Bank of Marin Bancorp 10-Q

ITEM 1. Financial Statements BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CONDITION (in thousands, except share data; unaudited) September 30, 2022 December 31, 2021 Assets Cash, cash equivalents and restricted cash $ 185,552 $ 347,641 Investment securities Held-to-maturity, at amortized cost (net of zero allowance for credit losses at September 30, 2022 and December 31, 2021) 959,867 342,222 Available-for-sale, at fair value (net of zero allowance for credit losses at September 30, 2022 and December 31, 2021) 812,493 1,167,568 Total investment securities 1,772,360 1,509,790 Loans, at amortized cost 2,158,336 2,255,645 Allowance for credit losses on loans ( 22,963 ) ( 23,023 ) Loans, net of allowance for credit losses on loans 2,135,373 2,232,622 Goodwill 72,754 72,754 Bank-owned life insurance 62,056 61,473 Operating lease right-of-use assets 25,006 23,604 Bank premises and equipment, net 7,102 7,558 Core deposit intangible, net 5,481 6,605 Other real estate owned 455 800 Interest receivable and other assets 82,514 51,362 Total assets $ 4,348,653 $ 4,314,209 Liabilities and Stockholders' Equity Liabilities Deposits Non-interest bearing $ 2,051,975 $ 1,910,240 Interest bearing Transaction accounts 293,722 290,813 Savings accounts 342,630 340,959 Money market accounts 1,074,568 1,116,303 Time accounts 139,815 150,235 Total deposits 3,902,710 3,808,550 Borrowings and other obligations 365 419 Operating lease liabilities 26,744 25,429 Interest payable and other liabilities 22,242 29,443 Total liabilities 3,952,061 3,863,841 Commitments and contingent liabilities (Note 8) Stockholders' Equity Preferred stock, no par value, Authorized - 5,000,000 shares, none issued — — Common stock, no par value, Authorized - 30,000,000 shares; issued and outstanding - 16,029,048 and 15,929,243 at September 30, 2022 and December 31, 2021, respectively 214,720 212,524 Retained earnings 261,907 239,868 Accumulated other comprehensive loss, net of taxes ( 80,035 ) ( 2,024 ) Total stockholders' equity 396,592 450,368 Total liabilities and stockholders' equity $ 4,348,653 $ 4,314,209 The accompanying notes are an integral part of these consolidated financial statements (unaudited). Page-3 BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME Three months ended Nine months ended (in thousands, except per share amounts; unaudited) September 30, 2022 June 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 Interest income Interest and fees on loans $ 23,357 $ 23,334 $ 24,027 $ 70,368 $ 66,117 Interest on investment securities 9,674 8,273 4,084 24,640 10,717 Interest on federal funds sold and due from banks 546 180 178 832 274 Total interest income 33,577 31,787 28,289 95,840 77,108 Interest expense Interest on interest-bearing transaction accounts 121 53 41 230 119 Interest on savings accounts 32 32 26 93 66 Interest on money market accounts 268 438 417 1,184 1,015 Interest on time accounts 128 67 44 209 221 Interest on borrowings and other obligations 1 — 8 2 8 Interest on subordinated debenture — — — — 1,361 Total interest expense 550 590 536 1,718 2,790 Net interest income 33,027 31,197 27,753 94,122 74,318 Provision for (reversal of) credit losses on loans 422 — 1,800 ( 63 ) ( 2,049 ) Reversal of credit losses on unfunded loan commitments — — — ( 318 ) ( 1,202 ) Net interest income after provision for (reversal of) credit losses 32,605 31,197 25,953 94,503 77,569 Non-interest income Wealth Management and Trust Services 507 630 597 1,737 1,615 Debit card interchange fees, net 502 531 483 1,538 1,268 Service charges on deposit accounts 535 465 464 1,488 1,062 Earnings on bank-owned life insurance, net 222 298 1,402 933 1,892 Dividends on Federal Home Loan Bank stock 251 249 179 759 505 Merchant interchange fees, net 141 149 129 430 247 (Losses) gains on sale of investment securities, net ( 63 ) — 1 ( 63 ) 1 Other income 628 406 310 1,496 823 Total non-interest income 2,723 2,728 3,565 8,318 7,413 Non-interest expense Salaries and related benefits 10,557 10,341 13,127 32,446 31,223 Occupancy and equipment 1,941 1,891 1,871 5,739 5,373 Data processing 1,093 1,199 1,613 3,569 3,252 Professional services 736 665 2,472 2,314 4,321 Information technology 573 468 496 1,519 1,105 Depreciation and amortization 414 393 431 1,259 1,279 Amortization of core deposit intangible 370 374 334 1,124 742 Federal Deposit Insurance Corporation insurance 300 296 236 886 597 Directors' expense 233 294 255 838 660 Charitable contributions 49 511 4 605 497 Other real estate owned 350 3 — 355 — Other expense 2,062 2,471 1,847 6,305 4,605 Total non-interest expense 18,678 18,906 22,686 56,959 53,654 Income before provision for income taxes 16,650 15,019 6,832 45,862 31,328 Provision for income taxes 4,476 3,953 1,550 12,157 7,814 Net income $ 12,174 $ 11,066 $ 5,282 $ 33,705 $ 23,514 Net income per common share: Basic $ 0.76 $ 0.70 $ 0.35 $ 2.12 $ 1.70 Diluted $ 0.76 $ 0.69 $ 0.35 $ 2.11 $ 1.69 Weighted average shares: Basic 15,939 15,921 14,922 15,912 13,798 Diluted 15,974 15,955 14,993 15,959 13,881 Comprehensive (loss) income: Net income $ 12,174 $ 11,066 $ 5,282 $ 33,705 $ 23,514 Other comprehensive (loss) income: Change in net unrealized (losses) gains on available-for-sale securities ( 31,816 ) ( 27,050 ) ( 2,274 ) ( 97,094 ) ( 8,558 ) Reclassification adjustment for losses (gains) on available-for-sale securities included in net income 63 — ( 1 ) 63 ( 1 ) Net unrealized losses on securities transferred from available-for-sale to held-to-maturity — — — ( 14,847 ) — Amortization of net unrealized losses on securities transferred from available-for-sale to held-to-maturity 510 472 104 1,126 385 Other comprehensive loss, before tax ( 31,243 ) ( 26,578 ) ( 2,171 ) ( 110,752 ) ( 8,174 ) Deferred tax benefit ( 9,236 ) ( 7,857 ) ( 641 ) ( 32,741 ) ( 2,421 ) Other comprehensive loss, net of tax ( 22,007 ) ( 18,721 ) ( 1,530 ) ( 78,011 ) ( 5,753 ) Total comprehensive (loss) income $ ( 9,833 ) $ ( 7,655 ) $ 3,752 $ ( 44,306 ) $ 17,761 The accompanying notes are an integral part of these consolidated financial statements (unaudited). Page-4 BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the three months ended September 30, 2022 and 2021 (in thousands, except share data; unaudited) Common Stock Retained Earnings Accumulated Other Comprehensive (Loss) Income, Net of Taxes Total Shares Amount Three months ended September 30, 2022 Balance at July 1, 2022 16,009,600 $ 213,864 $ 253,737 $ ( 58,028 ) $ 409,573 Net income — — 12,174 — 12,174 Other comprehensive loss, net of tax — — — ( 22,007 ) ( 22,007 ) Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings 363 — — — — Stock issued under employee stock purchase plan 574 16 — — 16 Stock issued under employee stock ownership plan 13,000 404 — — 404 Stock-based compensation - stock options — 106 — — 106 Stock-based compensation - restricted stock — 151 — — 151 Cash dividends paid on common stock ($ 0.25 per share) — — ( 4,004 ) — ( 4,004 ) Stock purchased by directors under director stock plan 515 16 — — 16 Stock issued in payment of director fees 4,996 163 — — 163 Balance at September 30, 2022 16,029,048 $ 214,720 $ 261,907 $ ( 80,035 ) $ 396,592 Three months ended September 30, 2021 Balance at July 1, 2021 13,055,105 $ 108,430 $ 231,841 $ 8,378 $ 348,649 Net income — — 5,282 — 5,282 Other comprehensive income, net of tax — — — ( 1,530 ) ( 1,530 ) Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings 3,098 72 — — 72 Stock issued under employee stock purchase plan 508 18 — — 18 Stock issued under employee stock ownership plan 9,100 332 — — 332 Stock-based compensation - stock options — 115 — — 115 Stock-based compensation - restricted stock — 98 — — 98 Cash dividends paid on common stock ($ 0.24 per share) — — ( 3,126 ) — ( 3,126 ) Stock purchased by directors under director stock plan 515 17 — — 17 Stock issued in payment of director fees 3,063 99 — — 99 Stock issued to American River Bankshares shareholders 3,441,235 124,401 — — 124,401 Stock repurchased, including commissions ( 445,735 ) ( 15,902 ) — — ( 15,902 ) Balance at September 30, 2021 16,066,889 $ 217,680 $ 233,997 $ 6,848 $ 458,525 The accompanying notes are an integral part of these consolidated financial statements (unaudited). BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the nine months ended September 30, 2022 and 2021 (in thousands, except share data; unaudited) Common Stock Retained Earnings Accumulated Other Comprehensive (Loss) Income, Net of Taxes Total Shares Amount Nine months ended September 30, 2022 Balance at January 1, 2022 15,929,243 $ 212,524 $ 239,868 $ ( 2,024 ) $ 450,368 Net income — — 33,705 — 33,705 Other comprehensive loss, net of tax — — — ( 78,011 ) ( 78,011 ) Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings 40,674 821 — — 821 Stock issued under employee stock purchase plan 1,510 46 — — 46 Stock issued under employee stock ownership plan 38,000 1,233 — — 1,233 Restricted stock granted 46,672 — — — — Restricted stock surrendered for tax withholdings upon vesting ( 1,169 ) ( 40 ) — — ( 40 ) Restricted stock forfeited / cancelled ( 13,267 ) — — — — Stock-based compensation - stock options — 221 — — 221 Stock-based compensation - restricted stock — 421 — — 421 Cash dividends paid on common stock ($ 0.73 per share) — — ( 11,666 ) — ( 11,666 ) Stock purchased by directors under director stock plan 515 16 — — 16 Stock issued in payment of director fees 10,145 355 — — 355 Stock repurchased, including commissions ( 23,275 ) ( 877 ) — — ( 877 ) Balance at September 30, 2022 16,029,048 $ 214,720 $ 261,907 $ ( 80,035 ) $ 396,592 Nine months ended September 30, 2021 Balance at January 1, 2021 13,500,453 $ 125,905 $ 219,747 $ 12,601 $ 358,253 Net income — — 23,514 — 23,514 Other comprehensive loss, net of tax — — — ( 5,753 ) ( 5,753 ) Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings 34,278 423 — — 423 Stock issued under employee stock purchase plan 2,117 72 — — 72 Stock issued under employee stock ownership plan 27,400 999 — — 999 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 — 315 — — 315 Stock-based compensation - restricted stock — 636 — — 636 Cash dividends paid on common stock ($ 0.70 per share) — — ( 9,264 ) — ( 9,264 ) Stock purchased by directors under director stock plan 1,034 34 — — 34 Stock issued in payment of director fees 6,410 216 — — 216 Stock issued to American River Bankshares shareholders 3,441,235 124,401 — — 124,401 Stock repurchased, including commissions ( 967,683 ) ( 35,165 ) — — ( 35,165 ) Balance at September 30, 2021 16,066,889 $ 217,680 $ 233,997 $ 6,848 $ 458,525 The accompanying notes are an integral part of these consolidated financial statements (unaudited). Page-5 BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CASH FLOWS For the nine months ended September 30, 2022 and 2021 (in thousands; unaudited) 2022 2021 Cash Flows from Operating Activities: Net income $ 33,705 $ 23,514 Adjustments to reconcile net income to net cash provided by operating activities: Reversal of credit losses on loans ( 63 ) ( 2,049 ) Reversal of credit losses on unfunded loan commitments ( 318 ) ( 1,202 ) Noncash contribution expense to employee stock ownership plan 1,233 999 Noncash director