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Item 2. Management’s Discussion and Analysis

2021-11-09 compared with 2021-08-05 · 219 added, 179 removed, 338 unchanged (54% of the section changed)

10 unchanged sentences

A number of factors, many of which are beyond management’s control, could cause future results to vary materially from current management expectations.

Such factors include, but are not limited to, general economic conditions and the economic uncertainty in the United States and abroad, including changes in interest rates, deposit flows, real estate values, and expected future cash flows on loans and securities;

Such factors include, but are not limited to, general economic conditions and the economic uncertainty in the United States and abroad, including changes interest rates, California unemployment rate, deposit flows, real estate values, and expected future cash flows on loans and securities;

costs or effects of acquisitions;

17 unchanged sentences

We consider accounting estimates to be critical to our financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain, (ii) management could have applied different assumptions during the reported period, and (iii) changes in the accounting estimate are reasonably likely to occur in the future and could have a material impact on our financial statements.

There have been no material changes to our critical accounting policies, which include:

There have been no material changes to our critical accounting policies previously reported, which include:

Allowance for Credit Losses on Loans and Unfunded Commitments, Allowance for Credit Losses on Investments Securities, Accounting for Income Taxes, and Fair Value Measurements .

For a detailed discussion of these accounting policies, refer to Note 1 in the Consolidated Financial Statements included in our 2020 Form 10-K filed with the SEC on March 15, 2021.

For a detailed discussion of these accounting policies, refer to Note 1, Summary of Significant Accounting Policies, in the Consolidated Financial Statements included in our 2020 Form 10-K filed with the SEC on March 15, 2021.

In addition, as a result of the acquisition of American River Bankshares in the third quarter of 2021, we consider the accounting policies and estimates for the following to be critical for this reporting period.

Business Combinations

Bancorp accounts for business combinations under the acquisition method of accounting in accordance with ASC 805, Business Combinations .

ASC 805 requires assets and liabilities in a business combination to be recorded at their fair values as of the date of acquisition.

This method often involves estimates based on third party or internal valuations based on discounted cash flow analyses or other valuation techniques, all of which are inherently subjective.

Business acquisition-related costs, including conversion and restructuring charges, are expensed as incurred.

For further information, refer to Note 10, Merger, herein, and Note 1, Summary of Significant Accounting Policies;

and Item 1A, Risk Factors, in the Consolidated Financial Statements included in our 2020 Form 10-K filed with the SEC on March 15, 2021.

Executive Summary

As previously reported, 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").

We expect the transaction to be accretive to Bancorp's earnings, adding to shareholder value.

AMRB shareholders will receive a fixed exchange ratio of 0.575 shares of Bancorp common stock for each share of AMRB common stock outstanding.

Based on Bancorp's closing stock price of $39.06 on April 16, 2021 (date of merger agreement), the transaction was valued at $134.5 million (with approximately 3.4 million of additional shares of Bancorp common stock to be issued), or $22.46 per share of AMRB common stock, which includes the value of AMRB options being paid in cash.

Such value will fluctuate with changes in Bancorp's stock price.

Based on information currently available, Bank of Marin will have approximately $4.0 billion in assets and operate 31 branches in ten counties (Alameda, Amador, Contra Costa, Marin, Napa, Placer, Sacramento, San Francisco, San Mateo, and Sonoma) upon closing.

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.

For other important factors regarding the AMRB acquisition, please see Note 10, Merger Agreement, and the Forward-Looking Statements section of this Form 10-Q.

Net income for the second quarter of 2021 totaled $9.3 million, compared to $7.4 million in the second quarter of 2020.

Diluted earnings per share were $0.71 in the second quarter of 2021, compared to $0.55 in the same quarter a year ago.

Earnings for the first six months of 2021 totaled $18.2 million, compared to $14.6 million in the same period a year ago.

Diluted earnings per share were $1.37, compared to $1.07 in the first half of 2020.

Net income included the recognition of $2.6 million and $4.3 million of SBA PPP fees, net of costs in the second quarter of 2021 and first six months of 2021, respectively, compared to $1.2 million in the same periods a year ago.

Additionally, reversals of the allowance for credit losses on loans totaling $920 thousand and $3.8 million in the second quarter and first half of 2021 contributed to the increase in earnings when compared to provisions of $2.0 million and $4.2 million in the comparative periods a year ago.

Increases to income in the first half of 2021 were partially offset by the early redemption of our last subordinated debenture, generating $1.3 million accelerated discount accretion in interest expense in the first quarter of 2021.

Bancorp completed its merger with American River Bankshares ("AMRB") on August 6, 2021 (the "merger date"), with Bancorp continuing as the surviving entity, followed thereafter at 12:05 a.m.

on August 7, 2021 by the Merger of American River Bank ("ARB") with and into Bank of Marin (collectively, the "Merger"), with Bank of Marin surviving.

AMRB shareholders received a fixed exchange ratio of 0.575 shares of Bancorp common stock for each share of AMRB common stock outstanding.

Based on Bancorp's closing stock price of $36.15 on August 6, 2021 (merger date), the transaction was valued at $124.5 million (with 3.4 million of additional shares of Bancorp common stock issued), or $20.80 per share of AMRB common stock, which includes the value of AMRB options paid in cash.

For other important factors regarding the AMRB acquisition, please see Note 10, Merger, and the Forward-Looking Statements section of this Form 10-Q.

The following are highlights of our operating and financial performance for the periods presented:

• Loans totaled $2.003 billion at June 30, 2021, compared to $2.089 billion at December 31, 2020, a decrease of $85.8 million, or 4.1%.

The first half of 2021 included a $43.3 million net decrease in PPP loans.

Non-PPP-related loan originations of $69.1 million were more than offset by loan payoffs of $95.4 million and a $34.8 million decrease in line utilization.

• Credit quality remained strong, with non-accrual loans representing $9.2 million at June 30, 2021 and December 31, 2020, or 0.46% and 0.44% of total loans, respectively.

The ratio of allowance for credit losses on loans to total loans was 0.95% at June 30, 2021 and 1.10% at December 31, 2020.

Excluding acquired and SBA PPP loans, the allowance for credit losses on loans represented 1.09% of total loans as of June 30, 2021, compared to 1.27% as of December 31, 2020 (see Results of Operations for a definition of this non-GAAP financial measure).

• Return on average assets ("ROA") and return on average equity ("ROE") were 1.20% and 10.72% in the second quarter of 2021, compared to 1.21% and 10.47% in the first half of 2021, respectively.

ROA and ROE were 1.01% and 8.52% in the second quarter of 2020, compared to 1.05% and 8.53% in the first half of 2020.

• The tax-equivalent net interest margin was 3.37% and 3.53% in the second quarters of 2021 and 2020, respectively.

The decrease from the same quarter a year ago was primarily attributed to the low interest rate environment.

