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Bank of Marin Bancorp - Quarter Report: 2021 September (Form 10-Q)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
FORM 10-Q
(Mark One)
 
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2021
OR
☐ 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  001-33572
Bank of Marin Bancorp
(Exact name of Registrant as specified in its charter)
California 20-8859754
(State or other jurisdiction of incorporation or organization)   (IRS Employer Identification No.)
504 Redwood Blvd. Suite 100NovatoCA 94947
(Address of principal executive office) (Zip Code)
 
Registrant’s telephone number, including area code:  (415) 763-4520

Not Applicable
(Former name, former address and formal fiscal year, if changed since last report)
Securities registered pursuant to 12(b) of the Act:
Title of each classTrading symbolName of each exchange on which registered
Common stock, no par value and attached Share Purchase RightsBMRCThe Nasdaq Stock Market

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 ☒                  No  ☐
 
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 ☒                  No ☐
 
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 ☐Accelerated filer☒
Non-accelerated filer ☐(Do not check if a smaller reporting company)Smaller reporting company ☐
Emerging growth company ☐
 
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. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes   ☐    No  ☒ 

As of October 31, 2021, there were 16,013,255 shares of common stock outstanding.


TABLE OF CONTENTS
 
PART I
   
ITEM 1.
 
 
 
 
 
   
ITEM 2.
   
ITEM 3.
   
ITEM 4.
   
PART II
   
ITEM 1.
   
ITEM 1A.
   
ITEM 2.
   
ITEM 3.
   
ITEM 4.
   
ITEM 5.
   
ITEM 6.
   



Page-2
PART I       FINANCIAL INFORMATION
 
ITEM 1.  Financial Statements 
BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF CONDITION 
(in thousands, except share data; unaudited)September 30, 2021December 31, 2020
Assets  
Cash, cash equivalents and restricted cash$584,739 $200,320 
Investment securities 
Held-to-maturity, at amortized cost (net of zero allowance for credit losses at September 30, 2021 and December 31, 2020 )
196,801 109,036 
Available-for-sale, at fair value (net of zero allowance for credit losses at September 30, 2021 and December 31, 2020 )
963,033 392,351 
Total investment securities1,159,834 501,387 
Loans, at amortized cost2,317,019 2,088,556 
Allowance for credit losses on loans(22,414)(22,874)
Loans, net of allowance for credit losses on loans
2,294,605 2,065,682 
Goodwill72,754 30,140 
Bank-owned life insurance61,171 43,552 
Operating lease right-of-use assets24,776 25,612 
Bank premises and equipment, net7,807 4,919 
Core deposit intangible6,998 3,831 
Other real estate owned800 — 
Interest receivable and other assets47,578 36,483 
Total assets$4,261,062 $2,911,926 
Liabilities and Stockholders' Equity  
Liabilities  
Deposits  
Non-interest bearing$1,837,595 $1,354,650 
Interest bearing 
Transaction accounts288,401 183,552 
Savings accounts336,867 201,507 
Money market accounts1,124,660 667,107 
Time accounts140,173 97,433 
Total deposits3,727,696 2,504,249 
Borrowings and other obligations451 58 
Subordinated debenture— 2,777 
Operating lease liabilities26,637 27,062 
Interest payable and other liabilities47,753 19,527 
Total liabilities3,802,537 2,553,673 
Stockholders' Equity  
Preferred stock, no par value,
    Authorized - 5,000,000 shares, none issued
— — 
Common stock, no par value,
Authorized - 30,000,000 shares; issued and outstanding - 16,066,889 and 13,500,453 at September 30, 2021 and December 31, 2020, respectively
217,680 125,905 
Retained earnings233,997 219,747 
Accumulated other comprehensive income, net of taxes6,848 12,601 
Total stockholders' equity458,525 358,253 
Total liabilities and stockholders' equity$4,261,062 $2,911,926 
The accompanying notes are an integral part of these consolidated financial statements (unaudited).
Page-3
BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three months endedNine months ended
(in thousands, except per share amounts; unaudited)September 30, 2021September 30, 2020September 30, 2021September 30, 2020
Interest income   
Interest and fees on loans$24,027 $21,776 $66,117 $63,880 
Interest on investment securities4,084 3,343 10,717 11,249 
Interest on federal funds sold and due from banks178 50 274 421 
Total interest income28,289 25,169 77,108 75,550 
Interest expense    
Interest on interest-bearing transaction accounts41 41 119 146 
Interest on savings accounts26 17 66 50 
Interest on money market accounts417 377 1,015 1,731 
Interest on time accounts44 133 221 436 
Interest on borrowings and other obligations8 — 8 3 
Interest on subordinated debenture— 35 1,361 124 
Total interest expense536 603 2,790 2,490 
Net interest income27,753 24,566 74,318 73,060 
Provision for (reversal of) credit losses on loans1,800 1,250 (2,049)5,450 
Provision for (reversal of) credit losses on unfunded loan commitments— 248 (1,202)610 
Net interest income after provision for (reversal of) credit losses25,953 23,068 77,569 67,000 
Non-interest income  
Earnings on bank-owned life insurance, net1,402 232 1,892 741 
Wealth Management and Trust Services597 450 1,615 1,375 
Debit card interchange fees483 383 1,268 1,051 
Service charges on deposit accounts464 284 1,062 1,028 
Dividends on Federal Home Loan Bank stock179 149 505 503 
Merchant interchange fees129 63 247 183 
Gains on sale of investment securities, net1 — 1 915 
Other income310 229 823 927 
Total non-interest income3,565 1,790 7,413 6,723 
Non-interest expense   
Salaries and related benefits13,127 8,638 31,223 25,979 
Occupancy and equipment1,871 1,776 5,373 5,100 
Professional services2,472 655 4,321 1,749 
Data processing1,613 822 3,252 2,437 
Depreciation and amortization431 539 1,279 1,591 
Information technology496 256 1,105 758 
Amortization of core deposit intangible334 213 742 639 
Directors' expense255 184 660 533 
Federal Deposit Insurance Corporation insurance236 181 597 299 
Charitable contributions4 481 497 921 
Other expense1,847 1,245 4,605 4,232 
Total non-interest expense22,686 14,990 53,654 44,238 
Income before provision for income taxes6,832 9,868 31,328 29,485 
Provision for income taxes1,550 2,377 7,814 7,360 
Net income$5,282 $7,491 $23,514 $22,125 
Net income per common share:  
Basic$0.35 $0.55 $1.70 $1.64 
Diluted$0.35 $0.55 $1.69 $1.62 
Weighted average shares:   
Basic14,922 13,539 13,798 13,526 
Diluted14,993 13,610 13,881 13,617 
Comprehensive income (loss):
Net income$5,282 $7,491 $23,514 $22,125 
Other comprehensive income (loss):
Change in net unrealized (losses) gains on available-for-sale securities(2,274)299 (8,558)11,605 
Reclassification adjustment for gains on available-for-sale securities included in net income(1)— (1)(915)
Amortization of net unrealized losses on securities transferred from available-for-sale to held-to-maturity104 149 385 394 
Other comprehensive income (loss), before tax(2,171)448 (8,174)11,084 
Deferred tax (benefit) expense(641)132 (2,421)3,277 
Other comprehensive income (loss), net of tax(1,530)316 (5,753)7,807 
Total comprehensive income$3,752 $7,807 $17,761 $29,932 
The accompanying notes are an integral part of these consolidated financial statements (unaudited).
Page-4
BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the three months ended September 30, 2021 and 2020
(in thousands, except share data; unaudited)Common StockRetained
Earnings		Accumulated Other
Comprehensive Income,
Net of Taxes		 Total
SharesAmount
Three months ended September 30, 2021
Balance at July 1, 202113,055,105 $108,430 $231,841 $8,378 $348,649 
Net income— — 5,282 — 5,282 
Other comprehensive income— — — (1,530)(1,530)
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings3,098 72 — — 72 
Stock issued under employee stock purchase plan508 18 — — 18 
Stock issued under employee stock ownership plan9,100 332 — — 332 
Stock-based compensation - stock options— 115 — — 115 
Stock-based compensation - restricted stock— 98 — — 98 
Cash dividends paid on common stock ($0.24 per share)
— — (3,126)— (3,126)
Stock purchased by directors under director stock plan515 17 — — 17 
Stock issued in payment of director fees3,063 99 — — 99 
Stock issued to American River Bankshares shareholders3,441,235 124,401 — — 124,401 
Stock repurchased, net of commissions(445,735)(15,902)— — (15,902)
Balance at September 30, 202116,066,889 $217,680 $233,997 $6,848 $458,525 
Three months ended September 30, 2020
Balance at July 1, 202013,591,835 $128,633 $211,613 $11,994 $352,240 
Net income— — 7,491 — 7,491 
Other comprehensive income— — — 316 316 
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings207 — — — — 
Stock issued under employee stock purchase plan728 20 — — 20 
Stock issued under employee stock ownership plan10,200 319 — — 319 
Restricted stock forfeited / cancelled(1,466)— — — — 
Stock-based compensation - stock options— 88 — — 88 
Stock-based compensation - restricted stock— 99 — — 99 
Cash dividends paid on common stock ($0.23 per share)
— — (3,128)— (3,128)
Stock purchased by directors under director stock plan746 25 — — 25 
Stock issued in payment of director fees3,113 100 — — 100 
Balance at September 30, 202013,605,363 $129,284 $215,976 $12,310 $357,570 

The accompanying notes are an integral part of these consolidated financial statements (unaudited).




BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the nine months ended September 30, 2021 and 2020
(in thousands, except share data; unaudited)Common StockRetained
Earnings		Accumulated Other
Comprehensive (Loss) Income,
Net of Taxes		 Total
SharesAmount
Nine months ended September 30, 2021
Balance at January 1, 202113,500,453 $125,905 $219,747 $12,601 $358,253 
Net income— — 23,514 — 23,514 
Other comprehensive (loss)— — — (5,753)(5,753)
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings34,278 423 423 
Stock issued under employee stock purchase plan2,117 72 — — 72 
Stock issued under employee stock ownership plan27,400 999 — — 999 
Restricted stock granted29,454 — — — — 
Restricted stock surrendered for tax withholdings upon vesting(3,961)(156)— — (156)
Restricted stock forfeited / cancelled(3,848)— — — — 
Stock-based compensation - stock options— 315 — — 315 
Stock-based compensation - restricted stock— 636 — — 636 
Cash dividends paid on common stock ($0.70 per share)
— — (9,264)— (9,264)
Stock purchased by directors under director stock plan1,034 34 — — 34 
Stock issued in payment of director fees6,410 216 — — 216 
Stock issued to American River Bankshares shareholders3,441,235 124,401 — — 124,401 
Stock repurchased, net of commissions(967,683)(35,165)— — (35,165)
Balance at September 30, 202116,066,889 $217,680 $233,997 $6,848 $458,525 
Nine months ended September 30, 2020
Balance at January 1, 202013,577,008 $129,058 $203,227 $4,503 $336,788 
Net income— — 22,125 — 22,125 
Other comprehensive income— — — 7,807 7,807 
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings64,022 1,277 — — 1,277 
Stock issued under employee stock purchase plan1,812 53 — — 53 
Stock issued under employee stock ownership plan29,600 967 — — 967 
Restricted stock granted29,100 — — — — 
Restricted stock surrendered for tax withholdings upon vesting(2,200)(73)— — (73)
Restricted stock forfeited / cancelled(8,184)— — — — 
Stock-based compensation - stock options— 299 — — 299 
Stock-based compensation - restricted stock— 673 — — 673 
Cash dividends paid on common stock ($0.69 per share)
— — (9,376)— (9,376)
Stock purchased by directors under director stock plan1,146 43 — — 43 
Stock issued in payment of director fees5,723 217 — — 217 
Stock repurchased, net of commissions(92,664)(3,230)— — (3,230)
Balance at September 30, 202013,605,363 $129,284 $215,976 $12,310 $357,570 
The accompanying notes are an integral part of these consolidated financial statements (unaudited).
Page-5
BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended September 30, 2021 and 2020
(in thousands; unaudited)September 30, 2021September 30, 2020
Cash Flows from Operating Activities:  
Net income$23,514 $22,125 
Adjustments to reconcile net income to net cash provided by operating activities:  
(Reversal of) provision for credit losses on loans(2,049)5,450 
(Reversal of) provision for credit losses on unfunded loan commitments(1,202)610 
Noncash contribution expense to employee stock ownership plan999 967 
Noncash director compensation expense347 226 
Stock-based compensation expense951 972 
Amortization of core deposit intangible742 639 
Amortization of investment security premiums, net of accretion of discounts3,222 864 
Accretion of discounts on acquired loans(201)(101)
Accretion of discount on subordinated debenture1,347 52 
Net change in deferred loan origination costs/fees(1,135)6,132 
Gain on sale of investment securities(1)(915)
Depreciation and amortization1,279 1,591 
Earnings on bank-owned life insurance policies(1,892)(741)
Net changes in Interest receivable and other assets5,615 (5,347)
Net changes in Interest payable and other liabilities790 (1,207)
Total adjustments8,812 9,192 
Net cash provided by operating activities32,326 31,317 
Cash Flows from Investing Activities:  
Purchase of held-to-maturity securities(133,493)— 
Purchase of available-for-sale securities(355,156)(71,744)
Proceeds from sale of available-for-sale securities4,099 33,756 
Proceeds from paydowns/maturities of held-to-maturity securities 65,497 19,880 
Proceeds from paydowns/maturities of available-for-sale securities 66,981 68,102 
Loans originated and principal collected, net193,265 (269,376)
Purchase of bank-owned life insurance policies(1,943)(941)
Cash receipts from bank-owned life insurance policies2,478 — 
Purchase of premises and equipment(833)(769)
Cash acquired from American River Bankshares140,577 — 
Cash paid for low income housing tax credit investment(396)(1,289)
Net cash used in investing activities(18,924)(222,381)
Cash Flows from Financing Activities:  
Net increase in deposits433,425 232,800 
Proceeds from stock options exercised423 1,277 
Payment of tax withholdings for vesting of restricted stock(156)(73)
Proceeds from stock issued under employee and director stock purchase plans106 96 
Stock repurchased, net of commissions(35,451)(3,333)
Repayment of subordinated debenture including execution costs(4,126)— 
Repayment of Federal Home Loan Bank borrowings(13,885)— 
Repayment of finance lease obligations(55)(131)
Cash dividends paid on common stock(9,264)(9,376)
Net cash provided by financing activities371,017 221,260 
Net increase in cash, cash equivalents and restricted cash384,419 30,196 
Cash, cash equivalents and restricted cash at beginning of period200,320 183,388 
Cash, cash equivalents and restricted cash at end of period$584,739 $213,584 
Supplemental disclosure of cash flow information:
Cash paid in interest$1,492 $2,450 
Cash paid in income taxes$9,000 $9,765 
Supplemental disclosure of noncash investing and financing activities:  
Change in net unrealized gains on available-for-sale securities$(8,558)$11,605 
Amortization of net unrealized loss on available-for-sale securities transferred to held-to-maturity$385 $394 
Purchase of investment security not yet settled$19,972 $— 
Stock issued to employee stock ownership plan$999 $967 
Stock issued for director compensation expense$347 $226 
Repurchase of stock not yet settled$127 $— 
Acquisition: Fair value of assets acquired, excluding cash acquired$757,844 $— 
                    Fair value of liabilities assumed$816,558 $— 
Restricted cash1
$— $— 
1 Restricted cash includes reserve requirements held with the Federal Reserve Bank of San Francisco. In response to the COVID-19 pandemic, the Federal Reserve reduced the reserve requirement ratios to zero percent effective March 26, 2020.

The accompanying notes are an integral part of these consolidated financial statements (unaudited).
Page-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
 
Note 1:  Basis of Presentation

The consolidated financial statements include the accounts of Bancorp, a bank holding company, and its wholly-owned bank subsidiary, Bank of Marin, a California state-chartered commercial bank. Effective August 6, 2021 (the "merger date"), American River Bankshares ("AMRB") merged with and into Bank of Marin Bancorp ("Bancorp"), with Bank of Marin Bancorp surviving, followed thereafter at 12:05 AM on August 7, 2021, by the merger of American River Bank ("ARB") with and into Bank of Marin, with Bank of Marin (the "Bank") surviving, (collectively the "Merger"). The Merger was accounted for under ASC 805, Business Combinations. See Note 10, Merger, for further detail. References to “we,” “our,” “us” mean Bancorp and the Bank that are consolidated for financial reporting purposes. The accompanying unaudited consolidated interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and note disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles ("GAAP") have been condensed or omitted pursuant to those rules and regulations. Certain items in prior financial statements were reclassified to conform to the current presentation, including the reclassification of the provision for credit losses on unfunded commitments in the second quarter of 2021 from non-interest expense to a separate line item under the provision for credit losses on loans in the consolidated statements of comprehensive income. This reclassification had no impact to net income or stockholders' equity.

Although we believe that the disclosures are adequate and the information presented is not misleading, we suggest that these interim financial statements be read in conjunction with the annual financial statements and the notes thereto included in our 2020 Annual Report on Form 10-K.  In the opinion of management, the unaudited consolidated financial statements reflect all adjustments, which are necessary for a fair presentation of the consolidated financial position, the results of operations, changes in comprehensive income, changes in stockholders’ equity, and cash flows for the periods presented. All material intercompany transactions have been eliminated. The results of these interim periods may not be indicative of the results for the full year or for any other period.

The NorCal Community Bancorp Trust II (the "Trust") was formed for the sole purpose of issuing trust preferred securities. Bancorp is not considered the primary beneficiary of the Trust (a variable interest entity), therefore the Trust is not consolidated in our consolidated financial statements, but rather the subordinated debenture is shown as a liability on our consolidated statements of condition. Bancorp's investment in the securities of the Trust is accounted for under the equity method and is included in interest receivable and other assets on the consolidated statements of condition. Refer to Note 6, Borrowings, for additional information on the subordinated debenture due to NorCal Community Bancorp Trust II and the early redemption that occurred on March 15, 2021.
 
The following table shows: 1) weighted average basic shares, 2) potentially dilutive weighted average common shares related to stock options and unvested restricted stock awards, and 3) weighted average diluted shares. Basic earnings per share (“EPS”) are calculated by dividing net income by the weighted average number of common shares outstanding during each period, excluding unvested restricted stock awards. Diluted EPS are calculated using the weighted average number of potentially dilutive common shares. The number of potentially dilutive common shares included in the quarterly diluted EPS is computed using the average market prices during the three months included in the reporting period under the treasury stock method. The number of potentially dilutive common shares included in year-to-date diluted EPS is a year-to-date weighted average of potentially dilutive common shares included in each quarterly diluted EPS computation. In computing diluted EPS, we exclude anti-dilutive shares such as options whose exercise prices exceed the current common stock price, as they would not reduce EPS under the treasury method. We have two forms of outstanding common stock: common stock and unvested restricted stock awards. Holders of unvested restricted stock awards receive non-forfeitable dividends at the same rate as common shareholders and they both share equally in undistributed earnings. Under the two-class method, there is no difference in EPS when considering these participating securities.
Page-7
Three months endedNine months ended
(in thousands, except per share data)September 30, 2021September 30, 2020September 30, 2021September 30, 2020
Weighted average basic common shares outstanding14,922 13,539 13,798 13,526 
Potentially dilutive common shares related to:
Stock options51 53 62 71 
Unvested restricted stock awards20 18 21 20 
Weighted average diluted shares outstanding14,993 13,610 13,881 13,617 
Net income$5,282 $7,491 $23,514 $22,125 
Basic EPS$0.35 $0.55 $1.70 $1.64 
Diluted EPS$0.35 $0.55 $1.69 $1.62 
Weighted average anti-dilutive common shares not included in the calculation of diluted EPS97 202 91 152 

Note 2: Recently Adopted and Issued Accounting Standards

Accounting Standards Adopted in 2021

In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (ASC Topic 740): Simplifying the Accounting for Income Taxes. This ASU is intended to reduce the cost and complexity related to accounting for income taxes by removing certain exceptions to the guidance in ASC 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and simplifying aspects of the accounting for franchise taxes and enacted changes in tax laws or rates. We adopted this ASU prospectively on January 1, 2021, which did not have a material impact on our financial condition or results of operations.