compensation expense 355 216 Stock-based compensation expense 642 951 Amortization of core deposit intangible 1,124 742 Amortization of investment security premiums, net of accretion of discounts 7,139 3,222 Amortization of premiums (accretion of discounts) on acquired loans, net 143 ( 201 ) Accretion of discount on subordinated debenture — 1,347 Net change in deferred loan origination costs/fees ( 2,484 ) ( 1,135 ) Write-down of other real estate owned 345 — Losses (gains) on sale of investment securities, net 63 ( 1 ) Depreciation and amortization 1,259 1,279 Earnings on bank-owned life insurance policies ( 933 ) ( 1,892 ) Net changes in interest receivable and other assets 2,230 5,615 Net changes in interest payable and other liabilities ( 5,489 ) 921 Total adjustments 5,246 8,812 Net cash provided by operating activities 38,951 32,326 Cash Flows from Investing Activities: Purchase of held-to-maturity securities ( 293,720 ) ( 133,493 ) Purchase of available-for-sale securities ( 243,459 ) ( 355,156 ) Proceeds from sale of available-for-sale securities 10,664 4,099 Proceeds from paydowns/maturities of held-to-maturity securities 33,198 65,497 Proceeds from paydowns/maturities of available-for-sale securities 112,793 66,981 Loan principal collected, net of originations 97,935 193,265 Purchase of bank-owned life insurance policies — ( 1,943 ) Cash receipts from bank-owned life insurance policies 350 2,478 Purchase of premises and equipment ( 762 ) ( 833 ) Cash acquired from American River Bankshares — 140,577 Cash paid for low income housing tax credit investment ( 30 ) ( 396 ) Net cash used in investing activities ( 283,031 ) ( 18,924 ) Cash Flows from Financing Activities: Net increase in deposits 94,160 433,425 Proceeds from stock options exercised 821 423 Restricted stock surrendered for tax withholdings upon vesting ( 40 ) ( 156 ) Proceeds from stock issued under employee and director stock purchase plans 62 106 Stock repurchased, including commissions ( 1,250 ) ( 35,451 ) Repayment of subordinated debenture including execution costs — ( 4,126 ) Repayment of Federal Home Loan Bank borrowings — ( 13,885 ) Repayment of finance lease obligations ( 96 ) ( 55 ) Cash dividends paid on common stock ( 11,666 ) ( 9,264 ) Net cash provided by financing activities 81,991 371,017 Net (decrease) increase in cash, cash equivalents and restricted cash ( 162,089 ) 384,419 Cash, cash equivalents and restricted cash at beginning of period 347,641 200,320 Cash, cash equivalents and restricted cash at end of period $ 185,552 $ 584,739 Supplemental disclosure of cash flow information: Cash paid in interest $ 1,716 $ 1,492 Cash paid in income taxes $ 11,075 $ 9,000 Supplemental disclosure of noncash investing and financing activities: Change in net unrealized gain or (loss) on available-for-sale securities $ ( 97,094 ) $ ( 8,558 ) Securities transferred from available-for-sale to held-to-maturity, at fair value $ 357,482 $ — Amortization of net unrealized loss on available-for-sale securities transferred to held-to-maturity $ 1,126 $ 385 Purchase of investment securities not yet settled $ — $ 19,972 Stock issued to employee stock ownership plan $ 1,233 $ 999 Stock issued in payment of director fees $ 355 $ 216 Repurchase of stock not yet settled $ — $ 127 Acquisition: Fair value of assets acquired, excluding cash acquired $ — $ 757,844 Fair value of liabilities assumed $ — $ 816,558 Restricted cash 1 $ 2,996 $ 15,805 1 Restricted cash includes reserve requirements held with the Federal Reserve Bank of San Francisco and other cash pledged. In response to the COVID-19 pandemic, the Federal Reserve reduced the reserve requirement ratios to zero percent effective March 26, 2020. The accompanying notes are an integral part of these consolidated financial statements (unaudited). Page-6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1: Basis of Presentation The consolidated financial statements include the accounts of Bancorp, a bank holding company, and its wholly-owned bank subsidiary, Bank of Marin, a California state-chartered commercial bank. References to “we,” “our,” “us” mean Bancorp and the Bank that are consolidated for financial reporting purposes. The accompanying unaudited consolidated interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and note disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles ("GAAP") have been condensed or omitted pursuant to those rules and regulations. Although we believe that the disclosures are adequate and the information presented is not misleading, we suggest that these interim financial statements be read in conjunction with the annual financial statements and the notes thereto included in our 2021 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 following table shows: 1) weighted average basic shares, 2) potentially dilutive weighted average common shares related to stock options and unvested restricted stock awards, and 3) weighted average diluted shares. Basic earnings per share (“EPS”) are calculated by dividing net income by the weighted average number of common shares outstanding during each period, excluding unvested restricted stock awards. Diluted EPS are calculated using the weighted average number of potentially dilutive common shares. The number of potentially dilutive common shares included in the quarterly diluted EPS is computed using the average market prices during the three months included in the reporting period under the treasury stock method. The number of potentially dilutive common shares included in year-to-date diluted EPS is a year-to-date weighted average of potentially dilutive common shares included in each quarterly diluted EPS computation. In computing diluted EPS, we exclude anti-dilutive shares such as options whose exercise prices exceed the current common stock price, as they would not reduce EPS under the treasury method. We have two forms of outstanding common stock: common stock and unvested restricted stock awards. Holders of unvested restricted stock awards receive non-forfeitable dividends at the same rate as common shareholders and they both share equally in undistributed earnings. Under the two-class method, the difference in EPS is nominal for these participating securities. Three months ended Nine months ended (in thousands, except per share data) September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 Weighted average basic common shares outstanding 15,939 14,922 15,912 13,798 Potentially dilutive common shares related to: Stock options 22 51 33 62 Unvested restricted stock awards 13 20 14 21 Weighted average diluted shares outstanding 15,974 14,993 15,959 13,881 Net income $ 12,174 $ 5,282 $ 33,705 $ 23,514 Basic EPS $ 0.76 $ 0.35 $ 2.12 $ 1.70 Diluted EPS $ 0.76 $ 0.35 $ 2.11 $ 1.69 Weighted average anti-dilutive common shares not included in the calculation of diluted EPS 237 97 213 91 Note 2: Recently Adopted and Issued Accounting Standards Accounting Standards Not Yet Effective In March 2020, the FASB issued Accounting Standards Update ("ASU") No. 2020-04, Reference Rate Reform (Topic 848) . The amendments in this ASU are elective and provide optional guidance for a limited period of time to ease the potential burden of accounting for, or recognizing the effects of reference rate reform. The amendments in this ASU provide optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of Page-7 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 elected not to apply amendments at this time and to 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 intend 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. As of September 30, 2022, we had four interest rate swap contracts with notional values totaling $ 12.3 million indexed to LIBOR that will either be subject to the fall-back index rate stipulated by the ISDA protocol or modified to other reference rates such as Prime or SOFR as mutually agreed by our counterparty and us . We have not elected to apply the amendments at this time and will continue to assess the applicability of this ASU to us as we monitor guidance for reference rate reform from FASB and its impact on our financial condition and results of operations. In October 2021, the FASB issued ASU No. 2021-08, Accounting for Contract Assets and Contract Liabilities From Contracts With Customers (Topic 805). The amendments address diversity in accounting practices and require acquiring companies to apply ASC 606, Revenue from Contracts with Customers to recognize and measure contract assets and contract liabilities from contracts with customers acquired in a business combination, as opposed to other methods such as fair value. The amendments improve comparability after the business combination by providing consistent recognition and measurement guidance for revenue contracts with customers acquired in a business combination. The amendments are to be applied prospectively to business combinations occurring on or after December 15, 2022 and early adoption is permitted. In the event of a future business combination, we will assess the impact of the ASU on our financial condition and results of operations. In March 2022, the FASB issued ASU No. 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures . The amendment eliminates the recognition measurement guidance for troubled debt restructured ("TDR") loans, and instead requires an entity to evaluate whether a modification represents a new loan or a continuation of an existing loan in accordance with ASC Topic 310-20, Receivables - Nonrefundable Fees and Other Costs . In addition, the amendment requires that an entity include in its vintage disclosures the current period-gross loan charge-offs by year of origination. The amendments are effective for years beginning after December 15, 2022, and should be applied prospectively, except that an entity has the option to apply a modified retrospective method for TDR loans, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption. An entity may elect to early adopt each of the amendments separately. As such, we early adopted the current period charge-off disclosures in the first quarter of 2022 and intend to adopt the loan modification amendments when effective in the first quarter of 2023. Neither the early adoption of the amendments related to gross charge-off disclosures nor the future adoption of the TDR amendments had or will have a material impact on our financial condition or results of operations. In March 2022, the FASB issued ASU No. 2022-01, Derivatives and Hedging (Topic 815): Fair Value Hedging - Portfolio Layer Method . Among other things, the ASU renames the "last-of-layer" method to the "portfolio layer" method and makes fair value hedging more accessible for hedge accounting of interest rate risk for portfolios and financial assets. For example, the guidance permits an entity to apply the same portfolio hedging method to both prepayable and non-prepayable financial assets, thereby providing for consistency between accounting for similar hedges. The amendments are effective for years beginning after December 15, 2022. The adoption of the amendments will not affect our existing hedge accounting, disclosures, financial condition or