What changed in this filing

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Item 7. Management’s Discussion and Analysis

2023-03-16 compared with 2022-03-15 · 227 added, 230 removed, 607 unchanged (43% of the section changed)

11 unchanged sentences

The allowance for credit losses on unfunded commitments is a liability account included in interest payable and other liabilities.

Management estimates these allowances quarterly using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.

Management estimates these allowances quarterly using relevant available information, from

internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.

Credit loss experience among the Bank and peer groups provides the basis for the estimation of expected credit losses.

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For periods beyond the forecast horizon the economic factors revert to historical averages on a straight-line basis over a one-year period.

We performed a sensitivity analysis as of December 31, 2021 and determined that a 1% change (e.g., 5.5% to 6.5%) in the forecasted quarterly unemployment rates over the next four quarters resulted in an 8% change to our allowance for credit losses on loans.

This impact does not consider other assumption changes to either the quantitative factors, such as probability of default, loss given

default, loan mix or cash flows, prepayment/curtailment rates, and individually analyzed loans, or qualitative factors as discussed in Note 1 - Summary of Significant Accounting Policies.

Additionally, because current economic conditions and forecasts can change, as future events are inherently difficult to predict, the estimated credit losses on loans and unfunded commitments could change significantly.

We performed a sensitivity analysis as of December 31, 2022 and determined that a 1% change (e.g., 4.5% to 5.5%) in the forecasted quarterly unemployment rates over the next four quarters resulted in a 6% change to our allowance for credit losses on loans.

This impact does not consider other assumption changes to either the quantitative factors, such as probability of default, loss given default, loan mix or cash flows, prepayment/curtailment rates, and individually analyzed loans, or qualitative factors as discussed in Note 1 - Summary of Significant Accounting Policies.

Additionally, b ecause current economic conditions and forecasts can change, as future events are inherently difficult to predict, the estimated credit losses on loans and unfunded commitments could change significantly.

While we believe we use the best information available to determine the allowance for credit losses, our results of operations could be significantly affected if circumstances differ substantially from the assumptions used in determining the allowance.

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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.

The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used in the measurement are observable or unobservable.

The classification of assets and liabilities

within the hierarchy is based on whether the inputs to the valuation methodology used in the measurement are observable or unobservable.

Observable inputs reflect market-driven or market-based information obtained from independent sources, while unobservable inputs reflect our estimates about market data.

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Management assesses qualifications of third-party valuation specialists, reviews assumptions applied and takes responsibility for the results of fair value estimates.

Merger-related expenses include costs directly related to

merger activity such as legal and professional fees, system consolidation and conversion costs, and compensation costs associated with employee severance and retention incentives.

Merger-related expenses include costs directly related to merger activity such as legal and professional fees, system consolidation and conversion costs, and compensation costs associated with employee severance and retention incentives.

We account for merger-related costs as expenses in the periods in which the costs are incurred and the services received.

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Total assets $ 4,147,464 $ 4,314,209

Loans, net allowance for credit losses on loans 1

Investment securities $ 1,774,303 $ 1,509,790

Loans, net of allowance for credit losses on loans 1

$ 2,069,563 $ 2,232,622

1 unchanged sentence

Borrowings and other obligations $ 112,439 $ 419

Subordinated debenture $ — $ 2,777

Stockholders' equity $ 412,092 $ 450,368

3 unchanged sentences

1.10 % 1.07 %

Allowance for credit losses to non-accrual loans 3

Allowance for credit losses to non-accrual loans 9.45x 2.75x

Non-accrual loans to total loans 0.12 % 0.37 %

0.37 % 0.44 %

Capital ratios:

Tangible common equity to tangible assets 8.21 % 8.76 %

8.76 % 11.27 %

Total capital (to risk-weighted assets) 15.90 % 14.58 %

9 unchanged sentences

Net interest income $ 127,492 $ 104,951 $ 96,659

Provisions for (reversals of) credit losses on loans and unfunded loan commitments, net (2,441) 6,164 1,029

(Reversals of) provision for credit losses on loans and unfunded loan commitments, net (381) (2,441) 6,164

Non-interest income 10,905 10,132 8,550

9 unchanged sentences

Tax-equivalent net interest margin 3.11 % 3.17 % 3.55 %

3.17 % 3.55 % 3.98 %

Cost of deposits 0.06 % 0.07 % 0.11 %

6 unchanged sentences

Refer to footnote 1 above for SBA PPP totals.

3 Non-performing loans include loans on non-accrual status.

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

Tangible common equity of $371million, $324 million and $302 million at December 31, 2021, 2020 and 2019, respectively, includes common stock, retained earnings and unrealized gains (losses) on available-for sale securities, net of tax, less goodwill and intangible assets of $79million, $34 million and $35 million at December 31, 2021, 2020, and 2019, respectively.

Tangible assets excludes goodwill and core deposit intangible assets.

5 2021 included $6.5 million (or $4.9 million, net of taxes) in merger-related one-time and conversion costs.

6 Tax-equivalent net interest margin is computed by dividing taxable equivalent net interest income, which is adjusted for taxable equivalent income on tax-exempt loans and securities based on federal statutory rate of 21% in 2021, 2020 and 2019, by total average interest-earning assets.

3 2022 and 2021 included $858 thousand (or $604 thousand, net of taxes) and $6.5 million (or $4.9 million, net of taxes), respectively, in merger-related and conversion costs.

4 Calculated as dividends on common shares divided by basic net income per common share.

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The following are highlights of operating and financial performance for the year ended December 31, 2022:

• Merger-related one-time and conversion costs reduced net income by $4.9 million, net of taxes, or 34 cents per share for the year ended December 31, 2021.

Return on average assets ("ROA") and return on average equity ("ROE") were also significantly impacted by provisions for credit losses on acquired loans and shares issued in conjunction with the merger.

As shown in the reconciliation of GAAP to non-GAAP financial measures on pag e 28, year-to-date ROA of 0.94% and ROE 8.43% would have been 1.08% and 9.67%, respectively, compared to 1.04% and 8.60% in the prior year.