SBA PPP loans contributed 12 basis points to the second quarter's net interest margin due to PPP loans forgiven and paid off by the SBA.

The tax-equivalent net interest margin was 3.28% in the first six months of 2021 compared to 3.70% in the first six months a year ago.

The decrease from the same period a year ago was primarily attributed to the lower interest rate environment.

SBA PPP loans added 5 basis points to the first six months' net interest margin as compared to a 2 basis points reduction to the same period a year ago.

The early redemption of our last subordinated debenture reduced first quarter 2021 tax-equivalent net interest margin by approximately 18 basis points.

• The efficiency ratio was 58.58% for the three months ended June 30, 2021, up from 53.01% in the comparative period a year ago, mainly due to a $1.7 million increase in non-interest expense mostly attributable to fewer salary-related deferred SBA PPP loan origination costs and ARB acquisition-related expenses.

The efficiency ratio for the first half of 2021 was 61.43%, compared to 54.74% the same period a year ago.

The increase was primarily due to a $1.9 million decrease in net interest income and $1.1 million decrease in non-interest income.

Additionally, non-interest expenses increased by $1.7 million.

• Total deposits increased $179.3 million to $2.684 billion at June 30, 2021 from $2.504 billion at December 31, 2020.

The increase was primarily due to customers depositing PPP funds into their accounts and new account openings in the second quarter of 2021.

Non-interest bearing deposits represented 54% of total deposits as of June 30, 2021 and December 31, 2020.

The cost of average deposits was 0.07% in the second quarter and first half of 2021, a decrease of 2 basis points and 8 basis points from the equivalent periods a year ago.

• Net income for the third quarter of 2021 totaled $5.3 million, compared to $7.5 million in the third quarter of 2020.

Diluted earnings per share were $0.35 in the third quarter of 2021, compared to $0.55 in the same quarter a year ago.

Net income for the first nine months of 2021 totaled $23.5 million, compared to $22.1 million in the same period a year ago.

Diluted earnings per share were $1.69, compared to $1.62 in the first nine months of 2020.

Merger-related one-time and conversion costs reduced net income by $3.9 million, net of taxes, or 26 cents per share in the quarter and by $4.1 million, net of taxes, or 30 cents per share year-to-date.

See reconciliation of GAAP to non-GAAP financial measures on page 36.

• Loan balances of $2.317 billion at September 30, 2021 increased by $228.5 million compared to $2.089 billion at December 31, 2020.

The increase was largely due to $419.4 million in loans from the acquisition of ARB on August 6, 2021 and new non-PPP related loan originations totaling $101.7 million.

These increases were partially offset by non-PPP loan payoffs totaling $145.3 million, and a $126.8 million decrease in Small Business Administration ("SBA") Paycheck Protection Program ("PPP") loans outstanding.

• Credit quality remains strong, with non-accrual loans representing 0.36% of total loans as of September 30, 2021, compared to 0.44% at December 31, 2020.

The ratio of the allowance for credit losses on loans to total loans was 0.97% at September 30, 2021, compared to 1.10% at December 31, 2020.

Excluding SBA PPP loans, the ratio of allowance to loans would have been 1.04% and 1.27% at September 30, 2021 and December 31, 2020, respectively (see Results of Operations for a definition of this non-GAAP financial measure).

• The allowance for credit losses increased by $3.3 million in the third quarter and was comprised of a $1.8 million provision, mainly related to purchased ARB loans without credit deterioration, and a $1.5 million merger-date allowance established for purchased credit deteriorated loans.

There was no provision for credit losses on unfunded loan commitments in the third quarter of 2021.

• Total deposits of $3.728 billion at September 30, 2021 increased by $1.224 billion from $2.504 billion at December 31, 2020, mainly due to the ARB acquisition.

Non-interest bearing deposits were 49% of total deposits as of September 30, 2021, versus 54% as of December 31, 2020.

The decrease in this ratio was primarily due to an increase in interest bearing deposits from existing customers and a lower ratio of non-interest-bearing deposits acquired from ARB.

The cost of average deposits for the quarter and nine months ended September 30, 2021 was 0.06% and 0.07%, respectively, compared to 0.09% and 0.13% for the comparable periods in 2020.

• ROA and ROE ratios were significantly impacted by provisions for credit losses on acquired loans and shares issued in conjunction with the Merger.

A good indicator of the Merger's positive impact on operating earnings is the efficiency ratio, as it neither includes provisions for losses on loans and unfunded commitments, nor is it impacted by changes in share counts.

As shown in the reconciliation of GAAP to non-GAAP financial measures on page 36 the efficiency ratio excluding merger-related one-time and conversion costs of 56.02% for the quarter ended September 30, 2021, improved from 56.88% for the quarter a year ago.

The comparable year-to-date non-GAAP efficiency ratio for the first nine months of 2021 was 59.09%, compared to 55.45% in 2020, and was not as good an indicator of the positive effects of the acquisition because it was impacted by a significant decline in interest rates.

• All capital ratios were above well-capitalized regulatory requirements.

The total risk-based capital ratio for Bancorp was 15.5% at June 30, 2021, compared to 16.0% at December 31, 2020.

Tangible common equity to tangible assets was 10.4% at June 30, 2021, compared to 11.3% at December 31, 2020 (see Results of Operations for a definition of this non-GAAP financial measure).

The total risk-based capital ratio for the Bank was 15.3% at June 30, 2021, compared to 15.8% at December 31, 2020.

• The Board of Directors declared a cash dividend of $0.24 per share on July 16, 2021, a $0.01 increase from the prior quarter.

This represents the 65th consecutive quarterly dividend paid by Bank of Marin Bancorp.

The dividend is payable on August 6, 2021, to shareholders of record at the close of business on July 30, 2021.

• Given our strong capital and liquidity, the Board of Directors approved a new share repurchase program on July 16, 2021 under which Bancorp may repurchase up to $25.0 million of its outstanding common stock through July 31, 2023.

The share repurchase program became effective July 22, 2021.

• As announced in May 2021, Tim Myers, Chief Operating Officer, was promoted from Executive Vice President to President.

Tim is now responsible for the management of Centralized Operations and Technology in addition to Commercial Banking, Retail Banking, Wealth Management & Trust, and Marketing.

The total risk-based capital ratio for Bancorp was 15.0% at September 30, 2021, compared to 16.0% at December 31, 2020.

Bancorp's tangible common equity to tangible assets was 9.1% at September 30, 2021, compared to 11.3% at December 31, 2020 (see Results of Operations for a definition of this non-GAAP financial measure).

The Bank's total risk-based capital ratio was 14.4% at September 30, 2021, compared to 15.8% at December 31, 2020.

• The Board of Directors declared a cash dividend of $0.24 per share on October 22, 2021, which represents the 66th consecutive quarterly dividend paid by Bank of Marin Bancorp.