results of operations. In June 2022, the FASB issued ASU No. 2022-03, Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions . The amendment reduces diversity in practice by clarifying that a separate contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. In addition, this ASU provided amended examples to illustrate that a restriction that is a characteristic of the equity security, which market participants would take into account when pricing them, would be considered in measuring fair value. This ASU also introduces new disclosure requirements. The amendments are effective prospectively for years beginning after December 15, 2023. Early adoption is permitted for both interim and annual financial statements. As discussed in Note 4, Investment Securities, we hold Visa Inc. Class B common stock that is legally restricted from resale to non-member banks of Visa U.S.A. until the covered litigation against Visa Inc. is settled. While the adoption of the amendments may require additional disclosures, we do not anticipate that it will impact our financial condition or 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 into three levels within the fair value hierarchy, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are: Level 1: Valuations are based on unadjusted quoted prices in active markets for identical assets or liabilities. Level 2: Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data. Level 3: Valuations are based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Values are determined using pricing models and discounted cash flow models and may include significant management judgment and estimation. Transfers between levels of the fair value hierarchy are recognized through our monthly and/or quarterly valuation process in the reporting period during which the event or circumstances that caused the transfer occurred. No such transfers occurred in the years presented. The following table summarizes our assets and liabilities that were required to be recorded at fair value on a recurring basis. (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 September 30, 2022 Securities available-for-sale: Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies $ 489,389 $ — $ 489,389 $ — OCI SBA-backed securities $ 44,791 $ — $ 44,791 $ — OCI Debentures of government sponsored agencies $ 134,921 $ — $ 134,921 $ — OCI U.S. Treasury securities $ 10,158 $ 10,158 $ — $ — OCI Obligations of state and political subdivisions $ 98,427 $ — $ 98,427 $ — OCI Corporate bonds $ 33,202 $ — $ 33,202 $ — OCI Asset-backed securities $ 1,605 $ — $ 1,605 $ — OCI Derivative financial assets (interest rate contracts) $ 649 $ — $ 649 $ — NI December 31, 2021 Securities available-for-sale: Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies $ 759,576 $ — $ 759,576 $ — OCI SBA-backed securities $ 33,478 $ — $ 33,478 $ — OCI Debentures of government sponsored agencies $ 188,527 $ — $ 188,527 $ — OCI U.S. Treasury securities $ 11,630 $ 11,630 $ — $ — OCI Obligations of state and political subdivisions $ 134,000 $ — $ 134,000 $ — OCI Corporate bonds $ 38,495 $ — $ 38,495 $ — OCI Asset-backed securities $ 1,862 $ — $ 1,862 $ — OCI Derivative financial liabilities (interest rate contracts) $ 1,085 $ — $ 1,085 $ — NI 1 Other comprehensive income ("OCI") or net income ("NI"). Page-9 Available-for-sale securities are recorded at fair value on a recurring basis. When available, quoted market prices (Level 1) are used to determine the fair value of available-for-sale securities. Level 1 securities include U.S. Treasury securities. If quoted market prices are not available, we obtain pricing information from a reputable third-party service provider, who may utilize valuation techniques that use current market-based or independently sourced parameters, such as bid/ask prices, dealer-quoted prices, interest rates, benchmark yield curves, prepayment speeds, probability of default, loss severity and credit spreads (Level 2). Level 2 securities include asset-backed securities, obligations of state and political subdivisions, U.S. agencies or government-sponsored agencies' debt securities, mortgage-backed securities, government agency-issued, and corporate bonds. As of September 30, 2022 and December 31, 2021, there were no Level 3 securities. Held-to-maturity securities may be written down to fair value as a result of an other-than-temporary impairment , and we did not record any write-downs during the nine months ended September 30, 2022 or September 30, 2021. Fair value of held-to-maturity securities is determined using the same techniques discussed above for available-for-sale securities. On a recurring basis, derivative financial instruments are recorded at fair value, which is based on the income approach using observable Level 2 market inputs, reflecting market expectations of future interest rates as of the measurement date. Standard valuation techniques are used to calculate the present value of the future expected cash flows assuming an orderly transaction. Valuation adjustments may be made to reflect both our own credit risk and the counterparties’ credit risk in determining the fair value of the derivatives. These unobservable inputs are not considered significant inputs to the fair value measurement overall. Level 2 inputs for the valuations are limited to observable market prices for London Interbank Offered Rate ("LIBOR") and Overnight Index Swap ("OIS") rates (for the very short term), quoted prices for LIBOR futures contracts, observable market prices for LIBOR and OIS swap rates, and one-month and three-month LIBOR basis spreads at commonly quoted intervals. Mid-market pricing of the inputs is used as a practical expedient in the fair value measurements. We project spot rates at reset days specified by each swap contract to determine future cash flows, then discount to present value using OIS curves as of the measurement date. When the value of any collateral placed with counterparties is less than the interest rate derivative liability, a credit valuation adjustment ("CVA") is applied to reflect the credit risk we pose to counterparties. We have used the spread between the Standard & Poor's BBB rated U.S. Bank Composite rate and LIBOR for the closest maturity term corresponding to the duration of the swaps to derive the CVA. A similar credit risk adjustment, correlated to the credit standing of the counterparty, is made when collateral posted by the counterparty does not fully cover their liability to us. For further discussion on our methodology in valuing our derivative financial instruments, refer to Note 9, Derivative Financial Instruments and Hedging Activities. Certain financial assets may be measured at fair value on a non-recurring basis. These assets are subject to fair value adjustments that result from the application of the lower of cost or fair value accounting or write-downs of individual assets, such as individually analyzed loans that are collateral dependent and other real estate owned ("OREO"). OREO represents collateral acquired through foreclosure and is initially recorded at fair value as established by a current appraisal of the collateral. Subsequent to foreclosure, OREO is carried at the lower of cost or fair value, less estimated costs to sell. OREO values are reviewed on an ongoing basis and any subsequent decline in fair value is recorded as a foreclosed asset expense in the current period. The value of OREO is classified as Level 3. Our current OREO resulted from the American River Bankshares ("AMRB") merger in 2021. The following table presents the carrying value of assets measured at fair value on a non-recurring basis and that were held in the consolidated statements of condition at each respective period end, by level within the fair value hierarchy as of September 30, 2022 and December 31, 2021. (in thousands) Carrying Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) September 30, 2022 Other real estate owned $ 455 $ — $ — $ 455 December 31, 2021 Other real estate owned $ 800 $ — $ — $ 800 Page-10 Disclosures about Fair Value of Financial Instruments The table below is a summary of fair value estimates for financial instruments as of September 30, 2022 and December 31, 2021, excluding financial instruments recorded at fair value on a recurring basis (summarized in the first table in this note). The carrying amounts in the following table are recorded in the consolidated statements of condition under the indicated captions. Further, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements such as bank-owned life insurance policies ("BOLI"), lease obligations and non-maturity deposit liabilities. Additionally, we held shares of Federal Home Loan Bank ("FHLB") of San Francisco stock and Visa Inc. Class B common stock, both recorded at cost, as there was no impairment or changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer as of September 30, 2022 or December 31, 2021. The values are discussed in Note 4, Investment Securities. September 30, 2022 December 31, 2021 (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 $ 185,552 $ 185,552 Level 1 $ 347,641 $ 347,641 Level 1 Investment securities held-to-maturity 959,867 829,048 Level 2 342,222 342,755 Level 2 Loans, net 2,135,373 2,123,520 Level 3 2,232,622 2,234,430 Level 3 Interest receivable 11,458 11,458 Level 2 11,889 11,889 Level 2 Financial liabilities (recorded at amortized cost): Time deposits 139,815 139,553 Level 2 150,235 150,475 Level 2 Interest payable 83 83 Level 2 81 81 Level 2 Fair value of loans is based on exit price techniques and obtained from an independent third-party that uses its proprietary valuation model and methodology and may differ from actual price from a prospective buyer. The discounted cash flow valuation approach reflects key inputs and assumptions that are unobservable, such as loan probability of default, loss given default, prepayment speed, and market discount rates. Fair value of fixed-rate time deposits is estimated by discounting future contractual cash flows using discount rates that reflect the current observable market rates offered for time deposits of similar remaining maturities. The value of off-balance-sheet financial instruments is estimated based on the fee income associated with the commitments, which in the absence of credit exposure, is considered to approximate their settlement value. The fair value of commitment fees was not material as of September 30, 2022 or December 31, 2021. Note 4: Investment Securities Our investment securities portfolio consists of U.S. Treasury securities, obligations of state and political subdivisions, U.S. federal government agencies such as Government National Mortgage Association ("GNMA") and Small Business Administration ("SBA"), U.S. government-sponsored enterprises ("GSEs"), such as Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC"), Federal Farm Credit Banks Funding Corporation and FHLB, U.S. Corporations and one asset-backed security collateralized by student loan pools. We also invest in residential and commercial mortgage-backed securities (“MBS”/"CMBS") and collateralized mortgage obligations (“CMOs”) issued or guaranteed by the GSEs, as reflected in the