Item 7. Management’s Discussion and Analysis
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of financial condition as of December 31, 2020 and 2019 and results of operations for each of the years in the two-year period ended December 31, 2020 should be read in conjunction with our consolidated financial statements and related notes thereto, included in Part II ITEM 8 of this report. Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances. All share and per share data have been adjusted to reflect the stock split effective November 27, 2018.
Forward-Looking Statements
The disclosures set forth in this item are qualified by important factors detailed in Part I captioned Forward-Looking Statements and ITEM 1A captioned Risk Factors of this report and other cautionary statements set forth elsewhere in the report.
Critical Accounting Policies and Estimates
The SEC requires us to disclose "critical accounting policies" defined as those that are both most important to the presentation of our financial condition and results of operations and require management's most difficult, subjective, or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and imprecise. We consider accounting estimates to be critical to our financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain, (ii) management could have applied different assumptions during the reported period, and (iii) changes in the accounting estimate are reasonably likely to occur in the future and could have a material impact on our financial statements.
Management has determined the following accounting policies to be critical:
Allowance for Credit Losses on Loans and Unfunded Commitments - For information regarding critical estimates related to our allowance methodology, the provision for credit losses, and risks to asset quality and lending activity, including the transition from the incurred loss method to the current expected credit loss ("CECL") method under ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) and related amendments , which we adopted as of December 31, 2020, see ITEM 1A - Risk Factors, the Allowance for Credit Losses section in ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations, Note 1 - Summary of Significant Accounting Policies, and Note 3 - Loans and Allowance for Credit Losses in ITEM 8 - Financial Statements and Supplementary Data of this Form 10‑K.
Allowance for Credit Losses on Investment Securities - For information regarding our investment securities and risks associated with identifying impairment and estimating the allowance for credit losses under the new CECL method, see ITEM 1A - Risk Factors, Note 1 - Summary of Significant Accounting Policies, and Note 2 - Investment Securities in ITEM 8 - Financial Statements and Supplementary Data of this Form 10‑K.
Accounting for Income Taxes - For information on our tax assets and liabilities, and related provision for income taxes, see Note 1 - Summary of Significant Accounting Policies and Note 11 - Income Taxes in ITEM 8 - Financial Statements and Supplementary Data of this Form 10-K.
Fair Value Measurements - For information on our use of fair value measurements and our related valuation methodologies, see Note 1 - Summary of Significant Accounting Policies and Note 9 - Fair Value of Assets and Liabilities in ITEM 8 - Financial Statements and Supplementary Data of this Form 10-K.
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Executive Summary
Annual earnings were $30.2 million in 2020 compared to $34.2 million in 2019. Diluted earnings were $2.22 per share in 2020, compared to $2.48 per share in 2019.
The following are highlights of operating and financial performance for the year ended December 31, 2020:
• The Bank achieved total loan growth of $245.3 million, or 13% in 2020, to $2.089 billion at December 31, 2020, from $1.843 billion at December 31, 2019. SBA PPP loans outstanding at December 31, 2020 were $291.6 million.
• Credit quality remains strong with non-accrual loans representing 0.44% of the Bank's loan portfolio as of December 31, 2020. The adoption of CECL in the fourth quarter of 2020 resulted in an increase to the allowance for credit losses on loans of $748 thousand and a $1.1 million increase to the allowance for unfunded loan commitments. See Note 1, Summary of Significant Accounting Policies, for additional information.
• Deposits grew $167.8 million, or 7%, to $2.504 billion at December 31, 2020, compared to $2.336 billion at December 31, 2019. Non-interest bearing deposits grew by $225.8 million in 2020, or 20%, and made up 54% of total deposits at year-end. Cost of deposits remained low at 0.11% in 2020, compared to 0.20% in 2019.
• Net interest income totaled $96.7 million and $95.7 million in 2020 and 2019, respectively. The $1.0 million increase in 2020 was primarily due to SBA PPP loans and lower rates on interest-bearing deposits, largely offset by lower yields on earning-assets. The tax-equivalent net interest margin decreased to 3.55% in 2020, compared to 3.98% in 2019. The 43 basis point decrease was primarily due to lower yields across interest-earning asset categories, partially offset by lower rates on interest-bearing deposits.
• The efficiency ratio was 57.06% in 2020, up from 55.33% in 2019. Contributing to this increase was the decrease in net interest margin, higher provision for credit losses on unfunded loan commitments, and lower income from s ervice charges on deposit accounts and ATM fees in 2020.
• For the year ended December 31, 2020, return on assets and return on equity were 1.04% and 8.60%, respectively, compared to 1.34% and 10.49% in the prior year.
• All capital ratios exceeded regulatory requirements. The total risk-based capital ratio for Bancorp was 16.0% at December 31, 2020 up from 15.1% at December 31, 2019. Tangible common equity to tangible assets was 11.3% at both December 31, 2020 and December 31, 2019 (See footnote 8, ITEM 6, Selected Financial Data, for the definition of this non-GAAP financial measure). The total risk-based capital ratio for the Bank was 15.8% at December 31, 2020 and 14.6% at December 31, 2019.
• The Board of Directors declared a cash dividend of $0.23 per share on January 22, 2021. This was the 63 rd consecutive quarterly dividend paid by Bank of Marin Bancorp. The cash dividend was paid on February 12, 2021 to shareholders of record at the close of business on February 5, 2021.
• Our strong capital and liquidity position afforded us the opportunity to eliminate a high cost funding source. On March 15, 2021 we redeemed the $2.8 million subordinated debenture, which carried a rate of 5.68% in 2020. The redemption consisted of $4.1 million principal balance, quarterly interest due, and $1.3 million in accelerated accretion of purchase discount. The contractual interest rate on the subordinated debenture was 3-month LIBOR plus 1.40%, or 1.62% as of December 31, 2020.
COVID-19 Pandemic-Related Response Update - We have remained open and responded to customer needs throughout 2020. We more than doubled our charitable contributions to non-profit organizations in our community to over $1.0 million in 2020. In March 2020, we began waiving all ATM and overdraft fees and cancelling early withdrawal penalties for time certificate of deposits when allowed by law. We accommodated loan payment relief requests for borrowers with financial hardships and lowered interest rate floors on commercial Prime Rate loans. Under the provisions of the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") of 2020, Bank of Marin originated over 1,800 PPP loans to small businesses, reaching nearly 28,000 employees in our markets. In 2021, we are once again diligently working with our customers to accommodate requests for round two of PPP
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loans under the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act ("Economic Aid Act"), which became law in December of 2020.
Paycheck Protection Program - While the PPP affords us an opportunity to assist our customers and community and requires a large of amount of human resources, the PPP loans do not pose a significant amount of risk of loss to the Bank as they are 100% guaranteed by the SBA. As of December 31, 2020, there were 1,777 PPP loans outstanding totaling $291.6 million, net of $5.4 million in unearned fees. During the fourth quarter Bank of Marin opened a secure PPP loan forgiveness application portal and gave all PPP borrowers access to apply. As of December 31, 2020 we received SBA loan forgiveness payments totaling $10.9 million for 35 loans that were forgiven. Of the total PPP loans rem aining, 74% (1,309 loans) totaling $58.7 million are less than or equal to $150 thousand and have access to streamlined forgiveness processing. On January 19, 2021, the Bank launched the application process and began accepting loan requests for the second round of PPP, as revised by the Economic Aid Act. As of March 11, 2021, we have received 974 loan applications totaling $131.6 million.
Payment Relief - During 2020, in accordance with section 4013 of the CARES Act, subsequently amended by the Economic Aid Act, we elected to apply the temporary accounting relief provisions for loan modifications that met certain criteria, which would otherwise be designated as TDRs under existing GAAP. Of the 269 loans totaling $402.9 million granted payment relief since the onset of the pandemic, 222 loans or $324.2 million have resumed normal payments and 18 loans or $7.7 million paid off. As of December 31, 2020, 21 borrowing relationships with 29 loans totaling $71.0 million had requested additional payment relief. We know each of these clients very well and monitor their loans closely, and anticipate that the vast majority will work through current adverse conditions and resume making full payments. The following table summarizes these loans by industry or collateral type.