The dividend is payable on November 12, 2021, to shareholders of record at the close of business on November 5, 2021.

• On October 22, 2021, the Board of Directors approved an amendment to the current share repurchase program which increased the total authorization from $25.0 million to $57.0 million.

The July 31, 2023 expiration date of the program remained unchanged.

• Effective October 31, 2021, Russell A.

Colombo retired as Chief Executive Officer of Bank of Marin and Bank of Marin Bancorp and the Board of Directors named Tim Myers, previously President and Chief Operating Officer, as his successor.

Colombo will remain on the Boards of Bancorp and the Bank, and Mr.

Myers will join both Boards.

Bank of Marin's strong balance sheet is built from our core values - relationship banking, disciplined fundamentals and commitment to the communities that we serve.

We believe that our robust liquidity and capital positions, high credit quality loan portfolio, excellent credit metrics, and low-cost deposit base, as well as our acquisition of AMRB will reinforce the long-term success of the bank and position us well for the remainder of 2021.

Statement Regarding use of Non-GAAP Financial Measures

In this Form 10-Q, Bancorp's financial results are presented in accordance with GAAP and refer to certain non-GAAP financial measures.

Management believes that presentation of operating results using non-GAAP financial measures provides useful supplemental information to investors and facilitates the analysis of Bancorp's core operating results and comparison of operating results across reporting periods.

Management also uses non-GAAP financial measures to establish budgets and manage Bancorp's business.

A reconciliation of the GAAP financial measures to comparable non-GAAP financial measures is presented below.

Reconciliation of GAAP and Non-GAAP Financial Measures

(in thousand, unaudited) Three months ended Nine months ended

Net income September 30, 2021 September 30, 2020 September 30, 2021 September 30, 2020

Net income (GAAP) $ 5,282 $ 7,491 $ 23,514 $ 22,125

Merger-related one-time and conversion costs:

Personnel and severance 2,668 — 2,668 —

Professional services 1,778 — 1,979 —

Data processing 433 — 433 —

Other 263 — 279 —

Income tax benefit of merger-related expenses (1,222) — (1,239) —

Total merger-related one-time and conversion costs, net of taxes 3,920 — 4,120 —

Comparable net income (non-GAAP) $ 9,202 $ 7,491 $ 27,634 $ 22,125

Diluted earnings per share

Weighted average diluted shares 14,993 13,610 13,881 13,617

Diluted earnings per share (GAAP) $ 0.35 $ 0.55 $ 1.69 $ 1.62

Comparable diluted earnings per share (non-GAAP) $ 0.61 $ 0.55 $ 1.99 $ 1.62

Return on average assets

Average assets $ 3,743,968 $ 3,029,342 $ 3,280,505 $ 2,876,618

Return on average assets (GAAP) 0.56 % 0.98 % 0.96 % 1.03 %

Comparable return on average assets (non-GAAP) 0.98 % 0.98 % 1.13 % 1.03 %

Return on average equity

Average stockholders' equity $ 420,124 $ 356,230 $ 374,445 $ 348,812

Return on average equity (GAAP) 4.99 % 8.37 % 8.40 % 8.47 %

Comparable return on average equity (non-GAAP) 8.69 % 8.37 % 9.87 % 8.47 %

Efficiency ratio

Non-interest expense (GAAP) $ 22,686 $ 14,990 $ 53,654 $ 44,238

Merger-related expenses (5,142) — (5,359) —

Non-interest expense (non-GAAP) $ 17,544 $ 14,990 $ 48,295 $ 44,238

Net interest income $ 27,753 $ 24,566 $ 74,318 $ 73,060

Non-interest income $ 3,565 $ 1,790 $ 7,413 $ 6,723

Efficiency ratio (GAAP) 72.44 % 56.88 % 65.65 % 55.45 %

Comparable efficiency ratio (non-GAAP) 56.02 % 56.88 % 59.09 % 55.45 %

RESULTS OF OPERATIONS

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

(dollars in thousands) June 30, 2021 December 31, 2020

(dollars in thousands) September 30, 2021 December 31, 2020

Selected financial condition data:

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Common equity Tier 1 capital (to risk weighted assets) 14.10 % 14.69 %

Three months ended Six months ended

(dollars in thousands, except per share data) June 30, 2021 June 30, 2020 June 30, 2021 June 30, 2020

Three months ended Nine months ended

(dollars in thousands, except per share data) September 30, 2021 September 30, 2020 September 30, 2021 September 30, 2020

Selected operating data:

Net interest income $ 27,753 $ 24,566 $ 74,318 $ 73,060

(Reversal of) provision for credit losses on loans (920) 2,000 (3,849) 4,200

Provision for (reversal of) credit losses on loans 1,800 1,250 (2,049) 5,450

Provision for (reversal of) credit losses on unfunded loan commitments

— 248 (1,202) 610

Non-interest income 3,565 1,790 7,413 6,723

14 unchanged sentences

1 The allowance for credit losses on loans to total loans, excluding SBA-guaranteed PPP loans, is considered a meaningful non-GAAP financial measure, as it represents only those loans that were considered in the calculation of the allowance for credit losses on loans.

SBA PPP loans at June 30, 2021 and December 31, 2020 totaled $248.3 million and $291.6 million, respectively.

SBA PPP loans at September 30, 2021 and December 31, 2020 totaled $164.8 million and $291.6 million, respectively.

2 Tangible common equity to tangible assets is considered to be a meaningful non-GAAP financial measure of capital adequacy and is useful for investors to assess Bancorp's ability to absorb potential losses.

Tangible common equity of $315 million and $324 million at June 30, 2021 and December 31, 2020, respectively, includes common stock, retained earnings and unrealized gains (losses) on available-for sale securities, net of tax, less goodwill and intangible assets.

Tangible assets exclude goodwill and intangible assets of $33.6 million and $34.0 million at June 30, 2021 and December 31, 2020, respectively.

Tangible common equity of $379 million and $324 million at September 30, 2021 and December 31, 2020, respectively, includes common stock, retained earnings and unrealized gains (losses) on available-for sale securities, net of tax, less goodwill and intangible assets.

Tangible assets exclude goodwill and intangible assets of $79.8 million and $34.0 million at September 30, 2021 and December 31, 2020, respectively.

3 Tax-equivalent net interest margin is computed by dividing taxable equivalent net interest income, which is adjusted for taxable equivalent income on tax-exempt loans and securities based on Federal statutory rate of 21 percent, by total average interest-earning assets.

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Three months ended Three months ended

June 30, 2021 June 30, 2020

September 30, 2021 September 30, 2020

Interest Interest

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Tax-equivalent net interest rate spread 3.07 % 3.33 %

Six months ended Six months ended

June 30, 2021 June 30, 2020

Nine months ended Nine months ended

September 30, 2021 September 30, 2020

Interest Interest

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Investment security interest is earned on 30/360 day basis monthly.