following table. A summary of the amortized cost, fair value and allowance for credit losses related to securities held-to-maturity as of September 30, 2022 and December 31, 2021 is presented below. Page-11 Held-to-maturity: Amortized Cost 1 Allowance for Credit Losses Net Carrying Amount Gross Unrealized Fair Value (in thousands) Gains (Losses) September 30, 2022 Securities of U.S. government-sponsored enterprises: MBS pass-through securities issued by FHLMC, FNMA and GNMA $ 335,959 $ — $ 335,959 $ — $ ( 53,659 ) $ 282,300 CMOs issued by FHLMC 236,061 — 236,061 — ( 30,272 ) 205,789 CMOs issued by FNMA 115,043 — 115,043 — ( 6,066 ) 108,977 CMOs issued by GNMA 32,070 — 32,070 — ( 2,204 ) 29,866 SBA-backed securities 2,373 — 2,373 — ( 143 ) 2,230 Debentures of government-sponsored agencies 145,747 — 145,747 — ( 25,193 ) 120,554 Obligations of state and political subdivisions 62,614 — 62,614 — ( 11,697 ) 50,917 Corporate bonds 30,000 — 30,000 — ( 1,585 ) 28,415 Total held-to-maturity $ 959,867 $ — $ 959,867 $ — $ ( 130,819 ) $ 829,048 December 31, 2021 Securities of U.S. government-sponsored enterprises: MBS pass-through securities issued by FHLMC, FNMA and GNMA $ 126,990 $ — $ 126,990 $ 2,110 $ ( 712 ) $ 128,388 CMOs issued by FHLMC 106,851 — 106,851 668 ( 1,045 ) 106,474 CMOs issued by FNMA 4,866 — 4,866 128 — 4,994 SBA-backed securities 4,840 — 4,840 198 — 5,038 Debentures of government-sponsored agencies 51,472 — 51,472 — ( 901 ) 50,571 Obligations of state and political subdivisions 47,203 — 47,203 296 ( 209 ) 47,290 Total held-to-maturity $ 342,222 $ — $ 342,222 $ 3,400 $ ( 2,867 ) $ 342,755 1 Amortized cost and fair values exclude accrued interest receivable of $ 2.6 million and $ 1.1 million at September 30, 2022 and December 31, 2021, respectively, which is included in interest receivable and other assets in the consolidated statements of condition. Management measures expected credit losses on held-to-maturity securities collectively by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. With regard to MBSs and CMOs issued or guaranteed by the GSEs, and SBA-backed securities, we expect to receive all the contractual principal and interest on these securities as such securities are backed by the full faith and credit of and/or guaranteed by the U.S. government. Accordingly, no allowance for credit losses has been recorded for these securities. With regard to securities issued by states and political subdivisions and corporate bonds, management considers: (i) issuer and/or guarantor credit ratings, (ii) historical probability of default and loss given default rates for given bond ratings and remaining maturity, (iii) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities, (iv) internal credit review of the financial information, and (v) whether or not such securities have credit enhancements such as guarantees, contain a defeasance clause, or are pre-refunded by the issuers. Based on 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 and corporate bonds by Moody's and/or Standard & Poor's bond ratings as of September 30, 2022. Obligations of state and political subdivisions Corporate bonds (in thousands) September 30, 2022 December 31, 2021 September 30, 2022 December 31, 2021 AAA / Aaa $ 43,087 $ 34,229 $ — $ — AA / Aa 19,527 12,873 — — A2 / A — 101 30,000 — Total $ 62,614 $ 47,203 $ 30,000 $ — Page-12 A summary of the amortized cost, fair value and allowance for credit losses related to securities available-for-sale as of September 30, 2022 and December 31, 2021 is presented below. Available-for-sale: Amortized Cost 1 Gross Unrealized Allowance for Credit Losses Fair Value (in thousands) Gains (Losses) September 30, 2022 Securities of U.S. government-sponsored enterprises: MBS pass-through securities issued by FHLMC, FNMA and GNMA $ 113,941 $ 3 $ ( 13,702 ) $ — $ 100,242 CMOs issued by FHLMC 357,486 — ( 35,575 ) — 321,911 CMOs issued by FNMA 38,125 — ( 4,177 ) — 33,948 CMOs issued by GNMA 36,747 — ( 3,459 ) — 33,288 SBA-backed securities 48,372 4 ( 3,585 ) — 44,791 Debentures of government- sponsored agencies 149,106 — ( 14,185 ) — 134,921 U.S. Treasury securities 11,899 — ( 1,741 ) — 10,158 Obligations of state and political subdivisions 117,161 — ( 18,734 ) — 98,427 Corporate bonds 36,989 — ( 3,787 ) — 33,202 Asset-backed securities 1,650 — ( 45 ) — 1,605 Total available-for-sale $ 911,476 $ 7 $ ( 98,990 ) $ — $ 812,493 December 31, 2021 Securities of U.S. government-sponsored enterprises: MBS pass-through securities issued by FHLMC, FNMA and GNMA $ 316,090 $ 1,224 $ ( 2,784 ) $ — $ 314,530 CMOs issued by FHLMC 343,047 3,209 ( 4,829 ) — 341,427 CMOs issued by FNMA 48,187 152 ( 611 ) — 47,728 CMOs issued by GNMA 56,345 99 ( 553 ) — 55,891 SBA-backed securities 32,640 993 ( 155 ) — 33,478 Debentures of government- sponsored agencies 191,449 25 ( 2,947 ) — 188,527 U.S. Treasury securities 11,886 — ( 256 ) 11,630 Obligations of state and political subdivisions 129,009 5,372 ( 381 ) — 134,000 Corporate bonds 39,001 — ( 506 ) — 38,495 Asset-backed securities 1,866 — ( 4 ) — 1,862 Total available-for-sale $ 1,169,520 $ 11,074 $ ( 13,026 ) $ — $ 1,167,568 1 Amortized cost and fair value exclude accrued interest receivable of $ 3.1 million and $ 3.7 million at September 30, 2022 and December 31, 2021, respectively, which is included in interest receivable and other assets in the consolidated statements of condition. As part of our ongoing review of our investment securities portfolio, we reassessed the classification of certain securities issued by government sponsored agencies. In March 2022, we transferred $ 357.5 million of these securities from available-for-sale to held-to-maturity at fair value. We intend and have the ability to hold these securities to maturity. The net unrealized pre-tax loss of $ 14.8 million that remained and the related accumulated other comprehensive loss are accreted to interest income over the remaining lives of the securities. Because these entries offset each other, there is no impact to net income. The amortized cost a nd fair value of investment debt securities by contractual maturity at September 30, 2022 and December 31, 2021 are shown below. Expected maturities may differ from contractual maturities if the issuers of the securities have the right to call or prepay obligations with or without call or prepayment penalties. September 30, 2022 December 31, 2021 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 $ 453 $ 450 $ 1,831 $ 1,813 $ 101 $ 103 $ 10,785 $ 10,841 After one but within five years 90,541 86,684 273,040 251,164 25,666 26,559 219,474 219,957 After five years through ten years 260,148 220,313 256,608 228,766 182,604 182,303 299,937 300,187 After ten years 608,725 521,601 379,997 330,750 133,851 133,790 639,324 636,583 Total $ 959,867 $ 829,048 $ 911,476 $ 812,493 $ 342,222 $ 342,755 $ 1,169,520 $ 1,167,568 Page-13 Sales of investment securities and gross gains and losses are shown in the following table. Three months ended Nine months ended (in thousands) September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 Available-for-sale: Sales proceeds $ 10,664 $ 4,099 $ 10,664 $ 4,099 Gross realized gains 17 1 17 1 Gross realized losses ( 80 ) — ( 80 ) — Pledged investment securities are shown in the following table: (in thousands) September 30, 2022 December 31, 2021 Pledged to the State of California: Secure public deposits in compliance with the Local Agency Security Program $ 193,479 $ 213,861 Collateral for trust deposits 656 729 Collateral for Wealth Management and Trust Services checking account 554 614 Total investment securities pledged to the State of California 194,689 215,204 Bankruptcy trustee deposits pledged with Federal Reserve Bank 1,844 2,645 Total pledged investment securities $ 196,533 $ 217,849 There were 409 and 217 securities in unrealized loss positions at September 30, 2022 and December 31, 2021, respectively. Those securities are summarized and classified according to the duration of the loss period in the tables below: September 30, 2022 < 12 continuous months ≥ 12 continuous months Total securities in a loss position (in thousands) Fair value Unrealized loss Fair value Unrealized loss Fair value Unrealized loss Held-to-maturity: MBS pass-through securities issued by FHLMC, FNMA and GNMA $ 203,739 $ ( 36,140 ) $ 78,562 $ ( 17,519 ) $ 282,301 $ ( 53,659 ) CMOs issued by FHLMC 144,517 ( 18,126 ) 51,272 ( 12,146 ) 195,789 ( 30,272 ) CMOs issued by FNMA 108,978 ( 6,066 ) — — 108,978 ( 6,066 ) CMOs issued by GNMA 19,059 ( 735 ) 10,807 ( 1,469 ) 29,866 ( 2,204 ) SBA-backed securities 2,230 ( 143 ) — — 2,230 ( 143 ) Debentures of government-sponsored agencies 54,445 ( 6,704 ) 66,109 ( 18,489 ) 120,554 ( 25,193 ) Obligations of state and political subdivisions 35,899 ( 7,399 ) 15,018 ( 4,298 ) 50,917 ( 11,697 ) Corporate bonds 28,415 ( 1,585 ) — — 28,415 ( 1,585 ) Total held-to-maturity 597,282 ( 76,898 ) 221,768 ( 53,921 ) 819,050 ( 130,819 ) Available-for-sale: MBS pass-through securities issued by FHLMC, FNMA and GNMA 54,639 ( 6,702 ) 44,711 ( 7,000 ) 99,350 ( 13,702 ) CMOs issued by FHLMC 192,988 ( 17,898 ) 128,923 ( 17,677 ) 321,911 ( 35,575 ) CMOs issued by FNMA 7,310 ( 514 ) 26,638 ( 3,663 ) 33,948 ( 4,177 ) CMOs issued by GNMA 11,248 ( 399 ) 22,039 ( 3,060 ) 33,287 ( 3,459 ) SBA-backed securities 37,629 ( 3,443 ) 6,649 ( 142 ) 44,278 ( 3,585 ) Debentures of government- sponsored agencies 128,077 ( 12,060 ) 6,844 ( 2,125 ) 134,921 ( 14,185 ) U.S. Treasury securities — — 10,159 ( 1,741 ) 10,159 ( 1,741 ) Obligations of state and political subdivisions 84,021 ( 15,366 ) 14,406 ( 3,368 ) 98,427 ( 18,734 ) Corporate bonds 23,221 ( 1,779 ) 9,981 ( 2,008 ) 33,202 ( 3,787 ) Asset-backed securities 1,606 ( 45 ) — — 1,606 ( 45 ) Total available-for-sale 540,739 ( 58,206 ) 270,350 ( 40,784 ) 811,089 ( 98,990 ) Total securities at loss position $ 1,138,021 $ ( 135,104 ) $ 492,118 $ ( 94,705 ) $ 1,630,139 $ ( 229,809 ) Page-14 December 31, 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: MBS pass-through securities issued by FHLMC and FNMA $ 76,619 $ ( 712 ) $ — $ — $ 76,619 $ ( 712 ) CMOs issued by FHLMC 54,811 ( 1,045 ) — — 54,811 ( 1,045 ) Obligations of state and political subdivisions 19,203 ( 209 ) — — 19,203 ( 209 ) Debentures of government-sponsored agencies 50,571 ( 901 ) — — 50,571 ( 901 ) Total held-to-maturity 201,204 ( 2,867 ) — — 201,204 ( 2,867 ) Available-for-sale: MBS pass-through securities issued by FHLMC and FNMA 263,474 ( 2,784 ) — — 263,474 ( 2,784 ) SBA-backed securities 7,478 ( 112 ) 1,209 ( 43 ) 8,687 ( 155 ) CMOs issued by FHLMC 226,175 ( 4,677 ) 4,415 ( 152 ) 230,590 ( 4,829 ) CMOs issued by GNMA 44,790 ( 553 ) — — 44,790 ( 553 ) CMOs issued by FNMA 37,348 ( 611 ) — — 37,348 ( 611 ) Debentures of government- sponsored agencies 148,979 ( 2,527 ) 8,549 ( 420 ) 157,528 ( 2,947 ) U.S. Treasury securities 11,629 ( 256 ) — — 11,629 ( 256 ) Obligations of state and political subdivisions 17,552 ( 381 ) — — 17,552 ( 381 ) Corporate Bonds 38,495 ( 506 ) — — 38,495 ( 506 ) Asset-backed securities 1,861 ( 4 ) — — 1,861 ( 4 ) Total available-for-sale 797,781 ( 12,411 ) 14,173 ( 615 ) 811,954 ( 13,026 ) Total securities at loss position $ 998,985 $ ( 15,278 ) $ 14,173 $ ( 615 ) $ 1,013,158 $ ( 15,893 ) As of September 30, 2022, the investment portfolio included 173 investment securities that had been in a continuous loss position for twelve months or more and 236 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 September 30, 2022, management determined that it did not intend to sell any investment securities with unrealized losses, and it is more likely than not that we will not be required to sell securities with unrealized losses before recovery of their amortized cost. No allowances for credit losses have been recognized on available-for-sale securities in an unrealized loss position, as management does not believe any of the securities are impaired due to reasons of credit quality at September 30, 2022. Non-Marketable Securities Included in Other Assets FHLB Capital Stock As a member of the FHLB, we are required to maintain a minimum investment in FHLB capital stock determined by the Board of Directors of the FHLB. The minimum investment requirements can increase in the event we increase our total asset size or borrowings with the FHLB. Shares cannot be purchased or sold except between the FHLB and its members at the $ 100 per share par value. We held $ 16.7 million of FHLB stock included in other assets on the consolidated statements of condition at both September 30, 2022 and December 31, 2021. The carrying Page-15 amounts of these investments are reasonable estimates of fair value because the securities are restricted to member banks and they do not have a readily determinable market value. Based on our analysis of FHLB's financial condition and certain qualitative factors, we determined that the FHLB stock was not impaired at September 30, 2022 and December 31, 2021. On October 27, 2022, FHLB announced a cash dividend for the third quarter of 2022 at an annualized dividend rate of 7.00 % to be distributed in mid-November 2022. Cash dividends paid on FHLB capital stock are recorded as non-interest income. VISA Inc. Class B Common Stock As a member bank of Visa U.S.A., we held 10,439 shares of Visa Inc. Class B common stock at September 30, 2022 and December 31, 2021. 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 1.6059 and 1.6181 at September 30, 2022 and December 31, 2021, and the closing stock price of Class A shares at those respective dates, the converted value of our shares of Class B common stock would have been $ 3.0 million and $ 3.7 million at September 30, 2022 and December 31, 2021, respectively. The conversion rate is subject to further adjustment upon the final settlement of the covered litigation against Visa Inc. and its member banks. As such, the fair value of these Class B shares can differ significantly from their converted values. For further information, refer to Note 8, Commitments and Contingencies. Low Income Housing Tax Credits We invest in low-income housing tax credit funds as a limited partner, which totaled $ 2.6 million and $ 3.0 million recorded in other assets as of September 30, 2022 and December 31, 2021, respectively. In the first nine months of 2022, we recognized $ 475 thousand of low-income housing tax credits and other tax benefits, offset by $ 400 thousand of amortization expense of low-income housing tax credit investment, as a component of income tax expense. As of September 30, 2022, our unfunded commitments for these low-income housing tax credit funds totaled $ 392 thousand. We did not recognize any impairment losses on these low-income housing tax credit investments during the first nine months of 2022 or 2021, as the value of the future tax benefits exceeds the carrying value of the investments. Note 5: Loans and Allowance for Credit Losses on Loans The following table presents the amortized cost of loans by class as of September 30, 2022 and December 31, 2021. (in thousands) September 30, 2022 December 31, 2021 Commercial and industrial $ 207,488 $ 301,602 Real estate: Commercial owner-occupied 368,415 392,345 Commercial investor-owned 1,211,651 1,189,021 Construction 112,154 119,840 Home equity 89,244 88,746 Other residential 114,247 114,558 Installment and other consumer loans 55,137 49,533 Total loans, at amortized cost 1 2,158,336 2,255,645 Allowance for credit losses on loans ( 22,963 ) ( 23,023 ) Total loans, net of allowance for credit losses on loans $ 2,135,373 $ 2,232,622 1 Amortized cost includes net deferred loan origination costs (fees) of $ 1.6 million and $( 901 ) thousand at September 30, 2022 and December 31, 2021, respectively. Amounts are also net of unrecognized purchase discounts of $ 2.6 million and $ 2.5 million at September 30, 2022 and December 31, 2021, respectively. Amortized cost excludes accrued interest, which totaled $ 5.8 million and $ 7.1 million at September 30, 2022 and December 31, 2021, 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 Page-16 acquisitions. Management examines historical, current, and projected cash flows to determine the ability of the borrower to repay obligations as agreed. Commercial loans are made based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral and guarantor support. The cash flows of borrowers, however, may not occur as expected, and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed, such as accounts receivable and inventory, and typically include personal guarantees. We target stable businesses with guarantors who provide additional sources of repayment and have proven to be resilient in periods of economic stress. A weakened economy, and resultant decreased consumer and/or business spending, may have an effect on the credit quality of commercial loans. Pursuant to the 2020 CARES Act, Bank of Marin originated 2,876 guaranteed loans totaling $ 444.1 million in two rounds of the Small Business Administration's ("SBA") Paycheck Protection Program ("PPP"). Additionally in 2021, Bank of Marin assumed 113 PPP loans totaling $ 18.6 million from AMRB as of the merger date. As of September 30, 2022, there were 42 PPP loans outstanding totaling $ 7.6 million (net of $ 161 thousand in unrecognized fees and costs), compared to 368 loans outstanding at December 31, 2021 totaling $ 111.2 million (net of $ 2.5 million in unrecognized fees and costs) included in commercial and industrial loan balances. 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 if they meet the requirements of the program. As expected, the vast majority of the PPP loans have been fully forgiven by the SBA and we expect the majority of remaining loans to be forgiven as well. Commercial Real Estate Loans - Commercial real estate loans, which include income producing investment properties and owner-occupied real estate used for business purposes, are subject to underwriting standards and processes similar to commercial loans discussed above. We underwrite these loans to be repaid from cash flow from either the business or investment property and supported by real property collateral. Underwriting standards for commercial real estate loans include, but are not limited to, debt coverage and loan-to-value ratios. Furthermore, a large majority of our loans are guaranteed by the owners of the properties. Conditions in the real estate markets or downturn in the general economy may adversely affect our commercial real estate loans. In the event of a vacancy, we expect guarantors to carry the loans until they find a replacement tenant. The owner's substantial equity investment provides a strong economic incentive to continue to support the commercial real estate projects. As such, we have generally experienced a relatively low level of loss and delinquencies in this portfolio. Construction Loans - Construction loans are generally made to developers and builders to finance construction, renovation and occasionally land acquisitions in anticipation of near-term development. Construction loans include interest reserves that are used for the payment of interest during the development and marketing periods and are capitalized as part of the loan balance. When a construction loan is placed on nonaccrual status before the depletion of the interest reserve, we apply the interest funded by the interest reserve against the loan's principal balance. These loans are underwritten after evaluation of the borrower's financial strength, reputation, prior track record, and independent appraisals. We monitor all construction projects to determine whether they are on schedule, completed as planned and in accordance with the approved construction budgets. Significant events can affect the construction industry, including: the inherent volatility of real estate markets and vulnerability to delays due to weather, change orders, inability to obtain construction permits, labor or material shortages, and price changes. Estimates of construction costs and value associated with the completed project may be inaccurate. Repayment of construction loans is largely dependent on the ultimate success of the project. Consumer Loans - Consumer loans primarily consist of home equity lines of credit, other residential loans, floating homes, and indirect luxury auto loans, along with a small number of installment loans. Our other residential loans include tenancy-in-common fractional interest loans ("TIC") located almost entirely in San Francisco County. We originate consumer loans utilizing credit score information, debt-to-income ratio and loan-to-value ratio analysis. Diversification among consumer loan types, coupled with relatively small loan amounts that are spread across many individual borrowers, mitigates risk. We do not originate sub-prime residential mortgage loans, nor is it our practice to underwrite loans commonly referred to as "Alt-A mortgages," the characteristics of which are reduced documentation, borrowers with low FICO scores or collateral with high loan-to-value ratios. Page-17 Credit Quality Indicators We use a risk rating system to evaluate asset quality, and to identify and monitor credit risk in individual loans, and in the loan portfolio. Our definitions of “Special Mention” risk graded loans, or worse, are consistent with those used by the Federal Deposit Insurance Corporation ("FDIC"). Our internally assigned grades are as follows: Pass and Watch - Loans to borrowers of acceptable or better credit quality. Borrowers in this category demonstrate fundamentally sound financial positions, repayment capacity, credit history and management expertise. Loans in this category must have an identifiable and stable source of repayment and meet the Bank’s policy regarding debt-service-coverage ratios. These borrowers are capable of sustaining normal economic, market or operational setbacks without significant financial consequences. Negative external industry factors are generally not present. The loan may be secured, unsecured or supported by non-real estate collateral for which the value is more difficult to determine and/or marketability is more uncertain. This category also includes “Watch” loans, where the primary source of repayment has been delayed. “Watch” is intended to be a transitional grade, with either an upgrade or downgrade within a reasonable period. Special Mention - Potential weaknesses that deserve close attention. If left uncorrected, those potential weaknesses may result in deterioration of the payment prospects for the asset. Special Mention assets do not present sufficient risk to warrant adverse classification. Substandard - Inadequately protected by either the current sound worth and paying capacity of the obligor or the collateral pledged, if any. A Substandard asset has a well-defined weakness or weaknesses that jeopardize(s) the liquidation of the debt. Substandard assets are characterized by the distinct possibility that we will sustain some loss if such weaknesses or deficiencies are not corrected. Well-defined weaknesses include adverse trends or developments of the borrower’s financial condition, managerial weaknesses and/or significant collateral deficiencies. Doubtful - Critical weaknesses that make collection or liquidation in full improbable. There may be specific pending events that work to strengthen the asset; however, the amount or timing of the loss may not be determinable. Pending events generally occur within one year of the asset being classified as Doubtful. Examples include: merger, acquisition, or liquidation; capital injection; guarantee; perfecting liens on additional collateral; and refinancing. Such loans are placed on non-accrual status and usually are collateral-dependent. We regularly review our credits for accuracy of risk grades whenever we receive new information. Borrowers are generally required to submit financial information at regular intervals. Typically, commercial borrowers with lines of credit are required to submit financial information with reporting intervals ranging from monthly to annually depending on credit size, risk and complexity. In addition, investor commercial real estate borrowers with loans exceeding a certain dollar threshold are usually required to submit rent rolls or property income statements annually. We monitor construction loans monthly. We review home equity and other consumer loans based on delinquency. We also review loans graded “Watch” or worse, regardless of loan type, no less than quarterly. The following tables present the loan portfolio by loan class, origination year and internal risk rating as of September 30, 2022 and December 31, 2021. We early adopted the vintage disclosure requirements of ASU 2022-02 prospectively as described in Note 2 beginning with the first quarter of 2022. Accordingly, the 2022 vintage table reflects gross charge-offs by loan class and year of origination. Generally, existing term loans that were re-underwritten are reflected in the table in the year of renewal. Lines of credit that have a conversion feature at the time of origination, such as construction to perm loans, are presented by year of origination. (in thousands) Term Loans - Amortized Cost by Origination Year Revolving Loans Amortized Cost September 30, 2022 2022 2021 2020 2019 2018 Prior Total Commercial and industrial: Pass and Watch $ 10,791 $ 11,634 $ 8,266 $ 22,979 $ 6,007 $ 25,989 $ 114,750 $ 200,416 Special Mention — — — 477 4,166 — 403 5,046 Substandard — — 1,361 — — 665 — 2,026 Total commercial and industrial $ 10,791 $ 11,634 $ 9,627 $ 23,456 $ 10,173 $ 26,654 $ 115,153 $ 207,488 Gross current period charge-offs $ — $ — $ ( 9 ) $ — $ — $ — $ — $ ( 9 ) Commercial real estate, owner-occupied: Pass and Watch $ 52,024 $ 52,909 $ 41,096 $ 45,607 $ 30,178 $ 108,888 $ — $ 330,702 Special Mention — 16,336 — 309 5,284 4,532 — 26,461 Substandard — — 7,127 1,758 — 2,266 — 11,151 Doubtful — — 101 — — — — 101 Total commercial real estate, owner-occupied $ 52,024 $ 69,245 $ 48,324 $ 47,674 $ 35,462 $ 115,686 $ — $ 368,415 Page-18 (in thousands) Term Loans - Amortized Cost by Origination Year Revolving Loans Amortized Cost September 30, 2022 2022 2021 2020 2019 2018 Prior Total Commercial real estate, investor-owned: Pass and Watch $ 157,021 $ 219,857 $ 156,190 $ 165,464 $ 128,149 $ 332,987 $ 65 $ 1,159,733 Special Mention — 1,178 12,157 3,961 6,002 9,384 — 32,682 Substandard — — — — — 19,236 — 19,236 Total commercial real estate, investor-owned $ 157,021 $ 221,035 $ 168,347 $ 169,425 $ 134,151 $ 361,607 $ 65 $ 1,211,651 Construction: Pass and Watch $ 42,163 $ 16,897 $ 36,239 $ 7,744 $ 9,111 $ — $ — $ 112,154 Total construction $ 42,163 $ 16,897 $ 36,239 $ 7,744 $ 9,111 $ — $ — $ 112,154 Home equity: Pass and Watch $ — $ — $ — $ — $ — $ 742 $ 87,685 $ 88,427 Substandard — — — — — 499 318 817 Total home equity $ — $ — $ — $ — $ — $ 1,241 $ 88,003 $ 89,244 Other residential: Pass and Watch $ 16,623 $ 15,383 $ 29,942 $ 22,385 $ 11,438 $ 18,476 $ — $ 114,247 Total other residential $ 16,623 $ 15,383 $ 29,942 $ 22,385 $ 11,438 $ 18,476 $ — $ 114,247 Installment and other consumer: Pass and Watch 15,579 $ 14,591 $ 6,168 $ 6,837 $ 4,428 $ 6,656 $ 786 $ 55,045 Substandard — — — — — 92 — 92 Total installment and other consumer $ 15,579 $ 14,591 $ 6,168 $ 6,837 $ 4,428 $ 6,748 $ 786 $ 55,137 Gross current period charge-offs $ — $ — $ — $ — $ — $ ( 18 ) $ ( 5 ) $ ( 23 ) Total loans: Pass and Watch $ 294,201 $ 331,271 $ 277,901 $ 271,016 $ 189,311 $ 493,738 $ 203,286 $ 2,060,724 Total Special Mention $ — $ 17,514 $ 12,157 $ 4,747 $ 15,452 $ 13,916 $ 403 $ 64,189 Total Substandard $ — $ — $ 8,488 $ 1,758 $ — $ 22,758 $ 318 $ 33,322 Total Doubtful $ — $ — $ 101 $ — $ — $ — $ — $ 101 Totals $ 294,201 $ 348,785 $ 298,647 $ 277,521 $ 204,763 $ 530,412 $ 204,007 $ 2,158,336 Total gross current period charge-offs $ — $ — $ ( 9 ) $ — $ — $ ( 18 ) $ ( 5 ) $ ( 32 ) (in thousands) Term Loans - Amortized Cost by Origination Year Revolving Loans Amortized Cost December 31, 2021 2021 2020 2019 2018 2017 Prior Total Commercial and industrial: Pass and Watch $ 96,643 $ 35,967 $ 25,754 $ 12,763 $ 2,729 $ 31,280 $ 90,744 $ 295,880 Special Mention — 1,700 584 273 — — 2,088 4,645 Substandard — — — — — — 1,077 1,077 Total commercial and industrial $ 96,643 $ 37,667 $ 26,338 $ 13,036 $ 2,729 $ 31,280 $ 93,909 $ 301,602 Commercial real estate, owner-occupied: Pass and Watch $ 58,395 $ 43,216 $ 49,485 $ 36,174 $ 42,430 $ 104,898 $ — $ 334,598 Special Mention 16,748 — — 7,846 — 16,996 — 41,590 Substandard — 7,155 285 — — 8,603 — 16,043 Doubtful — 114 — — — — — 114 Total commercial real estate, owner-occupied $ 75,143 $ 50,485 $ 49,770 $ 44,020 $ 42,430 $ 130,497 $ — $ 392,345 Commercial real estate, investor-owned: Pass and Watch $ 225,722 $ 186,214 $ 187,418 $ 143,028 $ 75,419 $ 325,882 $ 84 $ 1,143,767 Special Mention — 1,214 2,714 11,773 1,787 9,540 — 27,028 Substandard — — — 695 — 17,531 — 18,226 Total commercial real estate, investor-owned $ 225,722 $ 187,428 $ 190,132 $ 155,496 $ 77,206 $ 352,953 $ 84 $ 1,189,021 Construction: Pass and Watch $ 31,269 $ 70,528 $ 8,935 $ 9,108 $ — $ — $ — $ 119,840 Total construction $ 31,269 $ 70,528 $ 8,935 $ 9,108 $ — $ — $ — $ 119,840 Home equity: Pass and Watch $ — $ — $ — $ — $ 10 $ 268 $ 87,693 $ 87,971 Substandard — — — — — 377 398 775 Total home equity $ — $ — $ — $ — $ 10 $ 645 $ 88,091 $ 88,746 Other residential: Pass and Watch $ 15,800 $ 31,981 $ 25,529 $ 15,411 $ 7,964 $ 17,873 $ — $ 114,558 Total other residential $ 15,800 $ 31,981 $ 25,529 $ 15,411 $ 7,964 $ 17,873 $ — $ 114,558 Installment and other consumer: Pass and Watch $ 17,207 $ 7,748 $ 9,436 $ 5,633 $ 1,123 $ 6,620 $ 1,766 $ 49,533 Total installment and other consumer $ 17,207 $ 7,748 $ 9,436 $ 5,633 $ 1,123 $ 6,620 $ 1,766 $ 49,533 Total loans: Pass and Watch $ 445,036 $ 375,654 $ 306,557 $ 222,117 $ 129,675 $ 486,821 $ 180,287 $ 2,146,147 Total Special Mention $ 16,748 $ 2,914 $ 3,298 $ 19,892 $ 1,787 $ 26,536 $ 2,088 $ 73,263 Total Substandard $ — $ 7,155 $ 285 $ 695 $ — $ 26,511 $ 1,475 $ 36,121 Doubtful $ — $ 114 $ — $ — $ — $ — $ — $ 114 Totals $ 461,784 $ 385,837 $ 310,140 $ 242,704 $ 131,462 $ 539,868 $ 183,850 $ 2,255,645 Page-19 The following table shows the amortized cost of loans by class, payment aging and non-accrual status as of September 30, 2022 and December 31, 2021. 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 September 30, 2022 30-59 days past due $ 1,007 $ — $ — $ — $ 520 $ — $ — $ 1,527 60-89 days past due 1,474 — — — 360 — — 1,834 90 days or more past due 255 — — — 54 — — 309 Total past due 2,736 — — — 934 — — 3,670 Current 204,752 368,415 1,211,651 112,154 88,310 114,247 55,137 2,154,666 Total loans 1 $ 207,488 $ 368,415 $ 1,211,651 $ 112,154 $ 89,244 $ 114,247 $ 55,137 $ 2,158,336 Non-accrual loans 2 $ — $ 9,846 $ — $ — $ 699 $ — $ 92 $ 10,637 Non-accrual loans with no allowance $ — $ 9,846 $ — $ — $ 699 $ — $ 92 $ 10,637 December 31, 2021 30-59 days past due $ 2 $ — $ — $ — $ 498 $ — $ 1,036 $ 1,536 60-89 days past due 394 — — — 67 — — 461 90 days or more past due 229 — — — 88 — — 317 Total past due 625 — — — 653 — 1,036 2,314 Current 300,977 392,345 1,189,021 119,840 88,093 114,558 48,497 2,253,331 Total loans 1 $ 301,602 $ 392,345 $ 1,189,021 $ 119,840 $ 88,746 $ 114,558 $ 49,533 $ 2,255,645 Non-accrual loans 2 $ — $ 7,269 $ 694 $ — $ 413 $ — $ — $ 8,376 Non-accrual loans with no allowance $ — $ 7,269 $ 694 $ — $ 413 $ — $ — $ 8,376 1 There were no non-performing loans past due more than ninety days and accruing interest as of September 30, 2022 and December 31, 2021. 2 None of the non-accrual loans as of September 30, 2022 or December 31, 2021 were earning interest on a cash basis. We recognized no interest income on non-accrual loans for the three and nine months ended September 30, 2022 and 2021. Accrued interest of $ 47 thousand was reversed from interest income for loans that were placed on non-accrual during the nine months ended September 30, 2022. No interest income was reversed for the single loan that was placed on non-accrual during the nine months ended September 30, 2021. Collateral Dependent Loans The following table presents the amortized cost basis of individually analyzed collateral-dependent loans, which are all on non-accrual status, by class at September 30, 2022 and December 31, 2021. Amortized Cost by Collateral Type (in thousands) Commercial Real Estate Residential Real Estate Other Total 1 Allowance for Credit Losses September 30, 2022 Commercial real estate, owner-occupied $ 9,846 $ — $ — $ 9,846 $ — Home equity — 699 — 699 — Installment and other consumer — — 92 92 — Total $ 9,846 $ 699 $ 92 $ 10,637 $ — December 31, 2021 Commercial real estate, owner-occupied $ 7,269 $ — $ — $ 7,269 $ — Commercial real estate, investor-owned 694 — — 694 — Home equity — 413 — 413 — Total $ 7,963 $ 413 $ — $ 8,376 $ — 1 There were no collateral-dependent residential real estate mortgage loans in process of foreclosure or in substance repossessed at September 30, 2022 or December 31, 2021. The weighted average loan-to-value of collateral dependent loans was approximately 66 % at September 30, 2022 and 67 % at December 31, 2021. 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. Page-20 We may remove a loan from TDR designation if it meets all of the following conditions: • The loan is subsequently refinanced or restructured at current market interest rates and the new terms are consistent with the treatment of creditworthy borrowers under regular underwriting standards; • The borrower is no longer considered to be in financial difficulty; • Performance on the loan is reasonably assured; and • Existing loan did not have any forgiveness of principal or interest. There were no loans removed from TDR designation during the nine months ended September 30, 2022. We removed one commercial loan with a remaining amortized cost of $ 2 thousand and an unfunded commitment of $ 600 thousand from TDR designation during the nine months ended September 30, 2021 after meeting all of the conditions above. In accordance with section 4013 of the CARES Act, subsequently amended by section 541 of the 2020 Economic Aid Act, we elected to apply the temporary accounting relief provisions for loan modifications that met certain criteria, which would otherwise be designated as TDRs under existing GAAP. As of September 30, 2022, one borrowing relationship with two loans totaling $ 7.1 million was continuing to benefit from payment relief. Shortly after quarter end, both of the loans, which were classified substandard and on non-accrual, were paid off. The following table summarizes the amortized cost of TDR loans by loan class as of September 30, 2022 and December 31, 2021. (in thousands) September 30, 2022 December 31, 2021 Commercial and industrial $ 941 $ 1,183 Commercial real estate, owner-occupied 9,436 7,155 Commercial real estate, investor-owned 165 179 Home equity 629 386 Installment and other consumer 561 607 Total 1 $ 11,732 $ 9,510 1 TDR loans on non-accrual status totaled $ 9.9 million and $ 7.4 million at September 30, 2022 and December 31, 2021, respectively. Unfunded commitments for TDR loans totaled $ 218 thousand and $ 441 thousand as of September 30, 2022 and December 31, 2021, respectively. The following table presents information for loans modified in a TDR during the presented periods, including the number of modified contracts, the amortized cost of the loans prior to modification, and the amortized cost of 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 September 30, 2022: Commercial real estate, owner occupied 2 $ 2,308 $ 2,308 $ 2,308 Home equity 2 147 147 147 Total 4 $ 2,455 $ 2,455 $ 2,455 TDRs during the three months ended September 30, 2021: Commercial and industrial 1 $ 1,101 $ 1,101 $ 1,101 (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 nine months ended September 30, 2022: Commercial real estate, owner occupied 2 $ 2,308 $ 2,308 $ 2,308 Home equity 3 247 247 247 Total 5 $ 2,555 $ 2,555 $ 2,555 TDRs during the nine months ended September 30, 2021: Commercial and industrial 1 $ 1,101 $ 1,101 $ 1,101 The loan modifications in 2022 included one or more of the following: payment deferment, maturity date extension, interest rate concession, and/or other payment modifications. Three of the modifications in 2022 (or 93%) were for Page-21 one borrowing relationship. The loan modified in 2021 reflected a maturity date extension and other loan term and payment modifications. During the three and nine months ended September 30, 2022 and 2021, 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. Allowance for Credit Losses on Loans Rollforward The following table discloses activity in the allowance for credit losses on loans for the periods presented. Allowance for Credit Losses on Loans Rollforward (in thousands) Commercial and industrial Commercial real estate, owner-occupied Commercial real estate, investor-owned Construction Home equity Other residential Installment and other consumer Unallocated Total Three months ended September 30, 2022 Beginning balance $ 1,699 $ 2,617 $ 12,439 $ 1,737 $ 530 $ 585 $ 733 $ 2,199 $ 22,539 Provision (reversal) 265 ( 81 ) 299 38 12 5 83 ( 199 ) 422 Charge-offs ( 9 ) — — — — — ( 1 ) — ( 10 ) Recoveries 3 — — 9 — — — — 12 Ending balance $ 1,958 $ 2,536 $ 12,738 $ 1,784 $ 542 $ 590 $ 815 $ 2,000 $ 22,963 Three months ended September 30, 2021 Beginning balance $ 1,590 $ 2,037 $ 10,761 $ 1,142 $ 412 $ 613 $ 238 $ 2,307 $ 19,100 Provision (reversal) 126 ( 30 ) 1,011 77 247 4 384 ( 19 ) 1,800 Initial allowance for PCD loans 405 559 533 — — 6 2 — 1,505 Charge-offs — — — — — — ( 2 ) — ( 2 ) Recoveries 3 — — 8 — — — — 11 Ending balance $ 2,124 $ 2,566 $ 12,305 $ 1,227 $ 659 $ 623 $ 622 $ 2,288 $ 22,414 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 Nine months ended September 30, 2022 Beginning balance $ 1,709 $ 2,776 $ 12,739 $ 1,653 $ 595 $ 644 $ 621 $ 2,286 $ 23,023 Provision (reversal) 248 ( 240 ) ( 1 ) 106 ( 53 ) ( 54 ) 217 ( 286 ) ( 63 ) Charge-offs ( 9 ) — — — — — ( 23 ) — ( 32 ) Recoveries 10 — — 25 — — — — 35 Ending balance $ 1,958 $ 2,536 $ 12,738 $ 1,784 $ 542 $ 590 $ 815 $ 2,000 $ 22,963 Nine months ended September 30, 2021 Beginning balance $ 2,530 $ 2,778 $ 12,682 $ 1,557 $ 738 $ 998 $ 291 $ 1,300 $ 22,874 Provision (reversal) ( 821 ) ( 771 ) ( 910 ) ( 356 ) ( 129 ) ( 381 ) 331 988 ( 2,049 ) Initial allowance for PCD loans 405 559 533 — — 6 2 — 1,505 Charge-offs — — — — — — ( 2 ) — ( 2 ) Recoveries 10 — — 26 50 — — — 86 Ending balance $ 2,124 $ 2,566 $ 12,305 $ 1,227 $ 659 $ 623 $ 622 $ 2,288 $ 22,414 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 $ 1.300 billion and $ 1.330 billion at September 30, 2022 and December 31, 2021, respectively. In addition, we pledge eligible TIC loans, which totaled $ 105.7 million and $ 106.2 million at September 30, 2022 and December 31, 2021, respectively, to secure our borrowing capacity with the Federal Reserve Bank ("FRB"). For additional information, see Note 6, Borrowings. Related Party Loans The Bank has, and expects to have in the future, banking transactions in the ordinary course of its business with directors, officers, principal shareholders and their businesses or associates. These transactions, including loans, are granted on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with persons not related to us. Likewise, these transactions do not involve more than the normal risk of collectability or present other unfavorable features. Related party loans totaled Page-22 $ 6.5 million at September 30, 2022 and $ 7.9 million at December 31, 2021. In addition, undisbursed commitments to related parties totaled $ 562 thousand at September 30, 2022 and $ 8.6 million at December 31, 2021. The decreases in both the outstanding amount and undisbursed commitment as of September 30, 2022 were primarily due to a Director retirement in the first quarter. Note 6: Borrowings and Other Obligations Federal Funds Purchased – The Bank had unsecured available lines of credit with correspondent banks for overnight borrowings totaling $ 150.0 million at September 30, 2022 and December 31, 2021. In general, interest rates on these lines approximate the federal funds target rate. We had no overnight borrowings under these credit facilities at September 30, 2022 or December 31, 2021 . Federal Home Loan Bank Borrowings – As of September 30, 2022 and December 31, 2021, the Bank had available lines of credit with the FHLB totaling $ 739.6 million and $ 820.5 million, respectively, based on eligible collateral of certain loans. There were no FHLB overnight borrowings at September 30, 2022 or December 31, 2021. Federal Reserve Line of Credit – The Bank has an available line of credit with the Federal Reserve Bank of San Francisco ("FRBSF") secured by certain residential loans. At September 30, 2022 and December 31, 2021, the Bank had borrowing capacity under this line totaling $ 54.2 million and $ 70.8 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 a 251.5 % effective rate for the first nine months of 2021, and included accelerated accretion of the $ 1.3 million remaining purchase discount due to the early redemption. Other Obligations – Finance lease liabilities totaling $ 365 thousand and $ 419 thousand at September 30, 2022 and December 31, 2021, 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 22, 2022, Bancorp declared a $ 0.25 per share cash dividend, payable on August 12, 2022 to shareholders of record at the close of business on August 5, 2022. Subsequent to quarter end on October 21, 2022, Bancorp declared a $ 0.25 per share cash dividend, payable on November 14, 2022 to shareholders of record at the close of business on November 7, 2022. 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 Page-23 probability that the performance criteria will be achieved to determine the amount of compensation expense to be recognized. The estimate is re-evaluated quarterly and total compensation expense is adjusted for any change in the current period. We record excess tax benefits (deficiencies) resulting from the exercise of non-qualified stock options, the disqualifying disposition of incentive stock options and vesting of restricted stock awards as income tax benefits (expense) in the consolidated statements of comprehensive income with a corresponding decrease (increase) to current taxes payable. The holders of unvested restricted stock awards are entitled to dividends on the same per-share ratio as holders of common stock. Tax benefits for dividends paid on unvested restricted stock awards are recorded as tax benefits in the consolidated statements of comprehensive income with a corresponding decrease to current taxes payable. Dividends on forfeited awards are included in stock-based compensation expense. Stock options and restricted stock may be net settled in a cashless exercise by a reduction in the number of shares otherwise deliverable upon exercise or vesting in satisfaction of the exercise payment and/or applicable tax withholding requirements. During the nine months ended September 30, 2022, we withheld 11,505 shares totaling $ 393 thousand at a weighted-average price of $ 34.13 for cashless exercises. During the nine months ended September 30, 2021, we withheld 27,679 shares totaling $ 1.1 million at a weighted-average price of $ 38.86 for cashless exercises. Shares withheld under net settlement arrangements are available for future grants. Share Repurchase Program Bancorp has an approved share repurchase program with $ 34.7 million outstanding. The last activity under the program was in the first quarter of 2022. Bancorp repurchased 23,275 shares totaling $ 877 thousand in the first nine months of 2022. Cumulative shares repurchased under the current program totaled 618,991 shares as of September 30, 2022 at an average price of $ 36.04 per share. Note 8: Commitments and Contingent Liabilities Financial Instruments with Off-Balance Sheet Risk We make commitments to extend credit in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because various commitments will expire without being fully drawn, the total commitment amount does not necessarily represent future cash requirements. Our credit loss exposure is equal to the contractual amount of the commitment in the event of nonperformance by the borrower. We use the same credit underwriting criteria for all credit exposure. The amount of collateral obtained, if deemed necessary by us, is based on management's credit evaluation of the borrower. Collateral types pledged may include accounts receivable, inventory, other personal property and real property. The contractual amount of unfunded loan commitments and standby letters of credit not reflected in the consolidated statements of condition are as follows: (in thousands) September 30, 2022 December 