277						1,295
Net cash provided by operating activities						25,621						11,332
Cash flows from investing activities:
Proceeds from sale of securities available-for-sale						—						1,623
Maturities, prepayments, and calls of securities available-for-sale						5,512						8,977
Purchases of securities available-for-sale						—						(1,641)
Net change in time deposits in banks						2,506						3,623
Loan originations, net of repayments						(128,757)						(436,195)
Purchase of premises and equipment						(335)						(311)
Purchase of FHLB stock						(4,110)						(4,223)
Purchase of BOLI						(2,000)						(3,050)
Net cash used in investing activities						(127,184)						(431,197)
Cash flows from financing activities:
Net change in deposits						147,735						215,421
FHLB advances						—						60,000
Cash dividends paid						(6,040)						(10,127)
Net cash provided by financing activities						141,695						265,294
Net change in cash and cash equivalents						40,132						(154,571)
Cash and cash equivalents at beginning of period						259,991						425,329
Cash and cash equivalents at end of period						$	300,123					$	270,758
Supplemental disclosure of cash flow information:
Interest paid						$	2,716					$	1,345
Income taxes paid						$	686					$	5,200
Supplemental disclosure of noncash items:
Transfer from loans held for sale to loans held for investment						9,416						10,671
Unrealized gain (loss) on securities						679						(17,287)
Operating lease liabilities recorded in conjunction with adoption of ASC 842						—						5,221
ROUA recorded in conjunction with adoption of ASC 842						—						4,974
Operating lease liabilities exchanged for ROUA						1,513						—
ROUA acquired						(1,534)						—
Cumulative effect of adoption of ASC 842 on retained earnings						—						68
Cumulative effect of adoption of ASC 326 on retained earnings						(4,491)						—

See accompanying notes to the unaudited consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 1: Basis of Presentation and Summary of Significant Accounting Policies

(a) Organization

Five Star Bank (the “Bank”) was chartered on October 26, 1999 and began operations on December 20, 1999. Five Star Bancorp (“Bancorp” or the “Company”) was incorporated on September 16, 2002 and subsequently obtained approval from the Federal Reserve to be a bank holding company in connection with its acquisition of the Bank. The Company became the sole shareholder of the Bank on June 2, 2003 in a statutory merger, pursuant to which each outstanding share of the Bank’s common stock was exchanged for one share of common stock of the Company.

The Company, through the Bank, provides financial services to customers who are predominately small and middle-market businesses, professionals, and individuals residing in the Northern California region. The Company’s primary loan products are commercial real estate loans, land development loans, construction loans, and operating lines of credit, and its primary deposit products are checking accounts, savings accounts, money market accounts, and term certificate accounts. The Bank currently has seven branch offices in Roseville, Natomas, Rancho Cordova, Redding, Elk Grove, Chico, and Yuba City, and one loan production office in Sacramento.

(b) Basis of Financial Statement Presentation and Consolidation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) as contained within the Financial Accounting Standards Board’s (“FASB”) ASC and the rules and regulations of the SEC, including the instructions to Regulation S-X. These interim unaudited consolidated financial statements reflect all adjustments (consisting solely of normal recurring adjustments and accruals) which, in the opinion of management, are necessary for a fair presentation of financial position, results of operations and comprehensive income, changes in shareholders’ equity, and cash flows for the interim periods presented. These unaudited consolidated financial statements have been prepared on a basis consistent with, and should be read in conjunction with, the audited consolidated financial statements as of and for the year ended December 31, 2022, and the notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022 (the “2022 Annual Report on Form 10-K”), which was filed with the SEC on February 24, 2023.

The unaudited consolidated financial statements include Five Star Bancorp and its wholly owned subsidiary, Five Star Bank. All significant intercompany transactions and balances are eliminated in consolidation.

The results of operations for the three and six months ended June 30, 2023 are not necessarily indicative of the results of operations that may be expected for any other interim period or for the year ending December 31, 2023.