3 Yields and interest income on tax-exempt securities and loans are presented on a taxable-equivalent basis using the Federal statutory rate of 21%.

3 Yields and interest income on tax-exempt securities and loans are presented on a taxable-equivalent basis using the Federal statutory rate of 21 percent in 2021 and 2020.

4 Average balances on loans outstanding include non-performing loans.

1 unchanged sentence

5 2021 interest on subordinated debenture included $1.3 million in accelerated discount accretion from the early redemption of our last subordinated debenture on March 15, 2021.

6 Average balances and rate consider $13.9 million in FHLB borrowings acquired from American River Bank that were redeemed on August 25, 2021.

Analysis of Changes in Net Interest Income

2 unchanged sentences

Rate variances are equal to the increase or decrease in rates multiplied by prior period average balances.

Mix variances are attributable to the change in yields or rates multiplied by the change in average balances, including one more day in the six months ended June 30, 2020.

Three Months Ended June 30, 2021 Compared to Three Months Ended June 30, 2020 Six Months Ended June 30, 2021 Compared to Six Months Ended

June 30, 2020

Mix variances are attributable to the change in yields or rates multiplied by the change in average balances, including one more day in the nine months ended September 30,2020.

Three Months Ended September 30, 2021 Compared to Three Months Ended September 30, 2020 Nine Months Ended September 30, 2021 Compared to Nine Months Ended September 30, 2020

(in thousands) Volume Yield/Rate Mix Total Volume Yield/Rate Mix Total

14 unchanged sentences

1 Yields and interest income on tax-exempt securities and loans are presented on a taxable-equivalent basis using the federal statutory rate of 21%.

2 Six months ended June 30, 2021 includes $1.3 million in accelerated discount accretion from the early redemption of our last subordinated debenture on March 15, 2021.

Second Quarter of 2021 Compared to Second Quarter of 2020

Net interest income totaled $24.5 million in the second quarter of 2021, compared to $24.4 million in the same quarter a year ago.

The $159 thousand increase was primarily due to higher income from SBA PPP loans, higher average investment securities and commercial real estate loan balances, and lower rates on interest-bearing liabilities.

Increases were mostly offset by lower yields on investment securities, and lower average commercial, home equity, and other residential loan balances.

The tax-equivalent net interest margin was 3.37% in the second quarter of 2021 compared to 3.53% in the same quarter of the previous year.

The decrease in tax-equivalent net interest margin was primarily attributed to the lower interest rate environment.

SBA PPP loans added 12 basis points to the second quarter 2021's net interest margin as compared to 3 basis points reduction for the same quarter a year ago due to higher fee income accretion in the second quarter of 2021 as more PPP loans were forgiven and paid off by the SBA.

First Six Months of 2021 Compared to First Six Months of 2020

Net interest income totaled $46.6 million in the six months ended June 30, 2021, compared to $48.5 million in the same period a year ago.

The decrease was primarily attributed to $1.3 million in accelerated discount accretion from the early redemption of a subordinated debenture in the first quarter of 2021, lower yielding interest-earning assets, lower average balances of commercial and consumer loans, and one less day in the period.

Decreases were partially offset by higher income from SBA PPP loans and higher investment securities, commercial real estate, and construction loan balances, and lower rates on interest-bearing liabilities.

We recognized $4.3 million in SBA PPP fees, net of cost in the first six months of 2021, compared to $1.2 million in the first six months a year ago.

As of June 30, 2021 $6.5 million PPP fees, net of deferred costs remain outstanding and will be recognized into income in future periods.

The tax-equivalent net interest margin was 3.28% in the six months ended June 30, 2021, compared to 3.70% in the same period a year ago.

The decrease from the first six months of 2020 was primarily attributed to the lower interest rate environment.

SBA PPP loans added 5 basis points to the first six months' net interest margin as compared to a 2 basis points reduction to the same period a year ago.

2 Nine months ended September 30, 2021 includes $1.3 million in accelerated discount accretion from the early redemption of our last subordinated debenture on March 15, 2021.

Third Quarter of 2021 Compared to Third Quarter of 2020

Net interest income totaled $27.8 million in the third quarter of 2021, compared to $24.6 million in the same quarter a year ago.

The $3.2 million increase was primarily due to the addition of ARB interest earning balances, higher yield on acquired ARB loans, and higher income from SBA PPP loans.

Increases were partially offset by lower yields on acquired ARB investment securities balances.

The tax-equivalent net interest margin was 3.15% in the third quarter of 2021 compared to 3.44% in the same quarter of last year.

The decrease in tax-equivalent net interest margin was primarily attributed to both $271.5 million increase in low yielding due from banks interest-earning balances and the lower interest rate environment.

SBA PPP loans added 13 basis points to the third quarter 2021 net interest margin as compared to a 4 basis points reduction to the net interest margin in the third quarter of 2020 due to higher fee income accretion in the third quarter of 2021 as more PPP loans were forgiven and paid off by the SBA.

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

Net interest income totaled $74.3 million in the first nine months ended September 30, 2021, compared to $73.1 million in the same period a year ago.

The $1.3 million increase was primarily attributed to the addition of ARB interest-earning assets and higher income from SBA PPP loans.

Increases were partially offset by $1.3 million in accelerated discount accretion on the early redemption of a subordinated debenture in the first quarter of 2021 and lower yielding interest-earning assets.

We recognized $6.6 million in SBA PPP fees, net of cost in the first nine months of 2021, compared to $2.8 million in the first nine months a year ago.

As of September 30, 2021 $4.2 million PPP fees, net of deferred costs remain outstanding and will be recognized into income in future periods.

The tax-equivalent net interest margin was 3.23% in the first nine months ended June 30, 2021, compared to 3.61% in the same period a year ago.

The decrease was primarily attributed to $1.3 million in accelerated discount accretion from the early redemption of a subordinated debenture in the first quarter of 2021, the lower interest rate environment and higher cash balances, partially offset by higher income from PPP loans.

SBA PPP loans added 9 basis points to the first nine months' net interest margin as compared to a 3 basis points reduction to net interest margin in the comparable period in 2020.

Market Interest Rates

9 unchanged sentences

The following table shows the provision for credit losses activity for the periods presented.

Three months ended Six months ended

(dollars in thousands) June 30, 2021 June 30, 2020 June 30, 2021 June 30, 2020

(Reversal of) provision for credit losses on loans $ (920) $ 2,000 $ (3,849) $ 4,200

The provision reversals in 2021 were primarily due to continued improvements in the forecasted California unemployment rates over the next four quarters and a $42.5 million year-to-date decrease in non-PPP loan balances.

Our allowance model is particularly sensitive to current and forecasted California unemployment rates, which decreased to 8.0% at June 30, 2021 from 9.1% at December 31, 2020.