• Loans increased $167.1 million in 2021, or 8%, to $2.256 billion at December 31, 2021, from $2.089 billion at December 31, 2020.

Year-over-year growth was largely attributable to $419.4 million in loans from the American River Bank ("ARB") acquisition on August 6, 2021.

Non-PPP loan originations of $181.7 million for the year were concentrated in commercial and real estate loans and compared to $165.5 million in 2020.

Payoffs included $218.1 million non-PPP loans compared to $169.2 million in 2020.

In 2021, PPP loan originations were $136.2 million and PPP loans forgiven and paid off were $328.5 million.

• Credit quality remains strong with non-accrual loans representing 0.37% of the Bank's loan portfolio as of December 31, 2021, compare to 0.44% at December 31, 2020.

During 2021, we reversed $1.4 million in credit losses on loans and $992 thousand in credit losses on unfunded commitments.

These reversals compared to provisions for credit losses on loans of $4.6 million and provisions for credit losses on unfunded commitments of $1.6 million in the prior year.

2021 activity included the effects of the business combination with ARB, partially offset by ongoing improvements in the underlying economic forecasts.

2020 credit loss provisions included significant qualitative adjustments for uncertainties associated with the COVID-19 pandemic as well as the adoption of the current expected credit loss methodology.

• Deposits grew $1.304 billion, or 52%, to $3.809 billion at December 31, 2021, compared to $2.504 billion at December 31, 2020.

Growth was comprised of $790.0 million related to the August 6, 2021 ARB acquisition, new accounts and growth in the existing customer base.

Non-interest bearing deposits grew by $555.6 million, or 41%, in 2021 and made up 50% of total deposits at year end.

Cost of deposits remained low at 0.07% for the full year of 2021, down from 0.11% in 2020.

Additionally, as part of our liquidity management, the Bank maintained $173.1 million and $173.4 million in off-balance sheet deposits with deposit networks at December 31, 2021 and 2020, respectively.

• Merger-related and conversion costs reduced net income by $604 thousand, or 4 cents per share in 2022, compared to $4.9 million, or 34 cents per share in 2021.

As shown in the reconciliation of GAAP to non-GAAP financial measu res on page 28, year- to-date return on average assets of 1.08% and return on average equity of 11.16% excluding these costs would have been 1.10% and 11.31%, respectively, compared to 1.08% and 9.67%, respectively, in 2021.

• Loans decreased by $163.1 million in 2022, or 7%, to $2.093 billion as of December 31, 2022, from $2.256 billion as of December 31, 2021.

Loan originations of $240.2 million in 2022 were the second highest on record, while payoffs were uncharacteristically high.

Payoffs included both Paycheck Protection Program ("P PP") loans and $258.5 million of non-PPP loans, many of which were outside the Bank's control and resulted from activities such as sales of businesses and properties, cash repayments, and project completions.

Shortly after December 31, we originated $45 million in commercial loans that were in process at year-end, $20 million of which was syndicated to a participant bank.

• Credit quality remained strong and improved during 2022, with classified loans decreasing $8.1 million and non-accrual loans representing 0.12% of the total loans as of December 31, 2022, compared to 0.37% as of December 31, 2021.

Non-accrual loans dropped by $5.9 million (or 71%) in 2022, substantially due to the payoff of three commercial real estate loans from two borrowers.

Subsequent to year-end, an additional $1.2 million in non-accrual loans paid off.

In 2022 and 2021, we recorded net reversals of the provision for credit losses on loans of $63 thousand and $1.4 million, respectively.

In addition, in 2022 and 2021, we recorded net reversals of the provision for credit losses on unfunded commitments of $318 thousand and $992 thousand, respectively.

• Deposits decreased by $235.2 million to $3.573 billion as of December 31, 2022, compared to $3.809 billion as of December 31, 2021, as the Bank continued to carefully manage deposit costs.

The decline was a result of anticipated outflows due to planned business activities by a few large clients and some customers moving into alternative investments.

At the end of 2021, the Bank held $347.6 million in cash and cash equivalents, and $173.1 million in off-balance sheet amounts with deposit networks in anticipation of expected and potential unexpected deposit outflows during 2022.

There were no balances held with deposit networks at the end of 2022.

Despite the decrease, non-interest bearing deposits to total deposits increased slightly to 51.5% as of December 31, 2022, compared to 50.2% as of December 31, 2021.

Cost of deposits remained low at 0.06% in 2022, down slightly from 0.07% in 2021.

• Net interest income totaled $127.5 million and $105.0 million in 2022 and 2021, respectively.

The $8.3 million increase in 2021 was primarily due to higher average loan and investment securities balances and higher SBA PPP loan fee accretion income.

These increases were partially offset by $1.3 million in accelerated discount accretion on the early redemption of a subordinated debenture in the first quarter of 2021, and lower yields on investment securities.

The tax-equivalent net interest margin decreased by 38 basis points to 3.17% in 2021, compared to 3.55% in 2020 for the reasons already mentioned.

• The efficiency ratio was 63.12% in 2021, up from 55.56% in 2020.

As shown in the reconciliation of GAAP to non-GAAP financial measures on pa ge 28, t he 2021 efficiency ratio excluding merger-related one-time and conversion costs would have been 57.51%.

The $22.5 million increase from the prior year was primarily due to higher balances in the investment securities and commercial real estate loan portfolios, a full year of net interest income from acquired earning assets of American River Bankshares ("AMRB"), compared to five months in 2021, and the early redemption of subordinated debt that generated $1.4 million of interest expense in 2021.

The tax-equivalent net interest margin decreased by 6 basis points to 3.11% in 2022, compared to 3.17% in 2021, as the proportion of average investment securities to average total interest-earning assets grew from 26% in 2021 to 44% in 2022 and fee income from PPP loans declined.

• The efficiency ratio was 54.39% in 2022, compared to 63.12% in 2021.

As shown in the reconciliation of GAAP to non-GAAP financial measures on page 28, t he efficiency ratios excluding merger-related and conversion costs would have been 53.77% and 57.51% in 2022 and 2021, respectively.

• After careful consideration, the Bank decided to close four brick-and-mortar branch locations in March 2023.

The acquisition of American River Bankshares resulted in an overlap in the Bank’s branch network in Santa Rosa and Healdsburg, prompting branch consolidations within Northern Sonoma County.

In addition, our

Tiburon and Buckhorn branches in Southern Marin and Amador counties are close to other branches that can serve our customers.

These closures fulfill the remaining expense savings anticipated from the acquisition, improve efficiency and optimize our delivery channels while generating savings that will help to fund strategic initiatives going forward.

The expected pre-tax savings in 2023 from the branch closures, net of accelerated costs, is approximately $470 thousand, and future annual pre-tax savings are expected to be approximately $1.4 million.

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

The total risk-based capital ratio for Bancorp was 15.9% at December 31, 2022 and 14.6% at December 31, 2021.

Tangible common equity to tangible assets declined to 8.8% at December 31, 2021 from 11.3% at December 31, 2020 primarily due to share repurchases and growth in excess liquidity from an increase in legacy Bank of Marin deposits (refer to footnote 4 on page 26 for definition of this non-GAAP financial measure).

Tangible common equity to tangible assets declined to 8.2% at December 31, 2022 from 8.8% at December 31, 2021, primarily due to $71.7 million increase in after-tax unrealized losses on available-for-sale securities associated with interest rate changes since December 31, 2021, partially offset by incremental earnings and the smaller balance sheet in 2022.

The total risk-based capital ratio for the Bank was 15.7% at December 31, 2022 and 14.4% at December 31, 2021.

• The Board of Directors declared a cash dividend of $0.25 per share on January 20, 2023.

This is the 67 th consecutive quarterly dividend paid by Bank of Marin Bancorp.

The cash dividend is payable on February 11, 2022 to shareholders of record at the close of business on February 4, 2022.

This is the 71 st consecutive quarterly dividend paid by Bank of Marin Bancorp.

The cash dividend was paid on February 10, 2023 to shareholders of record at the close of business on February 3, 2023.

• As recent events in the marketplace unfold, including the closures of Silicon Valley Bank on March 10, 2023 followed by Signature Bank on March 12, 2023, the Bank remains focused on our banking relationships.

We believe our deposit franchise is sound, with a focus on core deposits from community-based customers with whom we have strong relationships.

Those relationships are centered around the needs of local corporations, business operators and real estate investors, with very little exposure to technology start-up companies and no exposure to digital assets, two areas of risk that strongly influenced the aforementioned closures.

On March 13, 2023, we initiated an outreach effort to answer our customers' questions or concerns about the recent events, strengths of the Bank, and other matters such as FDIC insurance coverage.

In February 2023, we enhanced our borrowing capacity at the FHLB by pledging certain held-to-maturity securities to the Securities-Backed Credit Program, increasing our total immediate contingent funding sources to approximately $2.0 billion, or 59% of total deposits as of February 28, 2023.

The Bank also has the option to add another $267 million to its borrowing capacity through the Federal Reserve’s new Bank Term Funding Program ("BTFP").

Statement Regarding Use of Non-GAAP Financial Measures

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Net income (GAAP) $ 46,586 $ 33,228 $ 30,242

Merger-related one-time and conversion costs:

Merger-related and conversion costs:

Personnel and severance 393 3,005 —

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Income tax benefit of merger-related expenses (254) (1,547) —

Total merger-related one-time and conversion costs, net of tax benefits 4,911 — —

Total merger-related and conversion costs, net of tax benefits 604 4,911 —

Comparable net income (non-GAAP) $ 47,190 $ 38,139 $ 30,242

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Diluted earnings per share (GAAP) $ 2.92 $ 2.30 $ 2.22

Merger-related one-time and conversion costs, net of tax benefits 0.34 — —

Merger-related and conversion costs, net of tax benefits 0.04 0.34 —

Comparable diluted earnings per share (non-GAAP) $ 2.96 $ 2.64 $ 2.22

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Net Interest Income

Net interest income is the interest earned on loans, investment securities and other interest-earning assets minus the interest expense incurred on deposits and other interest-bearing liabilities.

Net interest income is the interest earned on loans, investment securities and other interest-earning assets minus interest expense incurred on deposits and other interest-bearing liabilities.

Net interest income is affected by changes in general market interest rates and by changes in the amounts and composition of interest-earning assets and interest-bearing liabilities.

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

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

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

Analysis of Changes in Net Interest Income

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Borrowings and other obligations 16 25 41 82 16 (2) (9) 5

Subordinated debentures (127) 6,851 (5,521) 1,203 6 (76) (1) (71)

Subordinated debenture — (1,361) — (1,361) (127) 6,851 (5,521) 1,203

Total interest-bearing liabilities 509 (1,402) 40 (853) 384 5,760 (5,721) 423

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2022 Compared to 2021

Net interest income totaled $105.0 million and $96.7 million in 2021 and 2020, respectively.

The $8.3 million increase in 2021 was primarily due to higher average loan and investment securities balances and higher SBA PPP loan income.

We recognized $8.3 million in SBA PPP fees, net of cost in 2021, compared to $3.8 million in 2020.

As of December 31, 2021, $2.5 million SBA PPP fees, net of deferred costs remained outstanding and will be recognized into income in future periods.

On March 15, 2021, we redeemed the $2.8 million subordinated debenture.

The redemption consisted of $4.1 million principal balance, quarterly interest due, and $1.3 million in accelerated accretion of purchase discount.

The subordinated debenture carried an average interest rate of 5.68% in 2020.

The tax-equivalent net interest margin decreased 38 basis points to 3.17% in 2021, from 3.55% in 2020 for the reasons already mentioned and as shown in the above table.

T he SBA PPP loans improved the 2021 net interest margin by 10 basis points, and the early redemption of the subordinated debenture reduced it by 4 basis points.

Net interest income totaled $127.5 million in 2022, compared to $105.0 million in 2021.

The $22.5 million increase from the prior year was primarily due to higher balances in the investment and commercial real estate loan portfolios, which added $18.4 million and $6.1 million, respectively, to net interest income.

Additionally, 2022 incorporated a full year of net interest income from acquired earning assets of AMRB, compared to five months in 2021.

Average interest-bearing liabilities increased $376.6 million while the average cost dropped nine basis points, largely due to the extinguishment of subordinated debt that generated $1.4 million of interest expense in 2021.

The tax-equivalent net interest margin decreased six basis points to 3.11% in 2022, from 3.17% in 2021, as the proportion of average investment securities to average total interest-earning assets grew from 26% in 2021 to 44% in 2022 and fee income from PPP loans declined.

2021 Compared to 2020

Net interest income totaled $105.0 million and $96.7 million in 2021 and 2020, respectively.

The $1.0 million increase in 2020 was primarily due to SBA PPP loans and lower rates on interest-bearing deposits, largely offset by lower yields on earning-assets, except for investment securities where we collected prepayment penalties on called securities in 2020.

Notable balance increases occurred in interest-earning deposits with other banks, commercial real estate loans and deposits.

The $8.3 million increase in 2021 was primarily due to higher average loan and investment securities balances.

In addition, we recognized $8.3 million in SBA PPP fees, net of cost in 2021, compared to $3.8 million in 2020.

These increases were partially offset by $1.4 million in interest and accelerated discount accretion on the early redemption of a subordinated debenture in the first quarter of 2021, and lower yields on investment securities.

The tax-equivalent net interest margin decreased 38 basis points to 3.17% in 2021, from 3.55% in 2020 for the reasons already mentioned and as shown in the above table.

Additionally, the SBA PPP loans lowered the 2020 net interest margin by 6 basis points.

T he SBA PPP loans improved the 2021 net interest margin by 10 basis points, and the early redemption of the subordinated debenture reduced it by 4 basis points.

Market Interest Rates

Market interest rates are, in part, based on the target federal funds interest rate (the interest rate banks charge each other for short-term borrowings) implemented by the Federal Reserve Open Market Committee ("FOMC").

In response to the evolving risks to economic activity posed by the COVID-19 pandemic, the FOMC made two emergency cuts totaling 150 basis points to the federal funds rate in March 2020.

The federal funds target rate range resided between 0.0% to 0.25% in 2021 and 2020, putting downward pressure on our asset yields and net interest margin.

In its January 26, 2022 meeting the FOMC kept the federal funds target rate range between 0.0% to 0.25%, but signaled that it will raise interest rates in 2022 to combat inflation.

Our net interest margin should benefit from a rising interest rate environment.

In response to the evolving risks to economic activity caused by the COVID-19 pandemic, the FOMC made two emergency federal funds rate cuts totaling 150 basis points in March 2020.

The federal funds rate range remained

between 0.0% to 0.25% through the beginning of 2022, putting downward pressure on our asset yields and net interest margin.

Beginning in March 2022, the FOMC began successive increases to the federal funds rate due to the evolving inflation risks, international political unrest and oil and other supply chain disruptions.

As a result of five rate adjustments during 2022, the federal funds target rate range increased to 4.25% to 4.50% at year-end.

Subsequently, on February 1, 2023, the FOMC increased the rate by another 25 basis points to a range of 4.50% to 4.75%.

As shown in the table above, higher interest rates contributed an additional $5.9 million to net interest income in 2022 compared to 2021.

Additional rate increases are anticipated in 2023, as Federal Reserve policymakers continue to monitor inflation and economic developments.

Quantitative and Qualitative Disclosure about Market Risk for further information.

Provision for Credit Losses on Loans

We recorded a $1.4 million reversal of the provision for credit losses on loans in 2021, compared to a $4.6 million provision for credit losses in 2020 and $900 thousand provision for credit losses in 2019.

We recorded a net $63 thousand reversal of the provision for credit losses on loans in 2022, compared to a $1.4 million reversal of the provision for credit losses in 2021 and $4.6 million provision for credit losses in 2020.

The net reversal of the provision in 2022 was largely due to a $55.4 million decrease in applicable loan balances (excludes the $107.7 million decrease in PPP loans for which there was no allowance) and improvements in the Moody's Analytics' Baseline Forecast of California unemployment rates since December 31, 2021, which decreased the quantitative "modeled" allowance for credit losses.

These decreas es were partially offset by adjustments to qualitative risk factors to account for the ongoing deterioration in the economic outlook that management believes is not captured in the quantitative portion of the allowance.

The net provision reversal in 2021 was primarily due to continued improvements in Moody's Analytics' Baseline Forecast of California unemployment rates and adjustments to qualitative risk factors due to a decline in the volume of loans downgraded to substandard classification, fewer delinquencies, and the elimination of an allowance related to a commercial real estate loan that had been individually analyzed for potential credit losses in the previous periods and paid off in 2021.

These reversals were partially offset by an increase in the allowance for credit losses related to qualitative risk factor adjustments for recent changes in executive leadership and senior lending positions, and integration of ARB.

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

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The pandemic also negatively affected the financial condition of many of our borrowers, which was partially alleviated by our payment relief program under the 2020 CARES Act and the SBA PPP.

The provision for credit losses in 2019 accounted for under the incurred loss methodology was consistent with loan growth.

For additional information about the allowance for credit losses and transition from the incurred loss method to the CECL method in 2020, see the Critical Accounting Estimates section above and Notes 1 and 3 to the Consolidated Financial Statements in ITEM 8 of this report.