The Company’s accounting and reporting policies conform to GAAP and to general practices within the banking industry.

Certain amounts reported in previous consolidated financial statements have been reclassified to conform to current period presentation. These reclassifications did not affect previously reported amounts of net income, total assets, or total shareholders’ equity.

(c) Segments

While the Company’s chief decision-makers monitor the revenue streams of the various products and services, operations are managed, and financial performance is evaluated, on a Company-wide basis. Discrete financial information is not available other than on a Company-wide basis. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.

(d) Emerging Growth Company

The Company qualifies as an emerging growth company as defined in the Jumpstart Our Business Startups Act of 2012, and, as such, may take advantage of specified reduced reporting requirements and deferred accounting standards adoption dates, and is relieved of other significant requirements that are otherwise generally applicable to other public companies. The Company will remain an Emerging Growth Company for five years after its IPO date, unless one of the following

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occurs: (i) total annual gross revenues are $1.235 billion or more; (ii) the Company issues more than $1 billion in non-convertible debt; or (iii) the Company becomes a large accelerated filer with a public float of more than $0.7 billion.

(e) Significant Accounting Policies

The Company’s significant accounting policies are included in Note 1, Basis of Presentation on the 2022 Annual Report on Form 10-K. There have been no changes to these significant accounting policies during the first six months of 2023 other than adoption of ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and all subsequent amendments that modified ASU 2016-13 (collectively, “ASC 326”) as discussed below in this Note, which impacted the following policies:

Allowance for Credit Losses (“ACL”)

The ACL is a valuation account that offsets the amortized cost basis of loans receivable and certain other financial assets, including unfunded loan commitments and held-to-maturity debt securities. Under ASC 326, amortized cost basis is the basis on which the ACL is determined. Amortized cost basis on loans receivable is principal outstanding, net of any purchase premiums and discounts, and net of any deferred loan fees and costs.

Credit losses are charged off when management believes that the collectability of at least some portion of outstanding principal is unlikely. These charge-offs are recorded as a reversal to, thereby reducing, the allowance for credit losses. Subsequent recoveries of previously charged-off amounts, if any, are recorded as a provision to, thereby increasing, the allowance for credit losses. The allowance for credit losses is maintained at a level to absorb expected credit losses over the contractual life, including consideration of prepayments. Determining the adequacy of the allowance is complex and requires judgments that are inherently subjective, as it requires estimates that are susceptible to revision as additional information becomes available. While the Company has determined an allowance for credit losses it considers appropriate, there can be no assurance that the allowance will be sufficient to absorb future losses.

The Company’s process for determining expected lifetime credit losses entails a loan-level, model-based approach and considers a broad range of information, including historical loss experience, current conditions, and reasonable and supportable forecasts. Credit loss is estimated for all loans. Accordingly, the Company has stratified the full loan population into segments sharing similar characteristics to perform the evaluation of the credit loss collectively. The Company can also further stratify loans of similar types, risk attributes, and methods for credit risk monitoring.

The Company has determined pools based primarily on regulatory reporting codes as the loans within each pool share similar risk characteristics and there is sufficient historical peer loss data from the Federal Financial Institutions Examination Council to provide statistically meaningful support in the models developed. The Company further stratified the C&I portfolio into traditional C&I loans and SBA loans, as the loans in these pools have different repayment structures and credit risk characteristics. The Company also stratified C&I loans and consumer loans that do not require reserves, as the Company has third party agreements in place to cover loan losses. The Company has identified the following pools subject to an estimate of credit loss: (1) 1-4 Family Construction; (2) Other Construction; (3) Farmland; (4) Revolving Secured by 1-4 Family; (5) Residential Secured by First Liens; (6) Residential Secured by Junior Liens; (7) Multifamily; (8) CRE Owner Occupied; (9) CRE Non-Owner Occupied; (10) Agriculture; (11) C&I; (12) C&I SBA; (13) Consumer; and (14) Municipal.