Three months ended Nine months ended

(dollars in thousands) September 30, 2021 September 30, 2020 September 30, 2021 September 30, 2020

Provision for (reversal of) credit losses on loans $ 1,800 $ 1,250 $ (2,049) $ 5,450

The $1.8 million provision for the three months ended September 30, 2021 was mainly related to purchased ARB loans without credit deterioration.

The net provision reversal for the first nine months in 2021 was primarily due to continued improvements in the forecasted California unemployment rates over the next four quarters, partially offset by the provision in the third quarter.

Our allowance model is particularly sensitive to current and forecasted California unemployment rates, which decreased to 6.4% at September 30, 2021 from 9.1% at December 31, 2020.

The provision for credit losses in 2020 calculated under the incurred loss method (prior to the adoption of the excepted credit loss method on December 31, 2020) was largely due to the uncertainty about the impact of the COVID-19 pandemic on the local and regional economies and our customers at that time.

Loans designated special mention, which are not considered adversely classified, decreased by $37.9 million to $49.0 million at June 30, 2021 from $86.9 million at December 31, 2020.

The decrease was largely due to the upgrading of several borrowing relationships totaling approximately $25.5 million because of their improved financial condition, loan reductions and payoffs totaling approximately $16.4 million, and the downgrade from special mention to substandard of one well-secured commercial real estate loan totaling $4.6 million.

These decreases were partially offset by two well-secured commercial real estate loans totaling $8.8 million that were downgraded from pass to special mention risk rating.

Classified assets (loans with risk ratings of substandard or doubtful) totaled $30.8 million at June 30, 2021, compared to $25.8 million at December 31, 2020.

The $5.0 million increase was primarily due to the downgrade of a $4.6 million commercial real estate loan mentioned above.

There were no loans considered doubtful at June 30, 2021 or December 31, 2020.

The ratio of allowance for credit losses on loans to total loans was 0.95% at June 30, 2021, compared to 1.10% at December 31, 2020.

Excluding SBA-guaranteed PPP loans, the ratio of the allowance for credit losses on loans to total loans was 1.09% and 1.27% at June 30, 2021 and December 31, 2020, respectively (Refer to footnote 1 on page 31 for a definition and reconciliation of this non-GAAP financial measure).

Non-accrual loans totaled $9.2 million, or 0.46% of total loans at June 30, 2021, and remained largely unchanged from $9.2 million, or 0.44% of total loans at December 31, 2020.

Loans designated special mention, which are not considered adversely classified, increased year-to-date by $16.6 million to $103.4 million at September 30, 2021 from $86.9 million at December 31, 2020.

The increase was largely due to the downgrading from pass to special mention several well-secured commercial real estate loans totaling $41.2 million and one borrowing relationship with three commercial loans totaling $5.4 million, also well collateralized.

In addition, we upgraded several borrowing relationships from substandard to special mention totaling $13.2 million because of their improved financial condition and assumed $13.7 million in special mention loans in the Merger.

These increases were partially offset by $32.7 million in upgrades to pass due to improved financial condition, $18.8 million in paydowns and payoffs and $5.4 million in downgrades to substandard comprised primarily of one well secured commercial real estate loan.

Classified assets (loans with risk ratings of substandard or doubtful) totaled $19.0 million at September 30, 2021, compared to $25.8 million at December 31, 2020.

The $6.8 million decrease was primarily due to the upgrading of $13.2 million in loans mentioned above and paydowns and payoffs totaling $1.9 million.

These decreases were primarily offset by the $5.4 million in downgrades mentioned above and $2.3 million in substandard loans assumed in the Merger.

Classified loans also included one $118 thousand loan acquired from ARB with a doubtful risk rating as of September 30, 2021, which is well-secured by real estate collateral.

There were no loans considered doubtful at December 31, 2020.

The ratio of allowance for credit losses on loans to total loans was 0.97% at September 30, 2021, compared to 1.10% at December 31, 2020.

Non-accrual loans totaled $8.4 million, or 0.36% of total loans at September 30, 2021, and remained largely unchanged from $9.2 million, or 0.44% of total loans at December 31, 2020.

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

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

Three months ended Amount Percent

(dollars in thousands) June 30, 2021 June 30, 2020 Increase (Decrease) Increase (Decrease)

Three months ended Amount Increase (Decrease Percent Increase (Decrease)

(dollars in thousands) September 30, 2021 September 30, 2020

Earnings on bank-owned life insurance, net 1,402 232 1,170 504.3 %

Wealth Management and Trust Services $ 597 $ 450 $ 147 32.7 %

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Service charges on deposit accounts 464 284 180 63.4 %

Earnings on bank-owned life insurance, net 233 234 (1) (0.4) %

Dividends on FHLB stock 177 146 31 21.2 %

Dividends on Federal Home Loan Bank stock 179 149 30 20.1 %

Merchant interchange fees 129 63 66 104.8 %

Gains on sale of investment securities, net — 115 (115) (100.0) %

Gains on sale of investment securities, net 1 — 1 NM

Other income 310 229 81 35.4 %

Total non-interest income $ 3,565 $ 1,790 $ 1,775 99.2 %

Six months ended Amount Percent

(dollars in thousands) June 30, 2021 June 30, 2020 Increase (Decrease) Increase (Decrease)

NM - not meaningful

Nine months ended Amount Increase (Decrease Percent Increase (Decrease)

(dollars in thousands) September 30, 2021 September 30, 2020

Earnings on bank-owned life insurance, net 1,892 741 1,151 155.3 %

Wealth Management and Trust Services $ 1,615 $ 1,375 $ 240 17.5 %

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Service charges on deposit accounts 1,062 1,028 34 3.3 %

Earnings on bank-owned life insurance, net 490 509 (19) (3.7) %

Dividends on FHLB stock 326 354 (28) (7.9) %

Dividends on Federal Home Loan Bank stock 505 503 2 0.4 %

Merchant interchange fees 247 183 64 35.0 %

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Total non-interest income $ 7,413 $ 6,723 $ 690 10.3 %

Second Quarter of 2021 Compared to Second Quarter of 2020

Non-interest income increased by $209 thousand in the second quarter of 2021 to $2.0 million, compared to $1.8 million in the same quarter a year ago.

The increase was mostly attributed to debit card interchange fees from increased levels of activity and volume, and higher wealth management and trust services income generated from new accounts and favorable market performance.

Increases relative to the prior year quarter were partially offset by the absence of gains on investment security sales in the second quarter of 2021.

First Six Months of 2021 Compared to First Six Months of 2020

Non-interest income decreased by $1.1 million in the first six months of 2021 to $3.8 million, from $4.9 million in the first half of 2020.

The decrease was primarily attributed to the absence of gains on investment security sales in the first six months of 2021, versus $915 thousand realized in the same period a year ago, lower service charges on deposit accounts, and lower fee income from one-way deposit sales to third-party deposit networks in the first quarter of 2021.

