Bank of Marin Bancorp 10-Q

ITEM 1. Financial Statements BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CONDITION (in thousands, except share data; unaudited) June 30, 2021 December 31, 2020 Assets Cash, cash equivalents and restricted cash $ 257,543 $ 200,320 Investment securities: Held-to-maturity, at amortized cost (net of zero allowance for credit losses at June 30, 2021 and December 31, 2020 ) 169,038 109,036 Available-for-sale, at fair value (net of zero allowance for credit losses at June 30, 2021 and December 31, 2020 ) 517,963 392,351 Total investment securities 687,001 501,387 Loans, at amortized cost 2,002,767 2,088,556 Allowance for credit losses on loans ( 19,100 ) ( 22,874 ) Loans, net of allowance for credit losses on loans 1,983,667 2,065,682 Bank premises and equipment, net 5,248 4,919 Goodwill 30,140 30,140 Core deposit intangible 3,423 3,831 Operating lease right-of-use assets 23,506 25,612 Interest receivable and other assets 83,290 80,035 Total assets $ 3,073,818 $ 2,911,926 Liabilities and Stockholders' Equity Liabilities Deposits Non-interest bearing $ 1,460,076 $ 1,354,650 Interest bearing Transaction accounts 168,226 183,552 Savings accounts 230,730 201,507 Money market accounts 729,193 667,107 Time accounts 95,350 97,433 Total deposits 2,683,575 2,504,249 Borrowings and other obligations 438 58 Subordinated debenture — 2,777 Operating lease liabilities 24,919 27,062 Interest payable and other liabilities 16,237 19,527 Total liabilities 2,725,169 2,553,673 Stockholders' Equity Preferred stock, no par value, Authorized - 5,000,000 shares, none issued — — Common stock, no par value, Authorized - 30,000,000 shares; issued and outstanding - 13,055,105 and 13,500,453 at June 30, 2021 and December 31, 2020, respectively 108,430 125,905 Retained earnings 231,841 219,747 Accumulated other comprehensive income, net of taxes 8,378 12,601 Total stockholders' equity 348,649 358,253 Total liabilities and stockholders' equity $ 3,073,818 $ 2,911,926 The accompanying notes are an integral part of these consolidated financial statements (unaudited). Page-3 BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Three months ended Six months ended (in thousands, except per share amounts; unaudited) June 30, 2021 June 30, 2020 June 30, 2021 June 30, 2020 Interest income Interest and fees on loans $ 21,429 $ 21,217 $ 42,090 $ 42,104 Interest on investment securities 3,504 3,741 6,633 7,906 Interest on federal funds sold and due from banks 54 39 96 371 Total interest income 24,987 24,997 48,819 50,381 Interest expense Interest on interest-bearing transaction accounts 39 39 78 105 Interest on savings accounts 21 17 40 33 Interest on money market accounts 312 383 598 1,354 Interest on time accounts 81 142 177 303 Interest on borrowings and other obligations — 1 — 3 Interest on subordinated debenture — 40 1,361 89 Total interest expense 453 622 2,254 1,887 Net interest income 24,534 24,375 46,565 48,494 (Reversal of) provision for credit losses on loans ( 920 ) 2,000 ( 3,849 ) 4,200 (Reversal of) provision for credit losses on unfunded loan commitments ( 612 ) 260 ( 1,202 ) 362 Net interest income after (reversal of) provision for credit losses 26,066 22,115 51,616 43,932 Non-interest income Wealth Management and Trust Services 530 421 1,018 925 Debit card interchange fees 419 308 785 668 Service charges on deposit accounts 317 293 598 744 Earnings on bank-owned life insurance, net 233 234 490 509 Dividends on Federal Home Loan Bank stock 177 146 326 354 Merchant interchange fees 61 47 118 120 Gains on sale of investment securities, net — 115 — 915 Other income 285 249 513 698 Total non-interest income 2,022 1,813 3,848 4,933 Non-interest expense Salaries and related benefits 8,888 7,864 18,096 17,341 Occupancy and equipment 1,751 1,661 3,502 3,324 Professional services 986 550 1,849 1,094 Data processing 820 829 1,639 1,615 Charitable contributions 462 273 493 440 Depreciation and amortization 389 526 848 1,052 Information technology 296 252 609 502 Directors' expense 230 175 405 349 Amortization of core deposit intangible 204 213 408 426 Federal Deposit Insurance Corporation insurance 182 116 361 118 Other expense 1,348 1,422 2,758 2,987 Total non-interest expense 15,556 13,881 30,968 29,248 Income before provision for income taxes 12,532 10,047 24,496 19,617 Provision for income taxes 3,247 2,641 6,264 4,983 Net income $ 9,285 $ 7,406 $ 18,232 $ 14,634 Net income per common share: Basic $ 0.71 $ 0.55 $ 1.38 $ 1.08 Diluted $ 0.71 $ 0.55 $ 1.37 $ 1.07 Weighted average shares: Basic 13,092 13,514 13,227 13,519 Diluted 13,164 13,585 13,316 13,621 Comprehensive income (loss): Net income $ 9,285 $ 7,406 $ 18,232 $ 14,634 Other comprehensive income (loss): Change in net unrealized gains on available-for-sale securities 2,798 1,494 ( 6,284 ) 11,306 Reclassification adjustment for gains on available-for-sale securities included in net income — ( 115 ) — ( 915 ) Amortization of net unrealized losses on securities transferred from available-for-sale to held-to-maturity 138 135 281 245 Other comprehensive income (loss), before tax 2,936 1,514 ( 6,003 ) 10,636 Deferred tax expense (benefit) 864 448 ( 1,780 ) 3,145 Other comprehensive income (loss), net of tax 2,072 1,066 ( 4,223 ) 7,491 Total comprehensive income $ 11,357 $ 8,472 $ 14,009 $ 22,125 The accompanying notes are an integral part of these consolidated financial statements (unaudited). Page-4 BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the three months ended June 30, 2021 and 2020 (in thousands, except share data; unaudited) Common Stock Retained Earnings Accumulated Other Comprehensive Income, Net of Taxes Total Shares Amount Three months ended June 30, 2021 Balance at April 1, 2021 13,326,509 $ 118,386 $ 225,600 $ 6,306 $ 350,292 Net income — — 9,285 — 9,285 Other comprehensive income — — — 2,072 2,072 Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings 14,000 314 — — 314 Stock issued under employee stock purchase plan 831 25 — — 25 Stock issued under employee stock ownership plan 9,300 336 — — 336 Restricted stock granted 2,400 — — — — Stock-based compensation - stock options — 28 — — 28 Stock-based compensation - restricted stock — 95 — — 95 Cash dividends paid on common stock ($ 0.23 per share) — — ( 3,044 ) — ( 3,044 ) Stock repurchased, net of commissions ( 297,935 ) ( 10,754 ) — — ( 10,754 ) Balance at June 30, 2021 13,055,105 $ 108,430 $ 231,841 $ 8,378 $ 348,649 Three months ended June 30, 2020 Balance at April 1, 2020 13,565,969 $ 127,684 $ 207,328 $ 10,928 $ 345,940 Net income — — 7,406 — 7,406 Other comprehensive income — — — 1,066 1,066 Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings 14,760 453 — — 453 Stock issued under employee stock purchase plan 537 17 — — 17 Stock issued under employee stock ownership plan 11,500 324 — — 324 Restricted stock forfeited / cancelled ( 931 ) — — — — Stock-based compensation - stock options — 42 — — 42 Stock-based compensation - restricted stock — 113 — — 113 Cash dividends paid on common stock ($ 0.23 per share) — — ( 3,121 ) — ( 3,121 ) Balance at June 30, 2020 13,591,835 $ 128,633 $ 211,613 $ 11,994 $ 352,240 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, 2021 and 2020 (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, 2021 Balance at January 1, 2021 13,500,453 $ 125,905 $ 219,747 $ 12,601 $ 358,253 Net income — — 18,232 — 18,232 Other comprehensive (loss) — — — ( 4,223 ) ( 4,223 ) Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings 31,180 351 351 Stock issued under employee stock purchase plan 1,609 53 — — 53 Stock issued under employee stock ownership plan 18,300 668 — — 668 Restricted stock granted 29,454 — — — — Restricted stock surrendered for tax withholdings upon vesting ( 3,961 ) ( 156 ) — — ( 156 ) Restricted stock forfeited / cancelled ( 3,848 ) — — — — Stock-based compensation - stock options — 200 — — 200 Stock-based compensation - restricted stock — 538 — — 538 Cash dividends paid on common stock ($ 0.46 per share) — — ( 6,138 ) — ( 6,138 ) Stock purchased by directors under director stock plan 519 18 — — 18 Stock issued in payment of director fees 3,347 117 — — 117 Stock repurchased, net of commissions ( 521,948 ) ( 19,264 ) — — ( 19,264 ) Balance at June 30, 2021 13,055,105 $ 108,430 $ 231,841 $ 8,378 $ 348,649 Six months ended June 30, 2020 Balance at January 1, 2020 13,577,008 $ 129,058 $ 203,227 $ 4,503 $ 336,788 Net income — — 14,634 — 14,634 Other comprehensive income — — — 7,491 7,491 Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings 63,815 1,277 — — 1,277 Stock issued under employee stock purchase plan 1,084 33 — — 33 Stock issued under employee stock ownership plan 19,400 648 — — 648 Restricted stock granted 29,100 — — — — Restricted stock surrendered for tax withholdings upon vesting ( 2,200 ) ( 73 ) — — ( 73 ) Restricted stock forfeited / cancelled ( 6,718 ) — — — — Stock-based compensation - stock options — 211 — — 211 Stock-based compensation - restricted stock — 574 — — 574 Cash dividends paid on common stock ($ 0.46 per share) — — ( 6,248 ) — ( 6,248 ) Stock purchased by directors under director stock plan 400 18 — — 18 Stock issued in payment of director fees 2,610 117 — — 117 Stock repurchased, net of commissions ( 92,664 ) ( 3,230 ) — — ( 3,230 ) Balance at June 30, 2020 13,591,835 $ 128,633 $ 211,613 $ 11,994 $ 352,240 The accompanying notes are an integral part of these consolidated financial statements (unaudited). Page-5 BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CASH FLOWS For the six months ended June 30, 2021 and 2020 (in thousands; unaudited) June 30, 2021 June 30, 2020 Cash Flows from Operating Activities: Net income $ 18,232 $ 14,634 Adjustments to reconcile net income to net cash provided by operating activities: (Reversal of) provision for credit losses on loans ( 3,849 ) 4,200 (Reversal of) provision for credit losses on unfunded loan commitments ( 1,202 ) 362 Noncash contribution expense to employee stock ownership plan 668 648 Noncash director compensation expense 162 150 Stock-based compensation expense 738 785 Amortization of core deposit intangible 408 426 Amortization of investment security premiums, net of accretion of discounts 1,753 344 Accretion of discounts on acquired loans ( 78 ) ( 55 ) Accretion of discount on subordinated debenture 1,347 35 Net change in deferred loan origination costs/fees 1,146 7,829 Gain on sale of investment securities — ( 915 ) Depreciation and amortization 848 1,052 Earnings on bank-owned life insurance policies ( 490 ) ( 509 ) Net changes in: Interest receivable and other assets 952 ( 2,174 ) Interest payable and other liabilities ( 866 ) 2,816 Total adjustments 1,537 14,994 Net cash provided by operating activities 19,769 29,628 Cash Flows from Investing Activities: Purchase of held-to-maturity securities ( 74,521 ) — Purchase of available-for-sale securities ( 170,161 ) ( 56,912 ) Proceeds from sale of available-for-sale securities — 33,756 Proceeds from paydowns/maturities of held-to-maturity securities 14,376 11,530 Proceeds from paydowns/maturities of available-for-sale securities 36,936 36,951 Loans originated and principal collected, net 84,259 ( 273,169 ) Purchase of bank-owned life insurance policies ( 1,943 ) ( 941 ) Purchase of premises and equipment ( 765 ) ( 242 ) Cash paid for low income housing tax credit investment ( 346 ) ( 1,251 ) Net cash used in investing activities ( 112,165 ) ( 250,278 ) Cash Flows from Financing Activities: Net increase in deposits 179,326 443,377 Proceeds from stock options exercised 351 1,277 Payment of tax withholdings for vesting of restricted stock ( 156 ) ( 73 ) Proceeds from stock issued under employee and director stock purchase plans 71 51 Stock repurchased, net of commissions ( 19,677 ) ( 3,333 ) Repayment of subordinated debenture including execution costs ( 4,126 ) — Repayment of finance lease obligations ( 32 ) ( 90 ) Cash dividends paid on common stock ( 6,138 ) ( 6,248 ) Net cash provided by financing activities 149,619 434,961 Net increase in cash, cash equivalents and restricted cash 57,223 214,311 Cash, cash equivalents and restricted cash at beginning of period 200,320 183,388 Cash, cash equivalents and restricted cash at end of period $ 257,543 $ 397,699 Supplemental disclosure of cash flow information: Cash paid in interest $ 951 $ 1,871 Cash paid in income taxes $ 6,000 $ — Supplemental disclosure of noncash investing and financing activities: Change in net unrealized gains on available-for-sale securities $ ( 6,284 ) $ 11,306 Amortization of net unrealized loss on available-for-sale securities transferred to held-to-maturity $ 281 $ 245 Stock issued to employee stock ownership plan $ 668 $ 648 Stock issued for director compensation expense $ 162 $ 150 Restricted cash 1 $ — $ — 1 Restricted cash includes reserve requirements held with the Federal Reserve Bank of San Francisco. In response to the COVID-19 pandemic, the Federal Reserve reduced the reserve requirement ratios to zero percent effective March 26, 2020. The accompanying notes are an integral part of these consolidated financial statements (unaudited). Page-6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1: Basis of Presentation The consolidated financial statements include the accounts of Bank of Marin Bancorp (“Bancorp”), a bank holding company, and its wholly-owned bank subsidiary, Bank of Marin (the “Bank”), 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. Certain items in prior financial statements were reclassified to conform to the current presentation, including the reclassification of the provision for credit losses on unfunded commitments in the second quarter of 2021 from non-interest expense to a separate line item under the provision for credit losses on loans in the consolidated statements of comprehensive income. Although we believe that the disclosures are adequate and the information presented is not misleading, we suggest that these interim financial statements be read in conjunction with the annual financial statements and the notes thereto included in our 2020 Annual Report on Form 10-K. In the opinion of management, the unaudited consolidated financial statements reflect all adjustments, which are necessary for a fair presentation of the consolidated financial position, the results of operations, changes in comprehensive income, changes in stockholders’ equity, and cash flows for the periods presented. All material intercompany transactions have been eliminated. The results of these interim periods may not be indicative of the results for the full year or for any other period. The NorCal Community Bancorp Trust II (the "Trust") was formed for the sole purpose of issuing trust preferred securities. Bancorp is not considered the primary beneficiary of the Trust (a variable interest entity), therefore the Trust is not consolidated in our consolidated financial statements, but rather the subordinated debenture is shown as a liability on our consolidated statements of condition. Bancorp's investment in the securities of the Trust is accounted for under the equity method and is included in interest receivable and other assets on the consolidated statements of condition. Refer to Note 6, Borrowings, for additional information on the subordinated debenture due to NorCal Community Bancorp Trust II and the early redemption that occurred on March 15, 2021. The following table shows: 1) weighted average basic shares, 2) potentially dilutive weighted average common shares related to stock options and unvested restricted stock awards, and 3) weighted average diluted shares. Basic earnings per share (“EPS”) are calculated by dividing net income by the weighted average number of common shares outstanding during each period, excluding unvested restricted stock awards. Diluted EPS are calculated using the weighted average number of potentially dilutive common shares. The number of potentially dilutive common shares included in the quarterly diluted EPS is computed using the average market prices during the three months included in the reporting period under the treasury stock method. The number of potentially dilutive common shares included in year-to-date diluted EPS is a year-to-date weighted average of potentially dilutive common shares included in each quarterly diluted EPS computation. In computing diluted EPS, we exclude anti-dilutive shares such as options whose exercise prices exceed the current common stock price, as they would not reduce EPS under the treasury method. We have two forms of outstanding common stock: common stock and unvested restricted stock awards. Holders of unvested restricted stock awards receive non-forfeitable dividends at the same rate as common shareholders and they both share equally in undistributed earnings. Under the two-class method, the difference in EPS is nominal for these participating securities. Page-7 Three months ended Six months ended (in thousands, except per share data) June 30, 2021 June 30, 2020 June 30, 2021 June 30, 2020 Weighted average basic common shares outstanding 13,092 13,514 13,227 13,519 Potentially dilutive common shares related to: Stock options 54 54 67 80 Unvested restricted stock awards 18 17 22 22 Weighted average diluted shares outstanding 13,164 13,585 13,316 13,621 Net income $ 9,285 $ 7,406 $ 18,232 $ 14,634 Basic EPS $ 0.71 $ 0.55 $ 1.38 $ 1.08 Diluted EPS $ 0.71 $ 0.55 $ 1.37 $ 1.07 Weighted average anti-dilutive common shares not included in the calculation of diluted EPS 111 207 88 109 Note 2: Recently Adopted and Issued Accounting Standards Accounting Standards Adopted in 2021 In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (ASC Topic 740): Simplifying the Accounting for Income Taxes . This ASU is intended to reduce the cost and complexity related to accounting for income taxes by removing certain exceptions to the guidance in ASC 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and simplifying aspects of the accounting for franchise taxes and enacted changes in tax laws or rates. We adopted this ASU prospectively on January 1, 2021, which did not have a material impact on our financial condition or results of operations. In January 2020, the FASB issued ASU No. 2020-01, Investments - Equity Securities (ASC Topic 321), Investments - Equity Method and Joint Ventures (ASC Topic 323), and Derivatives and Hedging (ASC Topic 815) - Clarifying the Interactions between ASC 321, ASC 323, and ASC 815 . Among other things, this ASU clarifies that a company should consider observable transactions that require a company to either apply or discontinue the equity method of accounting under ASC 323, for the purposes of applying the measurement alternative in accordance with ASC 321. We adopted this ASU prospectively on January 1, 2021, which did not have a material impact on our financial condition or results of operations. In October 2020, the FASB issued ASU No. 2020-08, Codification Improvements to Subtopic 310-20, Receivables—Nonrefundable Fees and Other Costs . This ASU was issued as part of the Board's ongoing project to improve codification or correct unintended application. This ASU adds clarification to ASU 2017-08, which the Bank early-adopted in 2017, and delineates whether an entity with callable debt securities that have multiple call dates should amortize the amount above that which is repayable, to the next call date. We adopted this ASU prospectively on January 1, 2021. Because this ASU was narrow in scope and for clarification purposes, it did not have a material impact on our financial condition and results of operations. Accounting Standards Not Yet Effective In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848) . The amendments in this ASU are elective and provide optional guidance for a limited period of time to ease the potential burden of accounting for, or recognizing the effects of reference rate reform. The amendments in this ASU provide optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The amendments in this ASU may be elected as of March 12, 2020 through December 31, 2022. An entity may choose to elect the amendments in this update at an interim period subsequent to March 12, 2020 with adoption methods varying based on transaction type. We have not elected to apply amendments at this time, however, will assess the applicability of this ASU to us as we continue to monitor guidance for reference rate reform from FASB and its impact on our financial condition and results of operations. In January 2021, the FASB issued ASU No. 2021-01, Reference Rate Reform (Topic 848). The main amendments in this ASU are intended to clarify certain optional expedients and scope of derivative instruments. The amendments are elective and effective immediately upon issuance of this ASU. Amendments may be elected through December 31, 2022. We have not elected to apply amendments at this time, however, will assess the applicability of this ASU to us as we continue to monitor guidance for reference rate reform from FASB and its impact on our financial condition and results of operations. Page-8 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 in three levels within the fair value hierarchy, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are: Level 1: Valuations are based on unadjusted quoted prices in active markets for identical assets or liabilities. Level 2: Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data. Level 3: Valuations are based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Values are determined using pricing models and discounted cash flow models and may include significant management judgment and estimation. The following table summarizes our assets and liabilities that were required to be recorded at fair value on a recurring basis. (in thousands) Description of Financial Instruments Carrying Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Measurement Categories: Changes in Fair Value Recorded In 1 June 30, 2021 Securities available-for-sale: Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies $ 284,783 $ — $ 284,783 $ — OCI SBA-backed securities 29,460 — 29,460 — OCI Debentures of government sponsored agencies 74,711 — 74,711 — OCI Obligations of state and political subdivisions 123,224 — 123,224 — OCI Corporate bonds 5,785 — 5,785 — OCI Derivative financial liabilities (interest rate contracts) 1,363 — 1,363 — NI December 31, 2020 Securities available-for-sale: Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies $ 228,651 $ — $ 228,651 $ — OCI SBA-backed securities 32,862 — 36,286 — OCI Debentures of government sponsored agencies 20,186 — 20,186 — OCI Obligations of state and political subdivisions 110,652 — 110,652 — OCI Derivative financial liabilities (interest rate contracts) 1,912 — 1,912 — NI 1 Other comprehensive income ("OCI") or net income ("NI"). Available-for-sale securities are recorded at fair value on a recurring basis. When available, quoted market prices (Level 1) are used to determine the fair value of available-for-sale securities. 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 obligations of state and political subdivisions, U.S. agencies or government-sponsored agencies' debt securities, mortgage-backed securities, government agency-issued, privately-issued collateralized mortgage obligations, and corporate bonds. As of June 30, 2021 and December 31, 2020, there were no Level 1 or Level 3 securities. Page-9 Held-to-maturity securities may be written down to fair value as a result of impairment through a provision for credit losses in investments securities. We did no t record any write-downs during the six months ended June 30, 2021 or June 30, 2020. Fair value of held-to-maturity securities is determined using the same techniques discussed above for available-for-sale securities. On a recurring basis, derivative financial instruments are recorded at fair value, which is based on the income approach using observable Level 2 market inputs, reflecting market expectations of future interest rates as of the measurement date. Standard valuation techniques are used to calculate the present value of the future expected cash flows assuming an orderly transaction. Valuation adjustments may be made to reflect both our own credit risk and the counterparties’ credit risk in determining the fair value of the derivatives. Level 2 inputs for the valuations are limited to observable market prices for London Interbank Offered Rate ("LIBOR") and Overnight Index Swap ("OIS") rates (for the very short term), quoted prices for LIBOR futures contracts, observable market prices for LIBOR and OIS swap rates, and one-month and three-month LIBOR basis spreads at commonly quoted intervals. Mid-market pricing of the inputs is used as a practical expedient in the fair value measurements. We project spot rates at reset days specified by each swap contract to determine future cash flows, then discount to present value using OIS curves as of the measurement date. When the value of any collateral placed with counterparties is less than the interest rate derivative liability, a credit valuation adjustment ("CVA") is applied to reflect the credit risk we pose to counterparties. We have used the spread between the Standard & Poor's BBB rated U.S. Bank Composite rate and LIBOR for the closest maturity term corresponding to the duration of the swaps to derive the CVA. A similar credit risk adjustment, correlated to the credit standing of the counterparty, is made when collateral posted by the counterparty does not fully cover their liability to us. For further discussion on our methodology in valuing our derivative financial instruments, refer to Note 9, Derivative Financial Instruments and Hedging Activities. Certain financial assets may be measured at fair value on a non-recurring basis. These assets are subject to fair value adjustments that result from the application of the lower of cost or fair value accounting or write-downs of individual assets, such as impaired loans that are collateral dependent and other real estate owned ("OREO"). As of June 30, 2021 and December 31, 2020, we did no t carry any assets measured at fair value on a non-recurring basis. Disclosures about Fair Value of Financial Instruments The table below is a summary of fair value estimates for financial instruments as of June 30, 2021 and December 31, 2020, excluding financial instruments recorded at fair value on a recurring basis (summarized in the first table in this note). The carrying amounts in the following table are recorded in the consolidated statements of condition under the indicated captions. Further, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements such as bank-owned life insurance policies ("BOLI") and non-maturity deposit liabilities. Additionally, we held shares of Federal Home Loan Bank ("FHLB") of San Francisco stock and Visa Inc. Class B common stock, both recorded at cost, as there was no impairment or changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer as of June 30, 2021 or December 31, 2020. The values are discussed in Note 4, Investment Securities. June 30, 2021 December 31, 2020 (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 $ 257,543 $ 257,543 Level 1 $ 200,320 $ 200,320 Level 1 Investment securities held-to-maturity 169,038 174,138 Level 2 109,036 115,185 Level 2 Loans, net 2,002,767 1,993,373 Level 3 2,065,682 2,089,192 Level 3 Interest receivable 10,160 10,160 Level 2 10,922 10,922 Level 2 Financial liabilities (recorded at amortized cost) Time deposits 95,350 95,572 Level 2 97,433 97,769 Level 2 Subordinated debenture — — Level 3 2,777 3,115 Level 3 Interest payable 53 53 Level 2 97 97 Level 2 Fair value of loans is based on exit price techniques and obtained from an independent third-party that uses its proprietary valuation model and methodology and may not reflect actual or prospective market valuations. The Page-10 discounted cash flow valuation approach reflects key inputs and assumptions such as loan probability of default, loss given default, prepayment speed, and market discount rates. Fair value of fixed-rate time deposits is estimated by discounting future contractual cash flows using discount rates that reflect the current market rates offered for time deposits of similar remaining maturities. Fair value of the subordinated debenture is estimated using a discounted cash flow approach based on current interest rates for similar financial instruments adjusted for credit and liquidity spreads. The value of unrecognized financial instruments is estimated based on the fee income associated with the commitments which, in the absence of credit exposure, is considered to approximate their settlement value. The fair value of commitment fees was not material as of June 30, 2021 or December 31, 2020. Note 4: Investment Securities Our investment securities portfolio consists of obligations of state and political subdivisions, U.S. Corporations, U.S. federal government agencies such as Government National Mortgage Association ("GNMA") and Small Business Administration ("SBA"), U.S. government-sponsored enterprises ("GSEs"), such as Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC"), Federal Farm Credit Banks Funding Corporation and FHLB. We also invest in residential and commercial mortgage-backed securities (“MBS”/"CMBS") and collateralized mortgage obligations (“CMOs”) issued or guaranteed by the GSEs, as reflected in the following table. A summary of the amortized cost, fair value and allowance for credit losses related to securities held-to-maturity as of June 30, 2021 and December 31, 2020 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, 2021 Securities of U.S. government-sponsored enterprises: MBS pass-through securities issued by FHLMC and FNMA $ 74,115 $ — $ 74,115 $ 3,247 $ — $ 77,362 CMOs issued by FHLMC 38,641 — 38,641 1,142 ( 38 ) 39,745 CMOs issued by FNMA 6,274 — 6,274 265 — 6,539 SBA-backed securities 5,697 — 5,697 361 — 6,058 Debentures of government-sponsored agencies 43,731 — 43,731 115 — 43,846 Obligations of state and political subdivisions 580 — 580 8 — 588 Total held-to-maturity $ 169,038 $ — $ 169,038 $ 5,138 $ ( 38 ) $ 174,138 December 31, 2020 Corporate bonds $ — $ — $ — $ — $ — $ — Securities of U.S. government-sponsored enterprises: MBS pass-through securities issued by FHLMC and FNMA $ 65,579 $ — $ 65,579 $ 3,924 $ — $ 69,503 CMOs issued by FHLMC 27,201 — 27,201 1,441 — 28,642 CMOs issued by FNMA 8,042 — 8,042 363 — 8,405 SBA-backed securities 6,547 — 6,547 400 — 6,947 Obligations of state and political subdivisions 1,667 — 1,667 21 — 1,688 Total held-to-maturity $ 109,036 $ — $ 109,036 $ 6,149 $ — $ 115,185 1 Amortized cost and fair values exclude accrued interest receivable of $ 550 thousand and $ 366 thousand at June 30, 2021 and December 31, 2020, respectively, which is included in interest receivable and other assets in the consolidated statements of condition. Management measures expected credit losses on held-to-maturity securities on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. With regard to MBSs and CMOs issued or guaranteed by the GSEs, and SBA-backed securities, we expect to receive all the contractual principal and interest on these securities as such securities are backed by the full faith and credit of and/or guaranteed by the U.S. government. Accordingly, no allowance for credit losses has been recorded for these securities. With regard to securities issued by states and political subdivisions, management considers (i) issuer and/or guarantor credit Page-11 ratings, (ii) historical probability of default and loss given default rates for given bond ratings and remaining maturity,(iii) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities, (iv) internal credit review of the financial information, and (v) whether or not such securities have credit enhancements such as guarantees, contain a defeasance clause, or are pre-refunded by the issuers. Based on the comprehensive analysis, no credit losses are expected. The following table summarizes the amortized cost of our portfolio of held-to-maturity securities issued by states and political subdivisions by Moody's and/or Standard & Poor's bond ratings as of June 30, 2021. Obligations of state and political subdivisions (in thousands) June 30, 2021 December 31, 2020 AA $ 376 $ 1,461 A 204 206 Total $ 580 $ 1,667 A summary of the amortized cost, fair value and allowance for credit losses related to securities available-for-sale as of June 30, 2021 and December 31, 2020 is presented below. Available-for-sale: Amortized Cost 1 Gross Unrealized Allowance for Credit Losses Fair Value (in thousands) Gains (Losses) June 30, 2021 Securities of U.S. government-sponsored enterprises: MBS pass-through securities issued by FHLMC and FNMA $ 57,653 $ 1,867 $ — $ — $ 59,520 CMOs issued by FHLMC 160,949 5,573 ( 436 ) — 166,086 CMOs issued by FNMA 36,636 428 — — 37,064 CMOs issued by GNMA 21,855 258 — — 22,113 SBA-backed securities 27,938 1,568 ( 46 ) — 29,460 Debentures of government- sponsored agencies 76,321 128 ( 1,738 ) — 74,711 Obligations of state and political subdivisions 117,595 5,694 ( 65 ) — 123,224 Corporate bonds 5,987 — ( 202 ) — 5,785 Total available-for-sale $ 504,934 $ 15,516 $ ( 2,487 ) $ — $ 517,963 December 31, 2020 Securities of U.S. government-sponsored enterprises: MBS pass-through securities issued by FHLMC and FNMA $ 50,686 $ 2,530 $ — $ — $ 53,216 CMOs issued by FHLMC 143,267 7,925 ( 1 ) — 151,191 CMOs issued by FNMA 16,450 580 — — 17,030 CMOs issued by GNMA 6,863 351 — — 7,214 SBA-backed securities 30,941 1,976 ( 55 ) — 32,862 Debentures of government- sponsored agencies 19,944 266 ( 24 ) — 20,186 Obligations of state and political subdivisions 104,887 5,765 — — 110,652 Total available-for-sale $ 373,038 $ 19,393 $ ( 80 ) $ — $ 392,351 1 Amortized cost and fair value exclude accrued interest receivable of $ 2.4 million and $ 1.9 million June 30, 2021 and December 31, 2020, which is included in interest receivable and other assets in the consolidated statements of condition. The amortized cost a nd fair value of investment debt securities by contractual maturity at June 30, 2021 and December 31, 2020 are shown below. Expected maturities may differ from contractual maturities if the issuers of the securities have the right to call or prepay obligations with or without call or prepayment penalties. Page-12 June 30, 2021 December 31, 2020 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 $ 245 $ 246 $ 14,263 $ 14,403 $ 246 $ 250 $ 11,530 $ 11,687 After one but within five years 20,203 21,184 53,194 55,835 7,550 7,961 59,028 62,397 After five years through ten years 58,465 60,963 183,706 189,492 52,113 55,872 144,908 154,089 After ten years 90,125 91,745 253,771 258,233 49,127 51,102 157,572 164,178 Total $ 169,038 $ 174,138 $ 504,934 $ 517,963 $ 109,036 $ 115,185 $ 373,038 $ 392,351 Sales of investment securities and gross gains and losses are shown in the following table: Three months ended Six months ended (in thousands) June 30, 2021 June 30, 2020 June 30, 2021 June 30, 2020 Available-for-sale: Sales proceeds $ — $ 6,314 $ — $ 33,756 Gross realized gains — 116 — 916 Gross realized losses — ( 1 ) — ( 1 ) Pledged investment securities are shown in the following table: (in thousands) June 30, 2021 December 31, 2020 Pledged to the State of California: Secure public deposits in compliance with the Local Agency Security Program $ 145,128 $ 131,051 Collateral for trust deposits 742 751 Total investment securities pledged to the State of California 145,870 131,802 Collateral for Wealth Management and Trust Services checking account 624 629 Total pledged investment securities $ 146,494 $ 132,431 There were 23 and 10 securities in unrealized loss positions at June 30, 2021 and December 31, 2020, respectively. Those securities are summarized and classified according to the duration of the loss period in the tables below: June 30, 2021 < 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: CMOs issued by FHLMC $ 4,372 $ ( 38 ) $ — $ — $ 4,372 $ ( 38 ) Total held-to-maturity 4,372 ( 38 ) — — 4,372 ( 38 ) Available-for-sale: MBS pass-through securities issued by FHLMC and FNMA — — — — — — SBA-backed securities — — 1,417 ( 46 ) 1,417 ( 46 ) CMOs issued by FNMA — — — — — — CMOs issued by FHLMC 33,740 ( 436 ) — — 33,740 ( 436 ) Debentures of government- sponsored agencies 63,594 ( 1,738 ) — — 63,594 ( 1,738 ) Obligations of state and political subdivisions 2,550 ( 65 ) — — 2,550 ( 65 ) Corporate bonds 5,785 ( 202 ) — — 5,785 ( 202 ) Total available-for-sale 105,669 ( 2,441 ) 1,417 ( 46 ) 107,086 ( 2,487 ) Total temporarily impaired securities $ 110,041 $ ( 2,479 ) $ 1,417 $ ( 46 ) $ 111,458 $ ( 2,525 ) Page-13 December 31, 2020 < 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 Available-for-sale: SBA-backed securities $ — $ — $ 1,790 $ ( 55 ) $ 1,790 $ ( 55 ) CMOs issued by FHLMC 5,975 ( 1 ) — — 5,975 ( 1 ) Debentures of government- sponsored agencies 3,943 ( 24 ) — — 3,943 ( 24 ) Total available-for-sale 9,918 ( 25 ) 1,790 ( 55 ) 11,708 ( 80 ) Total temporarily impaired securities $ 9,918 $ ( 25 ) $ 1,790 $ ( 55 ) $ 11,708 $ ( 80 ) As of June 30, 2021, the investment portfolio included 4 investment securities that had been in a continuous loss position for twelve months or more and 19 investment securities that had been in a loss position for less than twelve months. Securities issued by government-sponsored agencies, such as FNMA and FHLMC, usually have implicit credit support by the U.S. federal government. However, since 2008, FNMA and FHLMC have been under government conservatorship and, therefore, contractual cash flows for these investments carry explicit guarantees by the U.S. federal government. Securities issued by the SBA and GNMA have explicit credit guarantees by the U.S. federal government, which protects us from credit losses on the contractual cash flows of the securities. Our investment in obligations of state and political subdivisions bonds are deemed credit worthy after our comprehensive analysis of the issuers' latest financial information, credit ratings by major credit agencies, and/or credit enhancements. At June 30, 2021, management determined that it did not intend to sell any investment securities with unrealized losses, and it is more likely than not that we will not be required to sell securities with unrealized losses before recovery of their amortized cost. Therefore, no allowances for credit losses has been recognized on available for sale securities in an unrealized loss position as management does not believe any of the securities are impaired due to reasons of credit quality at June 30, 2021. Non-Marketable Securities Included in Other Assets FHLB Capital Stock As a member of the FHLB, we are required to maintain a minimum investment in FHLB capital stock determined by the Board of Directors of the FHLB. The minimum investment requirements can increase in the event we increase our total asset size or borrowings with the FHLB. Shares cannot be purchased or sold except between the FHLB and its members at the $ 100 per share par value. We held $ 11.9 million of FHLB stock included in other assets on the consolidated statements of condition at both June 30, 2021 and December 31, 2020. 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, 2021 and December 31, 2020. On July 29, 2021, FHLB announced a cash dividend for the second quarter of 2021 at an annualized dividend rate of 6.00 % to be distributed in mid-August 2021. Cash dividends paid on FHLB capital stock are recorded as non-interest income. VISA Inc. Class B Common Stock As a member bank of Visa U.S.A., we held 10,439 shares of Visa Inc. Class B common stock at June 30, 2021 and December 31, 2020. These shares have a carrying value of zero and are restricted from resale to non-member banks of Visa U.S.A. until their conversion into Class A (voting) shares upon the termination of Visa Inc.'s Covered Litigation escrow account. Because of the restriction and the uncertainty on the conversion rate to Class A shares, these shares lack a readily determinable fair value. When converting this Class B common stock to Class A common stock based on the estimated conversion rate of 1.6228 both at June 30, 2021 and December 31, 2020, and the closing stock price of Class A shares at those respective dates, the converted value of our shares of Class B common stock would have been $ 4.0 million and $ 3.7 million at June 30, 2021 and December 31, 2020, respectively. The conversion rate is subject to further adjustment upon the final settlement of the covered litigation Page-14 against Visa Inc. and its member banks. As such, the fair value of these Class B shares can differ significantly from their converted values. For further information, refer to Note 8, Commitments and Contingencies. Low Income Housing Tax Credits We invest in low-income housing tax credit funds as a limited partner, which totaled $ 3.3 million and $ 3.5 million recorded in other assets as of June 30, 2021 and December 31, 2020, respectively. In the first six months of 2021, we recognized $ 323 thousand of low-income housing tax credits and other tax benefits, offset by $ 271 thousand of amortization expense of low-income housing tax credit investment, as a component of income tax expense. As of June 30, 2021, our unfunded commitments for these low-income housing tax credit funds totaled $ 474 thousand. We did no t recognize any impairment losses on these low-income housing tax credit investments during the first six months of 2021 or 2020, 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 Under the accounting relief provisions of the Coronavirus Aid, Relief and Economic Security ("CARES") Act passed in March 2020, we postponed the adoption of the CECL standard from January 1, 2020 to December 31, 2020. Upon adoption we used a modified retrospective method effective October 1, 2020 (the beginning of the first reporting period in which the standard was effective due to the postponement of CECL) through a cumulative adjustment to retained earnings. The cumulative adjustment to retained earnings was recorded, net of taxes, based on economic forecasts and other assumptions as of December 31, 2019. Results for reporting periods beginning after September 30, 2020 have been presented under the new standard while prior period amounts continue to be reported in accordance with previously applicable GAAP. Certain prior period credit quality disclosures related to impaired loans and individually and collectively evaluated loans were superseded with the CECL accounting standards and have not been included below. Refer to Notes 1 and 3 under Part II, Item 8, of our 2020 Form 10-K for additional information regarding the adoption of CECL. In addition, refer to Note 5 under Part I, Item 1, of our June 30, 2020 Form 10-Q for prior period information. The following table presents the amortized cost of loans by class as of June 30, 2021 and December 31, 2020. (in thousands) June 30, 2021 December 31, 2020 Commercial and industrial $ 423,646 $ 498,408 Real estate: Commercial owner-occupied 296,407 304,963 Commercial investor-owned 967,335 961,208 Construction 80,841 73,046 Home equity 92,510 104,813 Other residential 120,903 123,395 Installment and other consumer loans 21,125 22,723 Total loans, at amortized cost 1 2,002,767 2,088,556 Allowance for credit losses on loans ( 19,100 ) ( 22,874 ) Total loans, net $ 1,983,667 $ 2,065,682 1 Amortized cost includes net deferred loan origination fees of $( 5.2 ) million and $( 4.9 ) million at June 30, 2021 and December 31, 2020, respectively. Amounts are also net of unrecognized purchase discounts of $ 737 thousand and $ 815 thousand at June 30, 2021 and December 31, 2020, respectively. Amortized cost excludes accrued interest, which totaled $ 7.3 million and $ 8.8 million at June 30, 2021 and December 31, 2020, respectively, and is included in interest receivable and other assets in the consolidated statements of condition. Lending Risks Commercial and Industrial Loans - Commercial loans are generally made to established small and mid-sized businesses to provide financing for their growth and working capital needs, equipment purchases and acquisitions. Management examines historical, current, and projected cash flows to determine the ability of the borrower to repay obligations as agreed. Commercial loans are made based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral and guarantor support. The cash flows of borrowers, however, may not occur as expected, and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed, such as accounts receivable and inventory, and typically include personal guarantees. We target stable businesses with guarantors who provide additional sources of repayment and have proven to be resilient in periods of economic stress. A weakened Page-15 economy, and resultant decreased consumer and/or business spending, may have an effect on the credit quality of commercial loans. In April 2020, the Bank began participating in the Small Business Administration's ("SBA") Paycheck Protection Program ("PPP"). As of June 30, 2021, there were 1,532 PPP loans outstanding. PPP loans totaling $ 248.3 million (net of $ 6.5 million in unrecognized fees and costs) and $ 291.6 million (net of $ 5.4 million in unrecognized fees and costs) as of June 30, 2021 and December 31, 2020, respectively, were included in commercial and industrial loan balances. Of the 1,532 PPP loans outstanding as of June 30, 2021, 1,060 loans totaling $ 136.0 million were funded during the first half of 2021 under the second round of the PPP stimulus plan. PPP loans have terms of two to five years and earn interest at 1%. In addition, the SBA paid the Bank a fee of 1%-5% depending on the loan amount, which was netted with loan origination costs and accreted/amortized into interest income using the effective yield method over the contractual life of each loan. The recognition of fees and costs is accelerated when the SBA forgives the loan and/or the loan is paid off prior to maturity. PPP loans are fully guaranteed by the SBA and have virtually no risk of loss. We expect the vast majority of the PPP loans to be fully forgiven by the SBA. Commercial Real Estate Loans - Commercial real estate loans, which include income producing investment properties and owner-occupied real estate used for business purposes, are subject to underwriting standards and processes similar to commercial loans discussed above. We underwrite these loans to be repaid from cash flow and to be 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 and floating homes along with a small number of installment loans. Our other residential loans include tenancy-in-common fractional interest loans ("TIC") located almost entirely in San Francisco County. We originate consumer loans utilizing credit score information, debt-to-income ratio and loan-to-value ratio analysis. Diversification among consumer loan types, coupled with relatively small loan amounts that are spread across many individual borrowers, mitigates risk. We do not originate sub-prime residential mortgage loans, nor is it our practice to underwrite loans commonly referred to as "Alt-A mortgages," the characteristics of which are reduced documentation, borrowers with low FICO scores or collateral with high loan-to-value ratios. Credit Quality Indicators We use a risk rating system to evaluate asset quality, and to identify and monitor credit risk in individual loans, and in the loan portfolio. Our definitions of “Special Mention” risk graded loans, or worse, are consistent with those used by the Federal Deposit Insurance Corporation ("FDIC"). Our internally assigned grades are as follows: Pass and Watch - Loans to borrowers of acceptable or better credit quality. Borrowers in this category demonstrate fundamentally sound financial positions, repayment capacity, credit history and management expertise. Loans in this category must have an identifiable and stable source of repayment and meet the Bank’s policy regarding debt-service-coverage ratios. These borrowers are capable of sustaining normal economic, market or operational setbacks without significant financial consequences. Negative external industry factors are generally Page-16 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. 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, 2021 and December 31, 2020. Generally, existing term loans that were re-underwritten are reflected in the table in the year of renewal. Lines of credit that have a conversion feature at the time of origination, such as construction to perm loans, are presented by year of origination. (in thousands) Term Loans - Amortized Cost by Origination Year Revolving Loans Amortized Cost June 30, 2021 2021 2020 2019 2018 2017 Prior Total Commercial and industrial: Pass $ 137,058 $ 129,992 $ 20,274 $ 10,797 $ 3,621 $ 35,228 $ 82,806 $ 419,776 Special Mention — — 638 442 101 5 445 1,631 Substandard — 1,099 369 — — — 771 2,239 Total commercial and industrial $ 137,058 $ 131,091 $ 21,281 $ 11,239 $ 3,722 $ 35,233 $ 84,022 $ 423,646 Commercial real estate, owner-occupied: Pass $ 19,776 $ 29,440 $ 26,861 $ 40,403 $ 40,695 $ 94,071 $ — $ 251,246 Special Mention — — — 2,360 16,419 8,173 — 26,952 Substandard — 7,148 293 — — 10,768 — 18,209 Total commercial real estate, owner-occupied $ 19,776 $ 36,588 $ 27,154 $ 42,763 $ 57,114 $ 113,012 $ — $ 296,407 Commercial real estate, investor-owned: Pass $ 115,580 $ 159,350 $ 142,354 $ 136,108 $ 72,393 $ 311,508 $ 98 $ 937,391 Special Mention — — 5,203 5,461 1,803 7,920 — 20,387 Substandard — — 2,715 4,422 — 2,420 — 9,557 Total commercial real estate, investor-owned $ 115,580 $ 159,350 $ 150,272 $ 145,991 $ 74,196 $ 321,848 $ 98 $ 967,335 Construction: Pass $ 3,699 $ 43,733 $ 24,379 $ 9,030 $ — $ — $ — $ 80,841 Special Mention — — — — — — — — Substandard — — — — — — — — Total construction $ 3,699 $ 43,733 $ 24,379 $ 9,030 $ — $ — $ — $ 80,841 Home equity: Pass $ — $ — $ — $ — $ — $ 511 $ 91,191 $ 91,702 Special Mention — — — — — — — — Substandard — — — — — 386 422 808 Total home equity $ — $ — $ — $ — $ — $ 897 $ 91,613 $ 92,510 Page-17 (in thousands) Term Loans - Amortized Cost by Origination Year Revolving Loans Amortized Cost June 30, 2021 2021 2020 2019 2018 2017 Prior Total Other residential: Pass $ 12,426 $ 33,282 $ 27,503 $ 18,566 $ 8,948 $ 20,178 $ — $ 120,903 Special Mention — — — — — — — — Substandard — — — — — — — — Total other residential $ 12,426 $ 33,282 $ 27,503 $ 18,566 $ 8,948 $ 20,178 $ — $ 120,903 Installment and other consumer: Pass $ 3,318 $ 2,038 $ 3,320 $ 2,305 $ 1,248 $ 7,183 $ 1,713 $ 21,125 Special Mention — — — — — — — — Substandard — — — — — — — — Total installment and other consumer $ 3,318 $ 2,038 $ 3,320 $ 2,305 $ 1,248 $ 7,183 $ 1,713 $ 21,125 Total loans: Pass $ 291,857 $ 397,835 $ 244,691 $ 217,209 $ 126,905 $ 468,679 $ 175,808 $ 1,922,984 Total Special Mention $ — $ — $ 5,841 $ 8,263 $ 18,323 $ 16,098 $ 445 $ 48,970 Total Substandard $ — $ 8,247 $ 3,377 $ 4,422 $ — $ 13,574 $ 1,193 $ 30,813 Totals $ 291,857 $ 406,082 $ 253,909 $ 229,894 $ 145,228 $ 498,351 $ 177,446 $ 2,002,767 (in thousands) Term Loans - Amortized Cost by Origination Year Revolving Loans Amortized Cost December 31, 2020 2020 2019 2018 2017 2016 Prior Total Commercial and industrial: Pass $ 308,237 $ 22,589 $ 12,596 $ 4,508 $ 5,915 $ 34,282 $ 85,889 $ 474,016 Special Mention — 2,034 1,318 141 11 49 19,092 22,645 Substandard 1,747 — — — — — — 1,747 Total commercial and industrial $ 309,984 $ 24,623 $ 13,914 $ 4,649 $ 5,926 $ 34,331 $ 104,981 $ 498,408 Commercial real estate, owner-occupied: Pass $ 31,029 $ 27,581 $ 32,603 $ 43,843 $ 12,768 $ 101,014 $ — $ 248,838 Special Mention — — 11,764 17,062 7,343 6,601 — 42,770 Substandard 7,147 — — — 6,208 — — 13,355 Total commercial real estate, owner-occupied $ 38,176 $ 27,581 $ 44,367 $ 60,905 $ 26,319 $ 107,615 $ — $ 304,963 Commercial real estate, investor-owned: Pass $ 162,300 $ 144,751 $ 173,955 $ 100,842 $ 94,862 $ 253,611 $ 117 $ 930,438 Special Mention — 10,695 — 1,819 — 8,124 — 20,638 Substandard — 2,716 4,435 — 1,553 1,428 — 10,132 Total commercial real estate, investor-owned $ 162,300 $ 158,162 $ 178,390 $ 102,661 $ 96,415 $ 263,163 $ 117 $ 961,208 Construction: Pass $ 31,654 $ 30,150 $ 11,242 $ — $ — $ — $ — $ 73,046 Special Mention — — — — — — — — Substandard — — — — — — — — Total construction $ 31,654 $ 30,150 $ 11,242 $ — $ — $ — $ — $ 73,046 Home equity: Pass $ — $ — $ — $ — $ 128 $ 694 $ 102,614 $ 103,436 Special Mention — — — — — — 799 799 Substandard — — — — — 391 187 578 Total home equity $ — $ — $ — $ — $ 128 $ 1,085 $ 103,600 $ 104,813 Other residential: Pass $ 34,447 $ 31,079 $ 23,673 $ 10,574 $ 6,035 $ 17,587 $ — $ 123,395 Special Mention — — — — — — — — Substandard — — — — — — — — Total other residential $ 34,447 $ 31,079 $ 23,673 $ 10,574 $ 6,035 $ 17,587 $ — $ 123,395 Installment and other consumer: Pass $ 2,361 $ 4,382 $ 3,483 $ 1,543 $ 3,423 $ 4,921 $ 2,593 $ 22,706 Special Mention — — — — — — — — Substandard — — — 17 — — — 17 Total installment and other consumer $ 2,361 $ 4,382 $ 3,483 $ 1,560 $ 3,423 $ 4,921 $ 2,593 $ 22,723 Total loans: Pass $ 570,028 $ 260,532 $ 257,552 $ 161,310 $ 123,131 $ 412,109 $ 191,213 $ 1,975,875 Total Special Mention $ — $ 12,729 $ 13,082 $ 19,022 $ 7,354 $ 14,774 $ 19,891 $ 86,852 Total Substandard $ 8,894 $ 2,716 $ 4,435 $ 17 $ 7,761 $ 1,819 $ 187 $ 25,829 Totals $ 578,922 $ 275,977 $ 275,069 $ 180,349 $ 138,246 $ 428,702 $ 211,291 $ 2,088,556 The following table shows the amortized cost of loans by class, payment aging and non-accrual status as of June 30, 2021 and December 31, 2020. Page-18 Loan Aging Analysis by Class (in thousands) Commercial and industrial Commercial real estate, owner-occupied Commercial real estate, investor-owned Construction Home equity Other residential Installment and other consumer Total June 30, 2021 30-59 days past due $ 367 $ — $ — $ — $ — $ — $ — $ 367 60-89 days past due — — — — 121 — — 121 90 days or more past due — — 878 — — — — 878 Total past due 367 — 878 — 121 — — 1,366 Current 423,279 296,407 966,457 80,841 92,389 120,903 21,125 2,001,401 Total loans 1 $ 423,646 $ 296,407 $ 967,335 $ 80,841 $ 92,510 $ 120,903 $ 21,125 $ 2,002,767 Non-accrual loans 2 $ — $ 7,148 $ 1,597 $ — $ 445 $ — $ — $ 9,190 Non-accrual loans with no allowance $ — $ 7,148 $ 1,597 $ — $ 445 $ — $ — $ 9,190 December 31, 2020 30-59 days past due $ — $ — $ 1,673 $ — $ 274 $ — $ 136 $ 2,083 60-89 days past due — — — — — — 622 622 90 days or more past due — — — — — — — — Total past due — — 1,673 — 274 — 758 2,705 Current 498,408 304,963 959,535 73,046 104,539 123,395 21,965 2,085,851 Total loans 1 $ 498,408 $ 304,963 $ 961,208 $ 73,046 $ 104,813 $ 123,395 $ 22,723 $ 2,088,556 Non-accrual loans 2 $ — $ 7,147 $ 1,610 $ — $ 459 $ — $ 17 $ 9,233 Non-accrual loans with no allowance $ — $ 7,147 $ 1,610 $ — $ 459 $ — $ 17 $ 9,233 1 There were no loans past due more than ninety days accruing interest at June 30, 2021 or December 31, 2020. 2 None of the non-accrual loans as of June 30, 2021 or December 31, 2020 were earning interest on a cash basis. We recognized no interest income on non-accrual loans for the three and six months ended June 30, 2021 and 2020. There were no new loans placed on non-accrual status during the six months ended June 30, 2021. Accrued interest of $ 20 thousand was reversed from interest income for loans that were placed on non-accrual status during the six months ended June 30, 2020. Collateral Dependent Loans The following table presents the amortized cost basis of individually analyzed collateral-dependent non-accrual loans by class at June 30, 2021 and December 31, 2020. Amortized Cost by Collateral Type (in thousands) Commercial Real Estate Residential Real Estate Other Total Allowance for Credit Losses June 30, 2021 Commercial real estate, owner-occupied $ 7,148 $ — $ — $ 7,148 $ — Commercial real estate, investor-owned 1,597 — — 1,597 — Home equity — 445 — 445 — Total $ 8,745 $ 445 $ — $ 9,190 $ — December 31, 2020 Commercial real estate, owner-occupied $ 7,147 $ — $ — $ 7,147 $ — Commercial real estate, investor-owned 1,610 — — 1,610 — Home equity — 459 — 459 — Installment and other consumer — — 17 17 — Total $ 8,757 $ 459 $ 17 $ 9,233 $ — No collateral-dependent loans were in process of foreclosure at June 30, 2021 or December 31, 2020. In addition, the weighted average loan-to-value of collateral dependent loans was approximately 58.7 % at June 30, 2021 and 59.2 % at December 31, 2020. Troubled Debt Restructuring Our loan portfolio includes certain loans modified in a troubled debt restructuring (“TDR”), where we have granted economic concessions to borrowers experiencing financial difficulties. These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. TDRs on non-accrual status at the time of restructure may be returned to accruing status after management considers the borrower’s sustained repayment performance for a reasonable period, generally nine months, and obtains reasonable assurance of repayment and performance. We may remove a loan from TDR designation if it meets all of the following conditions: Page-19 • The loan is subsequently refinanced or restructured at current market interest rates and the new terms are consistent with the treatment of creditworthy borrowers under regular underwriting standards; • The borrower is no longer considered to be in financial difficulty; • Performance on the loan is reasonably assured; and • Existing loan did not have any forgiveness of principal or interest. There were no loans removed from TDR designation during the six months ended June 30, 2021 and 2020. In accordance with section 4013 of the CARES Act, subsequently amended by section 541 of the Economic Aid Act, we elected to apply the temporary accounting relief provisions for loan modifications that met certain criteria, which would otherwise be designated TDRs under existing GAAP. As of June 30, 2021, 7 borrowing relationships with 12 loans totaling $ 49.8 million were continuing to benefit from payment relief. Subsequent to quarter end and prior to the filing of this report, one relationship with three loans totaling $ 6.4 million transitioned out of the payment relief program and resumed normal contractual payments. The weighted average loan-to-value ratio of the remaining payment relief loans was approximately 41 %. We accrue and recognize interest income on loans under payment relief based on the original contractual interest rates. When payments resume at the end of the relief period, the payments will generally be applied to accrued interest due until accrued interest is fully paid. The following table summarizes the carrying amount of TDR loans by loan class as of June 30, 2021 and December 31, 2020. (in thousands) Recorded Investment in Troubled Debt Restructurings 1 June 30, 2021 December 31, 2020 Commercial and industrial $ 821 $ 1,021 Commercial real estate, owner-occupied 7,148 7,147 Commercial real estate, investor-owned 1,729 3,305 Home equity 276 281 Installment and other consumer 745 752 Total $ 10,719 $ 12,506 1 TDR loans on non-accrual status totaled $ 7.4 million at both June 30, 2021 and December 31, 2020. Unfunded commitments for TDR loans totaled $ 845 thousand as of June 30, 2021 The following table presents information for loans modified in a TDR during the presented periods, including the number of modified contracts, the recorded investment in the loans prior to modification, and the recorded investment in the loans at period end after being restructured. The table excludes fully charged-off TDR loans and loans modified in a TDR and subsequently paid-off during the years presented, if applicable. (dollars in thousands) Number of Contracts Modified Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment at Period End TDRs during the three months ended June 30, 2021: None — $ — $ — $ — TDRs during the three months ended June 30, 2020: Home equity 1 $ 276 $ 276 $ 276 Installment and other consumer 1 108 108 108 Total 2 $ 384 $ 384 $ 384 TDRs during the six months ended June 30, 2021: None — $ — $ — $ — TDRs during the six months ended June 30, 2020: Commercial and industrial 1 $ 170 $ 162 $ 144 Home equity 1 276 276 276 Installment and other consumer 3 211 211 210 Total 5 $ 657 $ 649 $ 630 The loans modified in 2020 reflected debt consolidation, interest rate concessions, and/or other loan term and payment modifications. During the six months ended June 30, 2021 and 2020, there were no defaults on loans that had been modified in a TDR within the prior twelve-month period. We report defaulted TDRs based on a payment default definition of more than ninety days past due. Page-20 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, investor-owned Construction Home equity Other residential Installment and other consumer Unallocated Total Three months ended June 30, 2021 Beginning balance $ 1,654 $ 2,304 $ 10,856 $ 1,312 $ 520 $ 757 $ 255 $ 2,300 $ 19,958 Provision (reversal) - CECL ( 68 ) ( 267 ) ( 95 ) ( 178 ) ( 158 ) ( 144 ) ( 17 ) 7 ( 920 ) Charge-offs — — — — — — — — — Recoveries 4 — — 8 50 — — — 62 Ending balance $ 1,590 $ 2,037 $ 10,761 $ 1,142 $ 412 $ 613 $ 238 $ 2,307 $ 19,100 Three months ended June 30, 2020 Beginning balance $ 2,784 $ 2,797 $ 9,225 $ 727 $ 982 $ 1,098 $ 363 $ 908 $ 18,884 Provision - incurred loss ( 159 ) 113 1,178 109 62 168 63 466 2,000 Charge-offs ( 20 ) — — — — — — — ( 20 ) Recoveries 4 — — — — — — — 4 Ending balance $ 2,609 $ 2,910 $ 10,403 $ 836 $ 1,044 $ 1,266 $ 426 $ 1,374 $ 20,868 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, 2021 Beginning balance $ 2,530 $ 2,778 $ 12,682 $ 1,557 $ 738 $ 998 $ 291 $ 1,300 $ 22,874 Provision (reversal) - CECL ( 947 ) ( 741 ) ( 1,921 ) ( 433 ) ( 376 ) ( 385 ) ( 53 ) 1,007 ( 3,849 ) Charge-offs — — — — — — — — — Recoveries 7 — — 18 50 — — — 75 Ending balance $ 1,590 $ 2,037 $ 10,761 $ 1,142 $ 412 $ 613 $ 238 $ 2,307 $ 19,100 Six months ended June 30, 2020 Beginning balance $ 2,334 $ 2,462 $ 8,483 $ 638 $ 850 $ 973 $ 284 $ 653 $ 16,677 Provision - incurred loss 287 448 1,920 195 194 293 142 721 4,200 Charge-offs ( 20 ) — — — — — — — ( 20 ) Recoveries 8 — — 3 — — — — 11 Ending balance $ 2,609 $ 2,910 $ 10,403 $ 836 $ 1,044 $ 1,266 $ 426 $ 1,374 $ 20,868 We adopted the CECL accounting standard on December 31, 2020, which we had previously postponed under the optional accounting relief provisions of the CARES Act passed in March 2020 to the earlier of the end of the national emergency or December 31, 2020. During the first six months of 2020, we applied the incurred loss method under previous GAAP in determining the allowance for credit losses on loans. Pledged Loans Our FHLB line of credit is secured under terms of a blanket collateral agreement by a pledge of certain qualifying loans with unpaid principal balances of $ 1.092 billion and $ 1.165 billion at June 30, 2021 and December 31, 2020, respectively. In addition, we pledge eligible TIC loans, which totaled $ 113.0 million and $ 113.6 million at June 30, 2021 and December 31, 2020, respectively, to secure our borrowing capacity with the Federal Reserve Bank ("FRB"). Also, see Note 6, Borrowings. Related Party Loans The Bank has, and expects to have in the future, banking transactions in the ordinary course of its business with directors, officers, principal shareholders and their businesses or associates. These loans are granted on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with persons not related to us. Likewise, these transactions do not involve more than the normal risk of collectability or present other unfavorable features. Related party loans totaled $ 5.3 million at Page-21 June 30, 2021 and $ 6.4 million at December 31, 2020. In addition, undisbursed commitments to related parties totaled $ 9.1 million at June 30, 2021 and December 31, 2020. Note 6: Borrowings and Other Obligations Federal Funds Purchased – The Bank had unsecured available lines of credit with correspondent banks for overnight borrowings totaling $ 115.0 million at June 30, 2021 and $ 135.0 million at December 31, 2020. In general, interest rates on these lines approximate the federal funds target rate. We had no overnight borrowings under these credit facilities at June 30, 2021 or December 31, 2020 . Federal Home Loan Bank Borrowings – As of June 30, 2021 and December 31, 2020, the Bank had available lines of credit with the FHLB totaling $ 629.9 million and $ 642.5 million, respectively, based on eligible collateral of certain loans. There were no FHLB overnight borrowings at June 30, 2021 or December 31, 2020. Federal Reserve Line of Credit – The Bank has an available line of credit with the FRBSF secured by certain residential loans. At June 30, 2021 and December 31, 2020, the Bank had borrowing capacity under this line totaling $ 77.6 million and $ 78.7 million, respectively, and had no outstanding borrowings with the FRBSF. Subordinated Debenture – As part of an acquisition in 2013, Bancorp assumed a subordinated debenture with a contractual balance of $ 4.1 million due to NorCal Community Bancorp Trust II (the "Trust"), established for the sole purpose of issuing trust preferred securities. On March 15, 2021, Bancorp redeemed in full the $ 2.8 million (book value) subordinated debenture due to the Trust, which had an effective interest rate of 6.5 % for the first six months of 2020. The higher effective rate for the first six months of 2021 included accelerated accretion of the $ 1.3 million remaining purchase discount due to the early redemption. Accretion was $ 17 thousand and $ 35 thousand for the three and six months ended June 30, 2020, respectively. Other Obligations – Finance lease liabilities totaling $ 438 thousand and $ 58 thousand at June 30, 2021 and December 31, 2020, respectively, are included in borrowings and other obligations in the consolidated statements of condition. See Note 8, Commitments and Contingencies, for additional information. Note 7: Stockholders' Equity Dividends On July 16, 2021, Bancorp declared a $ 0.24 per share cash dividend, payable on August 6, 2021 to shareholders of record at the close of business on July 30, 2021. Share-Based Payments The fair value of stock options as of the grant date is recorded as stock-based compensation expense in the consolidated statements of comprehensive income over the requisite service period, which is generally the vesting period, with a corresponding increase in common stock. Stock-based compensation also includes compensation expense related to the issuance of restricted stock awards. The grant-date fair value of the restricted stock awards, which equals the grant date price, is recorded as compensation expense over the requisite service period with a corresponding increase in common stock as the shares vest. Beginning in 2018, stock option and restricted stock awards issued include a retirement eligibility clause whereby the requisite service period is satisfied at the 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. Page-22 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, 2021, we withheld 27,547 shares totaling $ 1.1 million at a weighted-average price of $ 38.87 for cashless exercises. During the six months ended June 30, 2020, we withheld 8,409 shares totaling $ 346 thousand at a weighted-average price of $ 41.17 for cashless exercises. Shares withheld under net settlement arrangements are available for future grants. Share Repurchase Program On April 23, 2018, Bancorp announced that its Board of Directors approved a share repurchase program under which Bancorp may repurchase up to $ 25.0 million of its outstanding common stock through May 1, 2019. Bancorp's Board of Directors subsequently extended the share repurchase program through February 28, 2020. After expiration of this share repurchase program, a new share repurchase program began on March 5, 2020. This new program was approved on January 24, 2020 by Bancorp Board of Directors, allowing Bancorp to repurchase up to $ 25.0 million of its outstanding common stock through February 28, 2022. The share repurchase program, which began on March 5, 2020, was suspended by the Board of Directors on March 20, 2020 in response to the COVID-19 pandemic. The program was reactivated by the Board of Directors on October 23, 2020 and completed in May 2021 upon depletion of repurchase funds. A new share repurchase program was approved by Bancorp Board of Directors on July 16, 2021 under which Bancorp may repurchase up to $ 25.0 million of its outstanding common stock through July 31, 2023. Under the share repurchase program, Bancorp may purchase shares of its common stock through various means such as open market transactions, including block purchases, and privately negotiated transactions. The number of shares repurchased and the timing, manner, price and amount of any repurchases will be determined at Bancorp's discretion. Factors include, but are not limited to, stock price, trading volume and general market conditions, along with Bancorp’s general business conditions. The program may be suspended or discontinued at any time and does not obligate Bancorp to acquire any specific number of shares of its common stock. As part of the share repurchase program, Bancorp entered into a trading plan adopted in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The 10b5-1 trading plan permits common stock to be repurchased at times that might otherwise be prohibited under insider trading laws or self-imposed trading restrictions. The 10b5-1 trading plan is administered by an independent broker and is subject to price, market volume and timing restrictions. During the six months ended June 30, 2021, Bancorp repurchased 521,948 shares totaling $ 19.3 million for a cumulative 691,519 shares amounting to $ 25.0 million under the $ 25.0 million share repurchase program that was approved by the Board of Directors on January 24, 2020. Note 8: Commitments and Contingencies Financial Instruments with Off-Balance Sheet Risk We make commitments to extend credit in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because various commitments will expire without being fully drawn, the total commitment amount does not necessarily represent future cash requirements. Page-23 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, 2021 December 31, 2020 Commercial lines of credit $ 282,611 $ 287,533 Revolving home equity lines 201,986 189,035 Undisbursed construction loans 73,757 41,033 Personal and other lines of credit 10,185 9,567 Standby letters of credit 3,167 1,964 Total commitments and standby letters of credit $ 571,706 $ 529,132 We record an allowance for credit losses on unfunded loan commitments at the balance sheet date based on estimates of the probability that these commitments will be drawn upon according to historical utilization experience of the different types of commitments and expected loss rates determined for pooled funded loans. The allowance for credit losses on unfunded commitments totaled $ 1.6 million and $ 2.8 million as of June 30, 2021 and December 31, 2020, respectively, which is recorded in interest payable and other liabilities in the consolidated statements of condition. We adopted the CECL accounting standard on December 31, 2020. We applied the incurred loss method under previous GAAP in determining the allowance for credit losses on unfunded commitments for the three and six month periods ended June 30, 2020. We recorded reversals of the allowance for credit losses on unfunded commitments totaling $ 612 thousand and $ 1.2 million for the three and six month periods ended June 30, 2021, respectively. This compares to provisions for credit losses on unfunded commitments for the three and six month periods ended June 30, 2020 totaling $ 260 thousand and $ 362 thousand, respectively. In the current period, we reclassified the provision for credit losses on unfunded commitments from non-interest expense to a separate line item under the provision for credit losses on loans in the consolidated statements of comprehensive income. Leases We lease premises under long-term non-cancelable operating leases with remaining terms of 1 year to 11 years, most of which include escalation clauses and one or more options to extend the lease term, and some of which contain lease termination clauses. Lease terms may include certain renewal options that were considered reasonably certain to be exercised. We lease certain equipment under finance leases with initial terms of 3 years to 4 years. The equipment finance leases do not contain renewal options, bargain purchase options or residual value guarantees. The following table shows the balances of operating and finance lease right-of-use assets and lease liabilities. (in thousands) June 30, 2021 December 31, 2020 Operating leases: Operating lease right-of-use assets $ 23,506 $ 25,612 Operating lease liabilities $ 24,919 $ 27,062 Finance leases: Finance lease right-of-use assets $ 473 $ 365 Accumulated amortization ( 37 ) ( 307 ) Finance lease right-of-use assets, net 1 $ 436 $ 58 Finance lease liabilities 2 $ 438 $ 58 1 Included in premises and equipment in the consolidated statements of condition. 2 Included in borrowings and other obligations in the consolidated statements of condition. Page-24 The following table shows supplemental disclosures of noncash investing and financing activities for the period presented. Six months ended (in thousands) June 30, 2021 June 30, 2020 Right-of-use assets obtained in exchange for operating lease liabilities $ — $ 14,030 Right-of-use assets obtained in exchange for finance lease liabilities $ 412 $ 18 The following table shows components of operating and finance lease cost. Three months ended Six months ended (in thousands) June 30, 2021 June 30, 2020 June 30, 2021 June 30, 2020 Operating lease cost $ 1,164 $ 1,114 $ 2,328 $ 2,169 Variable lease cost — 2 — 3 Total operating lease cost 1 $ 1,164 $ 1,116 $ 2,328 $ 2,172 Finance lease cost: Amortization of right-of-use assets 2 $ 7 $ 44 $ 34 $ 88 Interest on finance lease liabilities 3 — 1 — $ 2 Total finance lease cost 7 45 $ 34 $ 90 Total lease cost $ 1,171 $ 1,161 $ 2,362 $ 2,262 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, 2021. The discount rates used to calculate the present value of lease liabilities were based on the collateralized FHLB borrowing rates that were commensurate with lease terms and minimum payments on the later of the date we adopted the new lease accounting standards or lease commencement date. (in thousands) June 30, 2021 Year Operating Leases Finance Leases 2021 $ 2,246 $ 52 2022 4,424 118 2023 4,004 108 2024 3,300 104 2025 2,876 61 Thereafter 9,867 — Total minimum lease payments 26,717 443 Amounts representing interest (present value discount) ( 1,798 ) ( 5 ) Present value of net minimum lease payments (lease liability) $ 24,919 $ 438 Weighted average remaining term (in years) 7.5 4.0 Weighted average discount rate 1.79 % 0.66 % Litigation Matters Bancorp may be party to legal actions that arise from time to time in the normal course of business. Bancorp's management is not aware of any pending legal proceedings to which either it or the Bank may be a party or has recently been a party that will have a material adverse effect on the financial condition or results of operations of Bancorp or the Bank. The Bank is responsible for a proportionate share of certain litigation indemnifications provided to Visa U.S.A. ("Visa") by its member banks in connection with Visa's lawsuits related to anti-trust charges and interchange fees ("Covered Litigation"). Our proportionate share of the litigation indemnification liability does not change or transfer upon the sale of our Class B Visa shares to member banks. Visa established an escrow account to pay for settlements or judgments in the Covered Litigation. Under the terms of the U.S. retrospective responsibility plan, when Visa funds the litigation escrow account, it triggers a conversion rate reduction of the Class B common stock Page-25 to shares of Class A common stock, effectively reducing the aggregate value of the Class B common stock held by Visa's member banks like us. In 2012, Visa had reached a $ 4.0 billion interchange multidistrict litigation class settlement agreement with plaintiffs representing a class of U.S. retailers. The escrow balance of $ 894 million as of June 30, 2021, combined with funds previously deposited with the court, are expected to cover the settlement payment obligations. The outcome of the Covered Litigation affects the conversion rate of Visa Class B common stock held by us to Visa Class A common stock, as discussed above and in Note 4, Investment Securities. The final conversion rate is subject to change depending on the final settlement payments, and the full effect on member banks is still uncertain. Litigation is ongoing and until the court approval process is complete, there is no assurance that Visa will resolve the claims as contemplated by the amended class settlement agreement, and additional lawsuits may arise from individual merchants who opted out of the class settlement. However, until the escrow account is fully depleted and the conversion rate of Class B to Class A common stock is reduced to zero, no future cash settlement payments are required by the member banks, such as us, on the Covered Litigation. Therefore, we are not required to record any contingent liabilities for the indemnification related to the Covered Litigation, as we consider the probability of losses to be remote. Note 9: Derivative Financial Instruments and Hedging Activities We entered into interest rate swap agreements, primarily as an asset/liability management strategy, in order to mitigate the changes in the fair value of specified long-term fixed-rate loans (or firm commitments to enter into long-term fixed-rate loans) caused by changes in interest rates. These hedges allow us to offer long-term fixed-rate loans to customers without assuming the interest rate risk of a long-term asset. Converting our fixed-rate interest payments to floating-rate interest payments, generally benchmarked to the one-month U.S. dollar LIBOR index, protects us against changes in the fair value of our loans associated with fluctuating interest rates. Our credit exposure, if any, on interest rate swap asset positions is limited to the fair value (net of any collateral pledged to us) and interest payments of all swaps by each counterparty. Conversely, when an interest rate swap is 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, 2021, we had four interest rate swap agreements, which are scheduled to mature in June 2031, October 2031, July 2032, and October 2037. All of our derivatives are accounted for as fair value hedges. The notional amounts of the interest rate contracts are equal to the notional amounts of the hedged loans. Our interest rate swap payments are settled monthly with counterparties. Accrued interest on the swaps totaled $ 10 thousand at June 30, 2021 and $ 11 thousand at December 31, 2020. Information on our derivatives follows: Asset Derivatives Liability Derivatives (in thousands) June 30, 2021 December 31, 2020 June 30, 2021 December 31, 2020 Fair value hedges: Interest rate contracts notional amount $ — $ — $ 13,518 $ 13,991 Interest rate contracts fair value 1 $ — $ — $ 1,363 $ 1,912 1 See Note 3, Fair Value of Assets and Liabilities, for valuation methodology. The following table presents the carrying amount and associated cumulative basis adjustment related to the application of fair value hedge accounting that is included in the carrying amount of hedged assets as of June 30, 2021 and December 31, 2020. 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, 2021 December 31, 2020 June 30, 2021 December 31, 2020 Loans $ 14,734 $ 15,745 $ 1,216 $ 1,753 The following table presents the net losses recognized in interest income on loans on the consolidated statements of comprehensive income related to our derivatives designated as fair value hedges. Page-26 Three months ended Six months ended (in thousands) June 30, 2021 June 30, 2020 June 30, 2021 June 30, 2020 Interest and fees on loans 1 $ 21,429 $ 21,217 $ 42,090 $ 42,104 (Decrease) increase in fair value of designated interest rate swaps due to LIBOR interest rate movements $ ( 170 ) $ ( 63 ) $ 549 $ ( 1,504 ) Payment on interest rate swaps ( 93 ) ( 96 ) ( 185 ) ( 146 ) Increase (decrease) in fair value hedging adjustment of hedged loans 177 59 ( 537 ) 1,529 Decrease in value of yield maintenance agreement ( 2 ) ( 3 ) ( 6 ) ( 6 ) Net losses on fair value hedging relationships recognized in interest income $ ( 88 ) $ ( 103 ) $ ( 179 ) $ ( 127 ) 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) Assets Condition of Condition Instruments Received Net Amount June 30, 2021 Derivatives by Counterparty: Counterparty A $ — $ — $ — $ — $ — $ — December 31, 2020 Derivatives by Counterparty: Counterparty A $ — $ — $ — $ — $ — $ — Offsetting of Financial Liabilities and Derivative Liabilities Gross Amounts Net Amounts of Gross Amounts Not Offset in Gross Amounts Offset in the Liabilities Presented the Statements of Condition of Recognized Statements of in the Statements Financial Cash Collateral (in thousands) Liabilities 1 Condition of Condition 1 Instruments Pledged Net Amount June 30, 2021 Derivatives by Counterparty: Counterparty A $ 1,363 $ — $ 1,363 $ — $ ( 1,363 ) $ — December 31, 2020 Derivatives by Counterparty: Counterparty A $ 1,912 $ — $ 1,912 $ — $ ( 1,912 ) $ — 1 Amounts exclude accrued interest on swaps. For more information on how we account for our interest rate swaps, refer to Note 1 to the Consolidated Financial Statements included in our 2020 Form 10-K filed with the SEC on March 15, 2021. Note 10: Merger Agreement On April 16, 2021, Bancorp entered into a definitive agreement to acquire American River Bankshares ("AMRB"), parent company of American River Bank ("ARB"), whereby AMRB will merge with and into Bancorp and immediately thereafter ARB will merge with and into Bank of Marin (collectively, the "Merger"). The acquisition will expand Bank of Marin's presence throughout the Greater Sacramento, Amador and Sonoma County Regions where ARB has ten branches. Under the terms of the merger agreement, AMRB shareholders will receive a fixed exchange ratio of 0.575 shares of Bancorp's common stock for each share of AMRB's common stock outstanding upon consummation of the Merger. AMRB had total assets of $ 906.1 million, total deposits of $ 787.7 million, and total loans of $ 434.2 million as of June 30, 2021. These amounts are subject to fair value adjustments upon the close of the Merger. The merger has been approved by the Boards of Directors of each company, all applicable regulatory agencies and shareholders of AMRB and BMRC. The Merger is expected to close on August 6, 2021 . Page-27