The Company has determined, given its limited loss experience, that peer data and other external data to support loss history provides the best basis for its assessment of expected credit losses. The Company believes that the use of peer loss data from 2008 to 2019 presents loss histories that appropriately reflect a full economic cycle, reflects asset-specific risk characteristics at each pool level identified, and includes a historical look-back period that is objective and reflective of future expected credit losses. Loss data from 2020 to 2021 was excluded from the data set to exclude pandemic-related data in the models.

The method for determining the estimate of lifetime credit losses includes, among other things, the following main components: (i) the use of Probability of Default (“PD”) and Loss Given Default (“LGD”) assumptions under a Discounted Cash Flow model; (ii) a multi-scenario macroeconomic forecast; (iii) an initial and reasonable and supportable forecast period of one year for all loan segments; and (iv) a reversion period of one year using a linear transition method to historical loss rates.

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Given the inherent limitations of a quantitative-only model, qualitative adjustments are included to factor in data points not captured from a quantitative analysis alone.

Qualitative criteria that can be considered includes, among other things, the following:

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

•Volume – changes in the nature and volume of the portfolio and in the terms of the loans;

•Economic – changes in international, national, regional, and local economic and business conditions and developments that affect the collectibility of the portfolio, including the condition of various market segments;

•Policy – changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses;

•Quality – changes in the volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans; and

•External – the effect of other external factors, such as competition and legal and regulatory requirements on the level of estimated credit losses in the Company’s loan portfolio.

Management reviews current information on a quarterly basis to assess the forecasted future economic impact for purposes of evaluating the adequacy of the ACL. The forecasted direction and magnitude of change with respect to future economic conditions is then assessed against the estimate in the model. Any changes resulting from the quarterly assessment are recorded in “Provision for credit losses” in the unaudited consolidated statements of income.

Accrued Interest

Accrued interest receivable is excluded from amortized cost of all financial instrument types and included in “Interest receivable and other assets” in the unaudited consolidated balance sheets. Accrued interest receivable is not subject to an estimate for credit loss, as the Company has a policy to charge off accrued interest deemed uncollectible in a timely manner. When a loan is placed on non-accrual status, which occurs within 90 days of a borrower becoming delinquent, interest previously accrued but not collected is reversed against current period income.

Individually Assessed Loans

If an individual loan’s characteristics have deteriorated to below a range of the overall pool, the loan would be individually assessed. Individually assessed loans are measured for credit loss based on one of the following methods: (i) present value of future expected cash flows, discounted at the loan’s effective interest rate; (ii) amount by which carrying value of the loan exceeds the loan’s observable market price; or (iii) the fair value of the collateral, less estimated selling costs, if the loan is collateral dependent. The Company applies the practical expedient and defines collateral dependent loans as those where the borrower is experiencing financial difficulty and on which payment is expected to be provided substantially through the operation or sale of the collateral.

Available-for-sale (“AFS”) Debt Securities

Unrealized credit losses are recognized through an allowance for credit losses instead of an adjustment to amortized cost basis, eliminating the other-than-temporary impairment concept. For AFS debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell, the security before recovery of amortized cost basis. If either criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through earnings. For AFS debt securities that do not meet the above conditions, the Company evaluates at the individual security level whether the decrease in fair value has resulted from credit factors or non-credit factors. If assessment determines that a credit loss exists, the present value of cash flows expected to be collected from the security is compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis of the security, then a credit loss would be recognized, limited to the amount by which the fair value is less than the amortized cost basis. All other changes in fair value of an AFS debt security are recognized in other comprehensive income, net of applicable taxes. Changes in the allowance for credit losses, if any, are recognized as a provision for (or reversal of) credit losses. As of June 30, 2023, the Company’s portfolio of AFS debt securities is comprised primarily of debt, mortgage-backed securities, and collateralized mortgage obligations issued by the U.S. government, its agencies, or government-sponsored enterprises, which are either explicitly or implicitly guaranteed by the U.S. government. The remainder of the portfolio is primarily comprised of

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obligations of state and political subdivisions, which are generally rated as high grade. The history of minimal credit losses from these issuers indicates that expectation of non-payment of the amortized cost basis is zero. As such, the Company determined that the unrealized loss positions in AFS securities were not due to credit losses, but instead related to changes in interest rates and general market conditions and therefore, no credit loss expense was recognized.