On March 30, 2020, we implemented temporary waivers for all ATM fees, overdraft fees and early withdrawal penalties for time deposits to help ease the financial burden customers began experiencing due to the pandemic.

After honoring the fee waivers for one year, we provided our customers a 30-day notice and reinstituted the fees as of May 3, 2021.

Third Quarter of 2021 Compared to Third Quarter of 2020

Non-interest income increased by $1.8 million in the third quarter of 2021 to $3.6 million, compared to $1.8 million in the same quarter a year ago.

The increase was mostly attributed to the collection of $1.1 million in death benefits on bank-owned life insurance ("BOLI") policies and increases in fee income from deposit accounts and debit card interchange activity.

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

Non-interest income increased by $0.7 million in the first nine months of 2021 to $7.4 million, from $6.7 million in the first nine months of 2020.

The increase was primarily due to BOLI payments noted above, increases in Wealth Management and Trust Services income generated from new accounts and favorable market performance, and fees from deposit accounts and debit card interchange activity.

In March 2020, we implemented temporary waivers for all ATM fees, overdraft fees and early withdrawal penalties for time deposits to help ease the financial burden customers began experiencing due to the pandemic.

We reinstituted the fees in May 2021.

The increase was partially offset by the absence of gains on investment securities, as $915 thousand in gains were recognized in the comparative period a year ago.

Non-interest Expense

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

Three months ended Amount Percent

(dollars in thousands) June 30, 2021 June 30, 2020 Increase (Decrease) Increase (Decrease)

Three months ended Amount Increase (Decrease) Percent Increase (Decrease)

(dollars in thousands) September 30, 2021 September 30, 2020

Salaries and related benefits $ 13,127 $ 8,638 $ 4,489 52.0 %

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Data processing 1,613 822 791 96.2 %

Charitable contributions 462 273 189 69.2 %

Depreciation and amortization 431 539 (108) (20.0) %

Information technology 496 256 240 93.8 %

Directors' expense 230 175 55 31.4 %

Amortization of core deposit intangible 334 213 121 56.8 %

Directors' expense 255 184 71 38.6 %

Federal Deposit Insurance Corporation insurance 236 181 55 30.4 %

Charitable contributions 4 481 (477) (99.2) %

Other non-interest expense

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Total non-interest expense $ 22,686 $ 14,990 $ 7,696 51.3 %

Six months ended Amount Percent

(dollars in thousands) June 30, 2021 June 30, 2020 Increase (Decrease) Increase (Decrease)

Nine months ended Amount Increase (Decrease) Percent Increase (Decrease)

(dollars in thousands) September 30, 2021 September 30, 2020

Salaries and related benefits $ 31,223 $ 25,979 $ 5,244 20.2 %

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Information technology 1,105 758 347 45.8 %

Charitable contributions 493 440 53 12.0 %

Amortization of core deposit intangible 742 639 103 16.1 %

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Federal Deposit Insurance Corporation insurance 597 299 298 99.7 %

Charitable contributions 497 921 (424) (46.0) %

Other non-interest expense

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Total non-interest expense $ 53,654 $ 44,238 $ 9,416 21.3 %

Second Quarter of 2021 Compared to Second Quarter of 2020

Non-interest expense increased by $1.7 million to $15.6 million in the second quarter of 2021, compared to $13.9 million in the same period a year ago.

The increase was primarily attributed to $1.0 million in higher salaries and related benefits (mostly attributable to fewer deferred SBA PPP loan origination costs), $351 thousand increase in ARB acquisition-related expenses (mostly related to professional services), and $189 thousand increase in charitable contributions.

We expect higher ARB acquisition related expenses in the next two quarters.

The majority of our expected 2021 charitable contributions were disbursed in the second quarter.

First Six Months of 2021 Compared to First Six Months of 2020

Non-interest expense increased by $1.7 million to $31.0 million in the first half of 2021, compared to $29.2 million in the first half of 2020.

The increase was driven by higher salaries and related benefits of $755 thousand, most of which was attributed to fewer deferred SBA PPP loan origination costs.

Professional services increased by $755 thousand due to some pandemic-related delays in 2020 activities and ARB acquisition-related activities.

FDIC deposit insurance expenses increased by $243 thousand relative to the first six months of 2020 due to the absence of assessment credits, which were fully utilized as of June 30, 2020.

The (reversal of) or provision for credit losses on unfunded commitments was reclassified out of non-interest expense and included as a separate line item under net interest income in the consolidated statements of comprehensive income for all periods presented.

Efficiency ratios for all periods reported have been updated to reflect the reclassification.

Reclassification conforms to Call Report instructions.

Third Quarter of 2021 Compared to Third Quarter of 2020

Non-interest expense increased by $7.7 million to $22.7 million in the third quarter of 2021, compared to $15.0 million in the same period a year ago.

The increase was primarily due to a $5.1 million increase in merger-related one-time and conversion costs (mostly related to professional services, data processing contract termination, and personnel costs), salaries and benefits for retained ARB employees and other ARB-related operating expenses incurred since the merger date.

The increase was partially offset by a $477 thousand decrease in charitable contributions as the bank has transitioned to a more defined contributions disbursement schedule with funding occurring in the second and fourth quarters, and large pandemic-related contributions in 2020.

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

Non-interest expense increased by $9.4 million to $53.7 million in the first nine months of 2021, compared to $44.2 million in the first nine months of 2020.

Higher salaries and related benefits of $5.2 million included $2.7 million in personnel costs related to the Merger.

The increase in salaries and benefits was also attributed to fewer deferred

SBA PPP loan origination costs.

Professional services increased by $2.6 million and data processing expenses increased by $815 thousand, mainly due to merger-related expenses.

In addition, FDIC deposit insurance expenses were $298 thousand higher.

Charitable contributions were lower than 2020 for the reasons mentioned above.

Provision for Income Taxes

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Provisions also reflect permanent differences between income for tax and financial reporting purposes (such as earnings on tax exempt loans and municipal securities, BOLI, low-income housing tax credits, and stock-based compensation from the exercise of stock options, disqualifying dispositions of incentive stock options and vesting of restricted stock awards).

The provision for income taxes for the second quarter of 2021 totaled $3.2 million at an effective tax rate of 25.9%, compared to $2.6 million at an effective tax rate of 26.3% in the same quarter last year.

The provision for income taxes for the first half of 2021 totaled $6.3 million at an effective tax rate of 25.6%, compared to $5.0 million at an effective tax rate of 25.4% for the first half of 2020.

The increase in the provision reflected higher pre-tax income for both the second quarter and first half of 2021 compared to the same periods a year ago.

The 40 basis point decrease in the effective tax rate in the second quarter of 2021 as compared to the same quarter a year ago was primarily due to the true-up of low-income tax credits.