Payment Relief by Type
Industry/Collateral Type Outstanding Loan Balance
(in thousands) Weighted Average LTV
Education $ 17,580 26 %
Health Clubs 16,551 38 %
Office and Mixed Use 15,883 44 %
Hospitality 12,439 49 %
Retail Related CRE 6,899 52 %
Auto Dealership 393 49 %
Non-CRE Related 121 N/A
Residential Real Estate 1,130 60 %
Payment Relief Totals $ 70,996 40 %
Looking forward into the new year, with a low cost and stable deposit base, opportunities for loan growth, and our unwavering commitment to relationship banking, we believe we are well-positioned to navigate the remaining stages of the pandemic and build new capabilities. We have ample liquidity and capital to support organic growth and acquisitions in coming years. Acquisitions remain a component of our strategic plan and we will continue to evaluate merger and acquisition opportunities that fit with our culture and add value for our shareholders. Our disciplined credit culture and relationship-focused banking continue to be critical components of our success.
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RESULTS OF OPERATIONS
Net Interest Income
Net interest income is the interest earned on loans, investment securities and other interest-earning assets minus the interest expense incurred on deposits and other interest-bearing liabilities. Net interest income is affected by changes in general market interest rates and by changes in the amounts and composition of interest-earning assets and interest-bearing liabilities. Interest rate changes can create fluctuations in net interest income and/or margin due to an imbalance in the timing of repricing or maturity of assets or liabilities. We manage interest rate risk exposure with the goal of minimizing the effect of interest rate volatility on net interest income.
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.
The following table compares interest income, average interest-earning assets, interest expense, and average interest-bearing liabilities for the periods presented. The table also presents net interest income, net interest margin and net interest rate spread for the years indicated.
Table 1 Average Statements of Condition and Analysis of Net Interest Income
Year ended Year ended Year ended
December 31, 2020 December 31, 2019 December 31, 2018
Interest Interest Interest
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
(dollars in thousands; unaudited) Balance Expense Rate Balance Expense Rate Balance Expense Rate
Assets
Interest-earning deposits with banks 1
$ 153,794 $ 461 0.29 % $ 67,192 $ 1,321 1.94 % $ 78,185 $ 1,461 1.84 %
Investment securities 2, 3
533,186 15,025 2.82 % 555,618 15,102 2.72 % 566,883 14,512 2.56 %
Loans 1, 3, 4
2,023,203 85,398 4.15 % 1,775,193 85,062 4.73 % 1,704,390 80,406 4.65 %
Total interest-earning assets 1
2,710,183 100,884 3.66 % 2,398,003 101,485 4.17 % 2,349,458 96,379 4.05 %
Cash and non-interest-bearing due from banks 49,676 35,956 41,595
Bank premises and equipment, net 5,526 6,911 8,021
Interest receivable and other assets, net 131,780 109,837 86,709
Total assets $ 2,897,165 $ 2,550,707 $ 2,485,783
Liabilities and Stockholders' Equity
Interest-bearing transaction accounts $ 148,817 $ 186 0.13 % $ 133,922 $ 347 0.26 % $ 143,706 $ 226 0.16 %
Savings accounts 184,146 68 0.04 % 172,273 70 0.04 % 178,907 72 0.04 %
Money market accounts 763,689 2,009 0.26 % 680,296 3,439 0.51 % 612,372 1,355 0.22 %
Time accounts, including CDARS 96,558 554 0.57 % 106,783 595 0.56 % 137,339 542 0.39 %
Borrowings and other obligations 1
174 4 2.16 % 2,935 77 2.57 % 105 2 2.03 %
Subordinated debentures 1
2,741 158 5.68 % 2,673 229 8.44 % 5,025 1,339 26.29 %
Total interest-bearing liabilities 1,196,125 2,979 0.25 % 1,098,882 4,757 0.43 % 1,077,454 3,536 0.33 %
Demand accounts 1,308,199 1,094,806 1,085,870
Interest payable and other liabilities 41,347 30,578 18,514
Stockholders' equity 351,494 326,441 303,945
Total liabilities & stockholders' equity $ 2,897,165 $ 2,550,707 $ 2,485,783
Tax-equivalent net interest income/margin 1
$ 97,905 3.55 % $ 96,728 3.98 % $ 92,843 3.90 %
Reported net interest income/margin 1
$ 96,659 3.51 % $ 95,680 3.94 % $ 91,544 3.84 %
Tax-equivalent net interest rate spread 3.41 % 3.74 % 3.72 %
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%.
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.
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Table 2 Analysis of Changes in Net Interest Income
The following table presents the effects of changes in average balances (volume) or changes in average rates on tax-equivalent net interest income for the years 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.
2020 compared to 2019 2019 compared to 2018
(in thousands, unaudited) Volume Yield/Rate Mix Total Volume Yield/Rate Mix Total
Interest-earning deposits with banks $ 1,702 $ (1,120) $ (1,442) $ (860) $ (204) $ 75 $ (11) $ (140)
Investment securities 1
(610) 555 (22) (77) (288) 897 (19) 590
Loans 1
11,884 (10,337) (1,211) 336 3,340 1,263 53 4,656
Total interest-earning assets 12,976 (10,902) (2,675) (601) 2,848 2,235 23 5,106
Interest-bearing transaction accounts 39 (180) (20) (161) (15) 147 (11) 121
Savings accounts 5 (7) — (2) (3) 1 — (2)
Money market accounts 422 (1,655) (197) (1,430) 150 1,741 193 2,084
Time accounts, including CDARS (56) 15 — (41) (120) 223 (50) 53
Borrowings and other obligations (72) (12) 11 (73) 58 1 16 75
Subordinated debentures 6 (76) (1) (71) (627) (909) 426 (1,110)
Total interest-bearing liabilities 344 (1,915) (207) (1,778) (557) 1,204 574 1,221
Tax-equivalent net interest income $ 12,632 $ (8,987) $ (2,468) $ 1,177 $ 3,405 $ 1,031 $ (551) $ 3,885
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%.
2020 Compared to 2019
Net interest income totaled $96.7 million and $95.7 million in 2020 and 2019, respectively. The $1.0 million increase in 2020 was primarily due to SBA PPP loans and lower rates on interest-bearing deposits, largely offset by lower yields on earning-assets, except for investment securities where we collected prepayment penalties on called securities in 2020. Notable balance increases occurred in interest-earning deposits with other banks, commercial real estate loans and deposits. The tax-equivalent net interest margin decreased 43 basis points to 3.55% in 2020, from 3.98% in 2019 for the reasons already mentioned and as shown in the above table. Additionally, the SBA PPP loans lowered the 2020 net interest margin by 6 basis points.
On March 15, 2021, we redeemed the $2.8 million subordinated debenture. The redemption consisted of $4.1 million principal balance, quarterly interest due, and $1.3 million in accelerated accretion of purchase discount. The contractual interest rate on the subordinated debenture was 3-month LIBOR plus 1.40%, or 1.62% as of December 31, 2020.
2019 Compared to 2018
Net interest income totaled $95.7 million and $91.5 million in 2019 and 2018, respectively. The increase of $4.2 million in 2019 was primarily due to higher average loan balances and assets yields across all categories and the early redemption of a high-rate subordinated debenture in the fourth quarter of 2018. Positive variances were partially offset by higher balances and rates on money market accounts. The tax-equivalent net interest margin increased eight basis points to 3.98% in 2019 compared to 3.90% in 2018 for the same reasons.
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 posed by the COVID-19 pandemic, the FOMC made two emergency cuts totaling 150 basis points to the federal funds rate in March 2020. The federal funds target rate range resided between 0.0% to 0.25% for the majority of 2020, putting downward pressure on our asset yields and net interest margin. In each of its July, September and October 2019 meetings, the FOMC lowered the federal
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funds target rate by 0.25% to a range of 1.50% to 1.75% at the end of 2019. During 2018, the FOMC made four 25-basis-point increases to a range of 2.25% to 2.50% as of December 2018.
A low interest rate environment will continue to put downward pressure on asset yields and net interest margin to be fully seen in future periods. See ITEM 7A. 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 is increased by provisions charged to expense and loss recoveries and decreased by loans charged off. For additional information about the allowance for credit losses and transition from the incurred loss method to the CECL method in 2020, see Notes 1 and 3 to the Consolidated Financial Statements in ITEM 8 of this report.