Loan Commitments

Loan commitments not unconditionally cancellable are subject to an estimate of credit loss under the CECL model. The Company’s process for determining the estimate of credit loss on loan commitments is the same as it is on loans. Unfunded loan commitment reserves are included in “Interest payable and other liabilities” in the unaudited consolidated balance sheets.

Held-to-Maturity Debt Securities

The Company’s process for determining the estimate of credit loss on held-to-maturity debt securities is substantially similar to what it is on loans, with segmenting not being applicable. As the amount of held-to-maturity debt securities that the Company carries is limited and given the determination that expected credit loss was immaterial, an immaterial amount was recognized in allowance for credit loss upon adoption and no credit loss expense was recorded for the three and six months ended June 30, 2023.

TDRs and Other Loan Modifications

In accordance with the adoption of ASC 326, which includes ASU No. 2022-02, Financial Instruments-Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, accounting guidance for TDRs for creditors has been eliminated. New guidance with respect to recognition, measurement, and disclosures of loans for borrowers experiencing financial difficulties supersedes guidance on TDRs. As of June 30, 2023, the amount of loans modified for borrowers due to experiencing financial difficulties under criteria of principal forgiveness, interest rate reduction, other-than-insignificant payment delay, or term extension was immaterial.

(f) Recently Issued Accounting Standards

The following information reflects recent accounting standards that have been adopted or are pending adoption by the Company. The Company qualifies as an emerging growth company and, as such, has elected to use the extended transition period for complying with new or revised accounting standards and is not subject to the new or revised accounting standards applicable to public companies during the extended transition period. The accounting standards discussed below indicate effective dates for the Company as an emerging growth company using the extended transition period.

Accounting Standards Adopted

On January 1, 2023, the Company adopted ASC 326, which replaces the current “incurred loss” model for recognizing credit losses with an “expected loss” model referred to as the Current Expected Credit Loss (“CECL”) model. The CECL model applies to estimated credit losses on loans receivable, held-to-maturity debt securities, unfunded loan commitments, and certain other financial assets measured at amortized cost. Under ASC 326, available-for-sale debt securities are evaluated for impairment if fair value is less than amortized cost, with any estimated credit losses recorded through a credit loss expense and an allowance, rather than a write-down of the investment. Changes in fair value that are not credit-related will continue to be recorded in other comprehensive income. The Company adopted this standard using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance was effective for financial assets measured at amortized cost. For certain new disclosures required under ASC 326, such as credit quality indicators by year of origination, we have not restated comparative financial information before January 1, 2023 to conform under ASC 326. This adoption method is considered a change in accounting principle requiring additional disclosure of the nature and reason for the change, which is solely due to adoption of ASC 326. On January 1, 2023, the Company also adopted ASU No. 2022-02, Financial Instruments-Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, which had no material impact.

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The following table reflects the cumulative-effect adjustments the Company recorded on January 1, 2023 for the adoption of ASC 326.

						January 1, 2023
(in thousands)						Pre-ASC 326 Adoption						Impact of ASC 326 Adoption						Post-ASC 326 Adoption
Assets:
Allowance for Credit Losses						$	(28,389)					$	(5,282)					$	(33,671)
Deferred Tax Asset (Interest receivable and other assets)						12,273						1,883						14,156
Liabilities:
Reserve for Unfunded Commitments (Interest payable and other liabilities)						(125)						(1,092)						(1,217)
Shareholders’ Equity:
Retained Earnings						(46,736)						4,491						(42,245)

Accounting Standards Issued But Not Yet Adopted

For the fiscal year beginning January 1, 2023, there have been no new accounting standards issued but not yet adopted that are expected to be material to the Company. There are also no accounting standards issued before January 1, 2023 yet to be adopted.