The provision for income taxes for the third quarter of 2021 totaled $1.6 million at an effective tax rate of 22.7%, compared to $2.4 million at an effective tax rate of 24.1% in the same quarter last year.

The provision for income taxes for the first nine months of 2021 totaled $7.8 million at an effective tax rate of 24.9%, compared to $7.4 million at an effective tax rate of 25.0% for the first nine months of 2020.

The decrease in the provision reflected lower pre-tax income for the third quarter of 2021 compared to the same quarter a year ago.

The 140 basis point decrease in the effective tax rate in the third quarter of 2021 as compared to the same quarter a year ago was primarily due to higher BOLI and tax exempt loan and investment securities interest income from the ARB acquisition, partially offset by the non-deductible merger expenses incurred in the third quarter of 2021.

We file a consolidated return in the U.S.

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There were no ongoing federal or state income tax examinations at the issuance of this report.

At June 30, 2021, neither the Bank nor Bancorp had accruals for interest nor penalties related to unrecognized tax benefits.

At September 30, 2021, neither the Bank nor Bancorp had accruals for interest nor penalties related to unrecognized tax benefits.

FINANCIAL CONDITION SUMMARY

At June 30, 2021, assets totaled $3.074 billion, an increase of $161.9 million, from $2.912 billion at December 31, 2020, mainly due to increases in investment securities as we redeploy our excess liquidity from deposit inflows as discussed below.

At September 30, 2021, assets totaled $4.261 billion, an increase of $1.349 billion, from $2.912 billion at December 31, 2020, mainly due to the acquisition of ARB in August 2021, which added approximately $898.4 million in assets, as well as increases in deposit inflows as discussed below.

For additional information on the merger, refer to Note 10, Merger, in this Form 10-Q.

Cash, Cash Equivalents and Restricted Cash

Total cash, cash equivalents and restricted cash were $257.5 million at June 30, 2021, compared to $200.3 million at December 31, 2020.

The increase was mainly due to SBA PPP loan forgiveness and an increase in deposits.

Cash and cash equivalents do not include $174.0 million and $173.4 million in temporary one-way sale transfers of deposits to third-party deposit networks as part of our liquidity management at June 30, 2021 and December 31, 2020, respectively.

Total cash, cash equivalents and restricted cash were $584.7 million at September 30, 2021, compared to $200.3 million at December 31, 2020.

The increase was mainly due to the acquisition of ARB, SBA PPP loan forgiveness and an increase in deposits.

Cash and cash equivalents do not include $179.9 million and $173.4 million in temporary one-way sale transfers of deposits to third-party deposit networks as part of our liquidity management at September 30, 2021 and December 31, 2020, respectively.

Investment Securities

The investment securities portfolio totaled $687.0 million at June 30, 2021, an increase of $185.6 million from December 31, 2020.

The increase was primarily due to purchases of $244.7 million to deploy excess cash into interest earning assets in a more favorable interest rate environment in 2021, partially offset by paydowns, calls and maturities of $51.3 million.

Additionally, the fair value of available-for-sale securities decreased $6.3 million as a result of the higher interest rate environment in the first six months of 2021.

There were no security sales in the first six months of 2021.

The investment securities portfolio totaled $1.160 billion at September 30, 2021, an increase of $658.4 million from December 31, 2020.

The increase was primarily due to purchases of $508.6 million to deploy excess cash into interest earning assets in a more favorable interest rate environment in 2021, and securities of $297.8 million acquired from ARB, partially offset by paydowns, calls and maturities of $132.5 million.

Additionally, the fair value of available-for-sale securities decreased $8.6 million as a result of the higher interest rate environment in the first nine months of 2021.

Security sales in the first nine months of 2021 totaled $4.1 million.

See Note 4, Investment Securities, for additional information.

The following table summarizes our investment in obligations of state and political subdivisions at June 30, 2021 and December 31, 2020.

June 30, 2021 December 31, 2020

The following table summarizes our investment in obligations of state and political subdivisions at September 30, 2021 and December 31, 2020.

September 30, 2021 December 31, 2020

(dollars in thousands) Amortized Cost Fair Value % of Total State and Political Subdivisions Amortized Cost Fair Value % of Total State and Political Subdivisions

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Total obligations of state and political subdivisions $ 154,397 $ 159,736 100.0 % $ 106,554 $ 112,340 100.0 %

The portion of the portfolio outside the state of California is distributed among eleven states.

The portion of the portfolio outside the state of California is distributed among fourteen states.

Of the total investment in obligations of state and political subdivisions, the largest concentrations outside of California are in Texas (39.7%), Washington (18.8%) and Maryland (4.4%).

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We have $6.0 million in obligations of Texas school district issuers having high concentrations in oil and gas industry taxpayers and all of them have credit guarantees from PSF.

We have little or no exposure to municipal sectors such as higher education or health care that are most vulnerable to credit risks posed by the COVID-19 pandemic.

We have little or no exposure to municipal sectors such as health care that are most vulnerable to credit risks posed by the COVID-19 pandemic.

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

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• Credit ratings by major credit rating agencies

During the first six months of 2021, loans decreased by $85.8 million and totaled $2.003 billion at June 30, 2021, primarily due to SBA PPP loans which totaled $248.3 million at June 30 2021, compared to $291.6 million at December 31, 2020.

New non-PPP related loan originations totaled $69.1 million in the first six months of 2021.

Payoffs totaled $95.4 million and credit line utilization decreased $34.8 million during the first six months of 2021.

Loan payoffs in the first half of 2021 consisted largely of loans on which underlying assets were sold or paid off with cash (including completed construction projects).

Residential real estate and consumer loan payoffs as well as loans refinanced with other banks contributed to the decline.

As of June 30, 2021, there were 1,532 PPP loans outstanding totaling $248.3 million (net of $6.5 million in unrecognized fees and costs).

Of the total 2,876 PPP loans granted amounting to $444.1 million, we funded 1,813 loans totaling $307.9 million in the first round and 1,063 loans totaling $136.2 million in the second round.

As of June 30, 2021, PPP loans forgiven and paid off were 1,344 totaling $189.3 million.

Forgiveness of PPP loans continues with an additional 126 loans totaling $24.1 million approved between June 30, 2021 and July 31, 2021.

Of the number of PPP loans remaining as of July 31, 2021, 71% (1,002 loans) totaling $43.0 million were less than or equal to $150 thousand and had access to streamlined forgiveness processing.

As of July 31, 2021, 6 borrowing relationships with 9 loans totaling $43.4 million were benefiting from payment relief.

We monitor the financial situation of these clients closely and expect the majority to resume payments as the economy continues to reopen.

During the first six months of 2021, total liabilities increased by $171.5 million to $2.725 billion.

Deposits increased $179.3 million in the first six months of 2021, primarily driven by a combination of PPP loan proceeds and normal fluctuations in some of our larger commercial accounts.