We recorded a $4.6 million provision for credit losses in 2020, compared to a $900 thousand provision in 2019 and no provision for credit losses in 2018. The provision for credit losses in 2020 was largely due to the impact of the COVID-19 pandemic and its effect on the local and regional economies and economic outlook. In addition, under the CECL method, we increased our allowance for credit losses by approximately $925 thousand for previously acquired loans (i.e., non-purchased credit deteriorated or "non-PCD" loans); whereas, under previous GAAP (incurred loss method) we did not record an allowance on our unimpaired previously acquired non-PCD loans. Our allowance model is particularly sensitive to current and forecasted California unemployment rates, which increased from 3.7% at December 31, 2019 to 8.8% at December 31, 2020. The pandemic also negatively affected the financial condition of many of our borrowers, which was partially alleviated by our payment relief program under the CARES Act and the SBA PPP. Additionally, with the adoption of ASC 326 in 2020, our provision for credit losses may become more volatile in the future due to changes in macroeconomic conditions and forecasts, CECL model assumptions, and loan composition, which affect the allowance for credit losses balance. The provision for credit losses in 2019 was consistent with loan growth. The lack of a provision for credit losses in 2018 was primarily due to a $15.3 million decrease in classified loans, resulting from two borrowing relationships whose risk grades were upgraded from substandard to special mention in the second quarter of 2018.
Non-interest Income
The table below details the components of non-interest income.
Table 3 Components of Non-Interest Income
2020 compared to 2019 2019 compared to 2018
Years ended December 31, Amount Increase (Decrease) Percent Increase (Decrease) Amount Increase (Decrease) Percent Increase (Decrease)
(dollars in thousands; unaudited) 2020 2019 2018
Service charges on deposit accounts $ 1,314 $ 1,865 $ 1,891 $ (551) (29.5) % $ (26) (1.4) %
Wealth Management and Trust Services 1,851 1,907 1,919 (56) (2.9) % (12) (0.6) %
Debit card interchange fees 1,438 1,586 1,561 (148) (9.3) % 25 1.6 %
Earnings on bank-owned life insurance, net 973 1,196 913 (223) (18.6) % 283 23.7 %
Gains on investment securities, net 915 55 876 860 1,563.6 % (821) (1,492.7) %
Dividends on FHLB stock 654 799 959 (145) (18.1) % (160) (20.0) %
Merchant interchange fees 239 331 378 (92) (27.8) % (47) (14.2) %
Other income 1,166 1,345 1,642 (179) (13.3) % (297) (22.1) %
Total non-interest income $ 8,550 $ 9,084 $ 10,139 $ (534) (5.9) % $ (1,055) (11.6) %
2020 Compared to 2019
Non interest income totaled $8.6 million and $9.1 million in 2020 and 2019, respectively. The $534 thousand decline was primarily due to $551 thousand lower service charges on deposit accounts and ATM fees, as these fees were waived during the pandemic, lower income from bank-owned life insurance (" BOLI") policies due to a $562 thousand benefit collected on BOLI policies in the third quarter of 2019 (partially offset by $283 thousand underwriting expenses for two new BOLI policies in the first quarter of 2019), $182 thousand lower fee income from
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one-way deposit sales to third-party deposit networks and $145 thousand lower dividends on FHLB stock, partially offset by $860 thousand net gains on the sale of investment securities.
2019 Compared to 2018
Non-interest income totaled $9.1 million and $10.1 million in 2019 and 2018, respectively. The decrease compared to the prior year primarily related to a $956 thousand pre-tax gain on the sale of 6,500 shares of Visa Inc. Class B restricted common stock, a $180 thousand Federal Home Loan Bank special dividend, and higher fee income from one-way deposit sales to third-party networks in 2018. The decrease in non-interest income was partially offset by a $562 thousand gain from the settlement of death benefits on bank-owned life insurance in 2019, net of underwriting costs associated with two new bank-owned life insurance policies.
Non-interest Expense
The table below details the components of non-interest expense.
Table 4 Components of Non-Interest Expense
2020 compared to 2019 2019 compared to 2018
Years ended December 31, Amount Increase (Decrease) Percent Increase (Decrease) Amount Increase (Decrease) Percent Increase (Decrease)
(dollars in thousands; unaudited) 2020 2019 2018
Salaries and employee benefits $ 34,393 $ 34,253 $ 33,335 $ 140 0.4 % $ 918 2.8 %
Occupancy and equipment 6,943 6,143 5,976 800 13.0 % 167 2.8 %
Data processing 3,184 3,717 4,358 (533) (14.3) % (641) (14.7) %
Professional services 2,181 2,132 3,317 49 2.3 % (1,185) (35.7) %
Depreciation and amortization 2,149 2,228 2,143 (79) (3.5) % 85 4.0 %
Provision for credit losses on unfunded loan commitments 1,570 129 — 1,441 1,117.1 % 129 100.0 %
Information technology 1,050 1,065 1,023 (15) (1.4) % 42 4.1 %
Charitable contributions 1,034 508 463 526 103.5 % 45 9.7 %
Amortization of core deposit intangible 853 887 921 (34) (3.8) % (34) (3.7) %
Directors' expense 713 735 700 (22) (3.0) % 35 5.0 %
Federal Deposit Insurance Corporation insurance 474 361 756 113 31.3 % (395) (52.2) %
Other non-interest expense:
Advertising 769 775 666 (6) (0.8) % 109 16.4 %
Other expense 4,715 5,037 4,608 (322) (6.4) % 429 9.3 %
Total other non-interest expense 5,484 5,812 5,274 (328) (5.6) % 538 10.2 %
Total non-interest expense $ 60,028 $ 57,970 $ 58,266 $ 2,058 3.6 % $ (296) (0.5) %
2020 Compared to 2019
Non-interest expense increased $2.1 million to $60.0 million in 2020 from $58.0 million in 2019. The largest increases came from the provision for unfunded loan commitments, occupancy expenses (primarily due to lease renewals for our existing headquarters offices and new lease for a loan production office in San Mateo , common area maintenance and janitorial expenses), and charitable contributions due to our outreach to nonprofit organizations in our community during the pandemic. The decrease in data processing costs was due to our digital platform conversion in 2019. While salaries and related benefits were relatively unchanged year-over-year, annual merit and related increases were mostly offset by $915 thousand in SBA PPP-related deferred loan origination costs.
The increase in the provision for credit losses on unfunded loan commitments was mainly attributed to a $75.3 million increase in unfunded loan commitments, an increase in expected loss rates due to the COVID-19 pandemic, and changes in certain allowance model assumptions in the transition from the incurred loss method to the CECL method in 2020 (refer to Note 1, Summary of Significant Accounting Policies, for additional information).
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2019 Compared to 2018
In 2019, non-interest expense decreased by $296 thousand to $58.0 million. The decrease was primarily due to $1.0 million in consulting expenses related to core processing contract negotiations in 2018, lower data processing expenses in 2019 as a result of the renegotiation of the Bank's core systems contract, and lower Federal Deposit Insurance Corporation ("FDIC") deposit insurance expenses due to the FDIC Deposit Insurance Fund reserve exceeding its billing threshold in 2019. The decreases in non-interest expense were partially offset by $918 thousand higher salaries and related benefits as a result of annual merit increases, three additional full-time equivalent employees (on average), and personnel severance, as well as higher recruiting fees recorded in other expenses.
Provision for Income Taxes
Income tax provisions reflect accruals for taxes at the applicable rates for federal income tax and California franchise tax based upon reported pre-tax income. Provisions also reflect permanent differences between income for tax and financial reporting purposes (such as earnings on tax exempt loans and municipal securities, BOLI, low-income housing tax credits, and stock-based compensation from the exercise of stock options, disqualifying dispositions of incentive stock options and vesting of restricted stock awards).
The provision for income taxes totaled $10.3 million at an effective tax rate of 25.5% in 2020, compared to $11.7 million at an effective tax rate of 25.4% in 2019 and $10.8 million at an effective tax rate of 24.9% in 2018. The decrease in the provision in 2020 compared to 2019 reflected lower pre-tax income and higher tax-exempt interest income on municipal securities. The slight increase in the effective tax rate in 2020 as compared to 2019 was due to a favorable deferred tax liability true-up recognized in 2019 and a lower tax benefit from BOLI income in 2020. The increase in the effective tax rate in 2019 compared to 2018 was due to a higher level of tax benefits in 2018 from the exercise of non-qualified stock options and disqualifying dispositions of incentive stock options by former employees of Bank of Napa post-acquisition.
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 December 31, 2020 and 2019, neither the Bank nor Bancorp had accruals for interest or penalties related to unrecognized tax benefits.
FINANCIAL CONDITION
Our assets increased $204.6 million from December 31, 2019 to December 31, 2020, mainly due to loan growth of $245.3 million, primarily driven by PPP loan originations, which were offset by a $68.3 million decrease in investment security balances.
Investment Securities
We maintain an investment securities portfolio to provide liquidity and to generate earnings on funds that have not been loaned to customers. Management determines the maturities and types of securities to be purchased based on liquidity and interest rate risk position, and the desire to attain a reasonable investment yield balanced with risk exposure. Table 5 shows the composition of the debt securities portfolio by expected maturity at December 31, 2020 and 2019. Expected maturities differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties. We estimate and update expected maturity dates regularly based on current and historical prepayment speeds. The weighted average life of the investment portfolio at December 31, 2020 and 2019 was approximately five and six years, respectively.
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Table 5 Investment Securities
December 31, 2020 Within 1 Year 1-5 Years 5-10 Years After 10 Years Total
(dollars in thousands; unaudited) AmortizedCost 1
Average Yield 2
AmortizedCost 1
Average Yield 2
AmortizedCost 1
Average Yield 2
AmortizedCost 1
Average Yield 2
AmortizedCost 1
Fair Value Average Yield 2
Held-to-maturity:
MBS/CMOs issued by U.S. government agencies $ — — % $ 76,378 1.89 % $ 24,444 2.51 % $ — — % $ 100,822 $ 106,550 2.04 %
SBA-backed securities — — — — 6,547 3.17 — — 6,547 6,947 3.17
Obligations of state and political subdivisionsl 3
1,461 5.46 206 4.58 — — 1,667 1,688 5.35
Total held-to-maturity $ 1,461 5.46 $ 76,584 1.89 $ 30,991 2.65 $ — — $ 109,036 $ 115,185 2.16
Available-for-sale:
MBS/CMOs issued by U.S. government agencies $ 4,765 1.60 $ 94,844 2.36 $ 117,657 2.72 $ — — $ 217,266 $ 228,651 2.54
SBA-backed securities — — 16,994 2.40 13,947 3.43 — — 30,941 32,862 2.86
Obligations of state and political subdivisions 3
3,653 2.68 18,616 3.01 82,618 2.73 — — 104,887 110,652 2.78
Debentures of government sponsored agencies 9,993 2.18 5,984 2.62 1,976 1.42 1,991 1.39 19,944 20,186 2.16
Total available-for-sale $ 18,411 2.13 $ 136,438 2.46 $ 216,198 2.76 $ 1,991 1.39 $ 373,038 $ 392,351 2.61
Total $ 19,872 2.37 % $ 213,022 2.26 % $ 247,189 2.74 % $ 1,991 1.39 % $ 482,074 $ 507,536 2.51 %
December 31, 2019 Within 1 Year 1-5 Years 5-10 Years After 10 Years Total
(dollars in thousands; unaudited) AmortizedCost 1
Average Yield 2
AmortizedCost 1
Average Yield 2
AmortizedCost 1
Average Yield 2
AmortizedCost 1
Average Yield 2
AmortizedCost 1
Fair Value Average Yield 2
Held-to-maturity:
MBS/CMOs issued by U.S. government agencies $ 3,763 2.47 % $ 72,861 2.12 % $ 49,277 2.54 % $ — — % $ 125,901 $ 127,790 2.30 %
SBA-backed securities — — — — 7,999 3.19 — — 7,999 8,264 3.19
Obligations of state and political subdivisions 3
1,807 4.45 1,706 5.36 — — — — 3,513 3,588 4.89
Total held-to-maturity $ 5,570 3.11 $ 74,567 2.19 $ 57,276 2.63 $ — — $ 137,413 $ 139,642 2.41
Available-for-sale:
MBS/CMOs issued by U.S. government agencies $ 4,157 1.97 $ 126,702 2.67 $ 141,462 3.01 $ — — $ 272,321 $ 278,144 2.83
SBA-backed securities — — 5,280 2.54 30,394 2.88 — — 35,674 36,286 2.83
Obligations of state and political subdivisionsl 3
2,082 2.67 16,619 2.82 47,341 3.03 — — 66,042 67,282 2.96
Debentures of government sponsored agencies 498 2.05 16,040 2.92 21,881 2.75 9,970 2.91 48,389 49,046 2.83
Corporate bonds 1,497 3.54 — — — — — — 1,497 1,502 3.54
Total available-for-sale $ 8,234 2.44 $ 164,641 2.70 $ 241,078 2.97 $ 9,970 2.91 $ 423,923 $ 432,260 2.85
Total $ 13,804 2.71 % $ 239,208 2.54 % $ 298,354 2.91 % $ 9,970 2.91 % $ 561,336 $ 571,902 2.75 %
1 Book value reflects cost, adjusted for accumulated amortization and accretion.
2 Weighted average calculation is based on amortized cost of securities.
3 Yields on tax-exempt municipal bonds are presented on a taxable equivalent basis, using federal tax rate of 21%.
The amortized cost of our investment securities portfolio decreased $79.3 million or 14% during 2020. We purchased $97.5 million in securities in 2020 designated as available-for-sale to provide flexibility for liquidity and interest rate risk management. These purchases were offset by $143.1 million of paydowns, calls and maturities, and $32.8 million of sales during 2020.
During 2020, we purchased $57.6 million in obligations of state and political subdivisions, $31.0 million in collateralized mortgage obligations ("CMOs") and $9.0 million in debentures of government sponsored agencies. We consider agency debentures and CMOs issued by U.S. government sponsored entities to have low credit risk as they carry the credit support of the U.S. federal government. The debentures, CMOs and MBS issued by U.S. government sponsored agencies, state and municipal securities, and SBA-backed securities made up 70.1%, 22.1% and 7.8% of the portfolio at December 31, 2020, compared to 79.6%, 12.4% and 7.8%, respectively at December 31, 2019. See the discussion in the section captioned “Securities May Lose Value due to Credit Quality of the Issuers” in ITEM 1A Risk Factors above.
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At December 31, 2020, distribution of our investment in obligations of state and political subdivisions was as follows:
December 31, 2020 December 31, 2019
(dollars in thousands; unaudited) Amortized Cost Fair Value Percent of
State and Municipal Securities Amortized Cost Fair Value Percent of
State and Municipal Securities
Within California:
General obligation bonds $ 3,327 $ 3,565 3.1 % $ 4,597 $ 4,813 6.6 %
Revenue bonds 2,352 2,448 2.2 2,928 2,977 4.2
Tax allocation bonds 2,832 2,876 2.7 3,376 3,456 4.9
Total within California 8,511 8,889 8.0 10,901 11,246 15.7
Outside California:
General obligation bonds 78,299 82,100 73.5 45,974 46,976 66.1
Revenue bonds 19,744 21,351 18.5 12,680 12,648 18.2
Total outside California 98,043 103,451 92.0 58,654 59,624 84.3
Total obligations of state and political subdivisions $ 106,554 $ 112,340 100.0 % $ 69,555 $ 70,870 100.0 %
The portion of the portfolio outside the state of California is distributed among 10 states. The largest concentrations outside California are in Texas (55.3%), Washington (9.3%), and Maryland (6.4%). During March 2020, we strategically increased our credit exposure to obligations issued by high credit quality issuers in Texas that are either guaranteed by the AAA-rated Texas Permanent School Fund ("PSF") or backed by revenue sources from essential services such as utilities and transportation. We have $6.0 million in obligations of Texas school district issuers having high concentrations in oil and gas industry taxpayers and all of them have credit guarantees from PSF. We believe the healthy level of reserves and excess guarantee capacity at the PSF sufficiently mitigates any potential credit issues posed by the issuers' exposure to the oil and gas industry, as well as the negative effects of the recent winter storms in Texas. In addition, we have little or no exposure to municipal sectors such as higher education or health care that are most vulnerable to credit risks posed by the COVID-19 pandemic.
Investments in states, municipalities and political subdivisions are subject to an initial pre-purchase credit assessment and ongoing monitoring. Key considerations include:
• The soundness of a municipality’s budgetary position and stability of its tax revenues
• Debt profile and level of unfunded liabilities, diversity of revenue sources, taxing authority of the issuer
• Local demographics/economics including unemployment data, largest local taxpayers and employers, income indices and home values
• For revenue bonds, the source and strength of revenue for municipal authorities including obligors' financial condition and reserve levels, annual debt service and debt coverage ratio, and credit enhancement (such as insurer’s strength)
• Credit ratings by major credit rating agencies
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Loans
Table 6 Loans Outstanding by Class at December 31
(in thousands; unaudited) 2020 2019 2018 2017 2016
Commercial and industrial loans $ 498,408 $ 246,687 $ 230,739 $ 235,835 $ 218,615
Real estate
Commercial owner-occupied 304,963 308,824 313,277 300,963 247,713
Commercial investor-owned 961,208 946,317 873,410 822,984 724,228
Construction 73,046 61,095 76,423 63,828 74,809
Home equity 104,813 116,024 124,696 132,467 117,207
Other residential 123,395 136,657 117,847 95,526 78,549
Installment and other consumer loans 22,723 27,682 27,472 27,410 25,495
Total loans, at amortized cost 2,088,556 1,843,286 1,763,864 1,679,013 1,486,616
Allowance for credit losses on loans (22,874) (16,677) (15,821) (15,767) (15,442)
Total loans, net of allowance for credit losses $ 2,065,682 $ 1,826,609 $ 1,748,043 $ 1,663,246 $ 1,471,174
Loans increased $245.3 million in 2020, or 13%, to $2.089 billion at December 31, 2020, from $1.843 billion at December 31, 2019. SBA PPP loans outstanding at December 31, 2020 totaled $291.6 million and were included in commercial and industrial loans. For the year ended December 31, 2020, new non-PPP-related loan originations were $165.5 million, compared to $259.6 million in 2019. The decrease in non-PPP loan originations was largely due a decrease in conventional loan demand as a result of the pandemic and shelter-at-home orders. New loan originations were more than offset by payoffs of $180.1 million and reduction in line usage. Loan payoffs were concentrated in consumer and retail loans (mostly tenant in common and HELOC) and commercial loans on which underlying assets were sold, loans refinanced with other banks, or loans that were paid off with cash. Payoffs as a percentage of beginning of the year loan balances were 9.8%, 8.3% and 9.4% in 2020, 2019 and 2018, respectively. Approximate ly 77% and 88%, of total loans were secured by real estate at December 31, 2020 and 2019, respectively. The decrease in the percentage in 2020 was due to PPP loans, which are not secured by real estate. For additional information on loan concentration risk, see ITEM 1A, Risk Factors.
The following table summarizes our commercial real estate loan portfolio by the county in which the property was located as of December 31, 2020 and 2019.
Table 7 Commercial Real Estate Loans Outstanding by County
(dollars in thousands; unaudited) December 31, 2020 December 31, 2019
County Amount Percent of Commercial Real Estate Loans Amount Percent of Commercial Real Estate Loans
Marin $ 348,106 27.5 % $ 339,917 27.1 %
Sonoma 208,745 16.5 199,717 15.9
Napa 181,054 14.3 175,170 14.0
San Francisco 169,902 13.4 165,205 13.2
Alameda 164,921 13.0 175,664 14.0
Contra Costa 49,155 3.9 46,933 3.7
San Mateo 26,306 2.1 22,278 1.8
Solano 21,380 1.7 23,710 1.9
Other 96,602 7.6 106,547 8.4
Total $ 1,266,171 100.0 % $ 1,255,141 100.0 %
Commercial real estate loans increased $11.0 million in 2020, compared to a $68.5 million increase in 2019. Of the commercial real estate loans at December 31, 2020, 76% were investor-owned and 24% were owner-occupied. Almost the entire commercial real estate loan portfolio is comprised of term loans for which the primary source of repayment is either the cash flow from the leasing activities of the real estate collateral or the operating cash flow of the owner occupant.
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We occasionally provide interest-only term loans to borrowers who exhibit strong financial capacity and/or for commercial real estate loans during the occupancy stabilization period. After the initial inte rest-only payment period, these loans will normally require principal and interest payments. In addition, we may make interest-only concessions in a modified troubled debt restructuring ("TDR"). At December 31, 2020 and 2019, approximately 3.4% and 3.7%, respectively, of our commercial real estate loans contained an interest-only feature as part of the loan terms. All of these loans were current with their payments as of December 31, 2020. Except for two TDR loans to one borrowing relationship totaling $7.1 million as of December 31, 2020, all were considered to have low credit risk (graded "Pass").
The following table shows an analysis of construction loans by type and county as of December 31, 2020 and 2019.
Table 8 Construction Loans Outstanding by Type and County
(dollars in thousands; unaudited) December 31, 2020 December 31, 2019
Loan Type Amount Percent of Construction Loans Amount Percent of Construction Loans
Commercial real estate $ 29,788 40.8 % $ 29,568 48.4 %
Apartments and multifamily 22,331 30.6 13,202 21.6
1-4 Single family residential 18,308 25.1 13,257 21.7
Land - improved 1,371 1.9 3,775 6.2
Land - unimproved 1,248 1.6 1,293 2.1
Total $ 73,046 100.0 % $ 61,095 100.0 %
(dollars in thousands; unaudited) December 31, 2020 December 31, 2019
County Amount Percent of Construction Loans Amount Percent of Construction Loans
San Francisco $ 41,707 57.1 % $ 19,374 31.7 %
Sonoma 10,058 13.8 8,808 14.4
Solano 9,020 12.3 1,952 3.2
Marin 8,858 12.1 18,600 30.5
Alameda 1,862 2.5 2,092 3.4
San Mateo — — 5,323 8.7
Napa — — 4,284 7.0
Other 1,541 2.2 662 1.1
Total $ 73,046 100.0 % $ 61,095 100.0 %
Construction loans increased by $12.0 million in 2020, compared to a $15.3 million decrease in 2019. The increase in 2020 primarily resulted from additional borrowings under existing construction loans as well as advances on six new construction loans to well-known, experienced builders. The increase was partially offset by the successful completion of projects, one of which converted to a permanent commercial real estate loan. The decrease in 2019 was primarily due to a $14.8 million loan that converted to a commercial real estate loan and one payoff from a completed apartment building construction project.
The following table presents the maturity distribution of our commercial and construction loans as of December 31, 2020 based on their contractual maturity dates and does not include scheduled payments or potential prepayments.
Table 9A Commercial and Industrial and Construction Loan Maturity Distribution
Due within Due after 1 but Due after
(in thousands; unaudited) 1 year within 5 years 5 years Total
Commercial and industrial 1
$ 77,534 $ 373,463 $ 47,411 $ 498,408
Construction 2
28,454 21,862 22,730 73,046
Total $ 105,988 $ 395,325 $ 70,141 $ 571,454
1 Commercial and industrial due after 1 but within 5 years includes SBA PPP loans totaling $291.6 million, the majority of which are expected to be forgiven by the SBA in 2021.
2 Construction loans that mature after 5 years are structured to convert to permanent financing after the initial construction period.
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The following table shows the mix of variable-rate loans to fixed-rate loans for commercial and construction loans. The large majority of the variable-rate loans are tied to independent indices (such as the Prime Rate or a Treasury Constant Maturity Rate). Most loans with original terms of more than five years have provisions for the fixed rates to reset, or convert to variable rates, after three, five or seven years. These loans are included in variable-rate balances below.
Table 9B Commercial and industrial and Construction Loan Interest Rate Sensitivity
(in thousands; unaudited) Fixed Variable Total
Commercial and industrial 1
$ 395,619 $ 102,789 $ 498,408
Construction 43,851 29,195 73,046
Total $ 439,470 $ 131,984 $ 571,454
1 Commercial and industrial includes SBA PPP 1% fixed rate loans totaling $291.6 million, the majority of which are expected to be forgiven by the SBA in 2021.
Allowance for Credit Losses on Loans
As of December 31, 2020, we calculated the allowance for credit losses using the current expected loss methodology, or CECL, which required us to estimate credit losses over the expected life of a loan and consider future changes in macroeconomic conditions. All specifically identifiable and quantifiable losses are charged off against the allowance. The ultimate adequacy of the allowance is dependent upon a variety of factors beyond our control, including the real estate market, changes in interest rates and economic and political environments. Based on the current conditions of the loan portfolio and reasonable and supportable forecasts, management believes that the $22.9 million allowance for credit losses at December 31, 2020 is adequate to absorb expected credit losses in our loan portfolio, but provides no assurance that adverse changes in economic conditions or other circumstances over the remaining terms of our loans will not result in increased losses in the portfolio. For information on our allowance for credit losses methodology and adoption of FASB ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments , effective December 31, 2020, refer to Notes 1 and 3 to the Consolidated Financial Statements in ITEM 8 of this report.
The allowance for credit losses to loans was 1.10% at December 31, 2020 and 0.90% at both December 31, 2019 and 2018. The allowance for credit losses to loans, excluding SBA PPP loans and previously acquired loans was 1.27%, 0.96% and 0.98% at year-end 2020, 2019, and 2018, respectively (for a discussion of this non-GAAP financial measure, refer to ITEM 6, Selected Financial Data of this report). As stated in the Provision for Credit Losses section above, the increase in allowance for credit losses in 2020 was almost entirely due to the impact of the COVID-19 pandemic and its effect on the local and regional economies and economic outlook coupled with the transition to the CECL method. Due to the high credit quality of our loan portfolio, net charge-offs have been minimal for the past several years. Net charge-offs totaled $1 thousand in 2020 and $44 thousand in 2019, compared to net recoveries of $54 thousand in 2018.
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Table 10 shows the allocation of the allowance by loan class as well as the per centage of total loans in each of the same loan classes.
Table 10 Allocation of Allowance for Credit Losses
December 31, 2020 December 31, 2019 December 31, 2018 December 31, 2017 December 31, 2016
(dollars in thousands; unaudited) Allowance balance allocation Loans as a percent of total loans Allowance balance allocation Loans as a percent of total loans Allowance balance allocation Loans as a percent of total loans Allowance balance allocation Loans as a percent of total loans Allowance balance allocation Loans as a percent of total loans
Commercial and industrial $ 2,530 23.9 % $ 2,334 13.4 % $ 2,436 13.1 % $ 3,654 14.0 % $ 3,248 14.7 %
Real estate:
Commercial, owner-occupied 2,778 14.6 2,462 16.8 2,407 17.8 2,294 17.9 1,753 16.7
Commercial, investor-owned 12,682 46.0 8,483 51.3 7,703 49.5 6,475 49.1 6,320 48.7
Construction 1,557 3.5 638 3.3 756 4.3 681 3.8 781 5.0
Home Equity 738 5.0 850 6.3 915 7.1 1,031 7.9 973 7.9
Other residential 998 5.9 973 7.4 800 6.7 536 5.7 454 5.3
Installment and other consumer 291 1.1 284 1.5 310 1.5 378 1.6 372 1.7
Unallocated allowance 1,300 N/A 653 N/A 494 N/A 718 N/A 1,541 N/A
Total allowance for credit losses $ 22,874 $ 16,677 $ 15,821 $ 15,767 $ 15,442
Total percent 100.0% 100.0% 100.0% 100.0% 100.0%
Table 11 shows the activity in the allowance for credit losses for each of the five years presented below.
Table 11 Allowance for Credit Losses Rollforward
(dollars in thousands; unaudited) 2020 2019 2018 2017 2016
Beginning balance $ 16,677 $ 15,821 $ 15,767 $ 15,442 $ 14,999
Impact of CECL adoption 1,604 — — — —
Provision for (reversal of) credit losses 4,594 900 — 500 (1,850)
Loans charged-off:
Commercial and industrial (30) (75) (3) (289) (11)
Real estate:
Commercial real estate, owner-occupied — — — — (20)
Installment and other consumer (1) (3) (2) (4) (5)
Total loans charged-off (31) (78) (5) (293) (36)
Loans recovered:
Commercial and industrial 27 22 17 111 143
Real estate:
Commercial, investor-owned — 12 — — 2,156
Construction 3 — — — —
Home equity — — — — 3
Installment and other consumer — — 42 7 27
Total loans recovered 30 34 59 118 2,329
Net loans (charged-off) recovered (1) (44) 54 (175) 2,293
Ending balance $ 22,874 $ 16,677 $ 15,821 $ 15,767 $ 15,442
Total loans, at amortized cost $ 2,088,556 $ 1,843,286 $ 1,763,864 $ 1,679,013 $ 1,486,616
Average total loans outstanding during year $ 2,023,203 $ 1,775,193 $ 1,704,390 $ 1,511,503 $ 1,452,357
Ratio of allowance for credit losses to total loans at end of year 1.10 % 0.90 % 0.90 % 0.94 % 1.04 %
Net (charge-offs) recoveries to average loans NM NM NM (0.01) % 0.16 %
NM - Not meaningful.
Net charge-offs and recoveries for the years ended December 31, 2020, 2019 and 2018 were considered insignificant. Charge-offs in 2017 primarily included a $283 thousand unsecured commercial loan. Recoveries in 2016 primarily resulted from the resolution and pay-off of a commercial real estate credit.
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Table 12 shows non-performing assets and loans modified in a troubled debt restructuring ("TDR") for each of the years in the five-year period ended December 31, 2020.
Table 12 Non-Performing and Underperforming Assets and Troubled Debt Restructurings
(dollars in thousands; unaudited) 2020 2019 2018 2017 2016
Non-accrual loans:
Commercial and industrial $ — $ — $ 319 $ — $ —
Real estate:
Commercial, owner-occupied 7,147 — — — —
Commercial, investor-owned 1,610 — — — —
Home equity 459 168 313 406 91
Installment and other consumer 17 58 65 — 54
Total non-accrual loans 9,233 226 697 406 145
Other real estate owned 1
— — — — 408
Total non-performing assets $ 9,233 $ 226 $ 697 $ 406 $ 553
Accruing TDR loans: 2
Commercial and industrial $ 1,021 $ 1,223 $ 1,506 $ 2,165 $ 2,207
Real estate:
Commercial, owner-occupied — 6,998 6,993 6,999 6,993
Commercial, investor-owned 3,305 1,770 1,821 2,171 2,256
Construction — — 2,688 2,969 3,245
Home equity 10 251 251 347 625
Other residential — 452 462 1,148 1,965
Installment and other consumer 735 580 620 721 877
Total accruing TDR loans $ 5,071 $ 11,274 $ 14,341 $ 16,520 $ 18,168
Total non-performing assets and accruing TDR loans $ 14,304 $ 11,500 $ 15,038 $ 16,926 $ 18,721
Criticized and classified loans:
Special mention $ 86,852 $ 73,391 $ 17,340 $ 21,242 $ 15,937
Substandard $ 25,829 $ 9,934 $ 12,608 $ 27,906 $ 19,630
Allowance for credit losses to non-accrual loans 2.48x 73.86x 22.71x 38.88x 106.50x
Non-accrual loans to total loans 0.44 % 0.01 % 0.04 % 0.02 % 0.01 %
1 Other real estate owned decreased in 2017 from the sale of two properties obtained in a bank acquisition in 2013.
2 Excludes TDR loans on non-accrual status that are included above.
Non-Accrual and TDR
Non-accrual loans increased $9.0 million in 2020, primarily due to the placement of two existing well-secured owner-occupied commercial real estate TDR loans, secured by one property, totaling $7.1 million on non-accrual, as well as two well-secured investor-owned commercial loans totaling $1.6 million that were placed on non-accrual in 2020. In addition, we designated five loans totaling $2.1 million as TDRs during 2020, resulting in an overall increase of $2.8 million in total non-accrual and accruing TDR loans from 2019 to 2020. These increases were partially offset by approximately $1.0 million in paydowns and payoffs of non-accrual and TDR loans. The decrease in total non-accrual and accruing TDR loans from 2018 to 2019 primarily related to payoffs (including a $2.7 million TDR land development loan) and paydowns, partially offset by advances on existing impaired loans and the addition of one non-accrual home equity loan. The decrease in total non-accrual and accruing TDR loans from 2017 to 2018 primarily related to payoffs, paydowns, and two loans that were removed from TDR status.
Total accruing TDR loans were $5.1 million and $11.3 million as of December 31, 2020 and 2019, respectively. The $6.2 million decrease from 2019 to 2020 primarily related to the two existing well-secured commercial real estate TDR loans totaling $7.1 million that were transferred to non-accrual status coupled with payoffs and paydowns, partially offset by the $2.1 million in new TDR loans mentioned above. The decreases from 2018 to 2019 and from 2017 to 2018 primarily related to the same reasons mentioned in the preceding paragraph.
For information regarding temporary relief from TDR accounting afforded by the CARES Act, refer to the Executive Summary section above and Note 3 to the Consolidated Financial Statements in ITEM 8, under “Troubled Debt Restructuring."
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Criticized and Classified Loans
Loans designated special mention increased by $13.5 million in 2020, driven by loan downgrades totaling $31.0 million. Of these downgrades, approximately $24.5 million were loans to borrowers that were impacted by the pandemic, all of which were well-secured by commercial real estate. These additions to special mention were mostly offset by $15.8 million in upgrades to pass risk ratings, paydowns and payoffs, and $2.2 million in loans downgraded from special mention to substandard in 2020. Loans designated special mention increased by $56.1 million during 2019 due primarily to new commercial loan originations to three borrowing relationships totaling $17.7 million that were experiencing temporary financial conditions that warranted the initial designation, and downgrades of existing commercial real estate loans to two borrowing relationships totaling $26.7 million. Loans designated as special mention exhibit potential weakness that deserve close attention.
Loans classified substandard increased by $15.9 million in 2020, primarily due to downgrades totaling $18.5 million. Of these loans, $13.4 million were to borrowers that requested payment relief due to the pandemic, all of which were well-secured by commercial real estate. These downgrades to substandard were partially offset by approximately $2.8 million in payoffs and risk rating upgrades. Loans classified substandard decreased by $2.7 million during 2019 primarily due to the payoff of a land development loan.
Refer to Note 3 to the Consolidated Financial Statements in ITEM 8 of this report for an allocation of criticized and classified loans by loan class.
Other Assets
BOLI totaled $43.6 million at December 31, 2020, compared to $41.6 million at December 31, 2019, and is recorded in other assets. The increase of $1.9 million was due to the purchase of $943 thousand in new policies and a $973 thousand increase in the cash surrender value from net investment earnings.
Other assets also included net deferred tax assets of $6.9 million and $8.2 million at December 31, 2020 and 2019, respectively. Deferred tax assets consist primarily of tax benefits expected to be realized in future periods related to temporary differences such as the allowances for credit losses and unfunded loan commitments, net operating loss carryforwards, and deferred compensation and salary continuation plans. The $1.2 million decrease in net deferred tax assets in 2020 was primarily due to an increase in deferred tax liabilities related to unrealized gains on available-for-sale investment securities, partially offset by an increase in deferred tax assets related to the change in allowance for credit losses on loans and unfunded loan commitments. Management believes deferred tax assets will be realizable due to our consistent record of earnings and the expectation that earnings will continue at a level adequate to realize such benefits. Therefore, no valuation allowance was established as of December 31, 2020 or 2019. For additional information, refer to Note 11 to the Consolidated Financial Statements in ITEM 8 of this report.
In addition, we held $11.9 million and $11.7 million of FHLB stock recorded at cost in other assets at December 31, 2020 and 2019, respectively. The increase in 2020 resulted from the purchase of $176 thousand in FHLB stock. The FHLB paid $654 thousand, $799 thousand and $959 thousand in cash dividends in 2020, 2019 and 2018, respectively. FHLB dividends in 2018 included a special dividend of $180 thousand. For additional information, refer to Note 2 to the Consolidated Financial Statements in ITEM 8 of this report.
Deposits
Deposits grew by $167.8 million, to $2.504 billion at December 31, 2020, compared to $2.337 billion at December 31, 2019. Non-interest bearing deposits grew by $225.8 million in 2020 and made up 54% of total deposits at year end. See ITEM 1A, Risk Factors, for a discussion of potential risks associated with concentrations and volatility due to activity of our large deposit customers and impact of the PPP.
Table 13 Distribution of Average Deposits
Table 13 shows the relative composition of our average deposits for 2020 and 2019. For average rates paid on deposits, refer to Table 1 in ITEM 7- Management's Discussion and Analysis of Financial Condition and Results of Operations.
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Years ended December 31,
2020 2019
(dollars in thousands; unaudited) Amount Percent Amount Percent
Non-interest bearing $ 1,308,199 52.4 % $ 1,094,806 50.0 %
Interest bearing transaction 148,817 5.9 133,922 6.1
Savings 184,146 7.4 172,273 7.9
Money market 1
763,689 30.5 680,296 31.1
Time deposits, including CDARS:
Less than $100,000 28,643 1.1 32,035 1.5
$100,000 or more 67,914 2.7 74,748 3.4
Total time deposits 96,557 3.8 106,783 4.9
Total average deposits $ 2,501,408 100.0 % $ 2,188,080 100.0 %
1 Money market balances include Insured Cash Sweep ® ("ICS") in both 2020 and 2019. Demand Deposit Marketplace SM ("DDM") and ICS balances are discussed in Note 6 to the Consolidated Financial Statements in ITEM 8 of this report.
Table 14 Maturities of Time Deposits of $100,000 or More
Table 14 below shows the maturity groupings for time deposits of $100,000 or more at December 31, 2020 and 2019.
December 31,
(in thousands; unaudited) 2020 2019
Three months or less $ 18,018 $ 15,720
Over three months through six months 12,655 11,308
Over six months through twelve months 21,006 17,033
Over twelve months 17,737 23,818
Total $ 69,416 $ 67,879
Borrowings
As of December 31, 2020 and 2019, respectively, our available borrowing capacity included $642.5 million and $648.0 million in secured lines of credit with FHLB and $78.7 million and $80.3 million with the Federal Reserve Bank of San Francisco (“FRBSF”). We also had $135.0 million and $92.0 million in unsecured lines with correspondent banks to cover any short or long-term borrowing needs at December 31, 2020 and 2019, respectively. There were no FHLB overnight borrowings at December 31, 2020 and 2019. The FRBSF and correspondent bank lines were not utilized at December 31, 2020 or 2019.
As part of a bank acquisition in 2013, we assumed two subordinated debentures due to the NorCal Community Bancorp Trusts I and II at fair values totaling $5.0 million at the acquisition date and contractual balances totaling $8.2 million. On October 7, 2018, Bancorp redeemed in full the subordinated debenture due to NorCal Community Bancorp Trust I. The remaining subordinated debenture due to Trust II had been accreted up to $2.8 million and $2.7 million as of December 31, 2020 and 2019, respectively. On March 15, 2021, we redeemed the $2.8 million subordinated debenture due to Trust II, which carried an average interest rate of 5.68% in 2020.
For additional information, see Note 7, Borrowings and Other Obligations, in ITEM 8 of this report.
Deferred Compensation Obligations
We maintain a non-qualified, unfunded deferred compensation plan for certain key management personnel. Under this plan, participating employees may defer compensation, which will entitle them to receive certain payments for up to fifteen years commencing upon retirement, death, disability or termination of employment. The participating employee may elect to receive payments over periods not to exceed fifteen years. At December 31, 2020 and 2019, our aggregate payment obligations under this plan totaled $4.7 million and $4.4 million, respectively.
Our Salary Continuation Plan ("Plan") provides a percentage of salary continuation benefits to a select group of executive management upon retirement at age sixty-five and reduced benefits upon early retirement. At December 31, 2020 and 2019, our liability under the Plan was $3.2 million and $3.0 million, respectively, and is
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recorded in interest payable and other liabilities in the Consolidated Statements of Condition. The Plan is unfunded and non-qualified for tax purposes and for purposes of Title I of the Employee Retirement Income Security Act of 1974.
For additional information, see Note 10 to the Consolidated Financial Statements in ITEM 8 of this report.
Table 15 Off-Balance Sheet Arrangements, Commitments and Contractual Obligations
We make commitments to extend credit in the normal course of business to meet the financing needs of our customers. For additional information, see Note 16 to the Consolidated Financial Statements in ITEM 8 of this report.
Payments due by period
(in thousands; unaudited) <1 year 1-3 years 4-5 years >5 years Total
Operating leases $ 4,612 $ 8,428 $ 6,179 $ 9,869 $ 29,088
Finance leases 42 17 — — 59
Certificates of deposit 71,852 15,934 9,646 — 97,432
Other long term liabilities (salary continuation payments) 1
113 377 404 1,341 2,235
Total $ 76,577 $ 24,739 $ 16,229 $ 11,210 $ 128,755
1 Represents future benefit payments under executive salary continuation agreements for retired Bank of Marin employees and for agreements assumed in a bank ac quisition whereby participants receive payments upon reaching retirement age. Amounts exclude future benefit payment obligations totalin g $3.6 million under Bank of Marin executive salary continuation agreements whereby participants will begin receiving payments upon reaching retirement age and fulfilling their service requirements. Salary continuation obligations are based on retirement date assumptions and may be adjusted upon actual retirement. For additional information, see Note 10 to the Consolidated Financial Statements in ITEM 8 of this report.
The contractual amount of unfunded loan commitments not reflected on the consolidated statements of condition was $604.4 million and $529.1 million at December 31, 2020 and 2019, respectively.
As permitted or required under California law and to the maximum extent allowable under that law, we have certain obligations to indemnify our current and former officers and directors for certain events or occurrences while the officer or director is, or was serving, at our request in such capacity. These indemnification obligations are valid as long as the director or officer acted in good faith and in a manner the person reasonably believed to be in, or not opposed to, our best interests, and with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful. The maximum potential amount of future payments we could be required to make under these indemnification obligations is unlimited; however, we have a director and officer insurance policy that mitigates our exposure and enables us to recover a portion of any future amounts paid. As we believe the possibility of potential claims to be remote and any amounts under the indemnifications would be covered by the insurance policy, we have not recorded an indemnification obligation.
Capital Adequacy
As discussed in Note 15 to the Consolidated Financial Statements in ITEM 8 of this report, the Bank's capital ratios were above regulatory guidelines to be considered "well capitalized" and Bancorp's ratios exceeded the required minimum ratios for capital adequacy purposes. For further discussion of bank capital requirements refer to the SUPERVISION AND REGULATION section in ITEM 1 of this report.
The Bank's total risk-based capital ratio increased from 14.6% at December 31, 2019 to 15.8% at December 31, 2020, primarily due to the Bank's $31.3 million net income in 2020, partially offset by $16.2 million in dividends paid to Bancorp to cover share repurchases, quarterly common stock dividends, and operating costs. Bancorp's total risk-based capital ratio was 15.1% at December 31, 2019 and 16.0% at December 31, 2020. Bancorp's 2020 Tier 1 capital included a subordinated debenture due to NorCal Community Bancorp Trust II, which was recorded only at the parent company level and accounted for approximately 18 basis points of the total risk-based capital ratio as of December 31, 2020. This subordinated debenture was early redeemed on March 15, 2021.
Bancorp's share repurchase program and activity are discussed in detail in ITEM 5 and in Note 8 to the Consolidated Financial Statements in ITEM 8 of this report. We expect to maintain strong capital levels and do not
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expect that we will be required to raise additional capital in 2021. Our anticipated sources of capital in 2021 include future earnings and shares issued under the stock-based compensation program.
Liquidity
The goal of liquidity management is to provide adequate funds to meet loan demand and to fund operating activities and deposit withdrawals. We accomplish this goal by maintaining an appropriate level of liquid assets and formal lines of credit with the FHLB, FRBSF and correspondent banks that enable us to borrow funds as discussed in Note 7 to the Consolidated Financial Statement in ITEM 8 of this report. Our Asset Liability Management Committee ("ALCO"), which is comprised of independent Bank directors and the Bank's Chief Executive Officer, is responsible for approving and monitoring our liquidity targets and strategies. ALCO has adopted a contingency funding plan that provides early detection of potential liquidity issues in the market or the Bank and institutes prompt responses that may prevent or alleviate a potential liquidity crisis. Management monitors liquidity daily and regularly adjusts our position based on current and future liquidity needs. We also have relationships with third-party deposit networks and can adjust the placement of our deposits via reciprocal or one-way sales as part of our cash management strategy, as discussed in Note 6 to the consolidated financial statements in ITEM 8 of this report.
We obtain funds from the repayment and maturity of loans, deposit inflows, investment security maturities and paydowns, federal funds purchases, FHLB advances, other borrowings, and cash flow from operations. Our primary uses of funds are the origination of loans, the purchase of investment securities, withdrawals of deposits, maturity of certificates of deposit, repayment of borrowings, and dividends to common stockholders.
T he most significant component of our daily liquidity position is customer deposits. The attraction and retention of new deposits depends upon the variety and effectiveness of our customer account products, service and convenience, rates paid to customers, and our financial strength. The cash cycles and unique business activities of some of our large commercial depositors may cause short-term fluctuations in their deposit balances held with us. In 2020 the banking industry experienced abundant liquidity driven by pandemic-related government programs such as PPP and stimulus checks as well as an elevated savings rate system-wide.
Our cash and cash equivalents increased $16.9 million from December 31, 2019. Significant sources of liquidity during 2020 included $176.9 million in paydowns, maturities and sales of investment securities, an increase in deposits of $167.8 million, and $40.8 million in net cash provided by operating activities (including $10.7 million in processing fees received from the SBA for the origination of PPP loans).
Significant uses of liquidity during 2020 were $249.3 million in loan originations and advances, net of principal collected, $97.5 million in investment securities purchased, $12.5 million in cash dividends paid on common stock to our shareholders, and $6.9 million in common stock repurchases. Refer to the Consolidated Statement of Cash Flows in this Form 10-K for additional information on our sources and uses of liquidity. Management anticipates that our current strong liquidity position and core deposit base are adequate to fund our operations.
Undrawn credit commitments, as discussed in Note 16 to the Consolidated Financial Statements in ITEM 8 of this report, totaled $604.4 million at December 31, 2020. We expect to fund these commitments to the extent utilized primarily through the repayment of existing loans, deposit growth and liquid assets. Over the next twelve months, $71.9 million of time deposits will mature. We expect to replace these funds with new deposits. Our emphasis on local deposits, combined with our liquid investment portfolio, provides a very stable funding base.
Since Bancorp is a holding company and does not conduct regular banking operations, its primary sources of liquidity are dividends from the Bank. Under the California Financial Code, payment of a dividend from the Bank to Bancorp without advance regulatory approval is restricted to the lesser of the Bank’s retained earnings or the amount of the Bank’s net profits from the previous three fiscal years less the amount of dividends paid during that period. The primary uses of funds for Bancorp are shareholder dividends and ordinary operating expenses. Bancorp held $5.3 million of cash at December 31, 2020. In January 2021, Bancorp obtained a dividend distribution from the Bank totaling $30.0 million, which is deemed sufficient to cover Bancorp's operational needs, share repurchases, repayment of a subordinated debenture and cash dividends to shareholders through the end of 2021. 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.
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Quarterly Financial Data
Table 16 Summary of Quarterly Financial Data
2020 Quarters Ended 2019 Quarters Ended
(dollars in thousands; unaudited) Dec. 31 Sept. 30 Jun. 30 Mar. 31 Dec. 31 Sept. 30 Jun. 30 Mar. 31
Interest income $ 24,088 $ 25,169 $ 24,997 $ 25,384 $ 25,233 $ 25,332 $ 24,941 $ 24,931
Interest expense 489 603 622 1,265 1,339 1,181 1,152 1,085
Net interest income 23,599 24,566 24,375 24,119 23,894 24,151 23,789 23,846
(Reversal of) provision for credit losses on loans (856) 1,250 2,000 2,200 500 400 — —
Net interest income after provision for
credit losses 24,455 23,316 22,375 21,919 23,394 23,751 23,789 23,846
Non-interest income 1,827 1,790 1,813 3,120 2,318 2,721 2,274 1,771
Non-interest expense 15,180 15,238 14,141 15,469 13,326 14,200 14,916 15,528
Income before provision for income taxes 11,102 9,868 10,047 9,570 12,386 12,272 11,147 10,089
Provision for income taxes 2,985 2,377 2,641 2,342 3,307 2,824 2,912 2,610
Net income $ 8,117 $ 7,491 $ 7,406 $ 7,228 $ 9,079 $ 9,448 $ 8,235 $ 7,479
Net income available to common stockholders $ 8,117 $ 7,491 $ 7,406 $ 7,228 $ 9,079 $ 9,448 $ 8,235 $ 7,479
Net income per common share:
Basic $ 0.60 $ 0.55 $ 0.55 $ 0.53 $ 0.67 $ 0.70 $ 0.60 $ 0.54
Diluted $ 0.60 $ 0.55 $ 0.55 $ 0.53 $ 0.66 $ 0.69 $ 0.60 $ 0.54
Refer to the Executive Summary section above for a discussion of items that affected the financial results for the quarter ended December 31, 2020.