Note 2: Fair Value of Assets and Liabilities

Fair Value Hierarchy and Fair Value Measurement

Accounting standards require the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the Company has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect the Company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The fair values of securities are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

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The following table summarizes the Company’s assets and liabilities that were required to be recorded at fair value on a recurring basis.

(in thousands)						Carrying Value						Quoted Prices in Active Markets for Identical Assets (Level 1)						Significant Other Observable Inputs (Level 2)						Significant Unobservable Inputs (Level 3)						Measurement Categories: Changes in Fair Value Recorded In
June 30, 2023
Assets:
Securities available-for-sale:
U.S. government agencies, mortgage-backed securities, obligations of states and political subdivisions, collateralized mortgage obligations, and corporate bonds						$	110,794					$	—					$	110,794					$	—					OCI
Derivatives – interest rate swap						8						—						8						—						NI
Liabilities:
Derivatives – interest rate swap						8						—						8						—						NI
December 31, 2022
Assets:
Securities available-for-sale:
U.S. government agencies, mortgage-backed securities, obligations of states and political subdivisions, collateralized mortgage obligations, and corporate bonds						$	115,988					$	—					$	115,988					$	—					OCI
Derivatives – interest rate swap						16						—						16						—						NI
Liabilities:
Derivatives – interest rate swap						16						—						16						—						NI

Available-for-sale securities are recorded at fair value on a recurring basis. When available, quoted market prices (Level 1 inputs) are used to determine the fair value of available-for-sale securities. If quoted market prices are not available, management obtains pricing information from a reputable third-party service provider, who may utilize valuation techniques that use current market-based or independently sourced parameters, such as bid/ask prices, dealer-quoted prices, interest rates, benchmark yield curves, prepayment speeds, probability of default, loss severity, and credit spreads (Level 2 inputs). Level 2 securities include U.S. agencies’ or government-sponsored agencies’ debt securities, mortgage-backed securities, government agency-issued bonds, privately issued collateralized mortgage obligations, and corporate bonds. Level 3 securities are based on unobservable inputs that are supported by little or no market activity. In addition, values use discounted cash flow models and may include significant management judgment and estimation. As of June 30, 2023 and December 31, 2022, there were no Level 1 available-for-sale securities and no transfers between Level 1 and Level 2 classifications for assets or liabilities measured at fair value on a recurring basis.

On a recurring basis, derivative financial instruments are recorded at fair value, which is based on the income approach using observable Level 2 market inputs, reflecting market expectations of future interest rates as of the measurement date. Standard valuation techniques are used to calculate the present value of the future expected cash flows assuming an orderly transaction. Valuation adjustments may be made to reflect both the Company’s credit risk and the counterparties’ credit risk in determining the fair value of the derivatives. A similar credit risk adjustment, correlated to the credit standing of the counterparty, is made when collateral posted by the counterparty does not fully cover their liability to the Company.

Certain financial assets may be measured at fair value on a non-recurring basis. These assets are subject to fair value adjustments that result from the application of the lower of cost or fair value accounting or write-downs of individual assets, such as collateral dependent loans and other real estate owned. As of June 30, 2023 and December 31, 2022, the carrying amount of assets measured at fair value on a non-recurring basis was immaterial to the Company.

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Disclosures about Fair Value of Financial Instruments

The table below is a summary of fair value estimates for financial instruments as of June 30, 2023 and December 31, 2022. The carrying amounts in the following table are recorded in the consolidated balance sheets under the indicated captions. Further, management has not disclosed the fair value of financial instruments specifically excluded from disclosure requirements, such as BOLI.

						June 30, 2023																		December 31, 2022
(in thousands)						Carrying Amounts						Fair Value						Fair Value Hierarchy						Carrying Amounts						Fair Value						Fair Value Hierarchy
Financial assets:
Cash and cash equivalents						$	300,123					$	300,123					Level 1						$	259,991					$	259,991					Level 1
Time deposits in banks						7,343						7,343						Level 1						9,849						9,849						Level 1
Securities available-for-sale						110,794						110,794						Level 2						115,988						115,988						Level 2
Securities held-to-maturity						3,486						3,208						Level 3						3,756						3,432						Level 3
Loans held for sale						8,559						9,460						Level 2						9,416						9,785						Level 2
Loans held for investment, net of allowance for credit losses						2,893,427						2,715,210						Level 3						2,762,937						2,570,176						Level 3
FHLB stock and other investments						21,693						N/A						N/A						16,570						N/A						N/A
Interest rate swap						8						8						Level 2						16						16						Level 2
Financial liabilities:
Interest rate swap						8						8						Level 2						16						16						Level 2
FHLB advances						100,000						100,000						Level 2						100,000						100,000						Level 2
Subordinated notes						73,677						72,178						Level 3						73,606						72,273						Level 3

The following methods and assumptions were used by the Company to estimate the fair value of its financial instruments at June 30, 2023 and December 31, 2022:

Cash and cash equivalents and time deposits in banks: The carrying amount is estimated to be fair value due to the liquid nature of the assets and their short-term maturities.

Investment securities: See discussion above for the methods and assumptions used by the Company to estimate the fair value of investment securities. Fair value of held-to-maturity securities is based on observable market data, such as interest rates and yield curves (observable at commonly quoted intervals) as provided by an independent third party.

Loans held for sale: For loans held for sale, the fair value is based on what secondary markets are currently offering for portfolios with similar characteristics.

Loans held for investment, net of allowance for credit losses: For variable rate loans that reprice frequently with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash flow analyses, which use interest rates being offered at each reporting date for loans with similar terms to borrowers of comparable creditworthiness without considering widening credit spreads due to market illiquidity, which approximates the exit price notion. The allowance for credit losses is considered to be a reasonable estimate of loan discount for credit quality concerns.

FHLB stock and other investments: Carrying amounts of these investments are reasonable estimates of fair value because the securities are restricted to member banks and do not have a readily determinable market value.

Derivatives - interest rate swap: See above for a discussion of the methods and assumptions used by the Company to estimate the fair value of derivatives.

FHLB advances: For FHLB advances, the carrying amount is estimated to be fair value.

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Subordinated notes: The fair value is estimated by discounting the future cash flow using the current three-month CME Term SOFR. The Company’s subordinated notes are not registered securities and were issued through private placements, resulting in a Level 3 classification. The notes are recorded at carrying value.

Note 3: Investment Securities

The Company’s investment securities portfolio includes obligations of states and political subdivisions, securities issued by U.S. federal government agencies, such as the SBA, and securities issued by U.S. GSEs, such as FNMA, FHLMC, and FHLB. The Company also invests in residential and commercial mortgage-backed securities, collateralized mortgage obligations issued or guaranteed by government sponsored entities, and corporate bonds, as reflected in the following tables.

A summary of the amortized cost and fair value related to securities held-to-maturity as of June 30, 2023 and December 31, 2022 is presented below.

(in thousands)						Amortized Cost						Gross Unrealized												Fair Value
												Gains						(Losses)
June 30, 2023
Obligations of states and political subdivisions						$	3,486					$	—					$	(278)					$	3,208
Total held-to-maturity						$	3,486					$	—					$	(278)					$	3,208
December 31, 2022
Obligations of states and political subdivisions						$	3,756					$	—					$	(324)					$	3,432
Total held-to-maturity						$	3,756					$	—					$	(324)					$	3,432

For securities issued by states and political subdivisions, for purposes of evaluating whether to recognize credit loss expense, management considers: (i) issuer and/or guarantor credit ratings; (ii) historical probability of default and loss given default rates for given bond ratings and remaining maturity; (iii) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities; (iv) internal credit review of the financial information; and (v) whether or not such securities have credit enhancements such as guarantees, contain a defeasance clause, or are pre-refunded by the issuers.

The Company adopted ASC 326 on January 1, 2023, which affects accounting of credit loss expense on held-to-maturity and available-for-sale securities. Refer to Note 1, Basis of Presentation and Summary of Significant Accounting Policies, for further detail.

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A summary of the amortized cost and fair value related to securities available-for-sale as of June 30, 2023 and December 31, 2022 is presented below.

(in thousands)						Amortized Cost						Gross Unrealized												Fair Value
												Gains						(Losses)
June 30, 2023
U.S. government agencies						$	12,239					$	95					$	(197)					$	12,137
Mortgage-backed securities						70,117						—						(12,038)						58,079
Obligations of states and political subdivisions						44,458						4						(5,983)						38,479
Collateralized mortgage obligations						401						—						(42)						359
Corporate bonds						2,000						—						(260)						1,740
Total available-for-sale						$	129,215					$	99					$	(18,520)					$	110,794
December 31, 2022
U.S. government agencies						$	14,317					$	81					$	(225)					$	14,173
Mortgage-backed securities						73,111						1						(11,841)						61,271
Obligations of states and political subdivisions						45,223						21						(6,818)						38,426
Collateralized mortgage obligations						436						—						(41)						395
Corporate bonds						2,000						—						(277)						1,723
Total available-for-sale						$	135,087					$	103					$	(19,202)					$	115,988

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The amortized cost and fair value of investment securities by contractual maturity at June 30, 2023 and December 31, 2022 are shown below. Expected maturities may differ from contractual maturities if the issuers of the securities have the right to call or prepay obligations with or without call or prepayment penalties.

(in thousands)						June 30, 2023																								December 31, 2022
						Held-to-Maturity												Available-for-Sale												Held-to-Maturity												Available-for-Sale
						Amortized Cost						Fair Value						Amortized Cost						Fair Value						Amortized Cost						Fair Value						Amortized Cost						Fair Value
Within one year						$	326					$	300					$	—					$	—					$	417					$	381					$	501					$	501
After one but within five years						950						874						—						—						1,015						927						—						—
After five years through ten years						1,375						1,266						5,801						5,204						1,470						1,343						5,320						4,761
After ten years						835						768						38,657						33,275						854						781						39,402						33,164
Investment securities not due at a single maturity date:
U.S. government agencies						—						—						12,239						12,137						—						—						14,317						14,173
Mortgage-backed securities						—						—						70,117						58,079						—						—						73,111						61,271
Collateralized mortgage obligations						—						—						401						359						—						—						436						395
Corporate bonds						—						—						2,000						1,740						—						—						2,000						1,723
Total						$	3,486					$	3,208					$	129,215					$	110,794					$	3,756					$	3,432					$	135,087					$	115,988

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Sales of investment securities and gross gains and losses are shown in the following table:

(in thousands)						For the three months ended												For the six months ended
						June 30, 2023						June 30, 2022						June 30, 2023						June 30, 2022
Available-for-sale:
Sales proceeds						$	—					$	—					$	—					$	1,623
Gross realized gains						—						—						—						5

Pledged investment securities are shown in the following table:

(in thousands)						June 30, 2023						December 31, 2022
Pledged to:
The State of California, securing deposits of public funds and borrowings						$	57,688					$	40,465
The Federal Reserve Discount Window, increasing borrowing capacity						52,215						—
Total pledged investment securities						$	109,903					$	40,465

The following table details the gross unrealized losses and fair values aggregated by investment category and length of time that individual available-for-sale securities have been in a continuous unrealized loss position at June 30, 2023 and December 31, 2022:

						Less than 12 months												12 months or more												Total securities in a loss position
(in thousands)						Fair Value						Unrealized Loss						Fair Value						Unrealized Loss						Fair Value						Unrealized Loss
June 30, 2023
U.S. government agencies						$	2,404					$	(26)					$	8,158					$	(171)					$	10,562					$	(197)
Mortgage-backed securities						391						(6)						57,686						(12,032)						58,077						(12,038)
Obligations of states and political subdivisions						—						—						36,952						(5,983)						36,952						(5,983)
Collateralized mortgage obligations						—						—						359						(42)						359						(42)
Corporate bonds						—						—						1,740						(260)						1,740						(260)
						$	2,795					$	(32)					$	104,895					$	(18,488)					$	107,690					$	(18,520)
December 31, 2022
U.S. government agencies						$	3,090					$	(125)					$	8,392					$	(100)					$	11,482					$	(225)
Mortgage-backed securities						4,360						(470)						56,908						(11,371)						61,268						(11,841)
Obligations of states and political subdivisions						24,707						(4,097)						11,670						(2,721)						36,377						(6,818)
Collateralized mortgage obligations						395						(41)						—						—						395						(41)
Corporate bonds						—						—						1,723						(277)						1,723						(277)
						$	32,552					$	(4,733)					$	78,693					$	(14,469)					$	111,245					$	(19,202)

There were 153 and 152 available-for-sale securities in unrealized loss positions at June 30, 2023 and December 31, 2022, respectively. As of June 30, 2023, the investment portfolio included 148 investment securities that had been in a continuous loss position for twelve months or more and five investment securities that had been in a loss position for less than twelve months.

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There was one held-to-maturity security in a continuous unrealized loss position at June 30, 2023, which had been in a continuous loss position for more than twelve months.

Obligations issued or guaranteed by government agencies such as GNMA and the SBA or GSEs under conservatorship such as the FNMA and the FHLMC, are guaranteed or sponsored by agencies of the U.S. government and have strong credit profiles. The Company therefore expects to receive all contractual interest payments on time and believes the risk of credit losses on these securities is remote.

The Company’s investment in obligations of states and political subdivisions are deemed credit worthy after management’s comprehensive analysis of the issuers’ latest financial information, credit ratings by major credit agencies, and/or credit enhancements.

Non-Marketable Securities Included in Other Assets

FHLB capital stock: As a member of the FHLB, the Company is required to maintain a minimum investment in FHLB capital stock determined by the board of directors of the FHLB. The minimum investment requirements can increase in the event the Company increases its total asset size or borrowings with the FHLB. Shares cannot be purchased or sold except between the FHLB and its members at the $100 per share par value. The Company held $15.0 million and $10.9 million of FHLB stock at June 30, 2023 and December 31, 2022, respectively. The carrying amounts of these investments are reasonable estimates of fair value because the securities are restricted to member banks and do not have a readily determinable market value. Based on management’s analysis of the FHLB’s financial condition and certain qualitative factors, management determined that the FHLB stock was not impaired at June 30, 2023 and December 31, 2022. On April 27, 2023, the FHLB announced a cash dividend for the first quarter of 2023 at an annualized dividend rate of 7.00%, which was paid on May 11, 2023. Cash dividends received on FHLB capital stock amounted to $0.2 million and $0.1 million for the three months ended June 30, 2023 and 2022, respectively, and $0.4 million and $0.2 million for the six months ended June 30, 2023 and 2022, respectively, and were recorded as non-interest income on the unaudited consolidated statements of income.

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Note 4: Loans and Allowance for Credit Losses

The Company’s loan portfolio is its largest class of earning assets and typically provides higher yields than other types of earning assets. Associated with the higher yields is an inherent amount of credit risk which the Company attempts to mitigate through strong underwriting practices. The following table presents the balance of each major product type within the Company’s portfolio as of the dates indicated.

(in thousands)						June 30, 2023						December 31, 2022
Real estate:
Commercial						$	2,512,741					$	2,394,674
Commercial land and development						15,199						7,477
Commercial construction						100,514