In January 2020, the FASB issued ASU No. 2020-01, Investments - Equity Securities (ASC Topic 321), Investments - Equity Method and Joint Ventures (ASC Topic 323), and Derivatives and Hedging (ASC Topic 815) - Clarifying the Interactions between ASC 321, ASC 323, and ASC 815. Among other things, this ASU clarifies that a company should consider observable transactions that require a company to either apply or discontinue the equity method of accounting under ASC 323, for the purposes of applying the measurement alternative in accordance with ASC 321. We adopted this ASU prospectively on January 1, 2021, which did not have a material impact on our financial condition or results of operations.

In October 2020, the FASB issued ASU No. 2020-08, Codification Improvements to Subtopic 310-20, Receivables—Nonrefundable Fees and Other Costs. This ASU was issued as part of the Board's ongoing project to improve codification or correct unintended application. This ASU adds clarification to ASU 2017-08, which the Bank early-adopted in 2017, and delineates whether an entity with callable debt securities that have multiple call dates should amortize the amount above that which is repayable, to the next call date. We adopted this ASU prospectively on January 1, 2021. Because this ASU was narrow in scope and for clarification purposes, it did not have a material impact on our financial condition and results of operations.

Accounting Standards Not Yet Effective
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848). The amendments in this ASU are elective and provide optional guidance for a limited period of time to ease the potential burden of accounting for, or recognizing the effects of reference rate reform. The amendments in this ASU provide optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The amendments in this ASU may be elected as of March 12, 2020 through December 31, 2022. An entity may choose to elect the amendments in this update at an interim period subsequent to March 12, 2020 with adoption methods varying based on transaction type. We have not elected to apply amendments at this time and will assess the applicability of this ASU to us as we continue to monitor guidance for reference rate reform from FASB and its impact on our financial condition and results of operations.

In January 2021, the FASB issued ASU No. 2021-01, Reference Rate Reform (Topic 848). The main amendments in this ASU are intended to clarify certain optional expedients and scope of derivative instruments. The amendments are elective and effective immediately upon issuance of this ASU. Amendments may be elected through December 31, 2022. We have not elected to apply amendments at this time and will assess the applicability of this
Page-8
ASU to us as we continue to monitor guidance for reference rate reform from FASB and its impact on our financial condition and results of operations.

Note 3:  Fair Value of Assets and Liabilities
 
Fair Value Hierarchy and Fair Value Measurement
 
We group our assets and liabilities that are measured at fair value into three levels within the fair value hierarchy, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
 
Level 1: Valuations are based on unadjusted quoted prices in active markets for identical assets or liabilities.
 
Level 2: Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data.
 
Level 3: Valuations are based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Values are determined using pricing models and discounted cash flow models and may include significant management judgment and estimation.

The following table summarizes our assets and liabilities that were required to be recorded at fair value on a recurring basis.
(in thousands)  
Description of Financial Instruments
Carrying ValueQuoted 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 In1
September 30, 2021    
Securities available-for-sale:    
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies$693,532 $— $693,532 $— OCI
SBA-backed securities$34,609 $— $34,609 $— OCI
Debentures of government sponsored agencies$70,214 $— $70,214 $— OCI
U.S. Treasury securities$11,777 $11,777 $— $— OCI
Obligations of state and political subdivisions$137,215 $— $137,215 $— OCI
Corporate bonds$13,777 $— $13,777 $— OCI
   Asset-backed securities$1,909 $— $1,909 $— OCI
Derivative financial liabilities (interest rate contracts)$1,266 $— $1,266 $— NI
December 31, 2020    
Securities available-for-sale:   
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies$228,651 $— $228,651 $— OCI
SBA-backed securities$32,862 $— $36,286 $— OCI
Debentures of government sponsored agencies$20,186 $— $20,186 $— OCI
Obligations of state and political subdivisions$110,652 $— $110,652 $— OCI
Derivative financial liabilities (interest rate contracts)$1,912 $— $1,912 $— NI
 1 Other comprehensive income ("OCI") or net income ("NI").

Available-for-sale securities are recorded at fair value on a recurring basis. When available, quoted market prices (Level 1) are used to determine the fair value of available-for-sale securities. Level 1 securities include U.S. Treasury securities. If quoted market prices are not available, we obtain 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).   Level 2 securities include
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asset-backed securities, obligations of state and political subdivisions, U.S. agencies or government-sponsored agencies' debt securities, mortgage-backed securities, government agency-issued, and corporate bonds. As of September 30, 2021 and December 31, 2020, there were no Level 3 securities.

Held-to-maturity securities may be written down to fair value as a result of impairment through a provision for credit losses in investments securities. We did not record any write-downs during the nine months ended September 30, 2021 or September 30, 2020. Fair value of held-to-maturity securities is determined using the same techniques discussed above for available-for-sale securities.
 
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 our own credit risk and the counterparties’ credit risk in determining the fair value of the derivatives. Level 2 inputs for the valuations are limited to observable market prices for London Interbank Offered Rate ("LIBOR") and Overnight Index Swap ("OIS") rates (for the very short term), quoted prices for LIBOR futures contracts, observable market prices for LIBOR and OIS swap rates, and one-month and three-month LIBOR basis spreads at commonly quoted intervals.  Mid-market pricing of the inputs is used as a practical expedient in the fair value measurements.  We project spot rates at reset days specified by each swap contract to determine future cash flows, then discount to present value using OIS curves as of the measurement date.  When the value of any collateral placed with counterparties is less than the interest rate derivative liability, a credit valuation adjustment ("CVA") is applied to reflect the credit risk we pose to counterparties.  We have used the spread between the Standard & Poor's BBB rated U.S. Bank Composite rate and LIBOR for the closest maturity term corresponding to the duration of the swaps to derive the CVA. 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 us. For further discussion on our methodology in valuing our derivative financial instruments, refer to Note 9, Derivative Financial Instruments and Hedging Activities.

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 impaired loans that are collateral dependent and other real estate owned ("OREO").

OREO represents collateral acquired through foreclosure and is initially recorded at fair value as established by a current appraisal of the collateral. Subsequent to foreclosure, OREO is carried at the lower of cost or fair value, less estimated costs to sell. OREO values are reviewed on an ongoing basis and any subsequent decline in fair value is recorded as a foreclosed asset expense in the current period. The value of OREO is classified as Level 3. Our current OREO resulted from the ARB Merger.

The following table presents the carrying value of assets measured at fair value on a non-recurring basis and that were held in the consolidated statements of condition at each respective period end, by level within the fair value hierarchy as of September 30, 2021 and December 31, 2020.

(in thousands)Carrying ValueQuoted Prices in Active Markets for Identical Assets (Level 1)Significant Other Observable Inputs
(Level 2)		Significant Unobservable Inputs 
(Level 3)
September 30, 2021
Other real estate owned$800 $— $— $800 
December 31, 2020
Other real estate owned$— $— $— $— 

Disclosures about Fair Value of Financial Instruments
 
The table below is a summary of fair value estimates for financial instruments as of September 30, 2021 and December 31, 2020, excluding financial instruments recorded at fair value on a recurring basis (summarized in the first table in this note). The carrying amounts in the following table are recorded in the consolidated statements of condition under the indicated captions. Further, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements such as bank-owned life insurance policies ("BOLI") and non-maturity deposit liabilities. Additionally, we held shares of Federal Home Loan Bank ("FHLB") of San Francisco
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stock and Visa Inc. Class B common stock, both recorded at cost, as there was no impairment or changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer as of September 30, 2021 or December 31, 2020. The values are discussed in Note 4, Investment Securities.
 September 30, 2021December 31, 2020
(in thousands)Carrying AmountsFair ValueFair Value HierarchyCarrying AmountsFair ValueFair Value Hierarchy
Financial assets (recorded at amortized cost):  
Cash and cash equivalents$584,739 $584,739 Level 1$200,320 $200,320 Level 1
Investment securities held-to-maturity196,801 201,052 Level 2109,036 115,185 Level 2
Loans, net2,294,605 2,305,003 Level 32,065,682 2,089,192 Level 3
Interest receivable10,898 10,898 Level 210,922 10,922 Level 2
Financial liabilities (recorded at amortized cost):  
Time deposits140,173 140,385 Level 297,433 97,769 Level 2
Subordinated debenture— — Level 32,777 3,115 Level 3
Interest payable82 82 Level 297 97 Level 2

Fair value of loans is based on exit price techniques and obtained from an independent third-party that uses its proprietary valuation model and methodology and may not reflect actual or prospective market valuations. The discounted cash flow valuation approach reflects key inputs and assumptions such as loan probability of default, loss given default, prepayment speed, and market discount rates.
Fair value of fixed-rate time deposits is estimated by discounting future contractual cash flows using discount rates that reflect the current market rates offered for time deposits of similar remaining maturities.
Fair value of the subordinated debenture is estimated using a discounted cash flow approach based on current interest rates for similar financial instruments adjusted for credit and liquidity spreads.

The value of unrecognized financial instruments is estimated based on the fee income associated with the commitments which, in the absence of credit exposure, is considered to approximate their settlement value. The fair value of commitment fees was not material as of September 30, 2021 or December 31, 2020.

Note 4:  Investment Securities
 
Our investment securities portfolio consists of U.S. Treasury securities, obligations of state and political subdivisions, U.S. Corporations, U.S. federal government agencies such as Government National Mortgage Association ("GNMA") and Small Business Administration ("SBA"), U.S. government-sponsored enterprises ("GSEs"), such as Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC"), Federal Farm Credit Banks Funding Corporation and FHLB. We also invest in residential and commercial mortgage-backed securities (“MBS”/"CMBS") and collateralized mortgage obligations (“CMOs”) issued or guaranteed by the GSEs, as reflected in the following table. In addition, we hold an asset-backed security collateralized by student loan pools through the ARB acquisition.


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A summary of the amortized cost, fair value and allowance for credit losses related to securities held-to-maturity as of September 30, 2021 and December 31, 2020 is presented below.
Held-to-maturity:
Amortized Cost 1
Allowance for Credit LossesNet Carrying AmountGross UnrealizedFair Value
(in thousands)Gains(Losses)
September 30, 2021
Securities of U.S. government-sponsored enterprises:
MBS pass-through securities issued by FHLMC and FNMA$70,085 $— $70,085 $2,828 $(38)$72,875 
CMOs issued by FHLMC42,275 — 42,275 1,114 (95)43,294 
CMOs issued by FNMA5,598 — 5,598 163 — 5,761 
SBA-backed securities4,841 — 4,841 290 — 5,131 
Debentures of government-sponsored agencies51,470 — 51,470 — — 51,470 
Obligations of state and political subdivisions22,532 — 22,532 20 (31)22,521 
Total held-to-maturity$196,801 $— $196,801 $4,415 $(164)$201,052 
December 31, 2020
Securities of U.S. government-sponsored enterprises:
MBS pass-through securities issued by FHLMC and FNMA$65,579 $— $65,579 $3,924 $— $69,503 
CMOs issued by FHLMC27,201 — 27,201 1,441 — 28,642 
  CMOs issued by FNMA8,042 — 8,042 363 — 8,405 
  SBA-backed securities6,547 — 6,547 400 — 6,947 
Obligations of state and political subdivisions1,667 — 1,667 21 — 1,688 
Total held-to-maturity$109,036 $— $109,036 $6,149 $— $115,185 
1 Amortized cost and fair values exclude accrued interest receivable of $451 thousand and $366 thousand at September 30, 2021 and December 31, 2020, respectively, which is included in interest receivable and other assets in the consolidated statements of condition.
Management measures expected credit losses on held-to-maturity securities on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. With regard to MBSs and CMOs issued or guaranteed by the GSEs, and SBA-backed securities, we expect to receive all the contractual principal and interest on these securities as such securities are backed by the full faith and credit of and/or guaranteed by the U.S. government. Accordingly, no allowance for credit losses has been recorded for these securities. With regard to securities issued by states and political subdivisions, 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. Based on the comprehensive analysis, no credit losses are expected.

The following table summarizes the amortized cost of our portfolio of held-to-maturity securities issued by states and political subdivisions by Moody's and/or Standard & Poor's bond ratings as of September 30, 2021.
Obligations of state and political subdivisions
(in thousands)September 30, 2021December 31, 2020
AAA$7,455 $— 
AA14,975 1,461 
A102 206 
Total$22,532 $1,667 


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A summary of the amortized cost, fair value and allowance for credit losses related to securities available-for-sale as of September 30, 2021 and December 31, 2020 is presented below.
Available-for-sale:
Amortized Cost 1
Gross UnrealizedAllowance for Credit LossesFair Value
(in thousands)Gains(Losses)
September 30, 2021
Securities of U.S. government-sponsored enterprises:
MBS pass-through securities issued by FHLMC, FNMA and GNMA$207,557 $1,925 $(243)$— $209,239 
CMOs issued by FHLMC363,708 5,045 (1,065)— 367,688 
CMOs issued by FNMA55,178 244 (211)— 55,211 
CMOs issued by GNMA61,411 232 (249)— 61,394 
SBA-backed securities33,422 1,323 (136)— 34,609 
Debentures of government- sponsored agencies71,328 63 (1,177)— 70,214 
U.S. Treasury securities11,881 — (104)— 11,777 
Obligations of state and political subdivisions131,865 5,519 (169)— 137,215 
Corporate bonds14,014 — (237)— 13,777 
Asset-backed securities1,914 — (5)— 1,909 
Total available-for-sale$952,278 $14,351 $(3,596)$— $963,033 
December 31, 2020
Securities of U.S. government-sponsored enterprises:
MBS pass-through securities issued by FHLMC and FNMA$50,686 $2,530 $— $— $53,216 
CMOs issued by FHLMC143,267 7,925 (1)— 151,191 
CMOs issued by FNMA16,450 580 — — 17,030 
CMOs issued by GNMA6,863 351 — — 7,214 
SBA-backed securities30,941 1,976 (55)— 32,862 
Debentures of government- sponsored agencies19,944 266 (24)— 20,186 
Obligations of state and political subdivisions104,887 5,765 — — 110,652 
Total available-for-sale$373,038 $19,393 $(80)$— $392,351 
1 Amortized cost and fair value exclude accrued interest receivable of $2.9 million and $1.9 million September 30, 2021 and December 31, 2020, which is included in interest receivable and other assets in the consolidated statements of condition.

The amortized cost and fair value of investment debt securities by contractual maturity at September 30, 2021 and December 31, 2020 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.
 September 30, 2021December 31, 2020
 Held-to-MaturityAvailable-for-SaleHeld-to-MaturityAvailable-for-Sale
(in thousands)Amortized CostFair ValueAmortized CostFair ValueAmortized CostFair ValueAmortized CostFair Value
Within one year$102 $104 $11,700 $11,818 $246 $250 $11,530 $11,687 
After one but within five years23,536 24,725 75,784 77,755 7,550 7,961 59,028 62,397 
After five years through ten years51,125 53,105 314,110 318,801 52,113 55,872 144,908 154,089 
After ten years122,038 123,118 550,684 554,659 49,127 51,102 157,572 164,178 
Total$196,801 $201,052 $952,278 $963,033 $109,036 $115,185 $373,038 $392,351 

Sales of investment securities and gross gains and losses are shown in the following table:
 Three months endedNine months ended
(in thousands)September 30, 2021September 30, 2020September 30, 2021September 30, 2020
Available-for-sale:
Sales proceeds$4,099 $— $4,099 $33,756 
Gross realized gains1 — 1 916 
Gross realized losses— — — (1)

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Pledged investment securities are shown in the following table:
(in thousands)September 30, 2021December 31, 2020
Pledged to the State of California:
Secure public deposits in compliance with the Local Agency Security Program$234,390 $131,051 
Collateral for trust deposits738 751 
   Collateral for Wealth Management and Trust Services checking account622 629 
Total investment securities pledged to the State of California235,750 132,431 
Bankruptcy trustee deposits pledged with Federal Reserve Bank2,845 — 
Total pledged investment securities$238,595 $132,431 
 
There were 165 and 10 securities in unrealized loss positions at September 30, 2021 and December 31, 2020, respectively. Those securities are summarized and classified according to the duration of the loss period in the tables below:
September 30, 2021< 12 continuous months≥ 12 continuous monthsTotal securities
 in a loss position
(in thousands)Fair valueUnrealized lossFair valueUnrealized lossFair valueUnrealized loss
Held-to-maturity:
MBS pass-through securities issued by FHLMC and FNMA$17,074 $(38)$— $— $17,074 $(38)
CMOs issued by FHLMC9,320 (95)— — 9,320 (95)
Obligations of state and political subdivisions10,194 (31)— — 10,194 (31)
Total held-to-maturity36,588 (164)— — 36,588 (164)
Available-for-sale:
MBS pass-through securities issued by FHLMC, FNMA and GNMA63,171 (243)— — 63,171 (243)
CMOs issued by FHLMC142,557 (1,065)— — 142,557 (1,065)
CMOs issued by FNMA25,256 (211)— — 25,256 (211)
CMOs issued by GNMA25,879 (249)— — 25,879 (249)
SBA-backed securities8,115 (93)1,307 (43)9,422 (136)
Debentures of government- sponsored agencies50,344 (1,021)3,812 (156)54,156 (1,177)
U.S. Treasury securities11,777 (104)— — 11,777 (104)
Obligations of state and political subdivisions16,494 (169)— — 16,494 (169)
Corporate bonds13,778 (237)— — 13,778 (237)
Asset-backed securities1,909 (5)— — 1,909 (5)
Total available-for-sale359,280 (3,397)5,119 (199)364,399 (3,596)
Total securities at loss position$395,868 $(3,561)$5,119 $(199)$400,987 $(3,760)
December 31, 2020< 12 continuous months≥ 12 continuous monthsTotal securities
 in a loss position
(in thousands)Fair valueUnrealized lossFair valueUnrealized lossFair valueUnrealized loss
Available-for-sale:
CMOs issued by FHLMC$5,975 $(1)$— $— $5,975 $(1)
SBA-backed securities— — 1,790 (55)1,790 (55)
Debentures of government- sponsored agencies3,943 (24)— — 3,943 (24)
Total securities at loss position$9,918 $(25)$1,790 $(55)$11,708 $(80)

As of September 30, 2021, the investment portfolio included 6 investment securities that had been in a continuous loss position for twelve months or more and 159 investment securities that had been in a loss position for less than twelve months.

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Securities issued by government-sponsored agencies, such as FNMA and FHLMC, usually have implicit credit support by the U.S. federal government. However, since 2008, FNMA and FHLMC have been under government conservatorship and, therefore, contractual cash flows for these investments carry explicit guarantees by the U.S. federal government. Securities issued by the SBA and GNMA have explicit credit guarantees by the U.S. federal government, which protects us from credit losses on the contractual cash flows of the securities.
Our investment in obligations of state and political subdivisions bonds are deemed credit worthy after our comprehensive analysis of the issuers' latest financial information, credit ratings by major credit agencies, and/or credit enhancements.
At September 30, 2021, management determined that it did not intend to sell any investment securities with unrealized losses, and it is more likely than not that we will not be required to sell securities with unrealized losses before recovery of their amortized cost. No allowances for credit losses have been recognized on available-for-sale securities in an unrealized loss position as management does not believe any of the securities are impaired due to reasons of credit quality at September 30, 2021.

Non-Marketable Securities Included in Other Assets

FHLB Capital Stock

As a member of the FHLB, we are 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 we increase our 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. We held $16.7 million and $11.9 million of FHLB stock included in other assets on the consolidated statements of condition at September 30, 2021 and December 31, 2020, respectively. The carrying amounts of these investments are reasonable estimates of fair value because the securities are restricted to member banks and they do not have a readily determinable market value. Based on our analysis of FHLB's financial condition and certain qualitative factors, we determined that the FHLB stock was not impaired at September 30, 2021 and December 31, 2020. On October 28, 2021, FHLB announced a cash dividend for the third quarter of 2021 at an annualized dividend rate of 6.00% to be distributed in mid-November 2021. Cash dividends paid on FHLB capital stock are recorded as non-interest income.

VISA Inc. Class B Common Stock

As a member bank of Visa U.S.A., we held 10,439 shares of Visa Inc. Class B common stock at September 30, 2021 and December 31, 2020. These shares have a carrying value of zero and are restricted from resale to non-member banks of Visa U.S.A. until their conversion into Class A (voting) shares upon the termination of Visa Inc.'s Covered Litigation escrow account. Because of the restriction and the uncertainty on the conversion rate to Class A shares, these shares lack a readily determinable fair value. When converting this Class B common stock to Class A common stock based on the estimated conversion rate of 1.6228 both at September 30, 2021 and December 31, 2020, and the closing stock price of Class A shares at those respective dates, the converted value of our shares of Class B common stock would have been $3.8 million and $3.7 million at September 30, 2021 and December 31, 2020, respectively. The conversion rate is subject to further adjustment upon the final settlement of the covered litigation against Visa Inc. and its member banks. As such, the fair value of these Class B shares can differ significantly from their converted values. For further information, refer to Note 8, Commitments and Contingencies.

Low Income Housing Tax Credits

We invest in low-income housing tax credit funds as a limited partner, which totaled $3.2 million and $3.5 million recorded in other assets as of September 30, 2021 and December 31, 2020, respectively. In the first nine months of 2021, we recognized $484 thousand of low-income housing tax credits and other tax benefits, offset by $406 thousand of amortization expense of low-income housing tax credit investment, as a component of income tax expense. As of September 30, 2021, our unfunded commitments for these low-income housing tax credit funds totaled $425 thousand. We did not recognize any impairment losses on these low-income housing tax credit investments during the first nine months of 2021 or 2020, as the value of the future tax benefits exceeds the carrying value of the investments.


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Note 5:  Loans and Allowance for Credit Losses on Loans

Under the accounting relief provisions of the Coronavirus Aid, Relief and Economic Security ("CARES") Act passed in March 2020, we postponed the adoption of the CECL standard from January 1, 2020 to December 31, 2020. Upon adoption we used a modified retrospective method effective October 1, 2020 (the beginning of the first reporting period in which the standard was effective due to the postponement of CECL) through a cumulative adjustment to retained earnings. The cumulative adjustment to retained earnings was recorded, net of taxes, based on economic forecasts and other assumptions as of December 31, 2019. Results for reporting periods beginning after September 30, 2020 have been presented under the new standard while prior period amounts continue to be reported in accordance with previously applicable GAAP. Certain prior period credit quality disclosures related to impaired loans and individually and collectively evaluated loans were superseded with the CECL accounting standards and have not been included below. Refer to Notes 1 and 3 under Part II, Item 8, of our 2020 Form 10-K for additional information regarding the adoption of CECL. In addition, refer to Note 5 under Part I, Item 1, of our September 30, 2020 Form 10-Q for prior period information.

The following table presents the amortized cost of loans by class as of September 30, 2021 and December 31, 2020.
(in thousands)September 30, 2021December 31, 2020
Commercial and industrial$377,965 $498,408 
Real estate:
  Commercial owner-occupied398,543 304,963 
  Commercial investor-owned1,157,344 961,208 
  Construction125,060 73,046 
  Home equity92,396 104,813 
  Other residential117,778 123,395 
Installment and other consumer loans47,933 22,723 
Total loans, at amortized cost 1
2,317,019 2,088,556 
Allowance for credit losses on loans(22,414)(22,874)
Total loans, net$2,294,605 $2,065,682 
1 Amortized cost includes net deferred loan origination fees of $(2.9) million and $(4.9) million at September 30, 2021 and December 31, 2020, respectively. Amounts are also net of unrecognized purchase discounts of $2,834 thousand and $815 thousand at September 30, 2021 and December 31, 2020, respectively. Amortized cost excludes accrued interest, which totaled $7.7 million and $8.8 million at September 30, 2021 and December 31, 2020, respectively, and is included in interest receivable and other assets in the consolidated statements of condition.

Lending Risks

Commercial and Industrial Loans - Commercial loans are generally made to established small and mid-sized businesses to provide financing for their growth and working capital needs, equipment purchases and acquisitions.  Management examines historical, current, and projected cash flows to determine the ability of the borrower to repay obligations as agreed. Commercial loans are made based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral and guarantor support. The cash flows of borrowers, however, may not occur as expected, and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed, such as accounts receivable and inventory, and typically include personal guarantees. We target stable businesses with guarantors who provide additional sources of repayment and have proven to be resilient in periods of economic stress.  A weakened economy, and resultant decreased consumer and/or business spending, may have an effect on the credit quality of commercial loans.
 
In April 2020, the Bank began participating in the Small Business Administration's ("SBA") Paycheck Protection Program ("PPP"). As of September 30, 2021, there were 871 PPP loans outstanding, including 31 loans totaling $9.6 million that ARB financed prior to the merger date. PPP loans totaling $164.8 million (net of $4.2 million in unrecognized fees and costs) and $291.6 million (net of $5.4 million in unrecognized fees and costs) as of September 30, 2021 and December 31, 2020, respectively, were included in commercial and industrial loan balances. Of the 871 PPP loans outstanding as of September 30, 2021, 790 loans totaling $123.9 million were funded by Bank of Marin and ARB during the first half of 2021 under the second round of the PPP stimulus plan. PPP loans have terms of two to five years and earn interest at 1%. In addition, the SBA paid the Bank a fee of 1%-5% depending on the loan amount, which was netted with loan origination costs and accreted/amortized into interest income using the effective yield method over the contractual life of each loan. The recognition of fees and
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costs is accelerated when the SBA forgives the loan and/or the loan is paid off prior to maturity. PPP loans are fully guaranteed by the SBA and have virtually no risk of loss. We expect the vast majority of the PPP loans to be fully forgiven by the SBA.

Commercial Real Estate Loans - Commercial real estate loans, which include income producing investment properties and owner-occupied real estate used for business purposes, are subject to underwriting standards and processes similar to commercial loans discussed above. We underwrite these loans to be repaid from cash flow from either the business or investment property and supported by real property collateral. Underwriting standards for commercial real estate loans include, but are not limited to, debt coverage and loan-to-value ratios. Furthermore, a large majority of our loans are guaranteed by the owners of the properties. Conditions in the real estate markets or downturn in the general economy may adversely affect our commercial real estate loans. In the event of a vacancy, we expect guarantors to carry the loans until they find a replacement tenant.  The owner's substantial equity investment provides a strong economic incentive to continue to support the commercial real estate projects. As such, we have generally experienced a relatively low level of loss and delinquencies in this portfolio.

Construction Loans - Construction loans are generally made to developers and builders to finance construction, renovation and occasionally land acquisitions in anticipation of near-term development. Construction loans include interest reserves that are used for the payment of interest during the development and marketing periods and are capitalized as part of the loan balance. When a construction loan is placed on nonaccrual status before the depletion of the interest reserve, we apply the interest funded by the interest reserve against the loan's principal balance. These loans are underwritten after evaluation of the borrower's financial strength, reputation, prior track record, and independent appraisals. We monitor all construction projects to determine whether they are on schedule, completed as planned and in accordance with the approved construction budgets. Significant events can affect the construction industry, including: the inherent volatility of real estate markets and vulnerability to delays due to weather, change orders, inability to obtain construction permits, labor or material shortages, and price changes. Estimates of construction costs and value associated with the completed project may be inaccurate. Repayment of construction loans is largely dependent on the ultimate success of the project.

Consumer Loans - Consumer loans primarily consist of home equity lines of credit, other residential loans, floating homes, and indirect auto loans, along with a small number of installment loans. Our other residential loans include tenancy-in-common fractional interest loans ("TIC") located almost entirely in San Francisco County. We originate consumer loans utilizing credit score information, debt-to-income ratio and loan-to-value ratio analysis. Diversification among consumer loan types, coupled with relatively small loan amounts that are spread across many individual borrowers, mitigates risk. We do not originate sub-prime residential mortgage loans, nor is it our practice to underwrite loans commonly referred to as "Alt-A mortgages," the characteristics of which are reduced documentation, borrowers with low FICO scores or collateral with high loan-to-value ratios.

Credit Quality Indicators
 
We use a risk rating system to evaluate asset quality, and to identify and monitor credit risk in individual loans, and in the loan portfolio. Our definitions of “Special Mention” risk graded loans, or worse, are consistent with those used by the Federal Deposit Insurance Corporation ("FDIC").  Our internally assigned grades are as follows:
 
Pass and Watch - Loans to borrowers of acceptable or better credit quality. Borrowers in this category demonstrate fundamentally sound financial positions, repayment capacity, credit history and management expertise.  Loans in this category must have an identifiable and stable source of repayment and meet the Bank’s policy regarding debt-service-coverage ratios.  These borrowers are capable of sustaining normal economic, market or operational setbacks without significant financial consequences.  Negative external industry factors are generally not present.  The loan may be secured, unsecured or supported by non-real estate collateral for which the value is more difficult to determine and/or marketability is more uncertain. This category also includes “Watch” loans, where the primary source of repayment has been delayed. “Watch” is intended to be a transitional grade, with either an upgrade or downgrade within a reasonable period.
 
Special Mention - Potential weaknesses that deserve close attention. If left uncorrected, those potential weaknesses may result in deterioration of the payment prospects for the asset. Special Mention assets do not present sufficient risk to warrant adverse classification.
 
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Substandard - Inadequately protected by either the current sound worth and paying capacity of the obligor or the collateral pledged, if any. A Substandard asset has a well-defined weakness or weaknesses that jeopardize(s) the liquidation of the debt. Substandard assets are characterized by the distinct possibility that we will sustain some loss if such weaknesses or deficiencies are not corrected. Well-defined weaknesses include adverse trends or developments of the borrower’s financial condition, managerial weaknesses and/or significant collateral deficiencies.
 
Doubtful - Critical weaknesses that make collection or liquidation in full improbable. There may be specific pending events that work to strengthen the asset; however, the amount or timing of the loss may not be determinable. Pending events generally occur within one year of the asset being classified as Doubtful. Examples include: merger, acquisition, or liquidation; capital injection; guarantee; perfecting liens on additional collateral; and refinancing. Such loans are placed on non-accrual status and usually are collateral-dependent.

We regularly review our credits for accuracy of risk grades whenever we receive new information. Borrowers are generally required to submit financial information at regular intervals. Typically, commercial borrowers with lines of credit are required to submit financial information with reporting intervals ranging from monthly to annually depending on credit size, risk and complexity. In addition, investor commercial real estate borrowers with loans exceeding a certain dollar threshold are usually required to submit rent rolls or property income statements annually. We monitor construction loans monthly. We review home equity and other consumer loans based on delinquency. We also review loans graded “Watch” or worse, regardless of loan type, no less than quarterly.

The following tables present the loan portfolio by loan class, origination year and internal risk rating as of September 30, 2021 and December 31, 2020. Generally, existing term loans that were re-underwritten are reflected in the table in the year of renewal. Lines of credit that have a conversion feature at the time of origination, such as construction to perm loans, are presented by year of origination.
(in thousands)Term Loans - Amortized Cost by Origination YearRevolving Loans Amortized Cost
September 30, 202120212020201920182017PriorTotal
Commercial and industrial:
Pass$130,037 $54,621 $28,941 $18,245 $3,044 $33,707 $101,044 $369,639 
Special Mention— 1,787 613 346 — 2 4,037 6,785 
Substandard— — — — — — 1,541 1,541 
Total commercial and industrial$130,037 $56,408 $29,554 $18,591 $3,044 $33,709 $106,622 $377,965 
Commercial real estate, owner-occupied:
Pass$40,399 $43,782 $50,976 $53,139 $42,410 $109,020 $— $339,726 
Special Mention— — — 7,889 16,418 20,110 — 44,417 
Substandard— 7,155 289 — — 6,838 — 14,282 
Doubtful— 118 — — — — — 118 
Total commercial real estate, owner-occupied$40,399 $51,055 $51,265 $61,028 $58,828 $135,968 $— $398,543 
Commercial real estate, investor-owned:
Pass$153,943 $188,064 $188,508 $135,653 $83,895 $352,715 $90 $1,102,868 
Special Mention— 1,210 2,715 19,345 1,796 27,167 — 52,233 
Substandard— — — 709 — 1,534 — 2,243 
Total commercial real estate, investor-owned$153,943 $189,274 $191,223 $155,707 $85,691 $381,416 $90 $1,157,344 
Construction:
Pass$26,902 $63,355 $25,696 $9,107 $— $— $— $125,060 
Total construction$26,902 $63,355 $25,696 $9,107 $— $— $— $125,060 
Home equity:
Pass$— $— $— $— $— $259 $91,333 $91,592 
Substandard— — — — — 384 420 804 
Total home equity$— $— $— $— $— $643 $91,753 $92,396 
Other residential:
Pass$14,229 $32,700 $26,347 $17,476 $8,374 $18,652 $— $117,778 
Total other residential$14,229 $32,700 $26,347 $17,476 $8,374 $18,652 $— $117,778 
Installment and other consumer:
Pass$12,311 $8,514 $11,620 $5,777 $1,129 $6,833 $1,749 $47,933 
Total installment and other consumer$12,311 $8,514 $11,620 $5,777 $1,129 $6,833 $1,749 $47,933 
Total loans:
Pass$377,821 $391,036 $332,088 $239,397 $138,852 $521,186 $194,216 $2,194,596 
Total Special Mention$— $2,997 $3,328 $27,580 $18,214 $47,279 $4,037 $103,435 
Total Substandard$— $7,155 $289 $709 $— $8,756 $1,961 $18,870 
Total Doubtful$— $118 $— $— $— $— $— $118 
Totals$377,821 $401,306 $335,705 $267,686 $157,066 $577,221 $200,214 $2,317,019 
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(in thousands)Term Loans - Amortized Cost by Origination YearRevolving Loans Amortized Cost
December 31, 202020202019201820172016PriorTotal
Commercial and industrial:
Pass$308,237 $22,589 $12,596 $4,508 $5,915 $34,282 $85,889 $474,016 
Special Mention— 2,034 1,318 141 11 49 19,092 22,645 
Substandard1,747 — — — — — — 1,747 
Total commercial and industrial$309,984 $24,623 $13,914 $4,649 $5,926 $34,331 $104,981 $498,408 
Commercial real estate, owner-occupied:
Pass$31,029 $27,581 $32,603 $43,843 $12,768 $101,014 $— $248,838 
Special Mention— — 11,764 17,062 7,343 6,601 — 42,770 
Substandard7,147 — — — 6,208 — — 13,355 
Total commercial real estate, owner-occupied$38,176 $27,581 $44,367 $60,905 $26,319 $107,615 $— $304,963 
Commercial real estate, investor-owned:
Pass$162,300 $144,751 $173,955 $100,842 $94,862 $253,611 $117 $930,438 
Special Mention— 10,695 — 1,819 — 8,124 — 20,638 
Substandard— 2,716 4,435 — 1,553 1,428 — 10,132 
Total commercial real estate, investor-owned$162,300 $158,162 $178,390 $102,661 $96,415 $263,163 $117 $961,208 
Construction:
Pass$31,654 $30,150 $11,242 $— $— $— $— $73,046 
Total construction$31,654 $30,150 $11,242 $— $— $— $— $73,046 
Home equity:
Pass$— $— $— $— $128 $694 $102,614 $103,436 
Special Mention— — — — — — 799 799 
Substandard— — — — — 391 187 578 
Total home equity$— $— $— $— $128 $1,085 $103,600 $104,813 
Other residential:
Pass$34,447 $31,079 $23,673 $10,574 $6,035 $17,587 $— $123,395 
Total other residential$34,447 $31,079 $23,673 $10,574 $6,035 $17,587 $— $123,395 
Installment and other consumer:
Pass$2,361 $4,382 $3,483 $1,543 $3,423 $4,921 $2,593 $22,706 
Substandard— — — 17 — — — 17 
Total installment and other consumer$2,361 $4,382 $3,483 $1,560 $3,423 $4,921 $2,593 $22,723 
Total loans:
Pass$570,028 $260,532 $257,552 $161,310 $123,131 $412,109 $191,213 $1,975,875 
Total Special Mention$— $12,729 $13,082 $19,022 $7,354 $14,774 $19,891 $86,852 
Total Substandard$8,894 $2,716 $4,435 $17 $7,761 $1,819 $187 $25,829 
Totals$578,922 $275,977 $275,069 $180,349 $138,246 $428,702 $211,291 $2,088,556 

The following table shows the amortized cost of loans by class, payment aging and non-accrual status as of September 30, 2021 and December 31, 2020.
Loan Aging Analysis by Class
(in thousands)Commercial and industrialCommercial real estate, owner-occupiedCommercial real estate, investor-ownedConstructionHome equityOther residentialInstallment and other consumerTotal
September 30, 2021        
 30-59 days past due$181 $— $— $— $143 $— $73 $397 
 60-89 days past due924 — — — 121 — 1 1,046 
 90 days or more past due— — — — — — — 
Total past due1,105 — — — 264 — 74 1,443 
Current376,860 398,543 1,157,344 125,060 92,132 117,778 47,859 2,315,576 
Total loans 1
$377,965 $398,543 $1,157,344 $125,060 $92,396 $117,778 $47,933 $2,317,019 
Non-accrual loans 2
$— $7,273 $709 $— $441 $— $— $8,423 
Non-accrual loans with no allowance$— $7,273 $709 $— $441 $— $— $8,423 
December 31, 2020        
 30-59 days past due$— $— $1,673 $— $274 $— $136 $2,083 
 60-89 days past due— — — — — — 622 622 
 90 days or more past due— — — — — — — — 
Total past due— — 1,673 — 274 — 758 2,705 
Current498,408 304,963 959,535 73,046 104,539 123,395 21,965 2,085,851 
Total loans 1
$498,408 $304,963 $961,208 $73,046 $104,813 $123,395 $22,723 $2,088,556 
Non-accrual loans 2
$— $7,147 $1,610 $— $459 $— $17 $9,233 
Non-accrual loans with no allowance$— $7,147 $1,610 $— $459 $— $17 $9,233 
1 There were no loans past due more than ninety days accruing interest at September 30, 2021 or December 31, 2020.
2 None of the non-accrual loans as of September 30, 2021 or December 31, 2020 were earning interest on a cash basis. We recognized no interest income on non-accrual loans for the three and nine months ended September 30, 2021 and 2020. Other than a $118 thousand owner-occupied commercial real estate loan assumed in the ARB acquisition, there were no new loans placed on non-accrual status during the nine months ended September 30, 2021. Accrued interest of $20 thousand was reversed from interest income for loans that were placed on non-accrual status during the nine months ended September 30, 2020.
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Collateral Dependent Loans

The following table presents the amortized cost basis of individually analyzed collateral-dependent non-accrual loans by class at September 30, 2021 and December 31, 2020.
Amortized Cost by Collateral Type
(in thousands)Commercial Real EstateResidential Real EstateOtherTotalAllowance for Credit Losses
September 30, 2021
Commercial real estate, owner-occupied$7,273 $— $— $7,273 $— 
Commercial real estate, investor-owned709 — — 709 — 
Home equity— 441 — 441 — 
Total$7,982 $441 $— $8,423 $— 
December 31, 2020
Commercial real estate, owner-occupied$7,147 $— $— $7,147 $— 
Commercial real estate, investor-owned1,610 — — 1,610 — 
Home equity— 459 — 459 — 
Installment and other consumer— — 17 17 — 
Total$8,757 $459 $17 $9,233 $— 

No collateral-dependent loans were in process of foreclosure at September 30, 2021 or December 31, 2020. In addition, the weighted average loan-to-value of collateral dependent loans was approximately 61.7% at September 30, 2021 and 59.2% at December 31, 2020.

Troubled Debt Restructuring
 
Our loan portfolio includes certain loans modified in a troubled debt restructuring (“TDR”), where we have granted economic concessions to borrowers experiencing financial difficulties. These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. TDRs on non-accrual status at the time of restructure may be returned to accruing status after management considers the borrower’s sustained repayment performance for a reasonable period, generally nine months, and obtains reasonable assurance of repayment and performance.
 
We may remove a loan from TDR designation if it meets all of the following conditions:
•The loan is subsequently refinanced or restructured at current market interest rates and the new terms are consistent with the treatment of creditworthy borrowers under regular underwriting standards;
•The borrower is no longer considered to be in financial difficulty;
•Performance on the loan is reasonably assured; and
•Existing loan did not have any forgiveness of principal or interest.

We removed one commercial loan with a remaining amortized cost of $2 thousand and an unfunded commitment of $600 thousand from TDR designation during the nine months ended September 30, 2021 after meeting all of the conditions above. There were no loans removed from TDR designation during the nine months ended September 30, 2020.

In accordance with section 4013 of the CARES Act, subsequently amended by section 541 of the Economic Aid Act, we elected to apply the temporary accounting relief provisions for loan modifications that met certain criteria, which would otherwise be designated TDRs under existing GAAP. As of September 30, 2021, 2 borrowing relationships with 5 loans totaling $23.6 million were continuing to benefit from payment relief. The weighted average loan-to-value ratio of the remaining payment relief loans was approximately 33%. We accrue and recognize interest income on loans under payment relief based on the original contractual interest rates. When payments resume at the end of the relief period, the payments will generally be applied to accrued interest due until accrued interest is fully paid.


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The following table summarizes the carrying amount of TDR loans by loan class as of September 30, 2021 and December 31, 2020.
(in thousands)
Recorded Investment in Troubled Debt Restructurings 1
September 30, 2021December 31, 2020
Commercial and industrial$1,394 $1,021 
Commercial real estate, owner-occupied7,155 7,147 
Commercial real estate, investor-owned1,718 3,305 
Home equity273 281 
Installment and other consumer706 752 
Total$11,246 $12,506 
1TDR loans on non-accrual status totaled $7.4 million at both September 30, 2021 and December 31, 2020. Unfunded commitments for TDR loans totaled $242 thousand as of September 30, 2021.

The following table presents information for loans modified in a TDR during the presented periods, including the number of modified contracts, the recorded investment in the loans prior to modification, and the recorded investment in the loans at period end after being restructured. The table excludes fully charged-off TDR loans and loans modified in a TDR and subsequently paid-off during the years presented, if applicable.
(dollars in thousands)Number of Contracts ModifiedPre-Modification Outstanding Recorded InvestmentPost-Modification Outstanding Recorded InvestmentPost-Modification Outstanding Recorded Investment at Period End
TDRs during the three months ended September 30, 2021:   
Commercial and industrial1$1,101 $1,101 $1,101 
TDRs during the three months ended September 30, 2020:   
Commercial real estate, investor-owned1$1,553 $1,553 $1,553 
TDRs during the nine months ended September 30, 2021:  
Commercial and industrial1 $1,101 $1,101 $1,101 
TDRs during the nine months ended September 30, 2020:   
Commercial and industrial1 $170 $162 $144 
Commercial real estate, investor-owned1 1,553 1,553 1,553 
Home equity1 276 276 276 
Installment and other consumer3 211 211 210 
Total6 $2,210 $2,202 $2,183 

The loan modified in 2021 reflected a maturity date extension and other loan term and payment modifications. The loans modified in 2020 reflected debt consolidation, interest rate concessions, and/or other loan term and payment modifications. During the nine months ended September 30, 2021 and 2020, there were no defaults on loans that had been modified in a TDR within the prior twelve-month period. We report defaulted TDRs based on a payment default definition of more than ninety days past due.

Purchased Loans with Credit Deterioration

For purchased loans with a more-than-insignificant amount of credit deterioration since origination ("PCD loans") the initial allowance for credit losses at the date of acquisition was added to the purchase price (or fair value) to determine the initial amortized cost basis. Subsequent changes in expected credit losses (favorable or unfavorable) are recognized through net income as adjustments to the allowance for credit losses on loans. Refer to Notes 1 and 3 under Part II, Item 8, of our 2020 Form 10-K for additional information regarding the accounting for PCD and non-PCD loans.


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A reconciliation of the unpaid principal balance (or par value) to the purchase price (or fair value) for PCD loans as of the August 6, 2021 merger date is presented below.
(in thousands)
Unpaid principal balance (par value)$92,029 
Non-credit discount(1,662)
Amortized cost basis90,367 
Initial allowance for credit losses on PCD loans(1,505)
Purchase price (PCD loans at fair value)$88,862 

Allowance for Credit Losses on Loans Rollforward

The following table discloses activity in the allowance for credit losses on loans for the periods presented.
Allowance for Credit Losses on Loans Rollforward
(in thousands)Commercial and industrialCommercial real estate, owner-occupiedCommercial real estate, investor-ownedConstructionHome equityOther residentialInstallment and other consumerUnallocatedTotal
Three months ended September 30, 2021
Beginning balance$1,590 $2,037 $10,761 $1,142 $412 $613 $238 $2,307 $19,100 
Provision (reversal) - CECL126 (30)1,011 77 247 4 384 (19)1,800 
Initial allowance for PCD loans405 559 533 — — 6 2 — 1,505 
Charge-offs— — — — — — (2)— (2)
Recoveries3 — — 8 — — — — 11 
Ending balance$2,124 $2,566 $12,305 $1,227 $659 $623 $622 $2,288 $22,414 
Three months ended September 30, 2020
Beginning balance$2,609 $2,910 $10,403 $836 $1,044 $1,266 $426 $1,374 $20,868 
Provision - incurred loss(79)225 1,221 24 (6)(6)(20)(109)1,250 
Charge-offs(10)— — — — — — — (10)
Recoveries5 — — — — — — — 5 
Ending balance$2,525 $3,135 $11,624 $860 $1,038 $1,260 $406 $1,265 $22,113 
Allowance for Credit Losses on Loans Rollforward
(in thousands)Commercial and industrialCommercial real estate, owner-occupiedCommercial real estate, investorConstructionHome equityOther residentialInstallment and other consumerUnallocatedTotal
Nine months ended September 30, 2021
Beginning balance$2,530 $2,778 $12,682 $1,557 $738 $998 $291 $1,300 $22,874 
Provision (reversal) - CECL(821)(771)(910)(356)(129)(381)331 988 (2,049)
Initial allowance for PCD loans405 559 533 — — 6 2 — 1,505 
Charge-offs— — — — — — (2)— (2)
Recoveries10 — — 26 50 — — — 86 
Ending balance$2,124 $2,566 $12,305 $1,227 $659 $623 $622 $2,288 $22,414 
Nine months ended September 30, 2020
Beginning balance$2,334 $2,462 $8,483 $638 $850 $973 $284 $653 $16,677 
Provision - incurred loss208 673 3,141 219 188 287 122 612 5,450 
Charge-offs(30)— — — — — — — (30)
Recoveries13 — — 3 — — — — 16 
Ending balance$2,525 $3,135 $11,624 $860 $1,038 $1,260 $406 $1,265 $22,113 

We adopted the CECL accounting standard on December 31, 2020, which we had previously postponed under the optional accounting relief provisions of the CARES Act passed in March 2020 to the earlier of the end of the national emergency or December 31, 2020. During the first nine months of 2020, we applied the incurred loss method under previous GAAP in determining the allowance for credit losses on loans.

Pledged Loans

Our FHLB line of credit is secured under terms of a blanket collateral agreement by a pledge of certain qualifying loans with unpaid principal balances of $1.091 billion and $1.165 billion at September 30, 2021 and December 31,
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2020, respectively. In addition, we pledge eligible TIC loans, which totaled $109.2 million and $113.6 million at September 30, 2021 and December 31, 2020, respectively, to secure our borrowing capacity with the Federal Reserve Bank ("FRB"). Also, see Note 6, Borrowings.

Related Party Loans
 
The Bank has, and expects to have in the future, banking transactions in the ordinary course of its business with directors, officers, principal shareholders and their businesses or associates. These loans are granted on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with persons not related to us. Likewise, these transactions do not involve more than the normal risk of collectability or present other unfavorable features. Related party loans totaled $8.6 million at September 30, 2021 and $6.4 million at December 31, 2020. In addition, undisbursed commitments to related parties totaled $8.6 million at September 30, 2021 and $9.1 million at December 31, 2020.

Note 6: Borrowings and Other Obligations
 
Federal Funds Purchased – The Bank had unsecured available lines of credit with correspondent banks for overnight borrowings totaling $115.0 million at September 30, 2021 and $135.0 million at December 31, 2020.  In general, interest rates on these lines approximate the federal funds target rate. We had no overnight borrowings under these credit facilities at September 30, 2021 or December 31, 2020.
 
Federal Home Loan Bank Borrowings – As of September 30, 2021 and December 31, 2020, the Bank had available lines of credit with the FHLB totaling $651.4 million and $642.5 million, respectively, based on eligible collateral of certain loans. There were no FHLB overnight borrowings at September 30, 2021 or December 31, 2020. As part of our acquisition of ARB, we assumed FHLB advances in the amount of $13.8 million that we paid off on August 25, 2021.

Federal Reserve Line of Credit – The Bank has an available line of credit with the FRBSF secured by certain residential loans.  At September 30, 2021 and December 31, 2020, the Bank had borrowing capacity under this line totaling $72.7 million and $78.7 million, respectively, and had no outstanding borrowings with the FRBSF.

Subordinated Debenture – As part of an acquisition in 2013, Bancorp assumed a subordinated debenture with a contractual balance of $4.1 million due to NorCal Community Bancorp Trust II (the "Trust"), established for the sole purpose of issuing trust preferred securities. On March 15, 2021, Bancorp redeemed in full the $2.8 million (book value) subordinated debenture due to the Trust, which had an effective interest rate of 6.0% for the first nine months of 2020. The 251.5% effective rate for the first nine months of 2021 included accelerated accretion of the $1.3 million remaining purchase discount due to the early redemption. Accretion was $17 thousand and $52 thousand for the three and nine months ended September 30, 2020, respectively.

Other Obligations – Finance lease liabilities totaling $451 thousand and $58 thousand at September 30, 2021 and December 31, 2020, respectively, are included in borrowings and other obligations in the consolidated statements of condition. See Note 8, Commitments and Contingencies, for additional information.

Note 7:  Stockholders' Equity
 
Dividends

On October 22, 2021, Bancorp declared a $0.24 per share cash dividend, payable on November 12, 2021 to shareholders of record at the close of business on November 5, 2021.

Share-Based Payments
 
The fair value of stock options as of the grant date is recorded as stock-based compensation expense in the consolidated statements of comprehensive income over the requisite service period, which is generally the vesting period, with a corresponding increase in common stock. Stock-based compensation also includes compensation expense related to the issuance of restricted stock awards. The grant-date fair value of the restricted stock awards, which equals the grant date price, is recorded as compensation expense over the requisite service period with a corresponding increase in common stock as the shares vest. Beginning in 2018, stock option and restricted stock awards issued include a retirement eligibility clause whereby the requisite service period is satisfied at the
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retirement eligibility date. For those awards, we accelerate the recording of stock-based compensation when the award holder is eligible to retire. However, retirement eligibility does not affect the vesting of restricted stock or the exercisability of the stock options, which are based on the scheduled vesting period.

Performance-based stock awards (restricted stock) are issued to a selected group of employees. Stock award vesting is contingent upon the achievement of pre-established long-term performance goals set by the Compensation Committee of the Board of Directors. Performance is measured over a three-year period and cliff vested. These performance-based stock awards were granted at a maximum opportunity level, and based on the achievement of the pre-established goals, the actual payouts can range from 0% to 200% of the target award. For performance-based stock awards, an estimate is made of the number of shares expected to vest based on the probability that the performance criteria will be achieved to determine the amount of compensation expense to be recognized. The estimate is re-evaluated quarterly and total compensation expense is adjusted for any change in the current period.

We record excess tax benefits (deficiencies) resulting from the exercise of non-qualified stock options, the disqualifying disposition of incentive stock options and vesting of restricted stock awards as income tax benefits (expense) in the consolidated statements of comprehensive income with a corresponding decrease (increase) to current taxes payable.
 
The holders of unvested restricted stock awards are entitled to dividends on the same per-share ratio as holders of common stock. Tax benefits for dividends paid on unvested restricted stock awards are recorded as tax benefits in the consolidated statements of comprehensive income with a corresponding decrease to current taxes payable. Dividends on forfeited awards are included in stock-based compensation expense.

Stock options and restricted stock may be net settled in a cashless exercise by a reduction in the number of shares otherwise deliverable upon exercise or vesting in satisfaction of the exercise payment and/or applicable tax withholding requirements. During the nine months ended September 30, 2021, we withheld 27,679 shares totaling $1.1 million at a weighted-average price of $38.86 for cashless exercises. During the nine months ended September 30, 2020, we withheld 9,214 shares totaling $369 thousand at a weighted-average price of $40.01 for cashless exercises. Shares withheld under net settlement arrangements are available for future grants.

Share Repurchase Program

On April 23, 2018, Bancorp announced that its Board of Directors approved a share repurchase program under which Bancorp may repurchase up to $25.0 million of its outstanding common stock through May 1, 2019. Bancorp's Board of Directors subsequently extended the share repurchase program through February 28, 2020. After expiration of this share repurchase program, a new share repurchase program began on March 5, 2020. This new program was approved on January 24, 2020 by Bancorp Board of Directors, allowing Bancorp to repurchase up to $25.0 million of its outstanding common stock through February 28, 2022. The share repurchase program, which began on March 5, 2020, was suspended by the Board of Directors on March 20, 2020 in response to the COVID-19 pandemic. The program was reactivated by the Board of Directors on October 23, 2020 and completed in May 2021 upon depletion of repurchase funds. A new share repurchase program was approved by Bancorp Board of Directors on July 16, 2021 under which Bancorp may repurchase up to $25.0 million of its outstanding common stock through July 31, 2023. On October 22, 2021, Bancorp's Board of Directors approved an amendment to the current share repurchase program, which increased the total authorization from $25.0 million to $57.0 million and left the expiration date unchanged.
Under the share repurchase program, Bancorp may purchase shares of its common stock through various means such as open market transactions, including block purchases, and privately negotiated transactions. The number of shares repurchased and the timing, manner, price and amount of any repurchases will be determined at Bancorp's discretion. Factors include, but are not limited to, stock price, trading volume and general market conditions, along with Bancorp’s general business conditions. The program may be suspended or discontinued at any time and does not obligate Bancorp to acquire any specific number of shares of its common stock.

As part of the share repurchase program, Bancorp entered into a trading plan adopted in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The 10b5-1 trading plan permits common stock to be repurchased at times that might otherwise be prohibited under insider trading laws or self-imposed trading restrictions. The 10b5-1 trading plan is administered by an independent broker and is subject to price, market volume and timing restrictions.
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Bancorp repurchased 445,735 shares totaling $15.9 million in the third quarter of 2021 for a cumulative total of 967,683 shares and $35.2 million in the first nine months of 2021.


Note 8:  Commitments and Contingencies
 
Financial Instruments with Off-Balance Sheet Risk
 
We make commitments to extend credit in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because various commitments will expire without being fully drawn, the total commitment amount does not necessarily represent future cash requirements.
 
Our credit loss exposure is equal to the contractual amount of the commitment in the event of nonperformance by the borrower. We use the same credit underwriting criteria for all credit exposure. The amount of collateral obtained, if deemed necessary by us, is based on management's credit evaluation of the borrower. Collateral types pledged may include accounts receivable, inventory, other personal property and real property.
 
The contractual amount of unfunded loan commitments and standby letters of credit not reflected in the consolidated statements of condition are as follows:
(in thousands)September 30, 2021December 31, 2020
Commercial lines of credit$300,308 $297,898 
Revolving home equity lines204,846 191,969 
Undisbursed construction loans82,782 101,307 
Personal and other lines of credit10,981 10,611 
Standby letters of credit3,658 2,657 
   Total commitments and standby letters of credit$602,575 $604,442 

We record an allowance for credit losses on unfunded loan commitments at the balance sheet date based on estimates of the probability that these commitments will be drawn upon according to historical utilization experience of the different types of commitments and expected loss rates determined for pooled funded loans. The allowance for credit losses on unfunded commitments totaled $1.6 million and $2.8 million as of September 30, 2021 and December 31, 2020, respectively, which is included in interest payable and other liabilities in the consolidated statements of condition. We adopted the CECL accounting standard on December 31, 2020. We applied the incurred loss method under previous GAAP in determining the allowance for credit losses on unfunded commitments for the three and nine month periods ended September 30, 2020. We recorded no provision for credit losses on unfunded commitments for the three months ended September 30, 2021 and a reversal of the allowance for credit losses on unfunded commitments totaling $1.2 million for the nine month period ended September 30, 2021. This compares to provisions for credit losses on unfunded commitments for the three and nine month periods ended September 30, 2020 totaling $248 thousand and $610 thousand, respectively. In the second quarter of 2021, we reclassified the provision for credit losses on unfunded commitments from non-interest expense to a separate line item under the provision for credit losses on loans in the consolidated statements of comprehensive income.

Leases

We lease premises under long-term non-cancelable operating leases with remaining terms of 1 year to 11 years, most of which include escalation clauses and one or more options to extend the lease term, and some of which contain lease termination clauses. Lease terms may include certain renewal options that were considered reasonably certain to be exercised.

We lease certain equipment under finance leases with initial terms of 3 years to 4 years. The equipment finance leases do not contain renewal options, bargain purchase options or residual value guarantees.

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The following table shows the balances of operating and finance lease right-of-use assets and lease liabilities.
(in thousands)September 30, 2021December 31, 2020
Operating leases:
Operating lease right-of-use assets$24,776 $3,831 
Operating lease liabilities$26,637 $27,062 
Finance leases:
Finance lease right-of-use assets$499 $365 
Accumulated amortization(62)(307)
Finance lease right-of-use assets, net1
$437 $58 
Finance lease liabilities2
$451 $58 
1 Included in premises and equipment in the consolidated statements of condition.
2 Included in borrowings and other obligations in the consolidated statements of condition.

The following table shows supplemental disclosures of noncash investing and financing activities for the period presented.
Nine months ended
(in thousands)September 30, 2021September 30, 2020
Right-of-use assets obtained in exchange for operating lease liabilities$2,376 $18,021 
Right-of-use assets obtained in exchange for finance lease liabilities$444 $18 

The following table shows components of operating and finance lease cost.
Three months endedNine months ended
(in thousands)September 30, 2021September 30, 2020September 30, 2021September 30, 2020
Operating lease cost$1,216 $1,165 $3,543 $3,334 
Variable lease cost— 1 — 4 
Total operating lease cost1
$1,216 $1,166 $3,543 $3,338 
Finance lease cost:
Amortization of right-of-use assets2
$31 $41 $65 $129 
Interest on finance lease liabilities3
1 1 1 $3 
Total finance lease cost32 42 $66 $132 
Total lease cost$1,248 $1,208 $3,609 $3,470 
1 Included in occupancy and equipment expense in the consolidated statements of comprehensive income.
2 Included in depreciation and amortization in the consolidated statements of comprehensive income.
3 Included in interest on borrowings and other obligations in the consolidated statements of comprehensive income.
The following table shows the future minimum lease payments, weighted average remaining lease terms, and weighted average discount rates under operating and finance lease arrangements as of September 30, 2021. The discount rates used to calculate the present value of lease liabilities were based on the collateralized FHLB borrowing rates that were commensurate with lease terms and minimum payments on the later of the date we adopted the new lease accounting standards or lease commencement date.
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(in thousands)September 30, 2021
YearOperating LeasesFinance Leases
2021$1,315 $32 
20225,203 127 
20234,377 117 
20243,667 114 
20253,152 66 
Thereafter10,684 — 
Total minimum lease payments28,398 456 
Amounts representing interest (present value discount)(1,761)(5)
Present value of net minimum lease payments (lease liability)$26,637 $451 
Weighted average remaining term (in years)7.13.7
Weighted average discount rate1.68 %0.64 %
Litigation Matters

Bancorp may be party to legal actions that arise from time to time in the normal course of business. Bancorp's management is not aware of any pending legal proceedings to which either it or the Bank may be a party or has recently been a party that will have a material adverse effect on the financial condition or results of operations of Bancorp or the Bank.

The Bank is responsible for a proportionate share of certain litigation indemnifications provided to Visa U.S.A. ("Visa") by its member banks in connection with Visa's lawsuits related to anti-trust charges and interchange fees ("Covered Litigation"). Our proportionate share of the litigation indemnification liability does not change or transfer upon the sale of our Class B Visa shares to member banks. Visa established an escrow account to pay for settlements or judgments in the Covered Litigation. Under the terms of the U.S. retrospective responsibility plan, when Visa funds the litigation escrow account, it triggers a conversion rate reduction of the Class B common stock to shares of Class A common stock, effectively reducing the aggregate value of the Class B common stock held by Visa's member banks like us.

In 2012, Visa had reached a $4.0 billion interchange multidistrict litigation class settlement agreement with plaintiffs representing a class of U.S. retailers. The escrow balance of $894 million as of June 30, 2021 (latest information available), combined with funds previously deposited with the court, are expected to cover the settlement payment obligations.

The outcome of the Covered Litigation affects the conversion rate of Visa Class B common stock held by us to Visa Class A common stock, as discussed above and in Note 4, Investment Securities. The final conversion rate is subject to change depending on the final settlement payments, and the full effect on member banks is still uncertain. Litigation is ongoing and until the court approval process is complete, there is no assurance that Visa will resolve the claims as contemplated by the amended class settlement agreement, and additional lawsuits may arise from individual merchants who opted out of the class settlement. However, until the escrow account is fully depleted and the conversion rate of Class B to Class A common stock is reduced to zero, no future cash settlement payments are required by the member banks, such as us, on the Covered Litigation. Therefore, we are not required to record any contingent liabilities for the indemnification related to the Covered Litigation, as we consider the probability of losses to be remote.

Note 9: Derivative Financial Instruments and Hedging Activities

We entered into interest rate swap agreements, primarily as an asset/liability management strategy, in order to mitigate the changes in the fair value of specified long-term fixed-rate loans (or firm commitments to enter into long-term fixed-rate loans) caused by changes in interest rates. These hedges allow us to offer long-term fixed-rate loans to customers without assuming the interest rate risk of a long-term asset. Converting our fixed-rate interest payments to floating-rate interest payments, generally benchmarked to the one-month U.S. dollar LIBOR index, protects us against changes in the fair value of our loans associated with fluctuating interest rates.

Our credit exposure, if any, on interest rate swap asset positions is limited to the fair value (net of any collateral pledged to us) and interest payments of all swaps by each counterparty. Conversely, when an interest rate swap is
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in a liability position exceeding a certain threshold, we may be required to post collateral to the counterparty in an amount determined by the agreements. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values.

As of September 30, 2021, we had four interest rate swap agreements, which are scheduled to mature in June 2031, October 2031, July 2032, and October 2037. All of our derivatives are accounted for as fair value hedges. The notional amounts of the interest rate contracts are equal to the notional amounts of the hedged loans. Our interest rate swap payments are settled monthly with counterparties. Accrued interest on the swaps totaled $10 thousand at September 30, 2021 and $11 thousand at December 31, 2020. Information on our derivatives follows:
Asset DerivativesLiability Derivatives
(in thousands)September 30,
2021		December 31, 2020September 30,
2021		December 31, 2020
Fair value hedges:
Interest rate contracts notional amount$— $— $13,280 $13,991 
Interest rate contracts fair value1
$— $— $1,266 $1,912 
1 See Note 3, Fair Value of Assets and Liabilities, for valuation methodology.

The following table presents the carrying amount and associated cumulative basis adjustment related to the application of fair value hedge accounting that is included in the carrying amount of hedged assets as of September 30, 2021 and December 31, 2020.
Carrying Amounts of Hedged AssetsCumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Loans
(in thousands)September 30, 2021December 31, 2020September 30, 2021December 31, 2020
Loans$14,401 $15,745 $1,122 $1,753 

The following table presents the net losses recognized in interest income on loans on the consolidated statements of comprehensive income related to our derivatives designated as fair value hedges.
Three months endedNine months ended
(in thousands)September 30, 2021September 30, 2020September 30, 2021September 30, 2020
Interest and fees on loans 1
$24,027 $21,776 $66,117 $63,880 
Increase (decrease) in fair value of designated interest rate swaps due to LIBOR interest rate movements$97 $152 $646 $(1,351)
Payment on interest rate swaps(93)(108)(278)(255)
Decrease (increase) in fair value hedging adjustment of hedged loans(94)(155)(631)1,374 
Decrease in value of yield maintenance agreement(3)(3)(9)(9)
Net losses on fair value hedging relationships recognized in interest income $(93)$(114)$(272)$(241)
1 Represents the income line item in the statement of comprehensive income in which the effects of fair value hedges are recorded.
Our derivative transactions with counterparties are under International Swaps and Derivative Association (“ISDA”) master agreements that include “right of set-off” provisions. “Right of set-off” provisions are legally enforceable rights to offset recognized amounts and there may be an intention to settle such amounts on a net basis. We do not offset such financial instruments for financial reporting purposes. Information on financial instruments that are eligible for offset in the consolidated statements of condition follows:
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Offsetting of Financial Liabilities and Derivative Liabilities
Gross AmountsNet Amounts ofGross Amounts Not Offset in
Gross AmountsOffset in theLiabilities Presentedthe Statements of Condition
of RecognizedStatements ofin the StatementsFinancialCash Collateral
(in thousands)
Liabilities1
Condition
of Condition1
InstrumentsPledgedNet Amount
September 30, 2021
Derivatives by Counterparty:
Counterparty A$1,266 $— $1,266 $— $(1,266)$— 
December 31, 2020
Derivatives by Counterparty:
Counterparty A$1,912 $— $1,912 $— $(1,912)$— 
1 Amounts exclude accrued interest on swaps.
For more information on how we account for our interest rate swaps, refer to Note 1 to the Consolidated Financial Statements included in our 2020 Form 10-K filed with the SEC on March 15, 2021.

Note 10: Merger

Bancorp completed its merger with American River Bankshares ("AMRB") on August 6, 2021 (the "merger date"), with Bancorp continuing as the surviving entity, followed thereafter at 12:05 a.m. on August 7, 2021 by the merger of American River Bank ("ARB") with and into Bank of Marin (collectively, the "Merger"), with Bank of Marin surviving.

On August 6, 2021, each share of AMRB's common stock issued and outstanding immediately prior to the Merger was converted into 0.575 shares of Bancorp's common stock resulting in the issuance of 3,441,235 shares of Bancorp common stock. In addition, merger consideration included cash paid for outstanding stock options and cash paid in lieu of fractional shares, as summarized in the following table.
(in thousands)Merger Consideration
Value of common stock consideration paid to shareholders (0.575 fixed exchange ratio, stock price $36.15)
$124,401 
Cash consideration for stock options63
Cash paid in lieu of fractional shares13
Total merger consideration$124,477 

Bancorp accounted for the Merger using the acquisition method of accounting in accordance with ASC 805, Business Combinations. We recorded the estimated fair values of acquired assets and liabilities based on initial valuations as of August 6, 2021. Under ASC 805, during the measurement period of up to one year, the acquirer is allowed to adjust the amounts recognized at the acquisition date and may recognize additional assets or liabilities to reflect new information obtained from facts and circumstances that existed as of the merger date that, if known, would have affected the measurement of the amounts recognized as of that date. Measurement period adjustments are recognized in the reporting period in which they are determined. As such, the estimated fair values are considered preliminary as of September 30, 2021 and subject to adjustment for up to one year after August 6, 2021. Fair value amounts subject to change include, but are not limited to, loans, certain deposits, deferred tax assets and liabilities and certain other assets and other liabilities.


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The following table presents the preliminary fair values of the assets acquired and liabilities assumed, and the resulting goodwill as of August 6, 2021.
(in thousands)
Total merger consideration$124,477 
Assets acquired:
Cash and cash equivalents140,577 
Investment securities297,797 
Loans419,435 
Bank-owned life insurance16,259 
Operating lease right-of-use assets2,376 
Bank premises and equipment, net2,891 
Core deposit intangible3,909 
Other real estate owned800 
Interest receivable and other assets14,377 
Total assets acquired898,421 
Liabilities assumed:
Deposits:
Non-interest bearing331,459 
Interest bearing458,563 
Total deposits790,022 
FHLB borrowings13,885 
Operating lease liabilities2,798 
Interest payable and other liabilities9,853 
Total liabilities assumed816,558 
Fair value of net assets acquired81,863 
Goodwill$42,614 

We recorded $42.6 million in goodwill, which represents the excess of the total merger consideration paid over the fair value of the assets acquired, net of the fair values of liabilities assumed. Goodwill mainly reflects expected value created through the combined operations of AMRB and Bancorp. It is evaluated for impairment annually.

The following are descriptions of the methods used to determine the fair values of significant assets and liabilities presented above.

Cash and cash equivalents - The carrying amount of cash and cash equivalents is a reasonable estimate of fair value based on the short-term nature of these assets.

Investment securities - Fair values for securities are based on quoted market prices, where available. If quoted market prices are not available, fair value estimates are based on observable inputs including quoted market prices for similar instruments, quoted market prices that are not in an active market or other inputs that are observable in the market. In the absence of observable inputs, fair value is estimated based on pricing models and/or discounted cash flow methodologies.

Loans - The loan valuation methodology was based on a discounted cash flow approach that considered factors including the type of loan, risk classification status, fixed or variable interest rates, term, amortization status and current discount rates. Loans were grouped according to similar credit risk characteristics when applying various valuation techniques. The discount rates applied were based on current market rates for new originations of comparable loans and included adjustments for interest rate risk, equity return, servicing, credit and liquidity risk. ARB's allowance for credit losses and any existing deferred fees or costs and premiums and discounts were not carried over at the merger date.

Bank-owned life insurance - The cash surrender values of bank-owned life insurance policies approximated fair value.

Operating lease right-of-use assets and lease liabilities - Operating lease right-of-use assets were measured at the present value of the remaining lease payments, as if the acquired leases commenced on the merger date, and
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adjusted to reflect favorable and unfavorable terms of the leases when compared to current market terms. Lease liabilities were measured at the present value of the remaining lease payments.

Bank premises and equipment - The value of the land and buildings acquired were based on independent third-party appraisals. The fair values of other premises and equipment, such as tenant improvements, furniture and fixtures and equipment, approximated their carrying values.

Core deposit Intangible - The core deposit intangible ("CDI") represents the estimated future benefits of acquired deposits and is recorded separately from the related deposits. The value of the core deposit intangible asset was calculated using a discounted cash flow approach to arrive at the cost differential between the core deposits (non-maturity deposits such as transaction, savings and money market accounts) and alternative funding sources. It was calculated as the present value of the difference in cash flows between maintaining the core deposits (interest and net maintenance costs) and the cost of an equal amount of funds with a similar term from an alternative source. The core deposit intangible is amortized on an accelerated basis over an estimated ten-year life, and is evaluated periodically for impairment.

We recorded a core deposit intangible asset of $3.9 million at acquisition, of which $129 thousand was amortized from the merger date to September 30, 2021. The future amortization expense for the CDI arising from the Merger is as follows:
(in thousands)20212022202320242025ThereafterTotal
Core deposit intangible amortization$189 $707 $630 $552 $475 $1,227 $3,780 

Other real estate owned - The value of other real estate owned was based on an independent third-party appraisal.

Deposits - The fair values for the demand and savings deposits equaled the amount payable on demand at the merger date. The fair values for time deposits were estimated using a discounted cash flow calculation that applied interest rates currently being offered to the contractual interest rates on such time deposits.

FHLB borrowings - The carrying value of Federal Home Loan Bank borrowings was adjusted to reflect prepayment fees, which approximated fair value.

Pro Forma Results of Operations

AMRB's unaudited contributions to net interest income and net income from the August 6, 2021 merger date to September 30, 2021 included in the consolidated statements of comprehensive income are presented in the following table.
(in thousands)
Net interest income 1
$3,427 
Net loss 1
$(2,993)
1 AMRB's net interest income and net loss include merger-related costs incurred from the merger date to September 30, 2021, accretion of the net purchase discount on acquired loans, premises fair value adjustment depreciation, CDI amortization and time deposit premium amortization, as applicable. The pro forma net loss does not include allowance for credit losses adjustments related to acquired loans.

The following table presents certain unaudited pro forma net interest income and net income for illustrative purposes only for the three and nine months ended September 30, 2021 and 2020 as if AMRB was acquired on January 1, 2020. This unaudited pro forma information combines Bancorp's and AMRB's historical results and includes adjustments reflecting the estimated impact of certain fair value adjustments for the respective periods. The pro forma information is not indicative of what would have occurred had the acquisition consummated as of the beginning of the year prior to the acquisition. The unaudited pro forma information does not consider any changes to the provision for credit losses resulting from recording loans at fair value, cost savings, or business synergies. As a result, actual amounts would have differed from the unaudited pro forma information presented, and the differences could be significant.
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Three months endedNine months ended
(in thousands)September 30, 2021September 30, 2020September 30, 2021September 30, 2020
Net interest income - Pro forma$30,488 $31,386 $91,240 $92,791 
Net interest income - Actual$27,753 $24,566 $74,318 $73,060 
Net income - Pro forma 1
$9,953 $9,182 $33,422 $19,638 
Net income - Actual$5,282 $7,491 $23,514 $22,125 
1 The 2021 pro forma combined net income was adjusted to exclude merger-related costs of $5.4 million incurred by Bancorp and $3.6 million incurred by AMRB. These merger-related costs were included in the combined net income for the nine months ended September 30, 2020 as if the merger occurred on January 1, 2020.

Merger-related one time and conversion costs are recognized as incurred and continue until all systems have been converted and operational functions are fully integrated. Bancorp's merger-related costs reflected in the consolidated statements of comprehensive income are summarized in the following table.

Three months endedNine months ended
(in thousand, unaudited)September 30, 2021September 30, 2020September 30, 2021September 30, 2020
Personnel and severance$2,668 $— $2,668 $— 
Professional services1,778 — 1,979 — 
Data processing433 — 433 — 
Other expense263 — 279 — 
Total merger-related one-time and conversion costs$5,142 $— $5,359 $— 
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ITEM 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Management's discussion of the financial condition and results of operations, which is unaudited, should be read in conjunction with the related consolidated financial statements in this Form 10-Q and with the audited consolidated financial statements and accompanying notes included in our 2020 Annual Report on Form 10-K. Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances.
 
Forward-Looking Statements

This discussion of financial results includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, (the "1933 Act") and Section 21E of the Securities Exchange Act of 1934, as amended, (the "1934 Act"). Those sections of the 1933 Act and 1934 Act provide a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about their financial performance so long as they provide meaningful, cautionary statements identifying important factors that could cause actual results to differ significantly from projected results.
 
Our forward-looking statements include descriptions of plans or objectives of management for future operations, products or services, and forecasts of revenues, earnings or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include the words "believe," "expect," "intend," "estimate" or words of similar meaning, or future or conditional verbs preceded by "will," "would," "should," "could" or "may."
 
Forward-looking statements are based on management's current expectations regarding economic, legislative, and regulatory issues that may affect our earnings in future periods. A number of factors, many of which are beyond management’s control, could cause future results to vary materially from current management expectations. Such factors include, but are not limited to, general economic conditions and the economic uncertainty in the United States and abroad, including changes interest rates, California unemployment rate, deposit flows, real estate values, and expected future cash flows on loans and securities; costs or effects of acquisitions; competition; changes in accounting principles, policies or guidelines; changes in legislation or regulation (including the Coronavirus Aid, Relief and Economic Security Act of 2020, as amended, and the Economic Aid to Hard-Hit Small Businesses, Nonprofits and Venues Act of 2020); our borrowers’ actual payment performance as loan deferrals related to the COVID-19 pandemic expire, including the potential adverse impact of loan modifications and payment deferrals implemented consistent with recent regulatory guidance; natural disasters (such as wildfires and earthquakes in our area); adverse weather conditions; interruptions of utility service in our markets for sustained periods; and other economic, competitive, governmental, regulatory and technological factors (including external fraud and cybersecurity threats) affecting our operations, pricing, products and services.

In addition, events or factors that could cause results or performance to materially differ from those expressed in the forward-looking statements concerning the AMRB acquisition include, but are not limited to:
•the businesses of Bancorp and AMRB may not be integrated successfully or such integration may be more difficult, time-consuming or costly than expected;
•expected cost savings from the acquisition may not be fully realized or realized within the expected time frame;
•revenues following the Merger may be lower than expected;
•customer and employee relationships and business operations may be disrupted by the acquisition; and
•the ability to obtain required regulatory and shareholder approvals, and the ability to complete the acquisition within the expected timeframe may be more difficult, time-consuming or costly than expected.

Important factors that could cause results or performance to materially differ from those expressed in our prior forward-looking statements are detailed in the Risk Factors section of our 2020 Form 10-K as filed with the SEC, copies of which are available from us at no charge. We do not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events.


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Critical Accounting Policies and Estimates

The SEC requires us to disclose "critical accounting policies" defined as those that are both most important to the presentation of our financial condition and results of operations and require management's most difficult, subjective, or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and imprecise. We consider accounting estimates to be critical to our financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain, (ii) management could have applied different assumptions during the reported period, and (iii) changes in the accounting estimate are reasonably likely to occur in the future and could have a material impact on our financial statements. There have been no material changes to our critical accounting policies previously reported, which include: Allowance for Credit Losses on Loans and Unfunded Commitments, Allowance for Credit Losses on Investments Securities, Accounting for Income Taxes, and Fair Value Measurements. For a detailed discussion of these accounting policies, refer to Note 1, Summary of Significant Accounting Policies, in the Consolidated Financial Statements included in our 2020 Form 10-K filed with the SEC on March 15, 2021. In addition, as a result of the acquisition of American River Bankshares in the third quarter of 2021, we consider the accounting policies and estimates for the following to be critical for this reporting period.

Business Combinations

Bancorp accounts for business combinations under the acquisition method of accounting in accordance with ASC 805, Business Combinations. ASC 805 requires assets and liabilities in a business combination to be recorded at their fair values as of the date of acquisition. This method often involves estimates based on third party or internal valuations based on discounted cash flow analyses or other valuation techniques, all of which are inherently subjective. Business acquisition-related costs, including conversion and restructuring charges, are expensed as incurred. For further information, refer to Note 10, Merger, herein, and Note 1, Summary of Significant Accounting Policies; and Item 1A, Risk Factors, in the Consolidated Financial Statements included in our 2020 Form 10-K filed with the SEC on March 15, 2021.

Executive Summary
 
Bancorp completed its merger with American River Bankshares ("AMRB") on August 6, 2021 (the "merger date"), with Bancorp continuing as the surviving entity, followed thereafter at 12:05 a.m. on August 7, 2021 by the Merger of American River Bank ("ARB") with and into Bank of Marin (collectively, the "Merger"), with Bank of Marin surviving. AMRB shareholders received a fixed exchange ratio of 0.575 shares of Bancorp common stock for each share of AMRB common stock outstanding. Based on Bancorp's closing stock price of $36.15 on August 6, 2021 (merger date), the transaction was valued at $124.5 million (with 3.4 million of additional shares of Bancorp common stock issued), or $20.80 per share of AMRB common stock, which includes the value of AMRB options paid in cash. For other important factors regarding the AMRB acquisition, please see Note 10, Merger, and the Forward-Looking Statements section of this Form 10-Q.

The following are highlights of our operating and financial performance for the periods presented:
•Net income for the third quarter of 2021 totaled $5.3 million, compared to $7.5 million in the third quarter of 2020. Diluted earnings per share were $0.35 in the third quarter of 2021, compared to $0.55 in the same quarter a year ago. Net income for the first nine months of 2021 totaled $23.5 million, compared to $22.1 million in the same period a year ago. Diluted earnings per share were $1.69, compared to $1.62 in the first nine months of 2020. Merger-related one-time and conversion costs reduced net income by $3.9 million, net of taxes, or 26 cents per share in the quarter and by $4.1 million, net of taxes, or 30 cents per share year-to-date. See reconciliation of GAAP to non-GAAP financial measures on page 36.
•Loan balances of $2.317 billion at September 30, 2021 increased by $228.5 million compared to $2.089 billion at December 31, 2020. The increase was largely due to $419.4 million in loans from the acquisition of ARB on August 6, 2021 and new non-PPP related loan originations totaling $101.7 million. These increases were partially offset by non-PPP loan payoffs totaling $145.3 million, and a $126.8 million decrease in Small Business Administration ("SBA") Paycheck Protection Program ("PPP") loans outstanding.

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•Credit quality remains strong, with non-accrual loans representing 0.36% of total loans as of September 30, 2021, compared to 0.44% at December 31, 2020. The ratio of the allowance for credit losses on loans to total loans was 0.97% at September 30, 2021, compared to 1.10% at December 31, 2020. Excluding SBA PPP loans, the ratio of allowance to loans would have been 1.04% and 1.27% at September 30, 2021 and December 31, 2020, respectively (see Results of Operations for a definition of this non-GAAP financial measure).
•The allowance for credit losses increased by $3.3 million in the third quarter and was comprised of a $1.8 million provision, mainly related to purchased ARB loans without credit deterioration, and a $1.5 million merger-date allowance established for purchased credit deteriorated loans. There was no provision for credit losses on unfunded loan commitments in the third quarter of 2021.
•Total deposits of $3.728 billion at September 30, 2021 increased by $1.224 billion from $2.504 billion at December 31, 2020, mainly due to the ARB acquisition. Non-interest bearing deposits were 49% of total deposits as of September 30, 2021, versus 54% as of December 31, 2020. The decrease in this ratio was primarily due to an increase in interest bearing deposits from existing customers and a lower ratio of non-interest-bearing deposits acquired from ARB. The cost of average deposits for the quarter and nine months ended September 30, 2021 was 0.06% and 0.07%, respectively, compared to 0.09% and 0.13% for the comparable periods in 2020.
•ROA and ROE ratios were significantly impacted by provisions for credit losses on acquired loans and shares issued in conjunction with the Merger. A good indicator of the Merger's positive impact on operating earnings is the efficiency ratio, as it neither includes provisions for losses on loans and unfunded commitments, nor is it impacted by changes in share counts. As shown in the reconciliation of GAAP to non-GAAP financial measures on page 36 the efficiency ratio excluding merger-related one-time and conversion costs of 56.02% for the quarter ended September 30, 2021, improved from 56.88% for the quarter a year ago. The comparable year-to-date non-GAAP efficiency ratio for the first nine months of 2021 was 59.09%, compared to 55.45% in 2020, and was not as good an indicator of the positive effects of the acquisition because it was impacted by a significant decline in interest rates.
•All capital ratios were above well-capitalized regulatory requirements. The total risk-based capital ratio for Bancorp was 15.0% at September 30, 2021, compared to 16.0% at December 31, 2020. Bancorp's tangible common equity to tangible assets was 9.1% at September 30, 2021, compared to 11.3% at December 31, 2020 (see Results of Operations for a definition of this non-GAAP financial measure). The Bank's total risk-based capital ratio was 14.4% at September 30, 2021, compared to 15.8% at December 31, 2020.
•The Board of Directors declared a cash dividend of $0.24 per share on October 22, 2021, which represents the 66th consecutive quarterly dividend paid by Bank of Marin Bancorp. The dividend is payable on November 12, 2021, to shareholders of record at the close of business on November 5, 2021.
•On October 22, 2021, the Board of Directors approved an amendment to the current share repurchase program which increased the total authorization from $25.0 million to $57.0 million. The July 31, 2023 expiration date of the program remained unchanged.
•Effective October 31, 2021, Russell A. Colombo retired as Chief Executive Officer of Bank of Marin and Bank of Marin Bancorp and the Board of Directors named Tim Myers, previously President and Chief Operating Officer, as his successor. Mr. Colombo will remain on the Boards of Bancorp and the Bank, and Mr. Myers will join both Boards.

Bank of Marin's strong balance sheet is built from our core values - relationship banking, disciplined fundamentals and commitment to the communities that we serve. We believe that our robust liquidity and capital positions, high credit quality loan portfolio, excellent credit metrics, and low-cost deposit base, as well as our acquisition of AMRB will reinforce the long-term success of the bank and position us well for the remainder of 2021.


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Statement Regarding use of Non-GAAP Financial Measures

In this Form 10-Q, Bancorp's financial results are presented in accordance with GAAP and refer to certain non-GAAP financial measures. Management believes that presentation of operating results using non-GAAP financial measures provides useful supplemental information to investors and facilitates the analysis of Bancorp's core operating results and comparison of operating results across reporting periods. Management also uses non-GAAP financial measures to establish budgets and manage Bancorp's business. A reconciliation of the GAAP financial measures to comparable non-GAAP financial measures is presented below.

Reconciliation of GAAP and Non-GAAP Financial Measures

 (in thousand, unaudited)Three months endedNine months ended
Net incomeSeptember 30, 2021September 30, 2020September 30, 2021September 30, 2020
Net income (GAAP)$5,282 $7,491 $23,514 $22,125 
Merger-related one-time and conversion costs:
Personnel and severance2,668 — 2,668 — 
Professional services1,778 — 1,979 — 
Data processing433 — 433 — 
Other263 — 279 — 
Income tax benefit of merger-related expenses(1,222)— (1,239)— 
Total merger-related one-time and conversion costs, net of taxes3,920 — 4,120 — 
Comparable net income (non-GAAP)$9,202 $7,491 $27,634 $22,125 
Diluted earnings per share
Weighted average diluted shares14,993 13,610 13,881 13,617 
Diluted earnings per share (GAAP)$0.35 $0.55 $1.69 $1.62 
Comparable diluted earnings per share (non-GAAP)$0.61 $0.55 $1.99 $1.62 
Return on average assets
Average assets$3,743,968 $3,029,342 $3,280,505 $2,876,618 
Return on average assets (GAAP)0.56 %0.98 %0.96 %1.03 %
Comparable return on average assets (non-GAAP)0.98 %0.98 %1.13 %1.03 %
Return on average equity
Average stockholders' equity$420,124 $356,230 $374,445 $348,812 
Return on average equity (GAAP)4.99 %8.37 %8.40 %8.47 %
Comparable return on average equity (non-GAAP)8.69 %8.37 %9.87 %8.47 %
Efficiency ratio
Non-interest expense (GAAP)$22,686 $14,990 $53,654 $44,238 
Merger-related expenses(5,142)— (5,359)— 
Non-interest expense (non-GAAP)$17,544 $14,990 $48,295 $44,238 
Net interest income$27,753 $24,566 $74,318 $73,060 
Non-interest income$3,565 $1,790 $7,413 $6,723 
Efficiency ratio (GAAP)72.44 %56.88 %65.65 %55.45 %
Comparable efficiency ratio (non-GAAP)56.02 %56.88 %59.09 %55.45 %

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RESULTS OF OPERATIONS
 
Highlights of the financial results are presented in the following tables:
(dollars in thousands)September 30, 2021December 31, 2020
Selected financial condition data:
Total assets$4,261,062 $2,911,926 
Loans, net2,294,605 2,065,682 
Deposits3,727,696 2,504,249 
Borrowings and other obligations451 58 
Subordinated debenture— 2,777 
Stockholders' equity458,525 358,253 
Asset quality ratios:
Allowance for credit losses on loans to total loans0.97 %1.10 %
Allowance for credit losses on loans to total loans, excluding SBA PPP loans 1
1.04 %1.27 %
Allowance for credit losses on loans to non-accrual loans2.66x2.48x
Non-accrual loans to total loans0.36 %0.44 %
Capital ratios:
Equity to total assets ratio10.76 %12.30 %
Tangible common equity to tangible assets 2
9.06 %11.27 %
Total capital (to risk-weighted assets)14.97 %16.03 %
Tier 1 capital (to risk-weighted assets)14.10 %14.82 %
Tier 1 capital (to average assets)10.20 %10.80 %
Common equity Tier 1 capital (to risk weighted assets)14.10 %14.69 %
Three months endedNine months ended
(dollars in thousands, except per share data)September 30, 2021September 30, 2020September 30, 2021September 30, 2020
Selected operating data:
Net interest income$27,753 $24,566 $74,318 $73,060 
Provision for (reversal of) credit losses on loans1,800 1,250 (2,049)5,450 
Provision for (reversal of) credit losses on unfunded loan commitments
— 248 (1,202)610 
Non-interest income3,565 1,790 7,413 6,723 
Non-interest expense22,686 14,990 53,654 44,238 
Net income5,282 7,491 23,514 22,125 
Net income per common share:
Basic$0.35 $0.55 $1.70 $1.64 
Diluted$0.35 $0.55 $1.69 $1.62 
Performance and other financial ratios:
Return on average assets0.56 %0.98 %0.96 %1.03 %
Return on average equity4.99 %8.37 %8.40 %8.47 %
Tax-equivalent net interest margin 3
3.15 %3.44 %3.23 %3.61 %
Cost of deposits0.06 %0.09 %0.07 %0.13 %
Efficiency ratio72.44 %56.88 %65.65 %55.45 %
Cash dividend payout ratio on common stock 4
68.57 %41.82 %41.18 %42.07 %
1 The allowance for credit losses on loans to total loans, excluding SBA-guaranteed PPP loans, is considered a meaningful non-GAAP financial measure, as it represents only those loans that were considered in the calculation of the allowance for credit losses on loans. SBA PPP loans at September 30, 2021 and December 31, 2020 totaled $164.8 million and $291.6 million, respectively.
2 Tangible common equity to tangible assets is considered to be a meaningful non-GAAP financial measure of capital adequacy and is useful for investors to assess Bancorp's ability to absorb potential losses. Tangible common equity of $379 million and $324 million at September 30, 2021 and December 31, 2020, respectively, includes common stock, retained earnings and unrealized gains (losses) on available-for sale securities, net of tax, less goodwill and intangible assets. Tangible assets exclude goodwill and intangible assets of $79.8 million and $34.0 million at September 30, 2021 and December 31, 2020, respectively.
3 Tax-equivalent net interest margin is computed by dividing taxable equivalent net interest income, which is adjusted for taxable equivalent income on tax-exempt loans and securities based on Federal statutory rate of 21 percent, by total average interest-earning assets.
4 Calculated as dividends on common shares divided by basic net income per common share.
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Net Interest Income
 
Net interest income is the interest earned on loans, investment and other interest-earning assets minus the interest expense incurred on deposits and other interest-bearing liabilities. Net interest income is impacted by changes in general market interest rates and by changes in the composition of interest-earning assets and interest-bearing liabilities. Interest rate changes can create fluctuations in the net interest income and/or margin due to an imbalance in the timing of repricing and maturity of assets and liabilities. We manage interest rate risk exposure with the goal of minimizing the impact of interest rate volatility on net interest income. For more information, refer to Item 3. Quantitative and Qualitative Disclosure about Market Risk in this Form 10-Q.
 
Net interest margin is expressed as net interest income divided by average interest-earning assets. Net interest rate spread is the difference between the average rate earned on total interest-earning assets and the average rate incurred on total interest-bearing liabilities. Both of these measures are reported on a taxable-equivalent basis. Net interest margin is the higher of the two because it reflects interest income earned on assets funded with non-interest-bearing sources of funds, which include demand deposits and stockholders’ equity.

Average Statements of Condition and Analysis of Net Interest Income

The following table compares interest income, average interest-earning assets, interest expense, and average interest-bearing liabilities for the periods presented. The table also presents net interest income, net interest margin and net interest rate spread for each period reported.
Three months endedThree months ended
September 30, 2021September 30, 2020
InterestInterest
AverageIncome/Yield/AverageIncome/Yield/
(dollars in thousands)BalanceExpenseRateBalanceExpenseRate
Assets
Interest-earning deposits with banks 1
$456,405 $178 0.15 %$184,883 $50 0.11 %
Investment securities 2, 3
845,127 4,249 2.01 %527,077 3,481 2.64 %
Loans 1, 3, 4
2,189,563 24,229 4.33 %2,117,679 21,957 4.06 %
   Total interest-earning assets 1
3,491,095 28,656 3.21 %2,829,639 25,488 3.52 %
Cash and non-interest-bearing due from banks68,680 55,353 
Bank premises and equipment, net6,468 5,412 
Interest receivable and other assets, net177,725 138,938 
Total assets$3,743,968 $3,029,342 
Liabilities and Stockholders' Equity
Interest-bearing transaction accounts$237,883 $41 0.07 %$153,089 $41 0.11 %
Savings accounts293,434 26 0.03 %191,915 17 0.04 %
Money market accounts911,294 417 0.18 %802,585 377 0.19 %
Time accounts including CDARS124,247 44 0.14 %97,465 133 0.54 %
Borrowings and other obligations 1, 6
3,010 8 1.09 %113 — 2.51 %
Subordinated debenture 1, 5
— — — %

2,751 35 4.97 %
   Total interest-bearing liabilities1,569,868 536 0.14 %1,247,918 603 0.19 %
Demand accounts1,707,142 1,380,708 
Interest payable and other liabilities46,834 44,486 
Stockholders' equity420,124 356,230 
Total liabilities & stockholders' equity$3,743,968 $3,029,342 
Tax-equivalent net interest income/margin 1
$28,120 3.15 %$24,885 3.44 %
Reported net interest income/margin 1
$27,753 3.11 %$24,566 3.40 %
Tax-equivalent net interest rate spread3.07 %3.33 %
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Nine months endedNine months ended
September 30, 2021September 30, 2020
InterestInterest
AverageIncome/Yield/AverageIncome/Yield/
(in thousands)BalanceExpenseRateBalanceExpenseRate
Assets
Interest-earning deposits with banks 1
$273,045 $274 0.13 %$152,587 $421 0.36 %
Investment securities 2, 3
683,600 11,196 2.18 %544,754 11,632 2.85 %
Loans 1, 3, 4
2,117,631 66,665 4.15 %1,998,456 64,423 4.24 %
   Total interest-earning assets 1
3,074,276 78,135 3.35 %2,695,797 76,476 3.73 %
Cash and non-interest-bearing due from banks53,020 44,665 
Bank premises and equipment, net5,353 5,631 
Interest receivable and other assets, net147,856 130,525 
Total assets$3,280,505 $2,876,618 
Liabilities and Stockholders' Equity
Interest-bearing transaction accounts$193,502 $119 0.08 %$144,784 $146 0.13 %
Savings accounts245,374 66 0.04 %179,288 50 0.04 %
Money market accounts784,313 1,015 0.17 %786,012 1,731 0.29 %
Time accounts including CDARS105,419 221 0.28 %96,237 436 0.61 %
Borrowings and other obligations 1, 6
1,047 8 1.10 %208 3 2.14 %
Subordinated debenture 1, 5
713 1,361 251.54 %2,733 124 5.96 %
   Total interest-bearing liabilities1,330,368 2,790 0.28 %1,209,262 2,490 0.27 %
Demand accounts1,531,564 1,278,265 
Interest payable and other liabilities44,128 40,279 
Stockholders' equity374,445 348,812 
Total liabilities & stockholders' equity$3,280,505 $2,876,618 
Tax-equivalent net interest income/margin 1
$75,345 3.23 %$73,986 3.61 %
Reported net interest income/margin 1
$74,318 3.19 %$73,060 3.56 %
Tax-equivalent net interest rate spread3.07 %3.45 %
1 Interest income/expense is divided by actual number of days in the period times 360 days to correspond to stated interest rate terms, where applicable.
2 Yields on available-for-sale securities are calculated based on amortized cost balances rather than fair value, as changes in fair value are reflected as a component of stockholders' equity. Investment security interest is earned on 30/360 day basis monthly.
3 Yields and interest income on tax-exempt securities and loans are presented on a taxable-equivalent basis using the Federal statutory rate of 21 percent in 2021 and 2020.
4 Average balances on loans outstanding include non-performing loans. The amortized portion of net loan origination fees is included in interest income on loans, representing an adjustment to the yield.
5 2021 interest on subordinated debenture included $1.3 million in accelerated discount accretion from the early redemption of our last subordinated debenture on March 15, 2021.
6 Average balances and rate consider $13.9 million in FHLB borrowings acquired from American River Bank that were redeemed on August 25, 2021.

Analysis of Changes in Net Interest Income

The following table presents the effects of changes in average balances (volume) or changes in average rates on tax-equivalent net interest income for the periods indicated. Volume variances are equal to the increase or decrease in average balances multiplied by prior period rates. Rate variances are equal to the increase or decrease in rates multiplied by prior period average balances. Mix variances are attributable to the change in yields or rates multiplied by the change in average balances, including one more day in the nine months ended September 30,2020.
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Three Months Ended September 30, 2021 Compared to Three Months Ended September 30, 2020Nine Months Ended September 30, 2021 Compared to Nine Months Ended September 30, 2020
(in thousands)VolumeYield/RateMixTotalVolumeYield/RateMixTotal
Interest-earning deposits with banks$73 $22 $33 $128 $332 $(267)$(212)$(147)
Investment securities 1
2,101 (831)(502)768 2,965 (2,710)(691)(436)
Loans 1
745 1,477 50 2,272 3,842 (1,279)(321)2,242 
Total interest-earning assets2,919 668 (419)3,168 7,139 (4,256)(1,224)1,659 
Interest-bearing transaction accounts24 (16)(8)— 49 (57)(19)(27)
Savings accounts10 (1)— 9 18 — (2)16 
Money market accounts51 (11)— 40 (4)(710)(2)(716)
Time accounts, including CDARS37 (98)(28)(89)42 (238)(19)(215)
Borrowings and other obligations19 — (11)8 14 (2)(7)5 
Subordinated debenture 2
(35)— — (35)(92)5,108 (3,779)1,237 
Total interest-bearing liabilities106 (126)(47)(67)27 4,101 (3,828)300 
Changes in tax-equivalent net interest income$2,813 $794 $(372)$3,235 $7,112 $(8,357)$2,604 $1,359 
1 Yields and interest income on tax-exempt securities and loans are presented on a taxable-equivalent basis using the federal statutory rate of 21%.
2 Nine months ended September 30, 2021 includes $1.3 million in accelerated discount accretion from the early redemption of our last subordinated debenture on March 15, 2021.
Third Quarter of 2021 Compared to Third Quarter of 2020

Net interest income totaled $27.8 million in the third quarter of 2021, compared to $24.6 million in the same quarter a year ago. The $3.2 million increase was primarily due to the addition of ARB interest earning balances, higher yield on acquired ARB loans, and higher income from SBA PPP loans. Increases were partially offset by lower yields on acquired ARB investment securities balances.

The tax-equivalent net interest margin was 3.15% in the third quarter of 2021 compared to 3.44% in the same quarter of last year.  The decrease in tax-equivalent net interest margin was primarily attributed to both $271.5 million increase in low yielding due from banks interest-earning balances and the lower interest rate environment. SBA PPP loans added 13 basis points to the third quarter 2021 net interest margin as compared to a 4 basis points reduction to the net interest margin in the third quarter of 2020 due to higher fee income accretion in the third quarter of 2021 as more PPP loans were forgiven and paid off by the SBA.

First Nine Months of 2021 Compared to First Nine Months of 2020

Net interest income totaled $74.3 million in the first nine months ended September 30, 2021, compared to $73.1 million in the same period a year ago. The $1.3 million increase was primarily attributed to the addition of ARB interest-earning assets and higher income from SBA PPP loans. Increases were partially offset by $1.3 million in accelerated discount accretion on the early redemption of a subordinated debenture in the first quarter of 2021 and lower yielding interest-earning assets. We recognized $6.6 million in SBA PPP fees, net of cost in the first nine months of 2021, compared to $2.8 million in the first nine months a year ago. As of September 30, 2021 $4.2 million PPP fees, net of deferred costs remain outstanding and will be recognized into income in future periods.

The tax-equivalent net interest margin was 3.23% in the first nine months ended June 30, 2021, compared to 3.61% in the same period a year ago.  The decrease was primarily attributed to $1.3 million in accelerated discount accretion from the early redemption of a subordinated debenture in the first quarter of 2021, the lower interest rate environment and higher cash balances, partially offset by higher income from PPP loans. SBA PPP loans added 9 basis points to the first nine months' net interest margin as compared to a 3 basis points reduction to net interest margin in the comparable period in 2020.

Market Interest Rates

Market interest rates are, in part, based on the target federal funds interest rate (the interest rate banks charge each
other for short-term borrowings) implemented by the Federal Reserve Open Market Committee ("FOMC").

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In response to the evolving risks to economic activity posed by the COVID-19 pandemic, the FOMC made two emergency cuts totaling 150 basis points to the federal funds rate in March 2020. The federal funds target rate range has resided between 0.0% and 0.25% since March 15, 2020, putting downward pressure on our asset yields and net interest margin. A low interest rate environment will continue to put downward pressure on our asset yields and net interest margin. See ITEM 3. Quantitative and Qualitative Disclosure about Market Risk for further information.

Provision for Credit Losses on Loans
 
Management assesses the adequacy of the allowance for credit losses on loans quarterly based on several factors including growth of the loan portfolio, past events, current conditions, and reasonable and supportable forecasts to estimate expected losses over the contractual terms of our loans. The allowance for credit losses on loans is increased by provisions charged to expense and loss recoveries and decreased by loans charged off.

The following table shows the provision for credit losses activity for the periods presented.
Three months endedNine months ended
(dollars in thousands)September 30, 2021September 30, 2020September 30, 2021September 30, 2020
Provision for (reversal of) credit losses on loans$1,800 $1,250 $(2,049)$5,450 

The $1.8 million provision for the three months ended September 30, 2021 was mainly related to purchased ARB loans without credit deterioration. The net provision reversal for the first nine months in 2021 was primarily due to continued improvements in the forecasted California unemployment rates over the next four quarters, partially offset by the provision in the third quarter. Our allowance model is particularly sensitive to current and forecasted California unemployment rates, which decreased to 6.4% at September 30, 2021 from 9.1% at December 31, 2020. The provision for credit losses in 2020 calculated under the incurred loss method (prior to the adoption of the excepted credit loss method on December 31, 2020) was largely due to the uncertainty about the impact of the COVID-19 pandemic on the local and regional economies and our customers at that time.

Loans designated special mention, which are not considered adversely classified, increased year-to-date by $16.6 million to $103.4 million at September 30, 2021 from $86.9 million at December 31, 2020. The increase was largely due to the downgrading from pass to special mention several well-secured commercial real estate loans totaling $41.2 million and one borrowing relationship with three commercial loans totaling $5.4 million, also well collateralized. In addition, we upgraded several borrowing relationships from substandard to special mention totaling $13.2 million because of their improved financial condition and assumed $13.7 million in special mention loans in the Merger. These increases were partially offset by $32.7 million in upgrades to pass due to improved financial condition, $18.8 million in paydowns and payoffs and $5.4 million in downgrades to substandard comprised primarily of one well secured commercial real estate loan.

Classified assets (loans with risk ratings of substandard or doubtful) totaled $19.0 million at September 30, 2021, compared to $25.8 million at December 31, 2020. The $6.8 million decrease was primarily due to the upgrading of $13.2 million in loans mentioned above and paydowns and payoffs totaling $1.9 million. These decreases were primarily offset by the $5.4 million in downgrades mentioned above and $2.3 million in substandard loans assumed in the Merger. Classified loans also included one $118 thousand loan acquired from ARB with a doubtful risk rating as of September 30, 2021, which is well-secured by real estate collateral. There were no loans considered doubtful at December 31, 2020.

The ratio of allowance for credit losses on loans to total loans was 0.97% at September 30, 2021, compared to 1.10% at December 31, 2020. Non-accrual loans totaled $8.4 million, or 0.36% of total loans at September 30, 2021, and remained largely unchanged from $9.2 million, or 0.44% of total loans at December 31, 2020.

For more information, refer to Note 5 to the consolidated financial statements in this Form 10-Q.


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Non-interest Income
 
The following table details the components of non-interest income.
 Three months endedAmount Increase (DecreasePercent Increase (Decrease)
(dollars in thousands)September 30, 2021September 30, 2020
Earnings on bank-owned life insurance, net1,402 232 1,170 504.3 %
Wealth Management and Trust Services$597 $450 $147 32.7 %
Debit card interchange fees483 383 100 26.1 %
Service charges on deposit accounts464 284 180 63.4 %
Dividends on Federal Home Loan Bank stock179 149 30 20.1 %
Merchant interchange fees129 63 66 104.8 %
Gains on sale of investment securities, net1 — 1 NM
Other income310 229 81 35.4 %
Total non-interest income$3,565 $1,790 $1,775 99.2 %
NM - not meaningful
 Nine months endedAmount Increase (DecreasePercent Increase (Decrease)
(dollars in thousands)September 30, 2021September 30, 2020
Earnings on bank-owned life insurance, net1,892 741 1,151 155.3 %
Wealth Management and Trust Services$1,615 $1,375 $240 17.5 %
Debit card interchange fees1,268 1,051 217 20.6 %
Service charges on deposit accounts1,062 1,028 34 3.3 %
Dividends on Federal Home Loan Bank stock505 503 2 0.4 %
Merchant interchange fees247 183 64 35.0 %
Gains on sale of investment securities, net1 915 (914)(99.9)%
Other income823 927 (104)(11.2)%
Total non-interest income$7,413 $6,723 $690 10.3 %

Third Quarter of 2021 Compared to Third Quarter of 2020

Non-interest income increased by $1.8 million in the third quarter of 2021 to $3.6 million, compared to $1.8 million in the same quarter a year ago. The increase was mostly attributed to the collection of $1.1 million in death benefits on bank-owned life insurance ("BOLI") policies and increases in fee income from deposit accounts and debit card interchange activity.

First Nine Months of 2021 Compared to First Nine Months of 2020

Non-interest income increased by $0.7 million in the first nine months of 2021 to $7.4 million, from $6.7 million in the first nine months of 2020. The increase was primarily due to BOLI payments noted above, increases in Wealth Management and Trust Services income generated from new accounts and favorable market performance, and fees from deposit accounts and debit card interchange activity. In March 2020, we implemented temporary waivers for all ATM fees, overdraft fees and early withdrawal penalties for time deposits to help ease the financial burden customers began experiencing due to the pandemic. We reinstituted the fees in May 2021. The increase was partially offset by the absence of gains on investment securities, as $915 thousand in gains were recognized in the comparative period a year ago.


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Non-interest Expense
 
The following table details the components of non-interest expense.
 Three months endedAmount Increase (Decrease)Percent Increase (Decrease)
(dollars in thousands)September 30, 2021September 30, 2020
Salaries and related benefits$13,127 $8,638 $4,489 52.0 %
Occupancy and equipment1,871 1,776 95 5.3 %
Professional services2,472 655 1,817 277.4 %
Data processing1,613 822 791 96.2 %
Depreciation and amortization431 539 (108)(20.0)%
Information technology496 256 240 93.8 %
Amortization of core deposit intangible334 213 121 56.8 %
Directors' expense255 184 71 38.6 %
Federal Deposit Insurance Corporation insurance236 181 55 30.4 %
Charitable contributions4 481 (477)(99.2)%
Other non-interest expense
Advertising189 163 26 16.0 %
Other expense1,658 1,082 576 53.2 %
Total other non-interest expense1,847 1,245 602 48.4 %
Total non-interest expense$22,686 $14,990 $7,696 51.3 %
Nine months endedAmount Increase (Decrease)Percent Increase (Decrease)
(dollars in thousands)September 30, 2021September 30, 2020
Salaries and related benefits$31,223 $25,979 $5,244 20.2 %
Occupancy and equipment5,373 5,100 273 5.4 %
Professional services4,321 1,749 2,572 147.1 %
Data processing3,252 2,437 815 33.4 %
Depreciation and amortization1,279 1,591 (312)(19.6)%
Information technology1,105 758 347 45.8 %
Amortization of core deposit intangible742 639 103 16.1 %
Directors' expense660 533 127 23.8 %
Federal Deposit Insurance Corporation insurance597 299 298 99.7 %
Charitable contributions497 921 (424)(46.0)%
Other non-interest expense 
Advertising60357231 5.4 %
Other expense4,002 3,660 342 9.3 %
Total other non-interest expense4,605 4,232 373 8.8 %
Total non-interest expense$53,654 $44,238 $9,416 21.3 %

Third Quarter of 2021 Compared to Third Quarter of 2020

Non-interest expense increased by $7.7 million to $22.7 million in the third quarter of 2021, compared to $15.0 million in the same period a year ago. The increase was primarily due to a $5.1 million increase in merger-related one-time and conversion costs (mostly related to professional services, data processing contract termination, and personnel costs), salaries and benefits for retained ARB employees and other ARB-related operating expenses incurred since the merger date. The increase was partially offset by a $477 thousand decrease in charitable contributions as the bank has transitioned to a more defined contributions disbursement schedule with funding occurring in the second and fourth quarters, and large pandemic-related contributions in 2020.

First Nine Months of 2021 Compared to First Nine Months of 2020

Non-interest expense increased by $9.4 million to $53.7 million in the first nine months of 2021, compared to $44.2 million in the first nine months of 2020. Higher salaries and related benefits of $5.2 million included $2.7 million in personnel costs related to the Merger. The increase in salaries and benefits was also attributed to fewer deferred
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SBA PPP loan origination costs. Professional services increased by $2.6 million and data processing expenses increased by $815 thousand, mainly due to merger-related expenses. In addition, FDIC deposit insurance expenses were $298 thousand higher. Charitable contributions were lower than 2020 for the reasons mentioned above.

Provision for Income Taxes

Income tax provisions reflect accruals for taxes at the applicable rates for federal income tax and California franchise tax based upon reported pre-tax income. Provisions also reflect permanent differences between income for tax and financial reporting purposes (such as earnings on tax exempt loans and municipal securities, BOLI, low-income housing tax credits, and stock-based compensation from the exercise of stock options, disqualifying dispositions of incentive stock options and vesting of restricted stock awards).

The provision for income taxes for the third quarter of 2021 totaled $1.6 million at an effective tax rate of 22.7%, compared to $2.4 million at an effective tax rate of 24.1% in the same quarter last year. The provision for income taxes for the first nine months of 2021 totaled $7.8 million at an effective tax rate of 24.9%, compared to $7.4 million at an effective tax rate of 25.0% for the first nine months of 2020. The decrease in the provision reflected lower pre-tax income for the third quarter of 2021 compared to the same quarter a year ago. The 140 basis point decrease in the effective tax rate in the third quarter of 2021 as compared to the same quarter a year ago was primarily due to higher BOLI and tax exempt loan and investment securities interest income from the ARB acquisition, partially offset by the non-deductible merger expenses incurred in the third quarter of 2021.

We file a consolidated return in the U.S. Federal tax jurisdiction and a combined return in the State of California tax jurisdiction. There were no ongoing federal or state income tax examinations at the issuance of this report. At September 30, 2021, neither the Bank nor Bancorp had accruals for interest nor penalties related to unrecognized tax benefits.

FINANCIAL CONDITION SUMMARY

At September 30, 2021, assets totaled $4.261 billion, an increase of $1.349 billion, from $2.912 billion at December 31, 2020, mainly due to the acquisition of ARB in August 2021, which added approximately $898.4 million in assets, as well as increases in deposit inflows as discussed below. For additional information on the merger, refer to Note 10, Merger, in this Form 10-Q.
Cash, Cash Equivalents and Restricted Cash

Total cash, cash equivalents and restricted cash were $584.7 million at September 30, 2021, compared to $200.3 million at December 31, 2020. The increase was mainly due to the acquisition of ARB, SBA PPP loan forgiveness and an increase in deposits. Cash and cash equivalents do not include $179.9 million and $173.4 million in temporary one-way sale transfers of deposits to third-party deposit networks as part of our liquidity management at September 30, 2021 and December 31, 2020, respectively.

Investment Securities

The investment securities portfolio totaled $1.160 billion at September 30, 2021, an increase of $658.4 million from December 31, 2020. The increase was primarily due to purchases of $508.6 million to deploy excess cash into interest earning assets in a more favorable interest rate environment in 2021, and securities of $297.8 million acquired from ARB, partially offset by paydowns, calls and maturities of $132.5 million. Additionally, the fair value of available-for-sale securities decreased $8.6 million as a result of the higher interest rate environment in the first nine months of 2021. Security sales in the first nine months of 2021 totaled $4.1 million. See Note 4, Investment Securities, for additional information.

The following table summarizes our investment in obligations of state and political subdivisions at September 30, 2021 and December 31, 2020.
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September 30, 2021December 31, 2020
(dollars in thousands)Amortized CostFair Value% of Total State and Political SubdivisionsAmortized CostFair Value% of Total State and Political Subdivisions
Within California:
General obligation bonds$14,975 $15,180 9.7 %$3,327 $3,565 3.1 %
Revenue bonds5,478 5,526 3.6 2,352 2,448 2.2 
Tax allocation bonds1,614 1,624 1.0 2,832 2,876 2.7 
Total within California22,067 22,330 14.3 8,511 8,889 8.0 
Outside California:
General obligation bonds109,463 113,444 70.9 78,299 82,100 73.5 
Revenue bonds22,867 23,962 14.8 19,744 21,351 18.5 
Total outside California132,330 137,406 85.7 98,043 103,451 92.0 
Total obligations of state and political subdivisions$154,397 $159,736 100.0 %$106,554 $112,340 100.0 %

The portion of the portfolio outside the state of California is distributed among fourteen states. Of the total investment in obligations of state and political subdivisions, the largest concentrations outside of California are in Texas (39.7%), Washington (18.8%) and Maryland (4.4%). Our investment in obligations issued by municipal issuers in Texas are either guaranteed by the AAA-rated Texas Permanent School Fund ("PSF") or backed by revenue sources from essential services (such as utilities and transportation). We have $6.0 million in obligations of Texas school district issuers having high concentrations in oil and gas industry taxpayers and all of them have credit guarantees from PSF. We have little or no exposure to municipal sectors such as health care that are most vulnerable to credit risks posed by the COVID-19 pandemic.

Investments in states, municipalities and political subdivisions are subject to an initial pre-purchase credit assessment and ongoing monitoring. Key considerations include:

•The soundness of a municipality’s budgetary position and stability of its tax revenues
•Debt profile and level of unfunded liabilities, diversity of revenue sources, taxing authority of the issuer
•Local demographics/economics including unemployment data, largest taxpayers and local employers, income indices and home values
•For revenue bonds, the source and strength of revenue for municipal authorities including the obligor’s financial condition and reserve levels, annual debt service and debt coverage ratio, and credit enhancement (such as insurer’s strength and collateral in escrow accounts)
•Credit ratings by major credit rating agencies

Loans

During the first nine months of 2021, loans increased by $228.5 million and totaled $2.317 billion at September 30, 2021, primarily due to $419.4 million in loans from the acquisition of ARB on August 6,2021. New non-PPP related loan originations totaled $101.7 million in the first nine months of 2021. Non-PPP loan payoffs totaled $145.3 million during the first nine months of 2021. Loan payoffs in the third quarter of 2021 consisted largely of commercial borrower cash paydowns as part of ongoing deleveraging, real estate asset sales and third-party refinancing. A significant portion of the commercial third-party refinancing was attributable to price or structural elements outside the bank's desired credit profile.

As of September 30, 2021, there were 871 PPP loans outstanding totaling $164.8 million (net of $4.2 million in unrecognized fees and costs), including 31 loans totaling $9.6 million acquired from ARB. Of the 2,876 PPP loans totaling $444.1 million funded by Bank of Marin, 2,036 loans for $284.7 million have been forgiven and paid off. Of the remaining PPP loans, 580 loans or $25.5 million are less than or equal to $150 thousand and have access to streamlined forgiveness.

As of September 30, 2021, 2 borrowing relationships with 5 loans totaling $23.6 million were continuing to benefit from payment relief. We monitor the financial situation of these clients closely and expect the majority to resume payments as the economy continues to recover.

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Liabilities

During the first nine months of 2021, total liabilities increased by $1.248 billion to $3.803 billion. Deposits increased $1.223 billion in the first nine months of 2021, primarily driven by the acquisition of ARB and normal fluctuations in some of our larger commercial accounts. Non-interest bearing deposits increased $482.9 million in the first nine months of 2021 to $1.838 billion, and represented 49.3% of total deposits at September 30, 2021, compared to 54.1% at December 31, 2020. The decrease in this ratio was primarily due to an increase in interest-bearing deposits for a large existing customer and a lower ratio of non-interest bearing deposits from the ARB acquisition. The cost of average deposits was 0.06% in the third quarter and 0.07% in the first nine months of 2021, respectively, a decrease of 2 basis points and 6 basis points from the equivalent periods a year ago.

Capital Adequacy
 
We are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements as set forth in the following tables can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on our consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and the Bank’s prompt corrective action classification are also subject to qualitative judgments by the regulators about components of capital, risk weightings and other factors.

Management reviews capital ratios on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet our anticipated future needs.  For all periods presented, the Bank’s ratios exceed the regulatory definition of “well capitalized” under the regulatory framework for prompt corrective action and Bancorp’s ratios exceed the required minimum ratios to be considered a well-capitalized bank holding company. In addition, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action as of September 30, 2021. There are no conditions or events since that notification that management believes have changed the Bank’s categories and we expect the Bank to remain well capitalized for prompt corrective action purposes.

In August 2018, the Board of Governors of the Federal Reserve System changed the definition of a "Small Bank Holding Company" by increasing the asset threshold from $1.0 billion to $3.0 billion. As a result, Bancorp was not subject to separate minimum capital requirements as of December 31, 2020. However, we disclosed comparative capital ratios for Bancorp, which would have exceeded well-capitalized levels had Bancorp been subject to the same minimum capital requirements in 2020.

The Bancorp’s and Bank’s capital adequacy ratios as of September 30, 2021 and December 31, 2020 are presented in the following tables. The decrease in capital ratios as of September 30, 2021 from December 31, 2020 was largely attributable to shares repurchased totaling $35.2 million during the first nine months of 2021. Tier 1 Capital to average assets was also reduced by an increase in cash driven by deposit growth over and above that attributable to the Merger. In addition, as of December 31, 2020, Bancorp's Tier 1 capital included a subordinated debenture, which was not included at the Bank level. On March 15, 2021, Bancorp redeemed in full our last subordinated debenture due to NorCal Community Bancorp Trust II. Partially offsetting those factors, the Merger served to increase capital ratios as the proportion of risk-weighted assets to total assets was lower for ARB, and the full effect of the Merger will not reflect in average assets until the fourth quarter.
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Capital Ratios for Bancorp

(dollars in thousands)
Actual RatioAdequately Capitalized ThresholdRatio to be a Well Capitalized Bank Holding Company
September 30, 2021AmountRatioAmountRatioAmountRatio
Total Capital (to risk-weighted assets)$395,223 14.97 %≥ $277,278 ≥ 10.50 %≥ $264,074 ≥ 10.00 %
Tier 1 Capital (to risk-weighted assets)$372,293 14.10 %≥ $224,463 ≥   8.50 %≥ $211,259 ≥   8.00 %
Tier 1 Capital (to average assets)$372,293 10.20 %≥ $145,976 ≥   4.00 %≥ $182,470 ≥   5.00 %
Common Equity Tier 1 (to risk-weighted assets)$372,293 14.10 %≥ $184,852 ≥   7.00 %≥ $171,648 ≥   6.50 %
December 31, 2020   
Total Capital (to risk-weighted assets)$339,544 16.03 %≥ $222,393 ≥ 10.50 %≥ $211,802 ≥ 10.00 %
Tier 1 Capital (to risk-weighted assets)$313,891 14.82 %≥ $180,032 ≥   8.50 %≥ $169,442 ≥   8.00 %
Tier 1 Capital (to average assets)$313,891 10.80 %≥ $116,224 ≥   4.00 %≥ $145,280 ≥   5.00 %
Common Equity Tier 1 (to risk-weighted assets)$311,114 14.69 %≥ $148,262 ≥   7.00 %≥ $137,672 ≥   6.50 %
Capital Ratios for the Bank


(dollars in thousands)
Actual RatioAdequately Capitalized ThresholdRatio to be Well Capitalized under Prompt Corrective Action Provisions
September 30, 2021AmountRatioAmountRatioAmountRatio
Total Capital (to risk-weighted assets)$378,753 14.35 %≥ $277,156 ≥ 10.50 %≥ $263,958 ≥ 10.00 %
Tier 1 Capital (to risk-weighted assets)$355,823 13.48 %≥ $224,364 ≥   8.50 %≥ $211,166 ≥   8.00 %
Tier 1 Capital (to average assets)$355,823 9.75 %≥ $145,959 ≥   4.00 %≥ $182,449 ≥   5.00 %
Common Equity Tier 1 (to risk-weighted assets)$355,823 13.48 %≥ $184,770 ≥   7.00 %≥ $171,572 ≥   6.50 %
December 31, 2020      
Total Capital (to risk-weighted assets)$334,686 15.80 %≥ $222,391 ≥ 10.50 %≥ $211,801 ≥ 10.00 %
Tier 1 Capital (to risk-weighted assets)$309,033 14.59 %≥ $180,031 ≥   8.50 %≥ $169,441 ≥   8.00 %
Tier 1 Capital (to average assets)$309,033 10.64 %≥ $116,224 ≥   4.00 %≥ $145,280 ≥   5.00 %
Common Equity Tier 1 (to risk-weighted assets)$309,033 14.59 %≥ $148,261 ≥   7.00 %≥ $137,671 ≥   6.50 %


Liquidity

The goal of liquidity management is to provide adequate funds to meet loan demand and to fund operating activities and deposit withdrawals. We accomplish this goal by maintaining an appropriate level of liquid assets and formal lines of credit with the FHLB, FRBSF and correspondent banks that enable us to borrow funds as discussed in Note 6 to the Consolidated Financial Statements in ITEM 1 of this report. Our Asset Liability Management Committee ("ALCO"), which is comprised of independent Bank directors and the Bank's Chief Executive Officer, is responsible for approving and monitoring our liquidity targets and strategies. ALCO has adopted a contingency funding plan that provides early detection of potential liquidity issues in the market or the Bank and institutes prompt responses that may prevent or alleviate a potential liquidity crisis. Management monitors liquidity daily and regularly adjusts our position based on current and future liquidity needs. We also have relationships with third-party deposit networks and can adjust the placement of our deposits via reciprocal or one-way sales as part of our cash management strategy.
 
We obtain funds from the repayment and maturity of loans, deposit inflows, investment security maturities and paydowns, federal funds purchases, FHLB advances, other borrowings, and cash flow from operations.  Our primary uses of funds are the origination of loans, the purchase of investment securities, withdrawals of deposits, maturity of certificates of deposit, repayment of borrowings, and dividends to common stockholders.
 
The most significant component of our daily liquidity position is customer deposits. The attraction and retention of new deposits depends upon the variety and effectiveness of our customer account products, service and convenience, rates paid to customers, and our financial strength. The cash cycles and unique business activities of some of our large commercial depositors may cause short-term fluctuations in their deposit balances held with us. Since 2020, the banking industry experienced abundant liquidity driven by pandemic-related government programs such as PPP and stimulus checks as well as an elevated savings rate system-wide.

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The most significant source of liquidity during 2021 was an increase in deposits of $433.4 million. The increase was primarily due to SBA PPP loan forgiveness and other increases in customer deposits. Proceeds from loans collected net of loan originations was $193.3 million. Proceeds from principal paydowns and maturities of securities totaled $136.6 million, and $32.3 million in net cash was provided by operating activities.

Significant uses of liquidity during 2021 were $488.6 million in investment securities purchased, $35.5 million in common stock repurchases, $9.2 million in cash dividends paid on common stock to our shareholders, and $4.1 million in repayment of a subordinated debenture. Refer to the Consolidated Statement of Cash Flows in this Form 10-Q for additional information on our sources and uses of liquidity. Management anticipates that our current strong liquidity position and core deposit base are adequate to fund our operations.

Undrawn credit commitments, as discussed in Note 8 to the Consolidated Financial Statements in this Form 10-Q, totaled $602.6 million at September 30, 2021. We expect to fund these commitments to the extent utilized primarily through the repayment of existing loans, deposit growth and liquid assets. Over the next twelve months, $99.0 million of time deposits will mature. We expect to replace these funds with new deposits. Our emphasis on local deposits, combined with our liquid investment portfolio, provides a very stable funding base.
 
Since Bancorp is a holding company and does not conduct regular banking operations, its primary sources of liquidity are dividends from the Bank. Under the California Financial Code, payment of a dividend from the Bank to Bancorp without advance regulatory approval is restricted to the lesser of the Bank’s retained earnings or the amount of the Bank’s net profits from the previous three fiscal years less the amount of dividends paid during that period. The primary uses of funds for Bancorp are shareholder dividends and ordinary operating expenses.  Bancorp held $16.2 million of cash at September 30, 2021, which is sufficient to cover Bancorp's operational needs and cash dividends to shareholders through 2022. Management anticipates that there will be sufficient earnings at the Bank to provide dividends to Bancorp to meet its funding requirements for the foreseeable future.

ITEM 3.     Quantitative and Qualitative Disclosure about Market Risk

Market risk is defined as the risk of loss arising from an adverse change in the market value (or prices) of financial instruments. A significant component of market risk is interest rate risk, which is inherent in our lending, investment, borrowing and deposit gathering activities. The Bank manages interest rate sensitivity to minimize the exposure of our net interest margin, earnings, and capital to changes in interest rates. Interest rate changes can create fluctuations in the net interest margin due to an imbalance in the timing of repricing or maturity of assets or liabilities.

To mitigate interest rate risk, the structure of our assets and liabilities is managed with the objective of correlating the effects of interest rate changes on loans and investments with those of deposits and borrowings. The asset liability management policy sets limits on the acceptable amount of change to net interest income and economic value of equity in different interest rate environments.

From time to time, we enter into interest rate swap contracts to mitigate the changes in the fair value of specified long-term fixed-rate loans and firm commitments to enter into long-term fixed-rate loans caused by changes in interest rates. See Note 9 to the Consolidated Financial Statements in this Form 10-Q.

ALCO and the Board of Directors review our exposure to interest rate risk at least quarterly. We use simulation models to measure interest rate risk and to evaluate strategies to improve profitability. A simplified static statement of condition is prepared on a quarterly basis as a starting point, using instrument level data of our actual loans, investments, borrowings and deposits as inputs. If potential changes to net equity value and net interest income resulting from hypothetical interest rate changes are not within the limits established by the Board of Directors, management may adjust the asset and liability mix to bring the risk position within approved limits or take other actions. At September 30, 2021, interest rate risk was within policy guidelines established by ALCO and the Board. One set of interest rates modeled and evaluated against flat interest rates is a series of immediate parallel shifts in the yield curve. These are provided in the following table as an example rather than an expectation of likely interest rate movements.
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Immediate Changes in Interest Rates (in basis points)Estimated Change in Net Interest Income in Year 1, as percent of Net Interest IncomeEstimated Change in Net Interest Income in Year 2, as percent of Net Interest Income
up 40011.7 %28.1 %
up 3008.9 %21.4 %
up 2006.0 %14.4 %
up 1002.8 %6.9 %
down 100(2.6)%(4.2)%

Interest rate sensitivity is a function of the repricing characteristics of our assets and liabilities. The Bank runs a combination of scenarios and sensitivities in its attempt to capture the range of interest rate risk including the simulations mentioned above. As with any simulation model or other method of measuring interest rate risk, limitations are inherent in the process and dependent on assumptions. For example, if we choose to pay interest on certain business deposits that are currently non-interest bearing, causing those deposits to become rate sensitive in the future, we would become less asset sensitive than the model currently indicates. Assets and liabilities may react differently to changes in market interest rates in terms of both timing and responsiveness to market rate movements. Important deposit modeling assumptions are the speed of deposit run-off and the amount by which interest-bearing deposit rates increase or decrease when market interest rates change. Further, the actual rates and timing of prepayments on loans and investment securities could vary significantly from the assumptions applied in the various scenarios. Lastly, changes in U.S. Treasury rates accompanied by a change in the shape of the yield curve could produce different results from those presented in the table. Accordingly, the results presented should not be relied upon as indicative of actual results in the event of changing market interest rates.

ITEM 4.       Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures

Bank of Marin Bancorp and its subsidiary (the "Company") conducted an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934 (the “Act”)) as of the end of the period covered by this report. The term disclosure controls and procedures means controls and other procedures that are designed to ensure that information we are required to disclose in the reports that we file or submit under the Act (15 U.S.C. 78a et seq.) is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information we are required to disclose in the reports that we file or submit under the Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Changes in Internal Control over Financial Reporting

During the quarter ended September 30, 2021, we completed the merger with American River Bankshares and we continue to integrate and incorporate their business processes and systems into our internal control over financial reporting. Other than the interim effects of the Merger, there were no significant changes that materially affected, or are reasonably likely to affect, our internal control over financial reporting. The term internal control over financial reporting, as defined by Rule 15d-15(f) of the Act, is a process designed by, or under the supervision of, the issuer's principal executive and principal financial officers, or persons performing similar functions, and effected by the issuer's board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.

PART II       OTHER INFORMATION
 
ITEM 1         Legal Proceedings
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Refer to Note 12 to the Consolidated Financial Statements in Item 8 of our 2020 Form 10-K and Note 8 to the Consolidated Financial Statements in this Form 10-Q.

ITEM 1A      Risk Factors
 
There have been no material changes from the risk factors previously disclosed in our 2020 Form 10-K. Refer to "Risk Factors" in Item 1A of our 2020 Form 10-K, pages 12 through 21.

ITEM 2       Unregistered Sales of Equity Securities and Use of Proceeds

There were no unregistered sales of equity securities during the period covered by this report.
 
Issuer Purchases of Equity Securities

On July 16, 2021, Bancorp Board of Directors approved a share repurchase program under which Bancorp could repurchase up to $25.0 million of its outstanding common stock through July 31, 2023. During the three months ended September 30, 2021, Bancorp repurchased 445,735 shares at an average price of $35.64 per share for a total cost of $15.9 million. Approximately $9.1 million remained available for repurchases as of September 30, 2021. On October 22, 2021, Bancorp's Board of Directors approved an amendment to the current share repurchase program, which increased the total authorization from $25.0 million to $57.0 million and left the expiration date unchanged. The following table reflects repurchases under this share repurchase program for the periods presented.

(in thousands, except per share data)Total Number of Shares Purchased
Average Price Paid per Share 1
Total Number of Shares Purchased as Part of Publicly Announced ProgramsApproximate Dollar Value That May yet Be Purchased Under the Program
Period
July 1-31, 202137,182 $32.99 37,182 $23,772 
August 1-31, 2021159,360 35.98 159,360 $18,031 
September 1-30, 2021249,193 35.81 249,193 $9,098 
Total445,735 $35.64 445,735 
1 Average price paid per share excludes commission.

ITEM 3       Defaults upon Senior Securities
None.
 
ITEM 4      Mine Safety Disclosures
Not applicable.

ITEM 5      Other Information
None.
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ITEM 6       Exhibits

The following exhibits are filed as part of this report or hereby incorporated by references to filings previously made with the SEC.
 Incorporated by Reference 
Exhibit NumberExhibit DescriptionFormFile No.ExhibitFiling DateHerewith
2.018-K001-335722.1April 19, 2021
3.01S-4333-2570253.01June 11, 2021 
3.02S-4333-2570253.02June 11, 2021
4.018-A12B001-335724.1July 7, 2017
4.0210-K001-335724.02March 13, 2020
10.01S-8333-2182744.1May 26, 2017 
10.02S-8333-2212194.1October 30, 2017
10.03S-8333-2278404.1October 15, 2018 
10.04S-8333-2395554.1June 30, 2020 
10.0510-Q001-3357210.06November 7, 2007 
10.068-K001-3357210.1January 26, 2009 
10.0710-K001-3357210.07March 15, 2021 
10.088-K001-3357210.1January 6, 2011 
10.098-K001-3357210.2November 4, 2014
10.108-K001-3357210.3November 4, 2014 
10.118-K001-3357210.1October 31, 2007 
10.1210-Q001-3357210.12November 6, 2020
10.1310-K001-3357210.13March 15, 2021
10.148-K001-3357210.1September 24, 2021
31.01    Filed
31.02    Filed
32.01    Filed
101.INSInline XBRL Instance DocumentFiled
101.SCHInline XBRL Taxonomy Extension Schema DocumentFiled
101.CALInline XBRL Taxonomy Extension Calculation Linkbase DocumentFiled
101.LABInline XBRL Taxonomy Extension Label Linkbase Document    Filed
101.PREInline XBRL Taxonomy Extension Presentation Linkbase DocumentFiled
101.DEFInline XBRL Taxonomy Extension Definition Linkbase DocumentFiled
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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Bank of Marin Bancorp
(registrant)
November 9, 2021 /s/ Timothy D. Myers
Date Timothy D. Myers
  President and Chief Executive Officer
  (Principal Executive Officer)
  
November 9, 2021 /s/ Tani Girton
Date 
Tani Girton
  Executive Vice President &
  Chief Financial Officer
(Principal Financial Officer)
November 9, 2021 /s/ David A. Merck
 Date David A. Merck
Vice President &
Financial Reporting Manager
   (Principal Accounting Officer)

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