31, 2021 Commercial lines of credit $ 283,731 $ 330,234 Revolving home equity lines 216,632 210,938 Undisbursed construction loans 47,795 78,381 Personal and other lines of credit 11,556 11,001 Standby letters of credit 1,978 3,657 Total commitments and standby letters of credit $ 561,692 $ 634,211 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 Page-24 for credit losses on unfunded commitments totaled $ 1.5 million and $ 1.8 million as of September 30, 2022 and December 31, 2021, respectively, which is included in interest payable and other liabilities in the consolidated statements of condition. We recorded no provision for credit losses on unfunded commitments for the third quarters of 2022 and 2021. This compares to reversals of $ 318 thousand and $ 1.2 million for the nine months ended September 30, 2022 and 2021, respectively, due to improved economic forecasts at the time. Leases We lease premises under long-term non-cancelable operating leases with remaining terms of 3 months to 20 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 5 years. The equipment finance leases do not contain renewal options, bargain purchase options or residual value guarantees. The following table shows the balances of operating and finance lease right-of-use assets and lease liabilities. (in thousands) September 30, 2022 December 31, 2021 Operating leases: Operating lease right-of-use assets $ 25,006 $ 23,604 Operating lease liabilities $ 26,744 $ 25,429 Finance leases: Finance lease right-of-use assets $ 512 $ 499 Accumulated amortization ( 158 ) ( 93 ) Finance lease right-of-use assets, net 1 $ 354 $ 406 Finance lease liabilities 2 $ 365 $ 419 1 Included in premises and equipment in the consolidated statements of condition. 2 Included in borrowings and other obligations in the consolidated statements of condition. The following table shows supplemental disclosures of noncash investing and financing activities for the periods presented. Nine months ended (in thousands) September 30, 2022 September 30, 2021 Right-of-use assets obtained in exchange for operating lease liabilities $ 4,989 $ 2,376 Right-of-use assets obtained in exchange for finance lease liabilities $ 41 $ 444 The following table shows components of operating and finance lease cost. Three months ended Nine months ended (in thousands) September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 Operating lease cost $ 1,328 $ 1,216 $ 3,907 $ 3,543 Variable lease cost — — — — Total operating lease cost 1 $ 1,328 $ 1,216 $ 3,907 $ 3,543 Finance lease cost: Amortization of right-of-use assets 2 $ 31 $ 31 $ 93 $ 65 Interest on finance lease liabilities 3 1 1 2 1 Total finance lease cost $ 32 $ 32 $ 95 $ 66 Total lease cost $ 1,360 $ 1,248 $ 4,002 $ 3,609 1 Included in occupancy and equipment expense in the consolidated statements of comprehensive income. 2 Included in depreciation and amortization in the consolidated statements of comprehensive income. 3 Included in interest on borrowings and other obligations in the consolidated statements of comprehensive income. The following table shows the future minimum lease payments, weighted average remaining lease terms, and weighted average discount rates under operating and finance lease arrangements as of September 30, 2022. The discount rates used to calculate the present value of lease liabilities were based on the collateralized FHLB Page-25 borrowing rates that were commensurate with lease terms and minimum payments on the lease commencement date. (in thousands) September 30, 2022 Year Operating Leases Finance Leases 2022 $ 1,369 $ 32 2023 5,236 125 2024 4,412 123 2025 3,676 76 2026 2,888 10 Thereafter 11,938 5 Total minimum lease payments 29,519 371 Amounts representing interest (present value discount) ( 2,775 ) ( 6 ) Present value of net minimum lease payments (lease liability) $ 26,744 $ 365 Weighted average remaining term (in years) 7.8 3.1 Weighted average discount rate 2.13 % 0.94 % Litigation Matters Bancorp may be party to legal actions that arise from time to time in the normal course of business. Bancorp's management is not aware of any pending legal proceedings to which either it or the Bank may be a party or has recently been a party that will have a material adverse effect on the financial condition or results of operations of Bancorp or the Bank. The Bank is responsible for a proportionate share of certain litigation indemnifications provided to Visa U.S.A. ("Visa") by its member banks in connection with Visa's lawsuits related to anti-trust charges and interchange fees ("Covered Litigation"). Our proportionate share of the litigation indemnification liability does not change or transfer upon the sale of our Class B Visa shares to member banks. Visa established an escrow account to pay for settlements or judgments in the Covered Litigation. Under the terms of the U.S. retrospective responsibility plan, when Visa funds the litigation escrow account, it triggers a conversion rate reduction of the Class B common stock to shares of Class A common stock, effectively reducing the aggregate value of the Class B common stock held by Visa's member banks like us. In 2012, Visa reached a $ 4.0 billion interchange multidistrict litigation class settlement agreement with plaintiffs representing a class of U.S. retailers. For the fiscal year ended September 30, 2022, Visa deposited an additional $ 600 million into the litigation escrow account to address claims of certain merchants who opted out of the Amended Settlement Agreement for a balance of $ 1.5 billion. Combined with funds previously deposited with the court, these funds 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. Page-26 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 September 30, 2022, 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 $ 519 at September 30, 2022 and $ 11 thousand at December 31, 2021. Information on our derivatives follows: Asset Derivatives Liability Derivatives (in thousands) September 30, 2022 December 31, 2021 September 30, 2022 December 31, 2021 Fair value hedges: Interest rate contracts notional amount $ 12,298 $ — $ — $ 13,037 Interest rate contracts fair value 1 $ 649 $ — $ — $ 1,085 1 See Note 3, Fair Value of Assets and Liabilities, for valuation methodology. The following table presents the carrying amount and associated cumulative basis adjustment related to the application of fair value hedge accounting that is included in the carrying amount of hedged assets as of September 30, 2022 and December 31, 2021. Carrying Amounts of Hedged Assets Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Loans (in thousands) September 30, 2022 December 31, 2021 September 30, 2022 December 31, 2021 Loans $ 11,519 $ 13,976 $ ( 779 ) $ 939 The following table presents the net losses recognized in interest income on loans on the consolidated statements of comprehensive income related to our derivatives designated as fair value hedges. Three months ended Nine months ended (in thousands) September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 Interest and fees on loans 1 $ 23,357 $ 24,027 $ 70,368 $ 66,117 Increase in fair value of designated interest rate swaps due to LIBOR interest rate movements $ 547 $ 97 $ 1,734 $ 646 Payment on interest rate swaps ( 19 ) ( 93 ) ( 169 ) ( 278 ) Decrease in fair value hedging adjustment of hedged loans ( 538 ) ( 94 ) ( 1,718 ) ( 631 ) Decrease in value of yield maintenance agreement ( 3 ) ( 3 ) ( 8 ) ( 9 ) Net losses on fair value hedging relationships recognized in interest income $ ( 13 ) $ ( 93 ) $ ( 161 ) $ ( 272 ) 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: Page-27 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 September 30, 2022 Derivatives by Counterparty: Counterparty A $ 649 $ — $ 649 $ ( 649 ) $ — $ — December 31, 2021 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 September 30, 2022 Derivatives by Counterparty: Counterparty A $ — $ — $ — $ — $ — $ — December 31, 2021 Derivatives by Counterparty: Counterparty A $ 1,085 $ — $ 1,085 $ — $ ( 1,085 ) $ — 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 2021 Form 10-K filed with the SEC on March 15, 2022. Note 10: Merger Bancorp completed its merger and acquired all assets and assumed all liabilities of AMRB on August 6, 2021. The Merger expanded Bank of Marin's presence throughout the Greater Sacramento, Amador and Sonoma County Regions where AMRB had ten branches. T he Merger added $ 297.8 million in investment securities, $ 419.4 million in loans and $ 790.0 million in deposits to Bank of Marin as of the merger date. Bancorp accounted for the Merger as a business combination under the acquisition method of accounting. The assets acquired and liabilities assumed, both tangible and intangible, were recorded at their fair values as of the merger date in accordance with ASC 805, Business Combinations . AMRB shareholders received 0.575 shares of Bancorp's common stock for each share of AMRB common stock outstanding immediately prior to the Merger resulting in the issuance of 3,441,235 shares of Bancorp common stock. In addition, merger consideration included cash paid for outstanding stock options and cash paid in lieu of fractional shares, as summarized in the following table. (in thousands) Merger Consideration Value of common stock consideration paid to shareholders ( 0.575 fixed exchange ratio, stock price $ 36.15 ) $ 124,401 Cash consideration for stock options 63 Cash paid in lieu of fractional shares 13 Total merger consideration $ 124,477 We recorded $ 42.6 million in goodwill, which represents the excess of the total merger consideration paid over the fair value of the assets acquired, net of the fair values of liabilities assumed. Goodwill mainly reflects expected value created through the combined operations of AMRB and Bancorp and is evaluated for impairment annually. The core deposit intangible ("CDI") represents the estimated future benefits of acquired deposits and is recorded separately from the related deposits. We recorded a core deposit intangible asset of $ 3.9 million related to the AMRB merger, of w hic h $ 174 thousand and $ 537 thousand, respe ctively, were amort ized in the three and nine month periods ended September 30, 2022. Amortization for both the three and nine month periods ended September 30, 2021 totaled $ 129 thousand. The CDI is amortized on an accelerated basis over an estimated ten-year life and is evaluated periodically for impairment. No impairment losses were recognized as of September 30, 2022 and September 30, 2021. Page-28 Merger-related one time and conversion costs are recognized as incurred and continue until all systems have been converted and operational functions are fully integrated. Bancorp's merger-related costs reflected in the consolidated statements of comprehensive income are summarized in the following table. Three months ended Nine months ended (in thousands, unaudited) September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 Personnel and severance $ — $ 2,668 $ 393 $ 2,668 Professional services — 1,778 67 1,979 Data processing — 433 77 433 Other expense — 263 321 279 Total merger-related one-time and conversion costs $ — $ 5,142 $ 858 $ 5,359 Page-29