Non-interest bearing deposits increased $105.4 million in the first six months of 2021 to $1.460 billion, and represented 54.4% of total deposits at June 30, 2021, compared to 54.1% at December 31, 2020.

The cost of average deposits was 0.07% in the second quarter and first half of 2021, a decrease of 2 basis points and 8 basis points from the equivalent periods a year ago.

During the first nine months of 2021, loans increased by $228.5 million and totaled $2.317 billion at September 30, 2021, primarily due to $419.4 million in loans from the acquisition of ARB on August 6,2021.

New non-PPP related loan originations totaled $101.7 million in the first nine months of 2021.

Non-PPP loan payoffs totaled $145.3 million during the first nine months of 2021.

Loan payoffs in the third quarter of 2021 consisted largely of commercial borrower cash paydowns as part of ongoing deleveraging, real estate asset sales and third-party refinancing.

A significant portion of the commercial third-party refinancing was attributable to price or structural elements outside the bank's desired credit profile.

As of September 30, 2021, there were 871 PPP loans outstanding totaling $164.8 million (net of $4.2 million in unrecognized fees and costs), including 31 loans totaling $9.6 million acquired from ARB.

Of the 2,876 PPP loans totaling $444.1 million funded by Bank of Marin, 2,036 loans for $284.7 million have been forgiven and paid off.

Of the remaining PPP loans, 580 loans or $25.5 million are less than or equal to $150 thousand and have access to streamlined forgiveness.

As of September 30, 2021, 2 borrowing relationships with 5 loans totaling $23.6 million were continuing to benefit from payment relief.

We monitor the financial situation of these clients closely and expect the majority to resume payments as the economy continues to recover.

During the first nine months of 2021, total liabilities increased by $1.248 billion to $3.803 billion.

Deposits increased $1.223 billion in the first nine months of 2021, primarily driven by the acquisition of ARB and normal fluctuations in some of our larger commercial accounts.

Non-interest bearing deposits increased $482.9 million in the first nine months of 2021 to $1.838 billion, and represented 49.3% of total deposits at September 30, 2021, compared to 54.1% at December 31, 2020.

The decrease in this ratio was primarily due to an increase in interest-bearing deposits for a large existing customer and a lower ratio of non-interest bearing deposits from the ARB acquisition.

The cost of average deposits was 0.06% in the third quarter and 0.07% in the first nine months of 2021, respectively, a decrease of 2 basis points and 6 basis points from the equivalent periods a year ago.

Capital Adequacy

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For all periods presented, the Bank’s ratios exceed the regulatory definition of “well capitalized” under the regulatory framework for prompt corrective action and Bancorp’s ratios exceed the required minimum ratios to be considered a well-capitalized bank holding company.

In addition, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action as of June 30, 2021.

In addition, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action as of September 30, 2021.

There are no conditions or events since that notification that management believes have changed the Bank’s categories and we expect the Bank to remain well capitalized for prompt corrective action purposes.

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However, we disclosed comparative capital ratios for Bancorp, which would have exceeded well-capitalized levels had Bancorp been subject to the same minimum capital requirements in 2020.

The Bancorp’s and Bank’s capital adequacy ratios as of June 30, 2021 and December 31, 2020 are presented in the following tables.

As of December 31, 2020, Bancorp's Tier 1 capital included a subordinated debenture, which was not included at the Bank level.

The Bancorp’s and Bank’s capital adequacy ratios as of September 30, 2021 and December 31, 2020 are presented in the following tables.

The decrease in capital ratios as of September 30, 2021 from December 31, 2020 was largely attributable to shares repurchased totaling $35.2 million during the first nine months of 2021.

Tier 1 Capital to average assets was also reduced by an increase in cash driven by deposit growth over and above that attributable to the Merger.

In addition, as of December 31, 2020, Bancorp's Tier 1 capital included a subordinated debenture, which was not included at the Bank level.

On March 15, 2021, Bancorp redeemed in full our last subordinated debenture due to NorCal Community Bancorp Trust II.

The redemption reduced Bancorp's total risk-based capital ratio by approximately 18 basis points.

Partially offsetting those factors, the Merger served to increase capital ratios as the proportion of risk-weighted assets to total assets was lower for ARB, and the full effect of the Merger will not reflect in average assets until the fourth quarter.

Capital Ratios for Bancorp

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Actual Ratio Adequately Capitalized Threshold Ratio to be a Well Capitalized Bank Holding Company

June 30, 2021 Amount Ratio Amount Ratio Amount Ratio

September 30, 2021 Amount Ratio Amount Ratio Amount Ratio

Total Capital (to risk-weighted assets) $ 395,223 14.97 % ≥ $ 277,278 ≥ 10.50 % ≥ $ 264,074 ≥ 10.00 %

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Actual Ratio Adequately Capitalized Threshold Ratio to be Well Capitalized under Prompt Corrective Action Provisions

June 30, 2021 Amount Ratio Amount Ratio Amount Ratio

September 30, 2021 Amount Ratio Amount Ratio Amount Ratio

Total Capital (to risk-weighted assets) $ 378,753 14.35 % ≥ $ 277,156 ≥ 10.50 % ≥ $ 263,958 ≥ 10.00 %

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The most significant source of liquidity during 2021 was an increase in deposits of $433.4 million.

The increase was primarily due to increases in PPP borrower-related accounts and normal fluctuations in some of our large business accounts.

Proceeds from loans collected net of loan origination was $84.3 million.

The increase was primarily due to SBA PPP loan forgiveness and other increases in customer deposits.

Proceeds from loans collected net of loan originations was $193.3 million.

Proceeds from principal paydowns and maturities of securities totaled $136.6 million, and $32.3 million in net cash was provided by operating activities.

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Management anticipates that our current strong liquidity position and core deposit base are adequate to fund our operations.

Undrawn credit commitments, as discussed in Note 8 to the Consolidated Financial Statements in this Form 10-Q, totaled $571.7 million at June 30, 2021.

Undrawn credit commitments, as discussed in Note 8 to the Consolidated Financial Statements in this Form 10-Q, totaled $602.6 million at September 30, 2021.

We expect to fund these commitments to the extent utilized primarily through the repayment of existing loans, deposit growth and liquid assets.

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The primary uses of funds for Bancorp are shareholder dividends and ordinary operating expenses.

Bancorp held $4.6 million of cash at June 30, 2021.

Combined with $34.0 million of dividend from the Bank to the Bancorp in July 2021, there is sufficient cash to cover Bancorp's operational needs, share repurchases, and cash dividends to shareholders through 2022.

Bancorp held $16.2 million of cash at September 30, 2021, which is sufficient to cover Bancorp's operational needs and cash dividends to shareholders through 2022.

Management anticipates that there will be sufficient earnings at the Bank to provide dividends to Bancorp to meet its funding requirements for the foreseeable future.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis