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 June 30, 2023

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 100

Novato

CA

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 class			Trading symbol			Name of each exchange on which registered
Common stock, no par value			BMRC			The 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

☐

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 July 31, 2023, there were 16,120,092 shares of common stock outstanding.

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TABLE OF CONTENTS

 

PART I			FINANCIAL INFORMATION			3
ITEM 1.			Financial Statements (Unaudited)			3
			Consolidated Statements of Condition			3
			Consolidated Statements of Comprehensive (Loss) Income			4
			Consolidated Statements of Changes in Stockholders' Equity			5
			Consolidated Statements of Cash Flows			6
			Notes to Consolidated Financial Statements			7
ITEM 2.			Management’s Discussion and Analysis of Financial Condition and Results of Operations			29
ITEM 3.			Quantitative and Qualitative Disclosure about Market Risk			44
ITEM 4.			Controls and Procedures			45
PART II			OTHER INFORMATION			46
ITEM 1.			Legal Proceedings			46
ITEM 1A.			Risk Factors			46
ITEM 2.			Unregistered Sales of Equity Securities and Use of Proceeds			46
ITEM 3.			Defaults Upon Senior Securities			47
ITEM 4.			Mine Safety Disclosures			47
ITEM 5.			Other Information			47
ITEM 6.			Exhibits			48
SIGNATURES

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PART I       FINANCIAL INFORMATION

 

ITEM 1.  Financial Statements 

BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CONDITION

(in thousands, except share data; unaudited)			June 30, 2023			December 31, 2022
Assets
Cash, cash equivalents and restricted cash			$	39,657		$	45,424
Investment securities:
Held-to-maturity, at amortized cost (net of zero allowance for credit losses at June 30, 2023 and December 31, 2022)			946,808			972,207
Available-for-sale, at fair value (net of zero allowance for credit losses at June 30, 2023 and December 31, 2022)			770,942			802,096
Total investment securities			1,717,750			1,774,303
Loans, at amortized cost			2,102,796			2,092,546
Allowance for credit losses on loans			(23,832)			(22,983)
Loans, net of allowance for credit losses on loans			2,078,964			2,069,563
Goodwill			72,754			72,754
Bank-owned life insurance			67,367			67,066
Operating lease right-of-use assets			22,739			24,821
Bank premises and equipment, net			8,683			8,134
Core deposit intangible, net			4,431			5,116
Other real estate owned			415			455
Interest receivable and other assets			79,373			79,828
Total assets			$	4,092,133		$	4,147,464
Liabilities and Stockholders' Equity
Liabilities
Deposits:
Non-interest bearing			$	1,588,723		$	1,839,114
Interest bearing
Transaction accounts			229,434			287,651
Savings accounts			274,510			338,163
Money market accounts			1,029,082			989,390
Time accounts			203,463			119,030
Total deposits			3,325,212			3,573,348
Short-term borrowings and other obligations			292,572			112,439
Operating lease liabilities			25,220			26,639
Interest payable and other liabilities			25,188			22,946
Total liabilities			3,668,192			3,735,372
Commitments and contingent liabilities (Note 8)
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 - 16,107,192 and 16,029,138 at June 30, 2023 and December 31, 2022, respectively			216,589			215,057
Retained earnings			276,732			270,781
Accumulated other comprehensive loss, net of taxes			(69,380)			(73,746)
Total stockholders' equity			423,941			412,092
Total liabilities and stockholders' equity			$	4,092,133		$	4,147,464

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

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BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
			Three months ended												Six months ended
(in thousands, except per share amounts; unaudited)			June 30, 2023			March 31, 2023			June 30, 2022						June 30, 2023			June 30, 2022
Interest income
Interest and fees on loans			$	24,579		$	24,258		$	23,334					$	48,837		$	47,011
Interest on investment securities			9,994			10,033			8,273						20,027			14,966
Interest on federal funds sold and due from banks			48			56			180						104			286
Total interest income			34,621			34,347			31,787						68,968			62,263
Interest expense
Interest on interest-bearing transaction accounts			234			254			53						488			109
Interest on savings accounts			146			170			32						316			61
Interest on money market accounts			4,292			1,085			438						5,377			916
Interest on time accounts			946			223			67						1,169			81
Interest on borrowings and other obligations			4,873			2,716			—						7,589			1
Total interest expense			10,491			4,448			590						14,939			1,168
Net interest income			24,130			29,899			31,197						54,029			61,095
Provision for (reversal of) credit losses on loans			500			350			—						850			(485)
Reversal of credit losses on unfunded loan commitments			(168)			(174)			—						(342)			(318)
Net interest income after provision for (reversal of) credit losses			23,798			29,723			31,197						53,521			61,898
Non-interest income
Wealth Management and Trust Services			559			511			630						1,070			1,230
Earnings on bank-owned life insurance, net			362			705			298						1,067			711
Service charges on deposit accounts			520			533			465						1,053			953
Debit card interchange fees, net			555			447			531						1,002			1,036
Dividends on Federal Home Loan Bank stock			290			302			249						592			508
Merchant interchange fees, net			127			133			149						260			289
Other income			326			304			406						630			868
Total non-interest income			2,739			2,935			2,728						5,674			5,595
Non-interest expense
Salaries and related benefits			11,416			10,930			10,341						22,346			21,889
Occupancy and equipment			1,980			2,414			1,891						4,394			3,798
Data processing			922			1,045			1,199						1,967			2,476
Professional services			797			1,123			665						1,920			1,578
Depreciation and amortization			400			882			393						1,282			845
Federal Deposit Insurance Corporation insurance			666			289			296						955			586
Information technology			357			370			468						727			946
Charitable contributions			638			49			511						687			556
Amortization of core deposit intangible			340			345			374						685			754
Directors' expense			300			321			294						621			605
Other real estate owned			44			4			3						48			5
Other expense			2,805			2,008			2,471						4,813			4,243
Total non-interest expense			20,665			19,780			18,906						40,445			38,281
Income before provision for income taxes			5,872			12,878			15,019						18,750			29,212
Provision for income taxes			1,321			3,438			3,953						4,759			7,681
Net income			$	4,551		$	9,440		$	11,066					$	13,991		$	21,531
Net income per common share:
Basic			$	0.28		$	0.59		$	0.70					$	0.88		$	1.35
Diluted			$	0.28		$	0.59		$	0.69					$	0.87		$	1.35
Weighted average shares:
Basic			16,009			15,970			15,921						15,990			15,898
Diluted			16,016			15,999			15,955						16,008			15,950
Comprehensive (loss) income:
Net income			$	4,551		$	9,440		$	11,066					$	13,991		$	21,531
Other comprehensive (loss) income:
Change in net unrealized gains or losses on available-for-sale securities			(10,928)			16,213			(27,050)						5,285			(65,278)
Net unrealized losses on securities transferred from available-for-sale to held-to-maturity			—			—			—						—			(14,847)
Amortization of net unrealized losses on securities transferred from available-for-sale to held-to-maturity			451			463			472						914			616
Other comprehensive (loss) income, before tax			(10,477)			16,676			(26,578)						6,199			(79,509)
Deferred tax (benefit) expense			(3,097)			4,930			(7,857)						1,833			(23,505)
Other comprehensive (loss) income, net of tax			(7,380)			11,746			(18,721)						4,366			(56,004)
Total comprehensive (loss) income			$	(2,829)		$	21,186		$	(7,655)					$	18,357		$	(34,473)

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

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BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the three months ended June 30, 2023 and 2022

(in thousands, except share data; unaudited)			Common Stock						Retained Earnings			Accumulated Other Comprehensive (Loss) Income, Net of Taxes			Total
			Shares			Amount
			Three months ended June 30, 2023
Balance at April 1, 2023			16,107,210			$	215,965		$	276,209		$	(62,000)		$	430,174
Net income			—			—			4,551			—			4,551
Other comprehensive loss, net of tax			—			—			—			(7,380)			(7,380)
Stock issued under employee stock purchase plan			741			12			—			—			12
Stock issued under employee stock ownership plan			19,700			424			—			—			424
Restricted stock surrendered for tax withholdings upon vesting			(285)			(4)			—			—			(4)
Restricted stock forfeited / cancelled			(20,174)			—			—			—			—
Stock-based compensation - stock options			—			21			—			—			21
Stock-based compensation - restricted stock			—			171			—			—			171
Cash dividends paid on common stock ($0.25 per share)			—			—			(4,028)			—			(4,028)
Balance at June 30, 2023			16,107,192			$	216,589		$	276,732		$	(69,380)		$	423,941
			Three months ended June 30, 2022
Balance at April 1, 2022			16,003,847			$	213,204		$	246,511		$	(39,307)		$	420,408
Net income			—			—			11,066			—			11,066
Other comprehensive loss, net of tax			—			—			—			(18,721)			(18,721)
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings			4,768			81			—			—			81
Stock issued under employee stock purchase plan			936			30			—			—			30
Stock issued under employee stock ownership plan			13,000			412			—			—			412
Restricted stock surrendered for tax withholdings upon vesting			(333)			(11)			—			—			(11)
Restricted stock forfeited / cancelled			(12,618)			—			—			—			—
Stock-based compensation - stock options			—			29			—			—			29
Stock-based compensation - restricted stock			—			119			—			—			119
Cash dividends paid on common stock ($0.24 per share)			—			—			(3,840)			—			(3,840)
Balance at June 30, 2022			16,009,600			$	213,864		$	253,737		$	(58,028)		$	409,573

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 six months ended June 30, 2023 and 2022
(in thousands, except share data; unaudited)			Common Stock						Retained Earnings			Accumulated Other Comprehensive (Loss) Income, Net of Taxes			Total
			Shares			Amount
			Six months ended June 30, 2023
Balance at January 1, 2023			16,029,138			$	215,057		$	270,781		$	(73,746)		$	412,092
Net income			—			—			13,991			—			13,991
Other comprehensive income, net of tax			—			—			—			4,366			4,366
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings			11,530			230			—			—			230
Stock issued under employee stock purchase plan			1,156			21			—			—			21
Stock issued under employee stock ownership plan			34,000			847			—			—			847
Restricted stock granted			49,428			—			—			—			—
Restricted stock surrendered for tax withholdings upon vesting			(2,498)			(70)			—			—			(70)
Restricted stock forfeited / cancelled			(20,174)			—			—			—			—
Stock-based compensation - stock options			—			137			—			—			137
Stock-based compensation - restricted stock			—			217			—			—			217
Cash dividends paid on common stock ($0.50 per share)			—			—			(8,040)			—			(8,040)
Stock issued in payment of director fees			4,612			150			—			—			150
Balance at June 30, 2023			16,107,192			$	216,589		$	276,732		$	(69,380)		$	423,941
			Six months ended June 30, 2022
Balance at January 1, 2022			15,929,243			$	212,524		$	239,868		$	(2,024)		$	450,368
Net income			—			—			21,531			—			21,531
Other comprehensive loss, net of tax			—			—			—			(56,004)			(56,004)
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings			40,311			820			—			—			820
Stock issued under employee stock purchase plan			936			30			—			—			30
Stock issued under employee stock ownership plan			25,000			829			—			—			829
Restricted stock granted			46,672			—			—			—			—
Restricted stock surrendered for tax withholdings upon vesting			(1,169)			(40)			—			—			(40)
Restricted stock forfeited / cancelled			(13,267)			—			—			—			—
Stock-based compensation - stock options			—			115			—			—			115
Stock-based compensation - restricted stock			—			270			—			—			270
Cash dividends paid on common stock ($0.48 per share)			—			—			(7,662)			—			(7,662)
Stock issued in payment of director fees			5,149			193			—			—			193
Stock repurchased, including commissions			(23,275)			(877)			—			—			(877)
Balance at June 30, 2022			16,009,600			$	213,864		$	253,737		$	(58,028)		$	409,573
The accompanying notes are an integral part of these consolidated financial statements (unaudited).

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BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended June 30, 2023 and 2022

(in thousands; unaudited)			2023			2022
Cash Flows from Operating Activities:
Net income			$	13,991		$	21,531
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for (reversal of) credit losses on loans			850			(485)
Reversal of credit losses on unfunded loan commitments			(342)			(318)
Noncash contribution expense to employee stock ownership plan			847			829
Noncash director compensation expense			150			193
Stock-based compensation expense			354			385
Amortization of core deposit intangible			685			754
Amortization of investment security premiums, net of accretion of discounts			3,781			4,963
(Accretion of discounts) amortization of premiums on acquired loans, net			(415)			281
Net change in deferred loan origination costs/fees			(588)			(2,322)
Write-down of other real estate owned			40			—
Depreciation and amortization			1,282			845
Earnings on bank-owned life insurance policies			(1,067)			(711)
Net changes in interest receivable and other assets			(1,354)			(443)
Net changes in interest payable and other liabilities			3,284			(5,894)
Total adjustments			7,507			(1,923)
Net cash provided by operating activities			21,498			19,608
Cash Flows from Investing Activities:
Purchase of held-to-maturity securities			—			(208,784)
Purchase of available-for-sale securities			—			(243,459)
Proceeds from paydowns/maturities of held-to-maturity securities			25,377			16,827
Proceeds from paydowns/maturities of available-for-sale securities			33,595			76,276
(Increase) decrease in loans receivable, net			(9,271)			93,875
Proceeds from bank-owned life insurance policies			766			350
Purchase of premises and equipment			(1,823)			(354)
Cash paid for low income housing tax credit investment			(39)			(30)
Net cash provided by (used in) investing activities			48,605			(265,299)
Cash Flows from Financing Activities:
Net (decrease) increase in deposits			(248,136)			22,120
Proceeds from short-term Federal Home Loan Bank borrowings, net			180,200			—
Repayment of finance lease obligations			(75)			(63)
Proceeds from stock options exercised			230			820
Restricted stock surrendered for tax withholdings upon vesting			(70)			(40)
Cash dividends paid on common stock			(8,040)			(7,662)
Stock repurchased, including commissions			—			(1,250)
Proceeds from stock issued under employee and director stock purchase plans			21			30
Net cash (used in) provided by financing activities			(75,870)			13,955
Net decrease in cash, cash equivalents and restricted cash			(5,767)			(231,736)
Cash, cash equivalents and restricted cash at beginning of period			45,424			347,641
Cash, cash equivalents and restricted cash at end of period			$	39,657		$	115,905
Supplemental disclosure of cash flow information:
Cash paid in interest			$	14,151		$	1,175
Cash paid in income taxes			$	—		$	8,450
Supplemental disclosure of noncash investing and financing activities:
Change in net unrealized gains or losses on available-for-sale securities			$	5,285		$	(65,278)
Securities transferred from available-for-sale to held-to-maturity, at fair value			$	—		$	357,482
Amortization of net unrealized loss on available-for-sale securities transferred to held-to-maturity			$	914		$	616
Purchase of investment securities not yet settled			$	—		$	40,278
Stock issued to employee stock ownership plan			$	847		$	829
Restricted cash1			$	—		$	930

1 Restricted cash includes reserve requirements held with the Federal Reserve Bank of San Francisco and other cash pledged. 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).

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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. 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.

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 2022 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 (loss), 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 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, the difference in EPS is nominal for these participating securities.

			Three months ended									Six months ended
(in thousands, except per share data)			June 30, 2023			June 30, 2022						June 30, 2023			June 30, 2022
Weighted average basic common shares outstanding			16,009			15,921						15,990			15,898
Potentially dilutive common shares related to:
Stock options			—			24						7			38
Unvested restricted stock awards			7			10						11			14
Weighted average diluted common shares outstanding			16,016			15,955						16,008			15,950
Net income			$	4,551		$	11,066					$	13,991		$	21,531
Basic EPS			$	0.28		$	0.70					$	0.88		$	1.35
Diluted EPS			$	0.28		$	0.69					$	0.87		$	1.35
Weighted average anti-dilutive common shares not included in the calculation of diluted EPS			389			230						358			167

Note 2: Recently Adopted and Issued Accounting Standards

Accounting Standards Adopted in 2023

In March 2022, the FASB issued ASU No. 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. The amendment eliminated the recognition measurement guidance for troubled debt restructured ("TDR") loans and instead enhanced disclosure requirements for certain loan modifications when a borrower is experiencing financial difficulty. In addition, the amendment required that an entity include in its vintage disclosures the current period gross loan charge-offs by year of origination. We early adopted the current period charge-off disclosures in the first quarter of 2022. We adopted the loan modification provisions as

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of January 1, 2023 using a modified retrospective method. The cumulative-effect adjustment to retained earnings was considered immaterial. Refer to Note 5, Loans and Allowance for Credit Losses on Loans, for additional information.

In March 2022, the FASB issued ASU No. 2022-01, Derivatives and Hedging (Topic 815): Fair Value Hedging - Portfolio Layer Method. Among other things, the ASU renamed the "last-of-layer" method to the "portfolio layer" method and made fair value hedging more accessible for hedge accounting of interest rate risk for portfolios and financial assets. For example, the guidance permits an entity to apply the same portfolio hedging method to both prepayable and non-prepayable financial assets, thereby providing for consistency between accounting for similar hedges. We adopted the amendments on January 1, 2023, which had no effect on our existing hedge accounting, disclosures, financial condition or results of operations.

Accounting Standards Not Yet Effective

In March 2020, the FASB issued Accounting Standards Update ("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. Topic 848 was further amended in January 2021 with ASU No. 2021-01, which provided additional guidance on certain optional expedients and scope of derivative instruments, and in December 2022 with ASU 2022-06, which extended the sunset date of Topic 848 to December 31, 2024 given the UK Financial Conduct Authority ("FCA") March 2021 announcement that the intended cessation date of certain tenors of USD LIBOR would be June 30, 2023. An entity may elect the amendments in these updates at an interim period with adoption methods varying based on transaction type. As of June 30, 2023, we had four interest rate swap contracts with notional values totaling $11.5 million indexed to LIBOR, which transitioned to the Secured Overnight Financing Rate ("SOFR") effective July 1, 2023. The transition to SOFR did not have a material impact to either our financial condition or results of operations.

In June 2022, the FASB issued ASU No. 2022-03, Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions. The amendment reduces diversity in practice by clarifying that a separate contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. In addition, this ASU provided amended examples to illustrate that a restriction that is a characteristic of the equity security, which market participants would take into account when pricing them, would be considered in measuring fair value. This ASU also introduces new disclosure requirements. The amendments are effective prospectively for years beginning after December 15, 2023. Early adoption is permitted for both interim and annual financial statements. As discussed in Note 4, Investment Securities, on July 13, 2023 we sold our remaining shares of Visa Inc. Class B restricted common stock. As a result of the sale, this update will not impact our financial condition, results of operations or disclosures.

In March 2023, the FASB issued ASU No. 2023-01, Leases (Topic 842): Common Control Arrangements. For public companies, the amendment requires entities to amortize leasehold improvements associated with common control lease arrangements over the useful life of the improvements to the common control group, as opposed to the shorter of the remaining lease term and the useful life of the improvements for all other operating leases. The amendments are effective for years beginning after December 15, 2023, and may be adopted either prospectively or retrospectively. Early adoption is permitted for both interim and annual financial statements. We currently do not have common control lease arrangements, and therefore do not anticipate that the amendments will impact our financial condition and results of operations.

In March 2023, the FASB issued ASU No. 2023-02, Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method. Under current GAAP, an entity can only elect to apply the proportional amortization method to investments in low-income housing tax credit ("LIHTC") structures. The proportional amortization method results in the cost of the investment being amortized in proportion to the income tax credits and other income tax benefits received, with the amortization of the investment and the income tax credits being presented net in the consolidated statements of income as a component of income tax expense (benefit). The amendments will allow entities to elect to account for all other equity investments made primarily for the purpose of receiving income tax credits to using the proportional amortization method, regardless of the tax credit program through which the investment earns income tax credits,

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when certain conditions are met. The amendments are effective for fiscal years beginning after December 15, 2023, and may be adopted either on a modified retrospective basis or retrospectively. Other than investments in LIHTC funds, as disclosed in Note 4, Investment Securities, we currently have no other equity investments made primarily for the purpose of receiving income tax credits, and therefore do not anticipate that the amendments will impact 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.

Transfers between levels of the fair value hierarchy are recognized through our monthly and/or quarterly valuation process in the reporting period during which the event or circumstances that caused the transfer occurred. No such transfers occurred in the years presented.

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

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(in thousands)   Description of Financial Instruments			Carrying Value			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs  (Level 3)			Measurement Categories: Changes in Fair Value Recorded In1
June 30, 2023
Securities available-for-sale:
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies			$	449,823		$	—		$	449,823		$	—		OCI
SBA-backed securities			$	36,649		$	—		$	36,649		$	—		OCI
Debentures of government sponsored agencies			$	135,868		$	—		$	135,868		$	—		OCI
U.S. Treasury securities			$	10,334		$	10,334		$	—		$	—		OCI
Obligations of state and political subdivisions			$	102,916		$	—		$	102,916		$	—		OCI
Corporate bonds			$	34,043		$	—		$	34,043		$	—		OCI
Asset-backed securities			$	1,309		$	—		$	1,309		$	—		OCI
Derivative financial assets (interest rate contracts)			$	631		$	—		$	631		$	—		NI
December 31, 2022
Securities available-for-sale:
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies			$	475,505		$	—		$	475,505		$	—		OCI
SBA-backed securities			$	44,355		$	—		$	44,355		$	—		OCI
Debentures of government sponsored agencies			$	135,106		$	—		$	135,106		$	—		OCI
U.S. Treasury securities			$	10,269		$	10,269		$	—		$	—		OCI
Obligations of state and political subdivisions			$	102,123		$	—		$	102,123		$	—		OCI
Corporate bonds			$	33,276		$	—		$	33,276		$	—		OCI
Asset-backed securities			$	1,462		$	—		$	1,462		$	—		OCI
Derivative financial assets (interest rate contracts)			$	602		$	—		$	602		$	—		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 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 June 30, 2023 and December 31, 2022, there were no Level 3 securities.

Held-to-maturity securities may be subject to an allowance for credit losses as a result of our evaluation of expected losses due to credit quality factors. We did not record any credit loss expense on held-to-maturity securities during the six months ended June 30, 2023 or June 30, 2022. 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. These unobservable inputs are not considered significant inputs to the fair value measurement overall. 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

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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 individually analyzed 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 American River Bankshares ("AMRB") merger in 2021.

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 June 30, 2023 and December 31, 2022.

(in thousands)			Carrying Value			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs  (Level 3)
June 30, 2023
Other real estate owned			$	415		$	—		$	—		$	415
December 31, 2022
Other real estate owned			$	455		$	—		$	—		$	455

On July 12, 2023, the Bank completed the sale of its only other real estate owned property and realized a negligible gain after sales costs.

Disclosures about Fair Value of Financial Instruments

 

The table below is a summary of fair value estimates for financial instruments as of June 30, 2023 and December 31, 2022, 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"), lease obligations and non-maturity deposit liabilities. Additionally, we held shares of Federal Home Loan Bank ("FHLB") of San Francisco stock at cost and Visa Inc. Class B common stock with no carrying value, 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 June 30, 2023 or December 31, 2022. The values are discussed in Note 4, Investment Securities.

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			June 30, 2023												December 31, 2022
(in thousands)			Carrying Amounts			Fair Value			Fair Value Hierarchy						Carrying Amounts			Fair Value			Fair Value Hierarchy
Financial assets (recorded at amortized cost):
Cash and cash equivalents			$	39,657		$	39,657		Level 1						$	45,424		$	45,424		Level 1
Investment securities held-to-maturity			946,808			826,067			Level 2						972,207			845,239			Level 2
Loans, net			2,078,964			1,985,481			Level 3						2,069,563			1,993,866			Level 3
Interest receivable			12,810			12,810			Level 2						13,069			13,069			Level 2
Financial liabilities (recorded at amortized cost):
Time deposits			203,463			204,679			Level 2						119,030			118,333			Level 2
Federal Home Loan Bank short-term borrowings			292,200			292,200			Level 2						112,000			112,000			Level 2
Interest payable			868			868			Level 2						75			75			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 differ from actual price from a prospective buyer. The discounted cash flow valuation approach reflects key inputs and assumptions that are unobservable, 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 observable market rates offered for time deposits of similar remaining maturities.

Due to the short-term nature of the FHLB borrowings, the carrying value approximates fair value.

The value of off-balance-sheet 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 June 30, 2023 or December 31, 2022.

Note 4:  Investment Securities

 

Our investment securities portfolio consists of U.S. Treasury securities, obligations of state and political subdivisions, 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, U.S. Corporations and one asset-backed security collateralized by student loan pools. 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.

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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 June 30, 2023 and December 31, 2022 is presented below.

Held-to-maturity:			Amortized Cost 1			Allowance for Credit Losses			Net Carrying Amount			Gross Unrealized						Fair Value
(in thousands)												Gains			(Losses)
June 30, 2023
Securities of U.S. government-sponsored enterprises:
MBS pass-through securities issued by FHLMC, FNMA and GNMA			$	316,968		$	—		$	316,968		$	—		$	(48,904)		$	268,064
CMOs issued by FHLMC			231,217			—			231,217			177			(27,759)			203,635
CMOs issued by FNMA			106,894			—			106,894			113			(6,436)			100,571
CMOs issued by GNMA			51,511			—			51,511			216			(3,271)			48,456
SBA-backed securities			1,977			—			1,977			—			(130)			1,847
Debentures of government-sponsored agencies			145,973			—			145,973			—			(24,087)			121,886
Obligations of state and political subdivisions			62,268			—			62,268			6			(9,029)			53,245
Corporate bonds			30,000			—			30,000			—			(1,637)			28,363
Total held-to-maturity			$	946,808		$	—		$	946,808		$	512		$	(121,253)		$	826,067
December 31, 2022
Securities of U.S. government-sponsored enterprises:
MBS pass-through securities issued by FHLMC, FNMA and GNMA			$	331,281		$	—		$	331,281		$	—		$	(50,147)		$	281,134
CMOs issued by FHLMC			235,971			—			235,971			59			(29,503)			206,527
CMOs issued by FNMA			111,904			—			111,904			—			(5,419)			106,485
CMOs issued by GNMA			52,356			—			52,356			11			(3,076)			49,291
SBA-backed securities			2,372			—			2,372			—			(133)			2,239
Debentures of government-sponsored agencies			145,823			—			145,823			—			(26,467)			119,356
Obligations of state and political subdivisions			62,500			—			62,500			—			(10,741)			51,759
Corporate bonds			30,000			—			30,000			—			(1,552)			28,448
Total held-to-maturity			$	972,207		$	—		$	972,207		$	70		$	(127,038)		$	845,239
1 Amortized cost and fair values exclude accrued interest receivable of $3.6 million and $3.7 million at June 30, 2023 and December 31, 2022, 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 collectively 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 and corporate bonds, 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 our 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 and corporate bonds by Moody's and/or Standard & Poor's bond ratings as of June 30, 2023.

			Obligations of state and political subdivisions						Corporate bonds
(in thousands)			June 30, 2023			December 31, 2022			June 30, 2023			December 31, 2022
AAA / Aaa			$	42,783		$	42,986		$	—		$	—
AA / Aa			19,485			19,514			—			—
A2 / A			—			—			30,000			30,000
Total			$	62,268		$	62,500		$	30,000		$	30,000

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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 June 30, 2023 and December 31, 2022 is presented below.

Available-for-sale:			Amortized Cost 1			Gross Unrealized						Allowance for Credit Losses			Fair Value
(in thousands)						Gains			(Losses)
June 30, 2023
Securities of U.S. government-sponsored enterprises:
MBS pass-through securities issued by FHLMC, FNMA and GNMA			$	102,420		$	2		$	(11,758)		$	—		$	90,664
CMOs issued by FHLMC			333,374			—			(32,162)			—			301,212
CMOs issued by FNMA			32,916			—			(3,816)			—			29,100
CMOs issued by GNMA			32,193			31			(3,377)			—			28,847
SBA-backed securities			39,824			—			(3,175)			—			36,649
Debentures of government- sponsored agencies			149,129			—			(13,261)			—			135,868
U.S. Treasury securities			11,914			—			(1,580)			—			10,334
Obligations of state and political subdivisions			116,040			36			(13,160)			—			102,916
Corporate bonds			36,991			—			(2,948)			—			34,043
Asset-backed securities			1,365			—			(56)			—			1,309
Total available-for-sale			$	856,166		$	69		$	(85,293)		$	—		$	770,942
December 31, 2022
Securities of U.S. government-sponsored enterprises:
MBS pass-through securities issued by FHLMC, FNMA and GNMA			$	109,736		$	3		$	(12,133)		$	—		$	97,606
CMOs issued by FHLMC			347,437			—			(33,682)			—			313,755
CMOs issued by FNMA			36,172			—			(3,852)			—			32,320
CMOs issued by GNMA			35,120			—			(3,296)			—			31,824
SBA-backed securities			47,724			2			(3,371)			—			44,355
Debentures of government- sponsored agencies			149,114			—			(14,008)			—			135,106
U.S. Treasury securities			11,904			—			(1,635)						10,269
Obligations of state and political subdivisions			116,855			29			(14,761)			—			102,123
Corporate bonds			36,990			—			(3,714)			—			33,276
Asset-backed securities			1,553			—			(91)			—			1,462
Total available-for-sale			$	892,605		$	34		$	(90,543)		$	—		$	802,096
1 Amortized cost and fair value exclude accrued interest receivable of $3.1 million and $3.2 million at June 30, 2023 and December 31, 2022, respectively, which is included in interest receivable and other assets in the consolidated statements of condition.

As part of our ongoing review of our investment securities portfolio, we reassessed the classification of certain securities issued by government sponsored agencies. In March 2022, we transferred $357.5 million of these securities from available-for-sale to held-to-maturity at fair value. We intend and have the ability to hold these securities to maturity. The net unrealized pre-tax loss of $14.8 million that remained and the related accumulated other comprehensive loss are accreted to interest income over the remaining lives of the securities. Because these entries offset each other, there was no impact to net income.

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

			June 30, 2023																		December 31, 2022
			Held-to-Maturity									Available-for-Sale									Held-to-Maturity									Available-for-Sale
(in thousands)			Amortized Cost			Fair Value						Amortized Cost			Fair Value						Amortized Cost			Fair Value						Amortized Cost			Fair Value
Within one year			$	—		$	—					$	26,665		$	25,344					$	450		$	446					$	1,254		$	1,239
After one but within five years			89,625			85,060						354,735			324,368						87,418			83,663						335,813			307,843
After five years through ten years			266,785			227,818						130,738			117,530						262,072			222,280						185,997			166,273
After ten years			590,398			513,189						344,028			303,700						622,267			538,850						369,541			326,741
Total			$	946,808		$	826,067					$	856,166		$	770,942					$	972,207		$	845,239					$	892,605		$	802,096

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There were no sales of investment securities in either the first half of 2023 or 2022. However, in July 2023, the Bank sold $82.7 million of available-for-sale securities for a net loss of $2.8 million. In addition, on July 13, 2023, the Bank sold its remaining investment in Visa Inc. Class B restricted common stock, which had a zero carrying value, for a $2.8 million gain.

Three months ended

The carrying values of pledged investment securities are shown in the following table:

(in thousands)			June 30, 2023			December 31, 2022
Pledged to the State of California:
Secure public deposits in compliance with the Local Agency Security Program			$	199,327		$	235,587
Collateral for trust deposits			672			677
Collateral for Wealth Management and Trust Services checking account			565			569
Total investment securities pledged to the State of California			200,564			236,833
Bankruptcy trustee deposits pledged with Federal Reserve Bank			1,594			1,737
Pledged to FHLB Securities-Backed Credit Program			391,668			—
Pledged to the Federal Reserve Bank Term Funding Program ("BTFP")			274,215			—
Total pledged investment securities			$	868,041		$	238,570

There were 396 and 407 securities in unrealized loss positions at June 30, 2023 and December 31, 2022, respectively. Those securities are summarized and classified according to the duration of the loss period in the tables below:

June 30, 2023			< 12 continuous months									≥ 12 continuous months									Total securities  in a loss position
(in thousands)			Fair value			Unrealized loss						Fair value			Unrealized loss						Fair value			Unrealized loss
Held-to-maturity:
MBS pass-through securities issued by FHLMC, FNMA and GNMA			$	4,178		$	(132)					$	263,886		$	(48,772)					$	268,064		$	(48,904)
CMOs issued by FHLMC			31,915			(1,171)						162,369			(26,588)						194,284			(27,759)
CMOs issued by FNMA			43,167			(2,064)						39,161			(4,372)						82,328			(6,436)
CMOs issued by GNMA			27,024			(1,895)						9,902			(1,376)						36,926			(3,271)
SBA-backed securities			—			—						1,847			(130)						1,847			(130)
Debentures of government-sponsored agencies			29,245			(749)						92,642			(23,338)						121,887			(24,087)
Obligations of state and political subdivisions			—			—						50,154			(9,029)						50,154			(9,029)
Corporate bonds			—			—						28,363			(1,637)						28,363			(1,637)
Total held-to-maturity			135,529			(6,011)						648,324			(115,242)						783,853			(121,253)
Available-for-sale:
MBS pass-through securities issued by FHLMC, FNMA and GNMA			4,422			(177)						85,498			(11,581)						89,920			(11,758)
CMOs issued by FHLMC			12			—						301,200			(32,162)						301,212			(32,162)
CMOs issued by FNMA			37			(1)						29,063			(3,815)						29,100			(3,816)
CMOs issued by GNMA			—			—						25,070			(3,377)						25,070			(3,377)
SBA-backed securities			29			—						36,309			(3,175)						36,338			(3,175)
Debentures of government- sponsored agencies			—			—						135,868			(13,261)						135,868			(13,261)
U.S. Treasury securities			—			—						10,334			(1,580)						10,334			(1,580)
Obligations of state and political subdivisions			4,799			(54)						90,869			(13,106)						95,668			(13,160)
Corporate bonds			—			—						34,043			(2,948)						34,043			(2,948)
Asset-backed securities			—			—						1,309			(56)						1,309			(56)
Total available-for-sale			9,299			(232)						749,563			(85,061)						758,862			(85,293)
Total securities at loss position			$	144,828		$	(6,243)					$	1,397,887		$	(200,303)					$	1,542,715		$	(206,546)

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December 31, 2022			< 12 continuous months									≥ 12 continuous months									Total securities  in a loss position
(in thousands)			Fair value			Unrealized loss						Fair value			Unrealized loss						Fair value			Unrealized loss
Held-to-maturity:
MBS pass-through securities issued by FHLMC, FNMA and GNMA			$	62,627		$	(5,960)					$	218,507		$	(44,187)					$	281,134		$	(50,147)
CMOs issued by FHLMC			78,144			(5,874)						113,796			(23,629)						191,940			(29,503)
CMOs issued by FNMA			106,485			(5,419)						—			—						106,485			(5,419)
CMOs issued by GNMA			27,570			(1,676)						10,331			(1,400)						37,901			(3,076)
SBA-backed securities			2,239			(133)						—			—						2,239			(133)
Debentures of government- sponsored agencies			38,645			(2,530)						80,711			(23,937)						119,356			(26,467)
Obligations of state and political subdivisions			15,155			(589)						36,603			(10,152)						51,758			(10,741)
Corporate Bonds			28,448			(1,552)						—			—						28,448			(1,552)
Total held-to-maturity			359,313			(23,733)						459,948			(103,305)						819,261			(127,038)
Available-for-sale:
MBS pass-through securities issued by FHLMC, FNMA and GNMA			44,630			(4,501)						52,235			(7,632)						96,865			(12,133)
CMOs issued by FHLMC			169,760			(15,144)						143,995			(18,538)						313,755			(33,682)
CMOs issued by FNMA			4,790			(235)						27,529			(3,617)						32,319			(3,852)
CMOs issued by GNMA			8,214			(374)						23,612			(2,922)						31,826			(3,296)
SBA-backed securities			37,845			(3,228)						6,133			(143)						43,978			(3,371)
Debentures of government- sponsored agencies			19,054			(946)						116,052			(13,062)						135,106			(14,008)
U.S. Treasury securities			—			—						10,269			(1,635)						10,269			(1,635)
Obligations of state and political subdivisions			70,402			(9,459)						28,711			(5,302)						99,113			(14,761)
Corporate Bonds			—			—						33,276			(3,714)						33,276			(3,714)
Asset-backed securities			—			—						1,462			(91)						1,462			(91)
Total available-for-sale			354,695			(33,887)						443,274			(56,656)						797,969			(90,543)
Total securities at loss position			$	714,008		$	(57,620)					$	903,222		$	(159,961)					$	1,617,230		$	(217,581)

As of June 30, 2023, the investment portfolio included 373 investment securities that had been in a continuous loss position for twelve months or more and 23 investment securities that had been in a loss position for less than twelve months.

Securities issued by government-sponsored enterprises, 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.

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 credit risk factors at either June 30, 2023 or December 31, 2022.

On July 7, 2023, the Bank entered into various interest rate swap agreements with notional values totaling $101.8 million to hedge balance sheet interest rate sensitivity and protect selected securities in its available-for-sale portfolio against changes in fair value related to changes in the benchmark interest rate. For additional details, refer to Note 9, Derivative Financial Instruments and Hedging Activities.

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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 of FHLB stock included in other assets on the consolidated statements of condition at both June 30, 2023 and December 31, 2022. 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 June 30, 2023 and December 31, 2022. On July 27, 2023, FHLB announced a cash dividend for the second quarter of 2023 at an annualized dividend rate of 7.75% to be distributed on August 10, 2023. 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 June 30, 2023 and December 31, 2022. These shares had a carrying value of zero and were 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 lacked a readily determinable fair value. On July 13, 2023, the Bank sold the entirety of its remaining investment in Visa Inc. Class B restricted common stock for a $2.8 million gain.

For further information on the Covered Litigation, 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 $2.3 million and $2.5 million recorded in other assets as of June 30, 2023 and December 31, 2022, respectively. In the first six months of 2023, we recognized $300 thousand of low-income housing tax credits and other tax benefits, offset by $252 thousand of amortization expense of low-income housing tax credit investment, as a component of income tax expense. As of June 30, 2023, our unfunded commitments for these low-income housing tax credit funds totaled $346 thousand. We did not recognize any impairment losses on these low-income housing tax credit investments during the first six months of 2023 or 2022, as the value of the future tax benefits exceeds the carrying value of the investments.

Note 5:  Loans and Allowance for Credit Losses on Loans

The following table presents the amortized cost of loans by class as of June 30, 2023 and December 31, 2022.

(in thousands)			June 30, 2023			December 31, 2022
Commercial and industrial			$	183,157		$	173,547
Real estate:
Commercial owner-occupied			344,951			354,877
Commercial non-owner occupied			1,196,158			1,191,889
Construction			108,986			114,373
Home equity			85,587			88,748
Other residential			118,646			112,123
Installment and other consumer loans			65,311			56,989
Total loans, at amortized cost 1			2,102,796			2,092,546
Allowance for credit losses on loans			(23,832)			(22,983)
Total loans, net of allowance for credit losses on loans			$	2,078,964		$	2,069,563

1 Amortized cost includes net deferred loan origination costs of $2.4 million and $1.8 million at June 30, 2023 and December 31, 2022, respectively. Amounts are also net of unrecognized purchase discounts of $2.2 million and $2.6 million at June 30, 2023 and December 31, 2022, respectively. Amortized cost excludes accrued interest, which totaled $6.0 million and $6.1 million at June 30, 2023 and December 31, 2022, respectively, and is included in interest receivable and other assets in the consolidated statements of condition.

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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.

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 luxury 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

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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.

 

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 and at each quarterly and year-end reporting period. 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 June 30, 2023 and December 31, 2022. The current year vintage table reflects gross charge-offs by loan class and year of origination. 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 Year																		Revolving Loans Amortized Cost
June 30, 2023			2023			2022			2021			2020			2019			Prior						Total
Commercial and industrial:
Pass and Watch			$	30,686		$	11,481		$	3,726		$	5,173		$	16,419		$	25,287		$	67,323		$	160,095
Special Mention			—			—			—			—			2,718			664			8,656			12,038
Substandard			—			274			—			1,030			—			3,641			6,079			11,024
Total commercial and industrial			$	30,686		$	11,755		$	3,726		$	6,203		$	19,137		$	29,592		$	82,058		$	183,157
Gross current period charge-offs			$	—		$	—		$	—		$	—		$	(3)		$	—		$	—		$	(3)
Commercial real estate, owner-occupied:
Pass and Watch			$	1,045		$	55,268		$	50,712		$	39,447		$	44,398		$	125,506		$	—		$	316,376
Special Mention			—			—			15,919			—			293			10,537			—			26,749
Substandard			—			—			—			—			—			1,826			—			1,826
Total commercial real estate, owner-occupied			$	1,045		$	55,268		$	66,631		$	39,447		$	44,691		$	137,869		$	—		$	344,951
Commercial real estate, non-owner occupied:
Pass and Watch			$	21,865		$	175,197		$	208,613		$	153,439		$	145,528		$	419,415		$	—		$	1,124,057
Special Mention			—			2,815			3,320			11,918			15,903			13,797			—			47,753
Substandard			—			—			2,227			—			—			22,121			—			24,348
Total commercial real estate, non-owner occupied			$	21,865		$	178,012		$	214,160		$	165,357		$	161,431		$	455,333		$	—		$	1,196,158

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(in thousands)			Term Loans - Amortized Cost by Origination Year																		Revolving Loans Amortized Cost
June 30, 2023			2023			2022			2021			2020			2019			Prior						Total
Construction:
Pass and Watch			$	10,537		$	45,971		$	24,061		$	28,417		$	—		$	—		$	—		$	108,986
Total construction			$	10,537		$	45,971		$	24,061		$	28,417		$	—		$	—		$	—		$	108,986
Home equity:
Pass and Watch			$	—		$	—		$	—		$	—		$	—		$	717		$	84,007		$	84,724
Substandard			—			—			—			—			—			441			422			863
Total home equity			$	—		$	—		$	—		$	—		$	—		$	1,158		$	84,429		$	85,587
Other residential:
Pass and Watch			$	12,521		$	20,322		$	13,818		$	27,340		$	21,605		$	23,040		$	—		$	118,646
Total other residential			$	12,521		$	20,322		$	13,818		$	27,340		$	21,605		$	23,040		$	—		$	118,646
Installment and other consumer:
Pass and Watch			$	14,426		$	16,790		$	11,884		$	5,182		$	5,741		$	10,264		$	1,024		$	65,311
Total installment and other consumer			$	14,426		$	16,790		$	11,884		$	5,182		$	5,741		$	10,264		$	1,024		$	65,311
Gross current period charge-offs			$	(6)		$	(5)		$	—		$	(4)		$	—		$	(1)		$	(4)		$	(20)
Total loans:
Pass and Watch			$	91,080		$	325,029		$	312,814		$	258,998		$	233,691		$	604,229		$	152,354		$	1,978,195
Total Special Mention			$	—		$	2,815		$	19,239		$	11,918		$	18,914		$	24,998		$	8,656		$	86,540
Total Substandard			$	—		$	274		$	2,227		$	1,030		$	—		$	28,029		$	6,501		$	38,061
Totals			$	91,080		$	328,118		$	334,280		$	271,946		$	252,605		$	657,256		$	167,511		$	2,102,796
Total gross current period charge-offs			$	(6)		$	(5)		$	—		$	(4)		$	(3)		$	(1)		$	(4)		$	(23)

(in thousands)			Term Loans - Amortized Cost by Origination Year																		Revolving Loans Amortized Cost
December 31, 2022			2022			2021			2020			2019			2018			Prior						Total
Commercial and industrial:
Pass and Watch			$	15,349		$	6,679		$	7,603		$	19,982		$	5,362		$	24,954		$	84,655		$	164,584
Special Mention			275			—			—			2,272			3,836			—			402			6,785
Substandard			—			—			1,252			—			—			625			301			2,178
Total commercial and industrial			$	15,624		$	6,679		$	8,855		$	22,254		$	9,198		$	25,579		$	85,358		$	173,547
Commercial real estate, owner-occupied:
Pass and Watch			$	54,188		$	52,080		$	40,369		$	44,798		$	29,856		$	104,377		$	—		$	325,668
Special Mention			—			16,199			—			304			5,255			4,493			—			26,251
Substandard			—			—			—			1,160			—			1,699			—			2,859
Doubtful			—			—			99			—			—			—			—			99
Total commercial real estate, owner-occupied			$	54,188		$	68,279		$	40,468		$	46,262		$	35,111		$	110,569		$	—		$	354,877
Commercial real estate, non-owner occupied:
Pass and Watch			$	177,822		$	211,228		$	155,278		$	160,670		$	129,166		$	308,509		$	57		$	1,142,730
Special Mention			—			1,172			12,097			3,934			678			9,290			—			27,171
Substandard			—			2,264			—			—			—			19,724			—			21,988
Total commercial real estate, non-owner occupied			$	177,822		$	214,664		$	167,375		$	164,604		$	129,844		$	337,523		$	57		$	1,191,889
Construction:
Pass and Watch			$	49,262		$	19,393		$	28,861		$	7,745		$	9,112		$	—		$	—		$	114,373
Total construction			$	49,262		$	19,393		$	28,861		$	7,745		$	9,112		$	—		$	—		$	114,373
Home equity:
Pass and Watch			$	—		$	—		$	—		$	—		$	—		$	883		$	86,971		$	87,854
Substandard			—			—			—			—			—			480			414			894
Total home equity			$	—		$	—		$	—		$	—		$	—		$	1,363		$	87,385		$	88,748
Other residential:
Pass and Watch			$	21,154		$	14,547		$	29,018		$	21,890		$	11,064		$	14,450		$	—		$	112,123
Total other residential			$	21,154		$	14,547		$	29,018		$	21,890		$	11,064		$	14,450		$	—		$	112,123
Installment and other consumer:
Pass and Watch			$	20,054		$	13,022		$	5,727		$	6,492		$	4,181		$	6,478		$	944		$	56,898
Substandard			—			—			—			—			—			91			—			91
Total installment and other consumer			$	20,054		$	13,022		$	5,727		$	6,492		$	4,181		$	6,569		$	944		$	56,989
Total loans:
Pass and Watch			$	337,829		$	316,949		$	266,856		$	261,577		$	188,741		$	459,651		$	172,627		$	2,004,230
Total Special Mention			$	275		$	17,371		$	12,097		$	6,510		$	9,769		$	13,783		$	402		$	60,207
Total Substandard			$	—		$	2,264		$	1,252		$	1,160		$	—		$	22,619		$	715		$	28,010
Total Doubtful			$	—		$	—		$	99		$	—		$	—		$	—		$	—		$	99
Totals			$	338,104		$	336,584		$	280,304		$	269,247		$	198,510		$	496,053		$	173,744		$	2,092,546

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The following table shows the amortized cost of loans by class, payment aging and non-accrual status as of June 30, 2023 and December 31, 2022.

Loan Aging Analysis by Class
(in thousands)			Commercial and industrial			Commercial real estate, owner-occupied			Commercial real estate, non-owner occupied			Construction			Home equity			Other residential			Installment and other consumer			Total
June 30, 2023
30-59 days past due			$	—		$	—		$	371		$	—		$	124		$	—		$	51		$	546
60-89 days past due			436			—			—			—			91			—			1			528
90 days or more past due			—			164			906			—			218			—			—			1,288
Total past due			436			164			1,277			—			433			—			52			2,362
Current			182,721			344,787			1,194,881			108,986			85,154			118,646			65,259			2,100,434
Total loans 1			$	183,157		$	344,951		$	1,196,158		$	108,986		$	85,587		$	118,646		$	65,311		$	2,102,796
Non-accrual loans 2			$	—		$	457		$	906		$	—		$	749		$	—		$	—		$	2,112
Non-accrual loans with no allowance			$	—		$	457		$	906		$	—		$	749		$	—		$	—		$	2,112
December 31, 2022
30-59 days past due			$	3		$	—		$	—		$	—		$	319		$	93		$	5		$	420
60-89 days past due			—			—			—			—			244			—			—			244
90 days or more past due			264			—			—			—			414			—			—			678
Total past due			267			—			—			—			977			93			5			1,342
Current			173,280			354,877			1,191,889			114,373			87,771			112,030			56,984			2,091,204
Total loans 1			$	173,547		$	354,877		$	1,191,889		$	114,373		$	88,748		$	112,123		$	56,989		$	2,092,546
Non-accrual loans 2			$	—		$	1,563		$	—		$	—		$	778		$	—		$	91		$	2,432
Non-accrual loans with no allowance			$	—		$	1,563		$	—		$	—		$	778		$	—		$	91		$	2,432

1 There were no non-performing loans past due more than ninety days and accruing interest as of June 30, 2023 and December 31, 2022.

2 None of the non-accrual loans as of June 30, 2023 or December 31, 2022 were earning interest on a cash basis. We recognized no interest income on non-accrual loans for the three and six months ended June 30, 2023 and 2022. We reversed interest income of $14 thousand and less than $8 thousand for loans on non-accrual status during the six months ended June 30, 2023 and June 30, 2022, respectively.

Collateral Dependent Loans

The following table presents the amortized cost basis of individually analyzed collateral-dependent loans, which are all on non-accrual status, by class at June 30, 2023 and December 31, 2022.

			Amortized Cost by Collateral Type
(in thousands)			Commercial Real Estate			Residential Real Estate						Other			Total 1			Allowance for Credit Losses
June 30, 2023
Commercial real estate, owner-occupied			$	457		$	—					$	—		$	457		$	—
Commercial real estate, non-owner occupied			906			—						—			906			—
Home equity			—			749						—			749			—
Total			$	1,363		$	749					$	—		$	2,112		$	—
December 31, 2022
Commercial real estate, owner-occupied			$	1,563		$	—					$	—		$	1,563		$	—
Home equity			—			778						—			778			—
Installment and other consumer			—			—						91			91			—
Total			$	1,563		$	778					$	91		$	2,432		$	—

1 There were no collateral-dependent residential real estate mortgage loans in process of foreclosure or in substance repossessed at June 30, 2023 or December 31, 2022. The weighted average loan-to-value of collateral dependent loans was approximately 40% at June 30, 2023 and 42% at December 31, 2022.

Loan Modifications

We adopted ASU No. 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures on January 1, 2023, as described in Note 2, Recently Adopted and Issued Accounting Standards. The amendments enhanced disclosures related to certain types of loan modifications for borrowers experiencing financial difficulty, including principal forgiveness, interest rate reductions, other-than-insignificant payment delays, and/or term extensions. There were no material modifications during the six months ended June 30, 2023 requiring disclosure.

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Allocation of the Allowance for Credit Losses on Loans

The following table presents the details of the allowance for credit losses on loans segregated by loan portfolio segments as of June 30, 2023 and December 31, 2022.

Allocation of the Allowance for Credit Losses on Loans
(in thousands)			Commercial and industrial			Commercial real estate, owner-occupied			Commercial real estate, non-owner occupied			Construction			Home equity			Other residential			Installment and other consumer			Unallocated			Total
June 30, 2023
Modeled expected credit losses			$	1,100		$	1,329		$	7,441		$	195		$	486		$	558		$	609		$	—		$	11,718
Qualitative adjustments			711			1,260			5,760			1,747			75			40			331			2,169			12,093
Specific allocations			20			—			—			—			—			1			—			—			21
Total			$	1,831		$	2,589		$	13,201		$	1,942		$	561		$	599		$	940		$	2,169		$	23,832
December 31, 2022
Modeled expected credit losses			$	1,079		$	1,497		$	7,937		$	453		$	504		$	571		$	610		$	—		$	12,651
Qualitative adjustments			706			990			4,739			1,484			54			24			258			2,068			10,323
Specific allocations			9			—			—			—			—			—			—			—			9
Total			$	1,794		$	2,487		$	12,676		$	1,937		$	558		$	595		$	868		$	2,068		$	22,983

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 industrial			Commercial real estate, owner-occupied			Commercial real estate, non-owner occupied			Construction			Home equity			Other residential			Installment and other consumer			Unallocated			Total
Three months ended June 30, 2023
Beginning balance			$	1,941		$	2,640		$	12,701		$	2,019		$	538		$	577		$	882		$	2,032		$	23,330
(Reversal) Provision			(111)			(51)			500			(86)			23			22			66			137			500
(Charge-offs)			—			—			—			—			—			—			(9)			—			(9)
Recoveries			1			—			—			9			—			—			1			—			11
Ending balance			$	1,831		$	2,589		$	13,201		$	1,942		$	561		$	599		$	940		$	2,169		$	23,832
Three months ended June 30, 2022
Beginning balance			$	1,784		$	2,622		$	12,301		$	1,717		$	549		$	628		$	641		$	2,305		$	22,547
(Reversal) Provision			(89)			(5)			138			12			(19)			(43)			112			(106)			—
(Charge-offs)			—			—			—			—			—			—			(20)			—			(20)
Recoveries			4			—			—			8			—			—			—			—			12
Ending balance			$	1,699		$	2,617		$	12,439		$	1,737		$	530		$	585		$	733		$	2,199		$	22,539

Allowance for Credit Losses on Loans Rollforward
(in thousands)			Commercial and industrial			Commercial real estate, owner-occupied			Commercial real estate, investor			Construction			Home equity			Other residential			Installment and other consumer			Unallocated			Total
Six months ended June 30, 2023
Beginning balance			$	1,794		$	2,487		$	12,676		$	1,937		$	558		$	595		$	868		$	2,068		$	22,983
Provision (reversal)			36			102			525			(12)			3			4			91			101			850
Charge-offs			(3)			—			—			—			—			—			(20)			—			(23)
Recoveries			4			—			—			17			—			—			1			—			22
Ending balance			$	1,831		$	2,589		$	13,201		$	1,942		$	561		$	599		$	940		$	2,169		$	23,832
Six months ended June 30, 2022
Beginning balance			$	1,709		$	2,776		$	12,739		$	1,653		$	595		$	644		$	621		$	2,286		$	23,023
(Reversal) Provision			(17)			(159)			(300)			68			(65)			(59)			134			(87)			(485)
Charge-offs			—			—			—			—			—			—			(22)			—			(22)
Recoveries			7			—			—			16			—			—			—			—			23
Ending balance			$	1,699		$	2,617		$	12,439		$	1,737		$	530		$	585		$	733		$	2,199		$	22,539

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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 $1.293 billion and $1.298 billion at June 30, 2023 and December 31, 2022, respectively. In addition, we pledge eligible TIC loans, which totaled $109.0 million and $105.0 million at June 30, 2023 and December 31, 2022, respectively, to secure our borrowing capacity with the Federal Reserve Bank ("FRB"). For additional information, 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 transactions, including 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 $6.3 million at June 30, 2023 and $6.4 million at December 31, 2022. In addition, undisbursed commitments to related parties totaled $562 thousand at both June 30, 2023 and December 31, 2022.

Note 6: Short-Term Borrowings and Other Obligations

 

Federal Home Loan Bank – As of June 30, 2023 and December 31, 2022, the Bank had total lines of credit with the FHLB totaling $1.034 billion and $711.6 million, respectively, based on eligible collateral of certain loans and investment securities.

Federal Funds Lines of Credit – The Bank had unsecured lines of credit with correspondent banks for overnight borrowings totaling $135.0 million and $150.0 million at June 30, 2023 and December 31, 2022, respectively.  In general, interest rates on these lines approximate the federal funds target rate.

Federal Reserve Bank – The Bank has a line of credit with the Federal Reserve Bank of San Francisco ("FRBSF") secured by certain residential loans.  At June 30, 2023 and December 31, 2022, the Bank had total borrowing capacity under this line of $58.0 million and $58.7 million, respectively. In addition, under the Federal Reserve’s new BTFP facility, the Bank could borrow up to an additional $279.0 million based on the par value of pledged investment securities as of June 30, 2023.

Other Obligations – Finance lease liabilities totaling $372 thousand and $439 thousand at June 30, 2023 and December 31, 2022, respectively, are included in short-term borrowings and other obligations in the consolidated statements of condition. See Note 8, Commitments and Contingencies, for additional information.

Outstanding balances and weighted average interest rates on short-term borrowings and other obligations as of June 30, 2023 and December 31, 2022 are summarized in the following table.

			June 30, 2023						December 31, 2022
(dollars in thousands)			Outstanding Balance			Weighted Average Rate			Outstanding Balance			Weighted Average Rate
FHLB - short-term borrowings			$	292,200		5.28		%	$	112,000		4.65		%
Federal funds lines of credit			—			—		%	—			—		%
FRBSF - federal funds purchased			—			—		%	—			—		%
FRBSF - short-term borrowings under the BTFP			—			—		%	—			—		%
Other obligations (finance leases)			372			1.97		%	439			1.86		%
Total short-term borrowings and other obligations			$	292,572		5.28		%	$	112,439		4.64		%

Note 7:  Stockholders' Equity

Dividends

On April 21, 2023, Bancorp declared a $0.25 per share cash dividend, paid May 12, 2023 to shareholders of record at the close of business on May 5, 2023. Subsequent to quarter end on July 21, 2023, Bancorp declared a $0.25

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per share cash dividend, payable on August 11, 2023 to shareholders of record at the close of business on August 4, 2023.

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 (loss) 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 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 six months ended June 30, 2023, we withheld 3,132 shares totaling $86 thousand at a weighted-average price of $27.57 for cashless exercises. During the six months ended June 30, 2022, we withheld 10,208 shares totaling $351 thousand at a weighted-average price of $34.38 for cashless exercises. Shares withheld under net settlement arrangements are available for future grants.

Share Repurchase Program

Bancorp had an approved share repurchase program with $34.7 million outstanding at June 30, 2023. There have been no repurchases in 2023. Cumulative shares repurchased under this program totaled 618,991 shares as of June 30, 2023 at an average price of $36.04 per share. Subsequent to quarter end on July 21, 2023, Bancorp adopted a new share repurchase program, which replaced the existing program that expired on July 31, 2023, for up to $25.0 million and expiring on July 31, 2025.

Note 8:  Commitments and Contingent Liabilities

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

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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)			June 30, 2023			December 31, 2022
Commercial lines of credit			$	236,895		$	292,204
Revolving home equity lines			219,144			218,907
Undisbursed construction loans			22,683			43,179
Personal and other lines of credit			9,701			10,842
Standby letters of credit			1,157			1,738
Total unfunded loan commitments and standby letters of credit			$	489,580		$	566,870

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 $1.1 million and $1.5 million as of June 30, 2023 and December 31, 2022, respectively, which is included in interest payable and other liabilities in the consolidated statements of condition. The $168 thousand reversal of the provision for credit losses on unfunded loan commitments in the second quarter of 2023 was due primarily to a $39.9 million decrease in total unfunded commitments. This compares to no provision for the same quarter in 2022. The $342 thousand reversal of the provision for credit losses on unfunded loan commitments in the first half of 2023 was due primarily to a $77.3 million decrease in total unfunded commitments, compared to a $318 thousand provision reversal in the first half of 2022, due to improved economic forecasts at the time.

Leases

We lease premises under long-term non-cancelable operating leases with remaining terms of 10 months to 18 years, 11 months, 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 5 years. The equipment finance leases do not contain renewal options, bargain purchase options or residual value guarantees.

The following table shows the balances of operating and finance lease right-of-use assets and lease liabilities.

(in thousands)			June 30, 2023			December 31, 2022
Operating leases:
Operating lease right-of-use assets			$	22,739		$	24,821
Operating lease liabilities			$	25,220		$	26,639
Finance leases:
Finance lease right-of-use assets			$	608		$	616
Accumulated amortization			(245)			(187)
Finance lease right-of-use assets, net1			$	363		$	429
Finance lease liabilities2			$	372		$	439
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.

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The following table shows supplemental disclosures of noncash investing and financing activities for the periods presented.

			Six months ended
(in thousands)			June 30, 2023			June 30, 2022
Right-of-use assets obtained in exchange for operating lease liabilities, net of tenant improvement allowances received			$	572		$	1,124
Right-of-use assets obtained in exchange for finance lease liabilities			$	7		$	—

The following table shows components of operating and finance lease cost.

			Three months ended									Six months ended
(in thousands)			June 30, 2023			June 30, 2022						June 30, 2023			June 30, 2022
Operating lease cost			$	1,322		$	1,295					$	2,932		$	2,579
Variable lease cost			—			—						—			—
Total operating lease cost1			$	1,322		$	1,295					$	2,932		$	2,579
Finance lease cost:
Amortization of right-of-use assets2			$	37		$	31					$	74		$	62
Interest on finance lease liabilities3			2									4			1
Total finance lease cost			$	39		$	31					$	78		$	63
Total lease cost			$	1,361		$	1,326					$	3,010		$	2,642
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 June 30, 2023. 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 lease commencement date.

(in thousands)			June 30, 2023
Year			Operating Leases			Finance Leases
2023			$	2,587		$	78
2024			4,753			155
2025			4,112			108
2026			3,373			37
2027			3,097			5
Thereafter			10,017			—
Total minimum lease payments			27,939			383
Amounts representing interest (present value discount)			(2,719)			(11)
Present value of net minimum lease payments (lease liability)			$	25,220		$	372
Weighted average remaining term (in years)			7.5			2.6
Weighted average discount rate			2.36		%	1.97		%

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"). We sold our remaining shares on July 13, 2023, however 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 or, per the terms of the sale, to the recent purchaser of our shares. Visa established an escrow account for the Covered Litigation that it periodically funds, which is expected to cover the settlement payment obligations.

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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 (which transitioned to the SOFR effective July 1, 2023 due to the cessation of the LIBOR index on June 30, 2023) 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 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 June 30, 2023, we had four interest rate swap agreements, which are scheduled to mature at various dates ranging from June 2031 to 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 receivable on the swaps totaled $7 thousand at June 30, 2023 and $5 thousand at December 31, 2022. Information on our derivatives follows:

			Asset Derivatives									Liability Derivatives
(in thousands)			June 30, 2023			December 31, 2022						June 30, 2023			December 31, 2022
Fair value hedges:
Interest rate contracts notional amount			$	11,535		$	12,046					$	—		$	—
Interest rate contracts fair value1			$	631		$	602					$	—		$	—

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 June 30, 2023 and December 31, 2022.

			Carrying Amounts of Hedged Assets									Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Loans
(in thousands)			June 30, 2023			December 31, 2022						June 30, 2023			December 31, 2022
Loans			$	10,786		$	11,319					$	(749)		$	(726)

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The following table presents the net gains (losses) recognized in interest income on loans on the consolidated statements of comprehensive income (loss) related to our derivatives designated as fair value hedges.

			Three months ended						Six months ended
(in thousands)			June 30, 2023			June 30, 2022			June 30, 2023			June 30, 2022
Interest and fees on loans 1			$	24,579		$	23,334		$	48,837		$	47,011
Increase (decrease) in fair value of designated interest rate swaps due to LIBOR interest rate movements			$	250		$	430		$	29		$	1,187
Receivable (payment) on interest rate swaps			66			(65)			118			(150)
(Decrease) increase in fair value hedging adjustment of hedged loans			(243)			(428)			(23)			(1,180)
Decrease in value of yield maintenance agreement			(2)			(2)			(4)			(5)
Net gain (loss) on fair value hedging relationships recognized in interest income			$	71		$	(65)		$	120		$	(148)

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:

Offsetting of Financial Assets and Derivative Assets
						Gross Amounts			Net Amounts of			Gross Amounts Not Offset in
			Gross Amounts			Offset in the			Assets Presented			the Statements of Condition
			of Recognized			Statements of			in the Statements			Financial			Cash Collateral
(in thousands)			Assets1			Condition			of Condition1			Instruments			Received			Net Amount
June 30, 2023
Counterparty			$	631		$	—		$	631		$	—		$	—		$	631
December 31, 2022
Counterparty			$	602		$	—		$	602		$	—		$	—		$	602

Offsetting of Financial Liabilities and Derivative Liabilities

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 2022 Form 10-K filed with the SEC on March 16, 2023.

On July 7, 2023, the Bank entered into various interest rate swap agreements with notional values totaling approximately $101.8 million and split evenly between terms of 2.5 and 3.0 years to hedge balance sheet interest rate sensitivity and protect selected securities in its available-for-sale portfolio against changes in fair value related to changes in the benchmark interest rate. The interest rate swaps are expected to be immediately accretive to earnings.

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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 unaudited consolidated financial statements in this Form 10-Q and with the audited consolidated financial statements and accompanying notes included in our 2022 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 impact Bancorp's earnings in future periods. Factors that could cause future results to vary materially from current management expectations include, but are not limited to, general economic conditions and the economic uncertainty in the United States and abroad, including economic or other disruptions to financial markets caused by acts of terrorism, war or other conflicts such as Russia's military action in Ukraine, impacts from inflation, supply change disruptions, changes in interest rates (including the actions taken by the Federal Reserve to control inflation), California's unemployment rate, deposit flows, real estate values, and expected future cash flows on loans and securities; the impact of adverse developments at other banks, including bank failures, that impact general sentiment regarding the stability and liquidity of banks; costs or effects of acquisitions; competition; changes in accounting principles, policies or guidelines; changes in legislation or regulation; 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; and successful integration of acquisitions.

Important factors that could cause results or performance to materially differ from those expressed in our prior forward-looking statements are detailed in ITEM 1A, Risk Factors section of our 2022 Form 10-K as filed with the SEC, and ITEM 1A Risk Factors herein, copies of which are available from us at no charge. Forward-looking statements speak only as of the date they are made. 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.

Critical Accounting Estimates

Critical accounting estimates are those estimates made in accordance with generally accepted accounting principles that involve a significant level of estimation and uncertainty and have had or are reasonably likely to have a material impact on our financial condition and results of operations. 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. Our critical estimates include: Allowance for Credit Losses on Loans and Unfunded Commitments, Income Taxes, Fair Value Measurements, and Business Combinations. For a detailed discussion, refer to the Critical Accounting Estimates section of our 2022 Form 10-K filed with the SEC on March 16, 2023.

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Executive Summary

We generated earnings of $4.6 million for the second quarter of 2023, compared to $9.4 million for the first quarter of 2023. Diluted earnings per share were $0.28 for the second quarter of 2023, compared to $0.59 for the preceding quarter. Earnings for the first six months of 2023 totaled $14.0 million, compared to $21.5 million in the same period last year. Diluted earnings per share were $0.87 and $1.35 for the first six months of 2023 and 2022, respectively. 2023 earnings presented were impacted by the increased cost of interest bearing deposits catching up to market interest rates and higher average balances on borrowings.

The following are highlights of our operating and financial performance for the periods presented. Additional performance details can be found in the pages that follow.

•Deposits totaled $3.325 billion as of June 30, 2023, a decrease of $248.1 million from $3.573 billion at December 31, 2022. We are closing the gap on the deposit outflows experienced in the first quarter of 2023. Our deposit franchise exhibited good growth in new and existing relationships in the second quarter of 2023 as a result of our extensive customer outreach, with the addition of over 1,400 new accounts in the quarter and over 2,400 new accounts year-to-date at average rates well below our cost of borrowing. In fact, total deposits increased by $69 million post quarter-end through July 31, 2023, following a $75 million increase in second quarter as previously reported in our earnings release, and were less than $80 million below levels immediately preceding the first quarter bank failures that resulted in industry disruption.

•Non-interest bearing deposits made up 47.8% of total deposits at June 30, 2023, compared to 51.5% at December 31, 2022. We have successfully maintained high non-interest bearing deposit balances consistent with pre-pandemic levels, despite market and industry turbulence. Customer participation in the reciprocal deposit network program grew to $421.0 million, bringing estimated FDIC insured and/or collateralized deposits up to 71% of total deposits as of June 30, 2023. Our largest depositor represented 1.3% of total deposits as of June 30, 2023.

•Contingent liquidity provided 209% coverage of estimated uninsured and/or uncollateralized deposits at June 30, 2023. The Bank has long followed sound liquidity management practices similar to large banks with robust liquidity requirements and regular liquidity stress testing that have been enhanced subsequent to events of the first quarter.

•The credit quality of our loan portfolio remains strong with classified loans at only 1.81% of total loans and manageable delinquencies with no meaningful credit surprises during the first half of the year. Non-accrual loans were 0.10% of total loans as of June 30, 2023, compared to 0.12% at December 31, 2022. We recorded a $500 thousand provision for credit losses on loans in the second quarter, compared to a provision of $350 thousand in the previous quarter. For six months ended June 30, 2023, we recorded a provision for credit losses on loans of $850 thousand, compared to a reversal of $485 thousand for the same period in 2022.

•Loan balances of $2.103 billion increased $10.3 million during the six months ended June 30, 2023. Loan originations were $67.7 million and payoffs were $46.8 million for the six months ended June 30, 2023.

•The second quarter tax-equivalent net interest margin decreased 59 basis points to 2.45% from 3.04% for the previous quarter due primarily to increased deposit costs and average borrowing balances, partially offset by higher loan yields. The tax-equivalent net interest margin for the first six months of 2023 of 2.74% decreased 27 basis points from 3.01% for the same period in 2022 for the same reasons mentioned above.

•Return on average assets ("ROA") was 0.44% for the second quarter of 2023, compared to 0.92% for the first quarter of 2023. Return on average equity ("ROE") was 4.25% for the second quarter of 2023, compared to 9.12% for the prior quarter. ROA was 0.68% for the six months ended June 30, 2023, compared to 1.00% in the same period of the prior year. ROE was 6.65% for the six months ended June 30, 2023, compared to 10.16% in the same period of the prior year. The efficiency ratio for the second quarter of 2023 was 76.91%, compared to 60.24% for the prior quarter. The efficiency ratio was 67.74% for the six months ended June 30, 2023, compared to 57.40% in the same period of the prior year. The sequential declines in ROA and ROE and increase in the efficiency ratio in the first six months of 2023 were due primarily to a $13.8 million increase in interest expense.

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•All capital ratios were above well-capitalized regulatory requirements. The total risk-based capital ratios at June 30, 2023 for Bancorp and the Bank were 16.4% and 16.0%, respectively. Bancorp's tangible common equity to tangible assets ("TCE ratio") was 8.6% at June 30, 2023, compared to 8.2% as of December 31, 2022. As of June 30, 2023, Bancorp's TCE ratio, net of after tax unrealized losses on held-to-maturity securities, was 6.7%, compared to 6.2% at December 31, 2022 (refer to page 45 for a discussion and reconciliation of this non-GAAP financial measure).

•On July 12, 2023, the Bank completed the sale of its only other real estate owned property, which was obtained in the 2021 merger with American River Bankshares. After previously recorded write-downs totaling $385 thousand, including $40 thousand in the second quarter of 2023, the Bank realized a negligible gain after sales costs.

•On July 7, 2023, the Bank entered into various interest rate swap agreements with notional values totaling $101.8 million to hedge balance sheet interest rate sensitivity and protect selected securities in its available-for-sale portfolio against changes in fair value related to changes in the benchmark interest rate. The interest rate swaps are expected to be immediately accretive to earnings.

•In July 2023, the Bank sold $82.7 million of available-for-sale securities for a net loss of $2.8 million. We held the sales proceeds in cash as part of our liquidity strategy. The loss was offset by a $2.8 million gain from the July 13, 2023 sale of our remaining investment in Visa Inc. Class B restricted common stock, which had a zero carrying value.

•The Board of Directors declared a cash dividend of $0.25 per share on July 21, 2023, which represents the 73rd consecutive quarterly dividend paid by Bancorp. The dividend is payable on August 11, 2023, to shareholders of record at the close of business on August 4, 2023.

•On July 21, 2023, the Board of Directors approved the adoption of Bancorp's new share repurchase program for up to $25.0 million and expiring on July 31, 2025, replacing the program that expired on July 31, 2023.

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RESULTS OF OPERATIONS

 

Highlights of the financial results are presented in the following tables:

			Three months ended									Six months ended
(dollars in thousands, except per share data)			June 30, 2023			March 31, 2023									June 30, 2023			June 30, 2022
Selected operating data:
Net interest income			$	24,130		$	29,899								$	54,029		$	61,095
Provision for (reversal of) credit losses on loans			500			350									850			(485)
Reversal of credit losses on unfunded loan commitments			(168)			(174)									(342)			(318)
Non-interest income			2,739			2,935									5,674			5,595
Non-interest expense			20,665			19,780									40,445			38,281
Net income			4,551			9,440									13,991			21,531
Net income per common share:
Basic			$	0.28		$	0.59								$	0.88		$	1.35
Diluted			$	0.28		$	0.59								$	0.87		$	1.35
Performance and other financial ratios:
Return on average assets			0.44		%	0.92		%							0.68		%	1.00		%
Return on average equity			4.25		%	9.12		%							6.65		%	10.16		%
Tax-equivalent net interest margin			2.45		%	3.04		%							2.74		%	3.01		%
Cost of deposits			0.69		%	0.20		%							0.44		%	0.06		%
Efficiency ratio			76.91		%	60.24		%							67.74		%	57.40		%
Net (recoveries) charge-offs			$	(2)		$	3								$	1		$	(1)
Cash dividend payout ratio on common stock 1			89.29		%	42.37		%							56.82		%	35.56		%

(dollars in thousands, except per share data)			June 30, 2023			December 31, 2022
Selected financial condition data:
Total assets			$	4,092,133		$	4,147,464
Investment securities			1,717,750			1,774,303
Loans, net			2,078,964			2,069,563
Deposits			3,325,212			3,573,348
Short-term borrowings and other obligations			292,572			112,439
Stockholders' equity			423,941			412,092
Book value per share			26.32			25.71
Asset quality ratios:
Allowance for credit losses on loans to total loans			1.13		%	1.10		%
Allowance for credit losses on loans to non-performing loans			11.28x			9.45x
Non-accrual loans to total loans			0.10		%	0.12		%
Capital ratios:
Equity to total assets ratio			10.36		%	9.94		%
Tangible common equity to tangible assets			8.64		%	8.21		%
Total capital (to risk-weighted assets)			16.36		%	15.90		%
Tier 1 capital (to risk-weighted assets)			15.45		%	15.02		%
Tier 1 capital (to average assets)			10.10		%	9.60		%
Common equity Tier 1 capital (to risk weighted assets)			15.45		%	15.02		%
1 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, investments 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 tables compare interest income, average interest-earning assets, interest expense, and average interest-bearing liabilities for the periods presented. The tables also presents net interest income, net interest margin and net interest rate spread for each period reported.

						Three months ended									Three months ended
						June 30, 2023									March 31, 2023
									Interest									Interest
						Average			Income/			Yield/			Average			Income/			Yield/
(dollars in thousands)						Balance			Expense			Rate			Balance			Expense			Rate
Assets
			Interest-earning deposits with banks 1			$	3,578		$	48		5.35		%	$	4,863		$	56		4.58		%
			Investment securities 2, 3			1,819,486			10,103			2.22		%	1,851,743			10,194			2.20		%
			Loans 1, 3, 4			2,108,260			24,700			4.63		%	2,121,718			24,415			4.60		%
			Total interest-earning assets 1			3,931,324			34,851			3.51		%	3,978,324			34,665			3.49		%
			Cash and non-interest-bearing due from banks			38,154									39,826
			Bank premises and equipment, net			8,546									8,396
			Interest receivable and other assets, net			141,130									137,114
Total assets						$	4,119,154								$	4,163,660
Liabilities and Stockholders' Equity
			Interest-bearing transaction accounts			$	232,090		$	234		0.41		%	$	272,353		$	254		0.38		%
			Savings accounts			285,745			146			0.20		%	329,299			170			0.21		%
			Money market accounts			948,670			4,292			1.81		%	952,479			1,085			0.46		%
			Time accounts including CDARS			174,471			946			2.18		%	126,030			223			0.72		%
			Short-term borrowings and other obligations 1			372,308			4,873			5.18		%	222,571			2,716			4.88		%
			Total interest-bearing liabilities			2,013,284			10,491			2.09		%	1,902,732			4,448			0.95		%
			Demand accounts			1,627,730									1,792,998
			Interest payable and other liabilities			49,116									48,233
			Stockholders' equity			429,024									419,697
Total liabilities & stockholders' equity						$	4,119,154								$	4,163,660
Tax-equivalent net interest income/margin 1									$	24,360		2.45		%				$	30,217		3.04		%
Reported net interest income/margin 1									$	24,130		2.43		%				$	29,899		3.01		%
Tax-equivalent net interest rate spread												1.42		%							2.54		%

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						Six months ended												Six months ended
						June 30, 2023												June 30, 2022
									Interest												Interest
						Average			Income/			Yield/						Average			Income/			Yield/
(in thousands)						Balance			Expense			Rate						Balance			Expense			Rate
Assets
			Interest-earning deposits with banks 1			$	4,217		$	104		4.91		%				$	163,064		$	286		0.35		%
			Investment securities 2, 3			1,835,525			20,297			2.21		%				1,717,624			15,340			1.79		%
			Loans 1, 3, 4			2,114,952			49,115			4.62		%				2,211,062			47,403			4.26		%
			Total interest-earning assets 1			3,954,694			69,516			3.50		%				4,091,750			63,029			3.06		%
			Cash and non-interest-bearing due from banks			38,985												62,679
			Bank premises and equipment, net			8,471												7,305
			Interest receivable and other assets, net			139,134												167,265
Total assets						$	4,141,284											$	4,328,999
Liabilities and Stockholders' Equity
			Interest-bearing transaction accounts			$	252,110		$	488		0.39		%				$	297,734		$	109		0.07		%
			Savings accounts			307,402			316			0.21		%				343,333			61			0.04		%
			Money market accounts			950,564			5,377			1.14		%				1,099,439			916			0.17		%
			Time accounts including CDARS			150,384			1,169			1.57		%				146,061			81			0.11		%
			Short-term borrowings and other obligations 1			297,853			7,589			5.07		%				384			1			0.62		%
			Total interest-bearing liabilities			1,958,313			14,939			1.54		%				1,886,951			1,168			0.12		%
			Demand accounts			1,709,907												1,963,832
			Interest payable and other liabilities			48,678												50,846
			Stockholders' equity			424,386												427,370
Total liabilities & stockholders' equity						$	4,141,284											$	4,328,999
Tax-equivalent net interest income/margin 1									$	54,577		2.74		%							$	61,861		3.01		%
Reported net interest income/margin 1									$	54,029		2.72		%							$	61,095		2.97		%
Tax-equivalent net interest rate spread												1.96		%										2.94		%
			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 2023 and 2022.
			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.

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 three months ended June 30, 2023, compared to March 31, 2023.

			Three Months Ended June 30, 2023 Compared to Three Months Ended March 31, 2023															Six Months Ended June 30, 2023 Compared to Six Months Ended June 30, 2022
(in thousands)			Volume			Yield/Rate			Mix			Total						Volume			Yield/Rate			Mix			Total
Interest-earning deposits with banks			$	(15)		$	9		$	(2)		$	(8)					$	(280)		$	3,735		$	(3,637)		$	(182)
Investment securities 1			(178)			88			(1)			(91)						1,053			3,653			251			4,957
Loans 1			(155)			170			270			285						(2,061)			3,944			(171)			1,712
Total interest-earning assets			(348)			267			267			186						(1,288)			11,332			(3,557)			6,487
Interest-bearing transaction accounts			(38)			18			—			(20)						(17)			467			(71)			379
Savings accounts			(22)			(4)			2			(24)						(6)			292			(31)			255
Money market accounts			(4)			3,177			34			3,207						(124)			5,303			(718)			4,461
Time accounts, including CDARS			86			453			184			723						2			1,054			32			1,088
Short-term borrowings and other obligations			1,827			165			165			2,157						775			8			6,805			7,588
Total interest-bearing liabilities			1,849			3,809			385			6,043						630			7,124			6,017			13,771
Changes in tax-equivalent net interest income			$	(2,197)		$	(3,542)		$	(118)		$	(5,857)					$	(1,918)		$	4,208		$	(9,574)		$	(7,284)
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%.

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Second Quarter of 2023 Compared to the First Quarter of 2023

Net interest income totaled $24.1 million in the second quarter of 2023, compared to $29.9 million in the first quarter of 2023. The $5.8 million decrease from the prior quarter was primarily related to an increase in the cost of deposits and higher average borrowing balances.

The tax-equivalent net interest margin was 2.45% in the second quarter of 2023, compared to 3.04% in the first quarter of 2023. The decline from prior quarter was primarily due to higher deposit and borrowing costs slightly offset by higher yields on loans. Average interest-bearing deposit balances decreased by $39.2 million while the cost increased by 95 basis points. Average borrowing balances increased by $149.7 million and the cost of borrowings increased by 30 basis points. Average loan balances decreased by $13.5 million while the average yield increased by 3 basis points.

First Six Months of 2023 Compared to the First Six Months of 2022

Net interest income totaled $54.0 million for the six months ended June 30, 2023, a decrease of $7.1 million, compared to the six months ended June 30, 2022. The decrease was primarily due to higher deposit costs resulting in an incremental $6.2 million in interest expense, and borrowing costs of $7.6 million. These decreases were partially offset by higher average balances and yields on the investment portfolio, generating incremental income of $5.1 million, and higher yields on loans, adding $1.8 million.

The tax-equivalent net interest margin was 2.74% in the six months ended June 30, 2023, compared to 3.01% in the same period in the prior year. The decrease was primarily attributed to higher borrowing and deposit costs partially offset by higher yields on investments and loans. Average interest-bearing deposits balances decreased by $226.1 million while the cost increased by 77 basis points, mainly for money market and time deposit account types. Average borrowing balances increased by $297.5 million at an average cost of 4.45%. Average loan balances decreased by $96.1 million while the average yield increased by 36 basis points.

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").

In response to the evolving risks to economic activity caused by the COVID-19 pandemic, the FOMC made two emergency federal funds rate cuts totaling 150 basis points in March 2020. The federal funds rate range remained between 0.0% to 0.25% through the beginning of 2022, putting downward pressure on our asset yields and net interest margin. Beginning in March 2022, the FOMC began successive increases to the federal funds rate due to the evolving inflation risks, complicated by international political unrest and supply chain disruptions. As a result of seven rate adjustments during 2022, the federal funds target rate increased to a range of 4.25% to 4.50% at year-end 2022. In 2023, on each of February 1st, March 22nd, May 3rd, and July 26th the FOMC increased the target rate by 25 basis points to a range of 5.25% to 5.50%. Federal Reserve policymakers continue to monitor inflation and economic developments throughout 2023. 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 activity for the periods presented.

			Three months ended									Six months ended
(dollars in thousands)			June 30, 2023			March 31, 2023									June 30, 2023			June 30, 2022
Provision for (reversal of) credit losses on loans			$	500		$	350								$	850		$	(485)

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We recorded a $500 thousand provision for credit losses on loans in the second quarter. The provision was due primarily to increases in qualitative risk factors from continued negative trends in adversely graded loans and/or collateral values on our non-owner occupied commercial real estate office and multi-family real estate portfolios. These increases were partially offset by the impact of a decrease in loan balances.

We recorded a $350 thousand provision for credit losses on loans in the first quarter. The provision was due primarily to increases in qualitative risk factors to account for continued uncertainty about inflation and recession risks. Management believed that these risk factors were not adequately captured in the modeled quantitative portion of the allowance and took a more prudent approach to account for loan and collateral concentration risks, mainly in our construction and commercial real estate portfolios and the need for heightened portfolio management in light of current economic conditions. In addition, the $19.8 million increase in loans contributed modestly to the provision in the first quarter. These increases were partially offset by the quantitative impact of an improvement in Moody's Analytics' baseline California unemployment rate forecasts over the next four quarters at the time.

The reversal of the allowance for credit losses on loans for the six months ended June 30, 2022 primarily resulted from improved unemployment rate forecasts at the time.

For more information, refer to Note 5, Loans and Allowance for Credit Losses on Loans, to the consolidated financial statements in this Form 10-Q.

Non-interest Income

 

The following table details the components of non-interest income.

			Three months ended
(dollars in thousands)			June 30, 2023			March 31, 2023						Amount Change			Percent Change
Wealth Management and Trust Services			$	559		$	511					$	48		9.4		%
Earnings on bank-owned life insurance, net			362			$	705					(343)			(48.7)		%
Service charges on deposit accounts			520			533						(13)			(2.4)		%
Debit card interchange fees, net			555			447						108			24.2		%
Dividends on Federal Home Loan Bank stock			290			302						(12)			(4.0)		%
Merchant interchange fees, net			127			133						(6)			(4.5)		%
Other income			326			304						22			7.2		%
Total non-interest income			$	2,739		$	2,935					$	(196)		(6.7)		%

			Six months ended						Amount Change			Percent Change
(dollars in thousands)			June 30, 2023			June 30, 2022
Wealth Management and Trust Services			$	1,070		$	1,230		$	(160)		(13.0)		%
Earnings on bank-owned life insurance, net			1,067			711			356			50.1		%
Service charges on deposit accounts			1,053			953			100			10.5		%
Debit card interchange fees, net			1,002			1,036			(34)			(3.3)		%
Dividends on Federal Home Loan Bank stock			592			508			84			16.5		%
Merchant interchange fees, net			260			289			(29)			(10.0)		%
Other income			630			868			(238)			(27.4)		%
Total non-interest income			$	5,674		$	5,595		$	79		1.4		%

Second Quarter of 2023 Compared to the First Quarter of 2023

Non-interest income totaled $2.7 million for the second quarter of 2023, compared to $2.9 million for the prior quarter. The $196 thousand decrease from the prior quarter was primarily related to the recognition of a bank-owned life insurance benefit payment in the prior quarter, partially offset by increases in ATM and debit card interchange fees.

First Six Months of 2023 Compared to the First Six Months of 2022

Non-interest income totaled $5.7 million for the six months ended June 30, 2023, compared to $5.6 million for the same period of the prior year. The $79 thousand increase from the prior year period was mostly attributable to the

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higher bank-owned life insurance balances and benefit payments, partially offset by decreases in wealth management and trust services income and other income including one-way deposit and cash management fees.

Non-interest Expense

 

The following table details the components of non-interest expense.

			Three months ended
(dollars in thousands)			June 30, 2023			March 31, 2023						Amount Change			Percent Change
Salaries and related benefits			$	11,416		$	10,930					$	486		4.4		%
Occupancy and equipment			1,980			2,414						(434)			(18.0)		%
Data processing			922			1,045						(123)			(11.8)		%
Professional services			797			1,123						(326)			(29.0)		%
Depreciation and amortization			400			882						(482)			(54.6)		%
Federal Deposit Insurance Corporation insurance			666			289						377			130.4		%
Information technology			357			370						(13)			(3.5)		%
Charitable contributions			638			49						589			1,202.0		%
Amortization of core deposit intangible			340			345						(5)			(1.4)		%
Directors' expense			300			321						(21)			(6.5)		%
Other real estate owned			44			4						40			1,000.0		%
Other non-interest expense
Advertising			300			278						22			7.9		%
Other expense			2,505			1,730						775			44.8		%
Total other non-interest expense			2,805			2,008						797			39.7		%
Total non-interest expense			$	20,665		$	19,780					$	885		4.5		%

			Six months ended						Amount Change			Percent Change
(dollars in thousands)			June 30, 2023			June 30, 2022
Salaries and related benefits			$	22,346		$	21,889		$	457		2.1		%
Occupancy and equipment			4,394			3,798			596			15.7		%
Data processing			1,967			2,476			(509)			(20.6)		%
Professional services			1,920			1,578			342			21.7		%
Depreciation and amortization			1,282			845			437			51.7		%
Federal Deposit Insurance Corporation insurance			955			586			369			63.0		%
Information technology			727			946			(219)			(23.2)		%
Charitable contributions			687			556			131			23.6		%
Amortization of core deposit intangible			685			754			(69)			(9.2)		%
Directors' expense			621			605			16			2.6		%
Other real estate owned			48			5			43			NM
Other non-interest expense
Advertising			578			568			10			1.8		%
Other expense			4,235			3,675			560			15.2		%
Total other non-interest expense			4,813			4,243			570			13.4		%
Total non-interest expense			$	40,445		$	38,281		$	2,164		5.7		%
NM - Not Meaningful

Second Quarter of 2023 Compared to the First Quarter of 2023

Non-interest expense totaled $20.7 million for the three months ended June 30, 2023, compared to $19.8 million for the prior quarter. The $885 thousand increase from the prior quarter included $589 thousand in charitable contributions as part of our annual grant program, $486 thousand in salaries and related benefits, which included annual merit increases, and $393 thousand in expenses and fees associated with an increase in our customers' participation in reciprocal deposit networks to bolster their FDIC insured balances. In addition, our FDIC insurance expense increased by $377 thousand as the statutory rates increased uniformly by 2 basis points for all depository institutions effective January 1, 2023 in order to strengthen the FDIC's Deposit Insurance Fund. These and other lesser increases were partially offset by a $482 thousand reduction in depreciation and amortization expense and $434 thousand decrease in occupancy and equipment expense, primarily due to the acceleration of lease-related costs for branches closed in the first quarter. These branch closures also reduced maintenance, janitorial and

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utilities expenses for the quarter. In addition, professional services decreased by $326 thousand, mainly due to timing of audit work performed.

First Six Months of 2023 Compared to the First Six Months of 2022

Non-interest expense totaled $40.4 million for the six months ended June 30, 2023, compared to $38.3 million for the six months ended June 30, 2022, an increase of $2.2 million. The most significant increases over prior year came from occupancy and equipment and depreciation and amortization expenses, which rose $596 thousand and $437 thousand, respectively, from branch closures in the first quarter of 2023. In addition, expenses associated with reciprocal deposits placed into deposit networks included in other expenses increased $497 thousand due to higher average balances and fees. Salaries and related benefits increased by $457 thousand primarily due to regularly scheduled annual merit and other increases and lower deferred origination costs, which were partially offset by an adjustment to our incentive bonus accrual. The FDIC insurance assessment and professional services also increased by $369 thousand and $342 thousand, respectively, for the same reasons mentioned above. These increases were partially offset by a $509 thousand decrease in data processing expenses due to our core system contract renegotiation for the current period and because the prior year included data processing expenses largely eliminated after the systems conversion associated with the American River Bankshares merger. In addition, the pre-tax savings in 2023 from the branch closures, net of accelerated costs, are expected to be approximately $470 thousand, and future annual pre-tax savings are expected to be approximately $1.4 million.

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, bank-owned life insurance ("BOLI") income, 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 second quarter of 2023 totaled $1.3 million at an effective tax rate of 22.5%, compared to $3.4 million at an effective tax rate of 26.7% in the prior quarter. The decrease in the provision for income taxes in the second quarter of 2023 reflected lower pre-tax income. The 420 basis point decrease in the effective tax rate in the second quarter of 2023 was primarily due to the larger proportional effect of permanent tax differences on lower pretax income. This decrease was partially offset by a reduction in the tax-exempt interest exclusion (due to a larger IRC Section 291(e) interest expense disallowance) and lower tax-exempt BOLI income in the second quarter, compared to the prior quarter.

The provision for income taxes for the first half of 2023 totaled $4.8 million at an effective tax rate of 25.4%, compared to $7.7 million at an effective tax rate of 26.3% for the first half of 2022. The 90 basis point decrease in the effective tax rate in the first half of 2023, as compared to the same period a year ago, was primarily due the larger proportional effect of permanent tax differences on lower pretax income and higher tax-exempt BOLI income.

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 June 30, 2023, neither the Bank nor Bancorp had accruals for interest or penalties related to unrecognized tax benefits.

FINANCIAL CONDITION SUMMARY

Cash, Cash Equivalents and Restricted Cash

Total cash, cash equivalents and restricted cash were $39.7 million at June 30, 2023, compared to $45.4 million at December 31, 2022. The $5.8 million decrease was due primarily to increases in loans and decreases in deposits, partially offset by cash flows from investment securities and increased borrowings.

Investment Securities

The investment securities portfolio totaled $1.718 billion at June 30, 2023, a decrease of $56.6 million from $1.774 billion at December 31, 2022. The decrease was primarily the result of principal repayments and maturities totaling

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$58.9 million, partially offset by a $5.3 million decrease in pre-tax unrealized losses on available-for-sale investment securities, along with $2.9 million in net amortization in the first half of 2023. Both the available-for-sale and held-to maturity portfolios are eligible for pledging to either the FHLB or the Federal Reserve as collateral for borrowing. The portfolios are comprised of high credit quality investments with average effective durations of 3.8 on available-for-sale securities and 5.8 on held-to-maturity securities. Both portfolios generate cash inflows monthly from interest, principal amortization and payoffs, which supports the Bank's liquidity. Those cash inflows totaled $82.9 million in the first six months of 2023.

Subsequent to quarter end, the Bank sold $82.7 million of available-for-sale securities and recognized a $2.8 million net loss. We held the sales proceeds in cash as part of our liquidity strategy. The net loss was offset with the $2.8 million gain from the July 13, 2023 sale of the Bank's remaining investment in Visa Inc. Class B restricted common stock, which had a zero carrying value. See Note 4, Investment Securities, for additional information.

The following table summarizes our investment in obligations of state and political subdivisions at June 30, 2023 and December 31, 2022.

						June 30, 2023												December 31, 2022
(dollars in thousands)						Amortized Cost			Fair Value			% of Total State and Political Subdivisions						Amortized Cost			Fair Value			% of Total State and Political Subdivisions
Within California:
			General obligation bonds			$	25,755		$	21,352		14.4		%				$	25,806		$	20,768		14.4		%
			Revenue bonds			3,513			2,902			2.0						3,719			2,987			2.1
Total within California						29,268			24,254			16.4						29,525			23,755			16.5
Outside California:
			General obligation bonds			121,232			107,777			68.0						121,908			106,375			68.0
			Revenue bonds			27,808			24,130			15.6						27,922			23,752			15.5
Total outside California						149,040			131,907			83.6						149,830			130,127			83.5
Total obligations of state and political subdivisions						$	178,308		$	156,161		100.0		%				$	179,355		$	153,882		100.0		%
Percent of investment portfolio						9.7		%	9.5		%							9.6		%	9.3		%

Of the total investment in obligations of state and political subdivisions, the largest concentrations outside of California are in Texas (39.7%), Washington (14.3%) and Wisconsin (8.9%). 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).

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 and Credit Quality

During the first half of 2023, loans increased by $10.3 million and totaled $2.103 billion at June 30, 2023, compared to $2.093 billion at December 31, 2022. Loan originations were $67.7 million for the six months ended June 30, 2023, compared to $152.0 million for the first six months of 2022. Excluding PPP loans, payoffs were $45.0 million in the six months ended June 30, 2023, compared to $159.1 million for the same period in 2022. PPP loan payoffs during the six months ended June 30, 2023 and 2022 were $1.8 million and $94.2 million, respectively. In addition, loan amortization from scheduled repayments totaling $39.9 million was partially offset by a net increase in

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utilization of credit lines of $29.7 million for the six months ended June 30, 2023. Bank of Marin has continued its usual steadfast conservative underwriting practices, and has not changed its credit standards or policies specifically in reaction to the current market conditions. The Bank continues to be focused on achieving risk-adjusted returns.

The ratio of allowance for credit losses on loans to total loans was 1.13% at June 30, 2023 compared to 1.10% at December 31, 2022.

Non-accrual loans decreased $320 thousand to $2.1 million, or 0.10% of the loan portfolio at June 30, 2023 from $2.4 million, or 0.12% at December 31, 2022. All of the non-accrual loans are collateralized by real estate with no expected credit loss as of June 30, 2023. Accruing loans past due 30 to 89 days totaled $1.0 million at June 30, 2023, compared to $664 thousand at December 31, 2022.

Classified loans with risk ratings of substandard or doubtful totaled $38.1 million at June 30, 2023, compared to $28.1 million at December 31, 2022. Increases in 2023 were primarily due to a $5.8 million increase in the usage of a revolving line of credit that was previously downgraded and the addition of eight loans to seven borrowers totaling $7.4 million. Approximately 90% of the additions were comprised of one commercial loan and two non-owner occupied commercial real estate loans. Partially offsetting the additions were $2.3 million in payoffs and paydowns and $939 thousand in upgrades to pass risk rating.

Loans designated special mention, which are not considered adversely classified, increased by $26.3 million to $86.5 million at June 30, 2023 from $60.2 million at December 31, 2022. The increase was largely due to $35.9 million in downgrades from pass risk ratings and balance increases of $548 thousand, which were partially offset by $5.9 million in downgrades from special mention to substandard and $4.2 million in paydowns and payoffs.

With the heightened market concern about non-owner occupied commercial real estate, and in particular the office portfolios, we are providing the following additional information. Non-owner occupied commercial real estate loans made up 64% of total classified loans as of June 30, 2023, compared to 88% at December 31, 2022 and all are currently paying in accordance with loan terms. We continue to maintain diversity among property types and within our geographic footprint. Specifically, our office commercial real estate portfolio in the City of San Francisco represents just 3% of our total loan portfolio and 6% of our total non-owner occupied commercial real estate portfolio. As of the last annual review period (generally December 2022), the average loan-to-value and debt-service coverage for the entire non-owner occupied office portfolio were 55% and 1.67x, respectively. For the eleven non-owner occupied office loans in the City of San Francisco totaling $71.4 with an average loan balance of $6.5 million, the average loan-to-value and debt-service coverage ratios were 63% and 1.20x, respectively.

For more information, refer to Note 5, Loans and Allowance for Credit Losses on Loans, to the consolidated financial statements in this Form 10-Q.

Liabilities - Deposits and Borrowings

During the first six months of 2023, total liabilities decreased by $67.2 million to $3.668 billion. Deposits totaled $3.325 billion at June 30, 2023, a decrease of $248.1 million compared to $3.573 billion at December 31, 2022. Federal Home Loan Bank borrowings increased $180.2 million to $292.2 million at June 30, 2023 from $112.0 million at December 31, 2022. Post quarter end, we reduced borrowings by another $92 million through July 31, 2023 and maintained excess cash, mostly from the sale of available-for-sale securities mentioned above, that is available for further reductions.

Non-interest bearing deposits decreased $250.4 million, while money market deposits increased $39.7 million and time deposits increased $84.4 million in the first six months of 2023. There was a small shift in deposit composition in the first half of 2023, dropping non-interest bearing deposits from 51.5% of total deposits to 47.8%, and raising money markets from 27.7% to 30.9% and time deposits from 3.3% to 6.1%. While there was some runoff in the first quarter attributed to industry disruptions and bank deposits moving to money market funds, the Bank experienced a modest recovery and gained deposit growth momentum in the second quarter. Additionally, the Bank's competitive and balanced approach to relationship management and focused outreach supported the growth adding over 1,400 new accounts during the second quarter, bringing the total to over 2,400 new accounts in 2023 (excluding new reciprocal accounts). Of those, approximately 40% were new relationships to the Bank. The average cost of deposits was 0.44% in the first half of 2023, compared to 0.06% in the same period of 2022.

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At June 30, 2023, the Bank had $292.2 million outstanding in overnight borrowings from the Federal Home Loan Bank at a rate of 5.28%, an increase of $180.2 million, compared to $112.0 million in overnight borrowings at December 31, 2022 at a rate of 4.65%. The Bank is actively evaluating strategies for reducing borrowings in the current environment and as market conditions change. Total immediate contingent funding sources, including unrestricted cash, unencumbered available-for-sale securities, and remaining borrowing capacity was $1.992 billion, or 60% of total deposits and 209% of estimated uninsured and/or uncollateralized deposits as of June 30, 2023.

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 and produces a five-year capital plan semi-annually to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet our anticipated future needs.  Stress tests are performed on capital ratios and include scenarios such as additional unrealized losses on the investment portfolio, additional deposit growth and potential share repurchases. 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 June 30, 2023. 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.

Bancorp's TCE ratio was 8.6% at June 30, 2023, compared to 8.2% at December 31, 2022. Bancorp's TCE ratio, net of after tax unrealized losses on held-to-maturity securities, was 6.7%, compared to 6.2% at December 31, 2022. Management believes this non-GAAP measure is important because it reflects the level of capital available to withstand drastic changes in market conditions (refer to page 45 for a discussion and reconciliation of this non-GAAP financial measure).

The Bancorp’s and Bank’s capital adequacy ratios as of June 30, 2023 and December 31, 2022 are presented in the following tables.

Bancorp Capital Ratios (dollars in thousands)			Actual						Adequately Capitalized Threshold 1						Threshold to be a Well Capitalized Bank Holding Company
June 30, 2023			Amount			Ratio			Amount			Ratio			Amount			Ratio
Total Capital (to risk-weighted assets)			$	440,340		16.36		%	$	282,667		10.50		%	$	269,207		10.00		%
Tier 1 Capital (to risk-weighted assets)			$	415,943		15.45		%	$	228,826		8.50		%	$	215,365		8.00		%
Tier 1 Leverage Capital (to average assets)			$	415,943		10.10		%	$	164,763		4.00		%	$	205,954		5.00		%
Common Equity Tier 1 (to risk-weighted assets)			$	415,943		15.45		%	$	188,445		7.00		%	$	174,984		6.50		%
December 31, 2022
Total Capital (to risk-weighted assets)			$	431,667		15.90		%	$	285,079		10.50		%	$	271,504		10.00		%
Tier 1 Capital (to risk-weighted assets)			$	407,912		15.02		%	$	230,778		8.50		%	$	217,203		8.00		%
Tier 1 Leverage Capital (to average assets)			$	407,912		9.60		%	$	169,948		4.00		%	$	212,435		5.00		%
Common Equity Tier 1 (to risk-weighted assets)			$	407,912		15.02		%	$	190,053		7.00		%	$	176,478		6.50		%

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Bank Capital Ratios (dollars in thousands)			Actual						Adequately Capitalized Threshold 1						Threshold to be Well Capitalized under Prompt Corrective Action Provisions
June 30, 2023			Amount			Ratio			Amount			Ratio			Amount			Ratio
Total Capital (to risk-weighted assets)			$	430,491		15.99		%	$	282,659		10.50		%	$	269,199		10.00		%
Tier 1 Capital (to risk-weighted assets)			$	406,094		15.09		%	$	228,819		8.50		%	$	215,359		8.00		%
Tier 1 Leverage Capital (to average assets)			$	406,094		9.86		%	$	164,759		4.00		%	$	205,949		5.00		%
Common Equity Tier 1 (to risk-weighted assets)			$	406,094		15.09		%	$	188,439		7.00		%	$	174,979		6.50		%
December 31, 2022
Total Capital (to risk-weighted assets)			$	427,108		15.73		%	$	285,052		10.50		%	$	271,478		10.00		%
Tier 1 Capital (to risk-weighted assets)			$	403,352		14.86		%	$	230,757		8.50		%	$	217,183		8.00		%
Tier 1 Leverage Capital (to average assets)			$	403,352		9.49		%	$	169,940		4.00		%	$	212,425		5.00		%
Common Equity Tier 1 (to risk-weighted assets)			$	403,352		14.86		%	$	190,035		7.00		%	$	176,461		6.50		%

1 Except for Tier 1 Leverage Capital, the adequately capitalized thresholds reflect the regulatory minimum plus a 2.5% capital conservation buffer as required under the Basel III Capital Standards in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses.

Liquidity and Capital Resources

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 seen in the table below and 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 Bank directors and the Bank's Chief Executive Officer, is responsible for approving and monitoring our liquidity targets and strategies. The Bank has long-established minimum liquidity and diversification requirements using tools similar to larger banks such as the Liquidity Coverage Ratio and multi-scenario, long-horizon stress testing. Our contingency funding plan provides for 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 maintained $2.2 million in off-balance sheet one-way deposit sales with our deposit networks at both June 30, 2023 and December 31, 2022.

Net available contingent funding sources, including unrestricted cash, unencumbered available-for-sale securities and total available borrowing capacity was $1.992 billion, or 209% of estimated uninsured and/or uncollateralized deposits as of June 30, 2023. The Federal Reserve's new BTFP facility offers borrowing capacity based on par values of securities pledged making it less sensitive to changes in market rates. The following table details the components of our contingent liquidity sources as of June 30, 2023.

(in thousands)			Total Available			Amount Used			Net Availability
Internal Sources
Unrestricted cash 1			$	16,705		N/A			$	16,705
Unencumbered securities at market value			761,472			N/A			761,472
External Sources
FHLB line of credit			1,033,792			$	(292,200)		741,592
FRB line of credit and BTFP facility			337,047			—			337,047
Lines of credit at correspondent banks			135,000			—			135,000
Total Liquidity			$	2,284,016		$	(292,200)		$	1,991,816

1 Excludes cash items in transit.

Note: Brokered deposits available through third party networks are not included above.

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, dividends to common stockholders, and operating expenses.

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Customer deposits are a significant component of our daily liquidity position. The attraction and retention of new deposits depend 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.

Our cash and cash equivalents decreased $5.8 million in the first half of 2023. Significant uses of liquidity during 2023 were $248.1 million in withdrawals of deposits, $9.3 million in loan originations and advances, net of principal collected, and $8.0 million in cash dividends paid on common stock to our shareholders.

The most significant sources of liquidity during the first half of 2023 were increased Federal Home Loan Bank borrowings of $180.2 million, proceeds from principal paydowns and maturities of investment securities of $59.0 million, and $21.5 million in net cash provided by operating activities. 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, as detailed in this report, and contingent funding sources outlined in the table above are adequate to support our operational needs.

Unfunded loan commitments, as discussed in Note 8 to the Consolidated Financial Statements in this Form 10-Q, totaled $489.6 million at June 30, 2023. We expect to fund these commitments to the extent utilized primarily through the repayment of existing loans, principal paydowns of investment securities, and liquid assets.

Over the next twelve months, $179.4 million of time deposits will mature. We expect to replace these funds with new deposits or excess liquidity. Our emphasis on local deposits, combined with our immediately available funding sources, provides a very stable base for our liquidity needs.

We had borrowings under our credit facilities of $292.2 million at June 30, 2023, and $112.0 million at December 31, 2022, as discussed in Note 6 to the Consolidated Financial Statements in ITEM 1 of this report.

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 $9.7 million in cash at June 30, 2023 and 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.

Statement Regarding use of Non-GAAP Financial Measures

Our first half of 2022 was impacted by costs associated with our 2021 acquisition of American River Bankshares, which we considered immaterial to discuss in this report. For additional information regarding the impact of non-GAAP adjustments to our first half of 2022 performance measures, refer to Form 10-Q filed on August 8, 2022.

In this report, financial results are presented in accordance with GAAP and with reference to certain non-GAAP financial measures. Management believes that, given recent industry turmoil, the presentation of Bancorp's non-GAAP TCE ratio reflecting the after-tax impact of unrealized losses on held-to-maturity securities provides useful supplemental information to investors because it reflects the level of capital available to withstand drastic changes in market conditions. Because there are limits to the usefulness of this measure to investors, Bancorp encourages readers to consider its annual and quarterly consolidated financial statements and notes related thereto in their entirety, as filed with the Securities and Exchange Commission, and not to rely on any single financial measure. A reconciliation of the non-GAAP TCE ratio is presented below.

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Reconciliation of GAAP and Non-GAAP Financial Measures

(in thousands, unaudited)						June 30, 2023			December 31, 2022
Tangible Common Equity - Bancorp
Total stockholders' equity						$	423,941		412,092
Goodwill and core deposit intangible						(77,185)			(77,870)
Total TCE			a			346,756			334,222
Unrealized losses on HTM securities, net of tax 1						(85,046)			(89,432)
TCE, net of unrealized losses on HTM securities (non-GAAP)			b			$	261,710		244,790
Total assets						$	4,092,133		4,147,464
Goodwill and core deposit intangible						(77,185)			(77,870)
Total tangible assets			d			4,014,948			4,069,594
Unrealized losses on HTM securities, net of tax 1						(85,046)			(89,432)
Total tangible assets, net of unrealized losses on HTM securities (non-GAAP)			e			$	3,929,902		3,980,162
Bancorp TCE ratio			a / d			8.6		%	8.2		%
Bancorp TCE ratio, net of unrealized losses on HTM securities (non-GAAP)			b / e			6.7		%	6.2		%

1 Net unrealized losses on held-to-maturity securities as of June 30, 2023 and December 31, 2022 of $120.7 million and $127.0, respectively, as shown in Note 4, net of an estimated $35.7 million and $37.5, respectively, in deferred tax benefits based on a blended state and federal statutory tax rate of 29.56%.

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. Interest rate changes can also affect the market value of our financial instruments, such as available-for-sale securities and the related unrealized gains or losses, which affects our equity value.

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 and 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 in the context of policy guidelines. A simplified 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. Governing policies are subject to review by regulators and are updated to incorporate their observations and to adapt to changes in idiosyncratic and systemic risks. At June 30, 2023, 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 and a static balance sheet is a series of immediate parallel shifts in the yield curve. Our most recent analysis of our interest rate sensitivity is provided in the following table as an example rather than an expectation of likely interest rate movements.

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Immediate and Parallel Shift in Interest Rates (in basis points)			Estimated Change in Net Interest Income in Year 1, as percent of Net Interest Income			Estimated Change in Net Interest Income in Year 2, as percent of Net Interest Income
up 400			(18.0)		%	(4.9)		%
up 300			(13.6)		%	(3.8)		%
up 200			(9.1)		%	(2.8)		%
up 100			(4.5)		%	(1.2)		%
down 100			4.9		%	2.9		%
down 200			9.1		%	4.8		%

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, lower deposit growth than modeled may cause the Bank to increase its borrowing position, thereby increasing its liability sensitivity. Additionally, 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 include the speed of deposit run-off and the amount by which interest-bearing deposit rates increase or decrease when market interest rates change, otherwise known as the deposit beta. We applied deposit betas up to 45%, averaging 35%, to rates paid on non-maturity interest-bearing deposits in rising rate scenarios, reflected in the table above. The actual rates and timing of prepayments on loans and investment securities could vary significantly from the assumptions applied in the various scenarios. Lastly, uneven changes in different tenors of U.S. Treasury rates that result in changes to 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 June 30, 2023, there were no significant changes that materially affected, or were 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.

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PART II       OTHER INFORMATION

 

ITEM 1         Legal Proceedings

Refer to Note 12 to the Consolidated Financial Statements in Item 8 of our 2022 Form 10-K and Note 8 to the Consolidated Financial Statements in this Form 10-Q.

ITEM 1A      Risk Factors

Our business is influenced by many factors that are difficult to predict, involve uncertainties that may materially affect actual results and are often beyond our control. In evaluating an investment in Bancorp's common stock, investors should consider, among other things, the risks previously disclosed in Part I, Item 1A, "Risk Factors" of our 2022 Form 10-K, and the information contained in this quarterly report on Form 10-Q and other reports and registration statements filed with the SEC, which are incorporated herein by reference. Other than as noted below, there have been no material changes in the risk factors disclosed in our 2022 Form 10-K.

Recent Negative Developments Affecting the Banking Industry and Resulting Media Coverage Have Eroded Customer and Investor Confidence in the Banking System

The recent high-profile bank failures involving Silicon Valley Bank, Signature Bank, and First Republic Bank, as well as media and market coverage of the Bay Area economy and local financial institutions, have generated significant market volatility among publicly traded bank holding companies and, in particular, regional and community banks like the Company. These market developments have negatively impacted customer confidence in the safety and soundness of regional and community banks. As a result, customers may choose to maintain deposits with larger financial institutions or invest in higher yielding short-term fixed income securities, all of which could materially adversely impact the Company’s liquidity, loan funding capacity, net interest margin, capital and results of operations. Additionally, these recent events have, and could continue to, adversely impact the market price and volatility of the Company’s common stock independent from the Company’s actual underlying financial performance.

Rising Interest Rates Have Decreased the Value of the Company’s Held-To-Maturity and Available-for-Sale Securities Portfolio, and the Company Would Realize Losses if It Were Required to Sell Such Securities to Meet Liquidity Needs

Because of inflationary pressures and the resulting rapid increases in interest rates over the last year, the trading value of previously issued government and other fixed income securities has declined significantly. These securities make up a majority of the securities portfolio of most banks in the U.S., including the Company’s, resulting in unrealized losses embedded in the held-to-maturity portion of U.S. banks’ securities portfolios and unrealized losses on available-for-sale securities reflected in the Company’s accumulated other comprehensive income. While the Company may use the sale of eligible securities in the normal course of business as a source of liquidity or to reposition the balance sheet for strategic purposes, it is not our intention to sell securities at a net loss. However, if the Company were to sell such securities it may incur losses that could impair the Company’s capital, financial condition, and results of operations and may require the Company to raise additional capital on unfavorable terms, thereby negatively impacting its profitability.

Any Regulatory Examination Scrutiny or New Regulatory Requirements Arising From the Recent Events in the Banking Industry Could Increase the Company’s Expenses and Affect the Company’s Operations

The Company also anticipates increased regulatory scrutiny – in the course of routine examinations and otherwise – and new regulations directed towards banks of similar size to the Bank, designed to address the recent negative developments in the banking industry, all of which may increase the Company’s costs of doing business and reduce its profitability. As primarily a commercial bank, the Bank has a higher percentage of uninsured deposits compared to primarily retail focused banks. As a result, the Bank could face increased scrutiny or be viewed as higher risk by regulators and the investor community.

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.

 

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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. On October 22, 2021, Bancorp Board of Directors approved an amendment, which increased the total authorization to $57.0 million and left the expiration date unchanged. The last activity under the program was in the first quarter of 2022.

On July 21, 2023, Bancorp Board of Directors approved the adoption of a new share repurchase program under which Bancorp could repurchase up to $25.0 million of its outstanding common stock expiring on July 31, 2025, which replaced the existing program.

ITEM 3       Defaults upon Senior Securities

None.

 

ITEM 4      Mine Safety Disclosures

Not applicable.

ITEM 5      Other Information

Not applicable.

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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 Number

Exhibit Description

Form

File No.

Exhibit

Filing Date

Herewith

3.01

Articles of Incorporation, as amended

S-4

333-257025

3.01

June 11, 2021

3.02

Bylaws, as amended

S-4

333-257025

3.02

June 11, 2021

4.01

Description of Capital Stock

10-K

001-33572

4.01

March 16, 2023

10.01

Employee Stock Ownership Plan

S-8

333-218274

4.1

May 26, 2017

10.02

2017 Employee Stock Purchase Plan

S-8

333-221219

4.1

October 30, 2017

10.03

2017 Equity Plan, as amended

S-8

333-227840

4.1

October 15, 2018

10.04

2020 Director Stock Plan

S-8

333-239555

4.1

June 30, 2020

10.05

Form of Indemnification Agreement for Directors and Executive Officers, dated August 9, 2007

10-Q

001-33572

10.06

November 7, 2007

10.06

2010 Annual Individual Incentive Compensation Plan, revised 2019

10-K

001-33572

10.07

March 15, 2021

10.07

Salary Continuation Agreement for executive officer Tani Girton, Chief Financial Officer, dated October 18, 2013

8-K

001-33572

10.2

November 4, 2014

10.08

2007 Form of Change in Control Agreement

8-K

001-33572

10.1

October 31, 2007

10.09

Director Deferred Fee Plan, dated December 17, 2020

10-K

001-33572

10.13

March 15, 2021

10.10

Employment Agreement with Timothy Myers, dated September 23, 2021

8-K

001-33572

10.1

September 24, 2021

10.11

Salary Continuation Agreement, as amended for executive officer Timothy Myers, Chief Executive Officer, dated January 1, 2022

8-K

001-33572

10.1

December 21, 2022

10.12

Salary Continuation Agreement for executive officer Nicolette Sloan, Head of Commercial Banking, dated January 1, 2022

8-K

001-33572

10.2

December 21, 2022

10.13

Salary Continuation Agreement for executive officer Misako Stewart, Chief Credit Officer, dated January 1, 2022

8-K

001-33572

10.3

December 21, 2022

10.14

Salary Continuation Agreement for executive officer Brandi Campbell, Head of Retail Banking, dated July 1, 2022

8-K

001-33572

10.4

December 21, 2022

31.01

Certification of Principal Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Filed

31.02

Certification of Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Filed

32.01

Certification pursuant to 18 U.S.C. §1350 as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002

Filed

101.INS

Inline XBRL Instance Document

Filed

101.SCH

Inline XBRL Taxonomy Extension Schema Document

Filed

101.CAL

Inline XBRL Taxonomy Extension Calculation Linkbase Document

Filed

101.LAB

Inline XBRL Taxonomy Extension Label Linkbase Document

Filed

101.PRE

Inline XBRL Taxonomy Extension Presentation Linkbase Document

Filed

101.DEF

Inline XBRL Taxonomy Extension Definition Linkbase Document

Filed

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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)
			August 8, 2023						/s/ Timothy D. Myers
			Date						Timothy D. Myers
									President and Chief Executive Officer
									(Principal Executive Officer)
			August 8, 2023						/s/ Tani Girton
			Date						Tani Girton
									Executive Vice President &
									Chief Financial Officer
									(Principal Financial Officer)
			August 8, 2023						/s/ David A. Merck
			Date						David A. Merck
									First Vice President & Controller
									(Principal Accounting Officer)

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