Non-interest Income

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Wealth Management and Trust Services $ 2,227 $ 2,222 $ 1,851 $ 5 0.2 % $ 371 20.0 %

Earnings from bank-owned life insurance, net 2,194 973 1,196 1,221 125.5 % (223) (18.6) %

Earnings on bank-owned life insurance, net 1,229 2,194 973 (965) (44.0) % 1,221 125.5 %

Debit card interchange fees, net 2,051 1,812 1,438 239 13.2 % 374 26.0 %

Service charges on deposit accounts 2,007 1,593 1,314 414 26.0 % 279 21.2 %

Dividends on FHLB stock 760 654 799 106 16.2 % (145) (18.1) %

Dividends on Federal Home Loan Bank stock 1,056 760 654 296 38.9 % 106 16.2 %

Merchant interchange fees, net 549 422 239 127 30.1 % 183 76.6 %

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2022 Compared to 2021

Non-interest income totaled $10.9 million in 2022, a $773 thousand increase from $10.1 million in 2021.

The increase was primarily due to higher fees on deposit balances held in off-balance sheet deposit networks contributing $504 thousand in additional income, $414 thousand more service charges on deposit accounts, $296 thousand higher FHLB dividends, and a combination of smaller increases.

Increases were partially offset by a $965 thousand reduction in bank-owned life insurance as the prior year included $1.1 million in benefits collected on insurance policies.

Additionally, 2022 incorporated a full year of non-interest income from the AMRB acquisition, compared to five months in 2021.

2021 Compared to 2020

Non-interest income totaled $10.1 million and $8.6 million in 2021 and 2020, respectively.

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Increases were partially offset by the $931 thousand reduction in gains on sales of investment securities.

2020 Compared to 2019

Non-interest income totaled $8.6 million and $9.1 million in 2020 and 2019, respectively.

The $534 thousand decline was primarily due to $551 thousand lower service charges on deposit accounts and ATM fees, as these fees were waived during the pandemic, lower income from bank-owned life insurance (" BOLI") policies due to a $562 thousand benefit collected on BOLI policies in the third quarter of 2019 (partially offset by $283 thousand underwriting expenses for two new BOLI policies in the first quarter of 2019), $182 thousand lower fee income from one-way deposit sales to third-party deposit networks and $145 thousand lower dividends on FHLB stock, partially offset by $860 thousand net gains on the sale of investment securities.

Non-interest Expense

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Charitable contributions 709 587 1,034 122 20.8 % (447) (43.2) %

Other real estate owned 359 5 — 354 7,080.0 % 5 N/A

Other non-interest expense:

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Non-interest expense increased $2.6 million to $75.3 million in 2022 from $72.6 million in 2021.

The largest increase of $6.5 million came from acquisition related one-time and conversion costs.

In addition to $3.0 million in one-time merger cost, salaries and related benefits rose another $4.5 million due to increased numbers of employees, regularly scheduled annual merit and related increases, and lower deferred loan origination costs.

Information technology expenses increased $647 thousand due to investments in software and equipment during 2022.

Total o ccupancy expenses, including depreciation and amortization, increased $626 thousand resulting primarily from merger growth and $212 thousand in accelerated costs related to planned branch closures.

Other increases in 2022 included core deposit intangible amortization and FDIC insurance, largely attributable to the 2021 AMRB acquisition, a $345 thousand valuation adjustment in other real estate owned expense, and a $490 thousand increase in employment recruiting costs included in other expense.

Salaries and employee benefits expense was relatively flat year-over-year.

In 2022, increases in staffing and profit sharing expenses, a reduction in deferred loan origination costs, a nd a combination of smaller items were largely offset by a decrease in supplemental executive retirement plan expense from an adjustment to the discount rate, and a decline in merger-related expenses, as shown in the table on page 28.

Professional services decreased $1.7 million from the prior year, primarily due to higher merger-related costs and additional consulting expenses associated with PPP loan forgiveness application processing in 2021, partially offset by higher audit and accounting fees in 2022.

Data processing expenses decreased by $490 thousand primarily due to merger-related expenses in 2021, as shown in the table on page 28, partially offset by an increase in processing costs in 2022 associated with higher volumes for the larger bank.

2021 Compared to 2020

Non-interest expense increased $14.1 million to $72.6 million in 2021 from $58.5 million in 2020.

The largest increase of $6.5 million came from merger-related and conversion costs.

In addition to $3.0 million in merger costs, salaries and related benefits rose another $4.5 million due to increased numbers of employees, regularly scheduled annual merit and related increases, and lower deferred loan origination costs.

Professional services included $817 thousand more in consulting expenses for PPP loan forgiveness application processing, investment advisory services, and legal costs.

2 unchanged sentences

Charitable contributions decreased due to supplemental contributions in 2020 related to the pandemic.

2020 Compared to 2019

In 2020, non-interest expense increased by $617 thousand to $58.5 million from $57.8 million.

The largest increases came from the occupancy expenses (primarily due to lease renewals for our existing headquarters offices and new lease for a loan production of fice in San Mateo , common area maintenance and janitorial expenses), and charitable contributions due to our outreach to nonprofit organizations in our community during the pandemic.

The decrease in data processing costs was due to our digital platform conversion in 2019.

While salaries and related benefits were relatively unchanged year-over-year, annual merit and related increases were mostly offset by $915 thousand in SBA PPP-related deferred loan origination costs.

Provision for Income Taxes

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The increase in the provision in 2022 compared to 2021 reflected higher pre-tax income.

The 50 basis point increase in the effective tax rate in 2021 as compared to 2020 was primarily due to non-deductible merger expenses and executive compensation, partially offset by higher BOLI income and tax exempt loan and investment securities interest income.

The slight increase in the effective tax rate in 2020 compared to 2019 was due to a favorable deferred tax liability true-up recognized in 2019 and a lower tax benefit from BOLI income in 2020.

The 60 basis point increase in the effective tax rate in 2022 as compared to 2021 was primarily due to lower BOLI income and the smaller proportion of tax-exempt loan and investment securities interest income to pre-tax income in 2022, partially offset by the non-deductible merger expenses and executive compensation in 2021.

The 50 basis point increase in the effective tax rate in 2021 compared to 2020 was due to non-deductible merger expenses and executive compensation, partially offset by higher BOLI income and tax-exempt loan and investment securities interest income.

We file a consolidated return in the U.S.

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FINANCIAL CONDITION

Our assets increased $1.4 billion from December 31, 2020 to December 31, 2021.

Increases reflected both the acquisition of ARB and organic growth.

Investment Securities

1 unchanged sentence

Management determines the maturities and types of securities to be purchased based on liquidity and interest rate risk position, and the desire to attain a reasonable investment yield balanced with risk exposure.

The table below shows the composition of the debt securities portfolio by expected maturity at December 31, 2021 and 2020.

The tables below show the composition of the debt securities portfolio by expected maturity at December 31, 2022 and 2021.

Expected maturities differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.

We estimate and update expected maturity dates regularly based on current and historical prepayment speeds.

The weighted average life of the investment portfolio at December 31, 2021 and 2020 was approximately six and five years, respectively.

average life of the investment portfolio at December 31, 2022 and 2021 was approximately seven and six years, respectively.

December 31, 2022 Within 1 Year 1-5 Years 5-10 Years After 10 Years Total

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Obligations of state and political subdivisions - taxable — — — — 4,708 1.84 25,677 2.28 30,385 22,913 2.21

Corporate bonds — — 30,000 3.63 — — — — 30,000 28,448 3.63

Total held-to-maturity 463 0.63 210,182 3.50 477,062 2.20 284,500 2.22 972,207 845,239 2.49

22 unchanged sentences

Average Yield 2

AmortizedCost 1

Amortized Cost 1

Fair Value Average Yield 2

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SBA-backed securities — — 4,840 3.17 — — — — 4,840 5,038 3.17

Debentures of government-sponsored agencies — — — — 19,973 1.67 31,499 1.89 51,472 50,571 1.80

Obligations of state and political subdivisions - tax-exempt 3

2 unchanged sentences

Total held-to-maturity 1,651 1.27 103,902 2.08 178,651 1.84 58,018 1.96 342,222 342,755 1.93

December 31, 2020 Within 1 Year 1-5 Years 5-10 Years After 10 Years Total

(dollars in thousands;

unaudited) AmortizedCost 1

Average Yield 2

AmortizedCost 1

Average Yield 2

AmortizedCost 1

Average Yield 2

AmortizedCost 1

Average Yield 2

AmortizedCost 1

Fair Value Average Yield 2

Available-for-sale:

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Debentures of government sponsored agencies 6,000 2.62 120,115 1.11 16,411 1.39 48,923 1.88 191,449 188,527 1.38

Treasury securities — — — — 11,886 1.00 — — 11,886 11,630 1.00

Obligations of state and political subdivisions - tax-exempt 3

1 unchanged sentence

Obligations of state and political subdivisions - taxable 1,128 2.86 1,011 3.24 12,147 1.56 — — 14,286 14,030 1.78

Corporate bonds 2,013 2.73 31,000 1.03 5,988 1.23 — — 39,001 38,495 1.15

Asset-backed securities — — — — 1,866 0.72 — — 1,866 1,862 0.72

Total available-for-sale 23,732 1.93 406,502 1.57 602,740 1.87 136,546 1.48 1,169,520 1,167,568 1.72

3 unchanged sentences

3 Yields on tax-exempt municipal bonds are presented on a taxable equivalent basis, using federal tax rate of 21%.

The amortized cost of our investment securities portfolio increased $1.03 billion or 214% during 2021.

The amortized cost of our investment securities portfolio increased $353.1 thousand or 23.4% during 2022.

We purchased $243.5 million in securities in 2022 designated as available-for-sale to provide flexibility for liquidity and interest rate risk management.

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These purchases were offset by $177.3 million of paydowns, calls and maturities, and $10.7 million of sales during 2022.

We also acquired $297.8 million in securities from ARB.

The weighted average yield on the purchases of securities was 3.22% for the 2022 year and 6.08% for the fourth quarter of 2022.

During 2021, we purchased $287.6 million in agency mortgage-backed securities ("MBSs"), $271.7 million in debentures of government sponsored agencies, $268.6 million in agency collateralized mortgage obligations ("CMOs"), $60.7 million in obligations of state and political subdivisions and $37.0 million in corporate bonds.

We transferred $357.5 million of available-for-sale securities to held-to-maturity in March 2022.

R efer to Note 2, Investment Securities, to the Consolidated Financial Statements in ITEM 8 of this report for further information.

During 2022, we purchased $364.6 million in agency collateralized mortgage obligations ("CMOs"), $60.9 million in agency mortgage-backed securities ("MBSs"), $61.2 million in debentures of government sponsored agencies, $30.0 million in corporate bonds, $29.9 million in SBA-backed securities and $16.8 million in obligations of state and political subdivisions.

We consider agency debentures and CMOs issued by U.S.

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See the discussion in the section captioned “Securities May Lose Value due to Credit Quality of the Issuers” in ITEM 1A Risk Factors above.

At December 31, 2021, distribution of our investment in obligations of state and political subdivisions was as follows:

At December 31, 2022 and 2021, distribution of our investment in obligations of state and political subdivisions was as follows:

December 31, 2022 December 31, 2021

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Percent of investment portfolio 9.6% 9.3% 11.7% 12.0%

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

Of the total investment in obligations of state and political subdivisions, the largest concentrations outside California are in

Texas (38.4%), Washington (16.4%), and Wisconsin (6.7%).

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

Of the total investment in obligations of state and political subdivisions, the largest concentrations outside California are in Texas (39.6%), Washington (14.4%), and Wisconsin (8.9%).

Our investment in obligations issued by municipal issuers in Texas are either guaranteed by the AAA-rated Texas Permanent School Fund ("PSF") or backed by revenue sources from essential services (such as utilities and transportation).

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

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

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• Credit ratings by major credit rating agencies

Loans Outstanding by Class at December 31

Loans Outstanding by Class and Percent of Total

December 31, 2022 December 31, 2021

(in thousands;

unaudited) 2021 2020

unaudited) Amortized Cost Percent of Total Amortized Cost Percent of Total

Commercial and industrial $ 173,547 8.3 % $ 301,602 13.4 %

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Total loans, net of allowance for credit losses $ 2,069,563 $ 2,232,622

Loans increased $167.1 million in 2021, or 8%, to $2.256 billion at December 31, 2021, from $2.089 billion at December 31, 2020.

Year-over-year growth was largely attributable to $419.4 million in loans from the ARB acquisition on August 6, 2021.

Non-PPP loan originations of $181.7 million for the year were concentrated in commercial and real estate loans and compared to $165.5 million in 2020.

2021 payoffs included $218.1 million non-PPP loans, compared to $169.2 million in 2020.

In 2021, PPP loan originations were $136.2 million and PPP loans forgiven and paid off were $328.5 million.

Loans decreased by $163.1 million in 2022, or 7%, to $2.093 billion as of December 31, 2022, from $2.256 billion as of December 31, 2021.

Year-over-year changes were largely attributable to a $107.7 million decrease in PPP loans and a decrease in investor-owned commercial real estate loans, partially offset by growth in owner-occupied commercial real estate loans.

Loan originations were $240.2 million in 2022 compared to $181.7 million in 2021, an increase of 32%.

Non-PPP payoffs were $258.5 million in 2022, compared to $218.1 million in 2021.

Much of the payoffs in 2022 were outside the Bank's control and resulted from activities such as sales of businesses and properties, cash repayments, and project completions.

The originations and payoffs noted above, combined with utilization on lines of credit and amortization on existing loans, resulted in the net decreases for these periods.

Non-PPP payoffs as a percentage of beginning of the year loan balances were 11.5% in 2022 and 10.4% in 2021.

Approximate ly 86% and 77%, of total loans were secured by real estate at December 31, 2021 and 2020, respectively.

Approxim ately 90% and 86%, of total loans were secured by real estate as of December 31, 2022 and 2021, respectively.

The increase in the percentage secured by real estate from 2021 to 2022 was primarily due to a $107.7 million reduction in unsecured loans guaranteed by the SBA under the PPP, which are included in commercial and industrial loans.

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Napa 186,477 12.1 188,643 11.9

Alameda 176,871 11.2 164,921 13.0

San Francisco 173,511 11.2 172,120 10.9

Alameda 163,381 10.6 176,871 11.2

Sacramento 120,146 7.8 113,120 7.2

Contra Costa 67,356 4.4 69,656 4.4

Solano 40,837 2.6 21,380 1.7

San Mateo 37,681 2.4 28,119 1.8

Solano 32,235 2.1 40,837 2.6

Placer 28,928 1.9 28,477 1.8

Santa Clara 21,091 1.4 20,070 1.3

San Joaquin 15,585 1.0 8,829 0.6

El Dorado 12,822 0.8 14,708 0.9

Other 101,865 6.4 139,731 8.7

Total $ 1,546,766 100.0 % $ 1,581,366 100.0 %

Commercial real estate loans increased $315.2 million in 2021, compared to a $68.5 million increase in 2020.

The increase was primarily due to the ARB acquisition and expanded footprint in Northern California.

Commercial real estate loans decreased $34.6 million in 2022, compared to a $315.2 million increase in 2021.

The decrease in 2022 wa s primarily due to cash paydowns as part of ongoing deleveraging, refinancings and asset sales.

Th e increase in 2021 was primarily due to the AMRB acquisition and expanded footprint in Northern California.

Of the commercial real estate loans at December 31, 2022, 77% were investor-owned and 23% were owner-occupied.

Almost the entire commercial real estate loan portfolio is comprised of term loans for which the primary source of repayment is either the cash flow from the leasing activities of the real estate collateral or the operating cash flow of the owner occupant.

We occasionally provide interest-only term loans to borrowers who exhibit strong financial capacity and/or for commercial real estate loans during the occupancy stabilization period.

After the initial inte rest-only payment period, these loans will normally require principal and interest payments.

In addition, we may make interest-only concessions in a modified troubled debt restructuring ("TDR").

At December 31, 2021 and 2020, approximately 5.0% and 3.4%, respectively, of our commercial real estate loans contained an interest-only feature as part of the loan terms.

All of these loans were current with their payments as of December 31, 2021.

Except for three substandard classified loans to two borrowing relationships totaling $24.7 million (or 1.6%) as of December 31, 2021, all were considered to have low credit risk (graded "Pass").

Almost the entire commercial real estate loan portfolio is comprised of term loans for which the primary source of repayment is either the cash flow from leasing activities of the real estate collateral or the operating cash flow of the owner occupant.

The following table shows an analysis of construction loans by type and county as of December 31, 2022 and 2021.

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Loan Type Amount Percent of Construction Loans Amount Percent of Construction Loans

Commercial real estate $ 49,131 41.0 % $ 29,788 40.8 %

Apartments and multifamily $ 60,347 52.7 % $ 45,978 38.4 %

Commercial real estate 33,746 29.5 49,131 41.0

1-4 Single family residential 19,171 16.8 19,564 16.3

Land - improved 3,966 3.3 1,371 1.9

Land - unimproved 1,109 1.0 1,201 1.0

Land - improved — — 3,966 3.3

Total $ 114,373 100.0 % $ 119,840 100.0 %

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San Francisco $ 45,271 39.6 % $ 55,826 46.6 %

Alameda 20,163 17.6 12,908 10.8

Solano 18,873 16.5 16,367 13.7

Sonoma 17,843 15.6 13,640 11.4

Alameda 12,908 10.8 1,862 2.5

Marin 7,784 6.8 6,074 5.1

Sacramento 5,897 4.9 — —

Contra Costa 5,613 4.7 1,541 2.2

Other 4,439 3.9 15,025 12.4

Total $ 114,373 100.0 % $ 119,840 100.0 %

Construction loans increased by $46.8 million in 2021, compared to an increase of $12.0 million in 2020.

The increase in 2021 was primarily due to $48.8 million advanced on existing construction loans, $13.2 million in loans assumed in the ARB acquisition and $7.2 million in new financing.

Cons truction loans decreased by $5.5 million in 2022, compared to an increase of $46.8 million in 2021.

The decrease in 2022 was primarily due to $46.6 million in payoffs and $3.6 million in conversions to commercial real estate financing.

These decreases were partially offset by $37.5 million advanced on existing construction loans and $7.2 million in new financing.

T he increase in 2021 was primarily due to $48.8 million advanced on existing construction loans, $13.2 million in loans assumed in the AMRB acquisition and $7.2 million in new financing.

These increases were partially offset by $19.5 million in payoffs and $2.9 million in conversions to commercial real estate financing.

The increase in 2020 primarily resulted from additional borrowings under existing construction loans as well as advances on six new construction loans to well-known, experienced builders.

The increase was partially offset by the successful completion of projects, one of which converted to a permanent commercial real estate loan.

Undisbursed construction loan commitments at December 31, 2022 and 2021 were $43.2 million and $77.8 million, respectively.

The following table presents the amortized costs and maturity distribution of our loans by class as of December 31, 2022 based on their contractual maturity dates.

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Total $ 169,038 $ 535,251 $ 1,240,460 $ 147,797 $ 2,092,546

1 Commercial and industrial due after 1 but within 5 years includes SBA PPP loans totaling $111.2 million (net of $2.5 million in unrecognized fees and costs) , the majority of which are expected to be forgiven by the SBA in 2022.

1 Commercial and industrial due within 1 year includes SBA PPP loans totaling $3.5 million (net of $99 thousand in unrecognized fees and costs), which are expected to be forgiven by the SBA in 2023.

2 Construction loans that mature after 5 years are structured to convert to permanent financing after the initial construction period.

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Commercial and industrial $ 73,688 $ 38,678 $ 112,366

$ 175,697 $ 28,186 $ 203,883

Real estate —

Commercial owner-occupied 195,342 146,666 342,008

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Total $ 1,083,305 $ 840,203 $ 1,923,508

1 Commercial and industrial includes SBA PPP 1% fixed rate loans totaling $111.2 million (net of $2.5 million in unrecognized fees and costs), the majority of which are expected to be forgiven by the SBA in 2022.

Allowance for Credit Losses on Loans

As of December 31, 2021, we calculated the allowance for credit losses using the current expected loss methodology, or CECL, which required us to estimate credit losses over the expected life of a loan and consider future changes in macroeconomic conditions.

The allowance for credit losses on loans is calculated in accordance with ASC 326 based on management's best estimate of current expected credit losses over the loans' contractual terms, adjusted for estimated prepayments where applicable.

The contractual terms exclude anticipated extensions, renewals and modifications, except for reasonably expected extensions of certain troubled debt restructure loans.

Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts.

While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current portfolio-specific risk characteristics, environmental conditions or other relevant factors.

All specifically identifiable and quantifiable losses are charged off against the allowance.

The ultimate adequacy of the allowance depends on a variety of factors beyond our control, including the real estate market, changes in interest rates and economic and political environments.

Based on the current conditions of the loan portfolio and reasonable and supportable forecasts, management believes that the $23.0 million allowance for credit losses at December 31, 2021 was adequate to absorb expected credit losses in our loan portfolio, but provides no assurance that adverse changes in economic conditions or other circumstances over the remaining terms of our loans will not result in increased losses in the portfolio.

For information on our allowance for credit losses methodology and adoption of FASB ASU No.

2016-13, Financial Instruments - Credit Losses (Topic 326):

Measurement of Credit Losses on Financial Instruments , effective December 31, 2020, refer to Notes 1 and 3 to the Consolidated Financial Statements in ITEM 8 of this report.

The ultimate adequacy of the allowance depends on a variety of complex factors, some of which may be beyond management's control, such as volatility in the real estate market, changes in interest rates and economic and political environments.

For additional information on our allowance for credit losses methodology, refer to Notes 1 and 3 to the Consolidated Financial Statements in ITEM 8 of this report.

The allowance for credit losses to loans was 1.10% at December 31, 2022 and 1.02% at December 31, 2021.

The allowance for credit losses to loans, excluding SBA PPP loans and previously acquired loans was 1.07 an d 1.27% at year-end 2021 and 2020, respectively (for a discussion of this non-GAAP financial measure, refer to ITEM 7, Reconciliation of GAAP and Non-GAAP Financial Measures section of this report).

The $149 thousand increase in the allowance for credit losses on loans in 2021 was largely due to loans acquired from ARB, partially offset by improvements in economic factors that drive the quantitative portion of the allowance.

The $6.2 million increase in the allowance for credit losses in 2020 was almost entirely due to the impact of the COVID-19 pandemic and its effect on the local and regional economies and economic outlook coupled with the transition to the CECL method.

The allowance for credit losses to loans, excluding SBA PPP loans was 1.10% an d 1.07% at year-end 2022 and 2021, respectively (for a discussion of this non-GAAP financial measure, refer to ITEM 7, Financial Highlights section of this report).

The $40 thousand decrease in the allowance for credit losses on loans in 2022 was largely due to a $55.4 million decrease in applicable loan balances (excludes the $107.7 million decrease in PPP loans for which there was no allowance) and improvements in the Moody's Analytics' Baseline Forecast of California unemployment rates since December 31, 2021, which decreased the quantitative "modeled" allowance for credit losses.

For further information, refer to the Provision for Credit Losses section above, and Notes 1 and 3 to the Consolidated Financial Statements in ITEM 8 of this report.

Due to the high credit quality of our loan portfolio, net charge-offs have been minimal for the past several years.

Net recoveries totaled $93 thousand in 2021, compared to net charge-offs of $1 thousand in 2020 and $44 thousand in 2019.

The following table shows the allocation of the allowance by loan class as well as the per centage of total loans in each of the same loan classes.

Allocation of Allowance for Credit Losses

December 31, 2021 December 31, 2020

Due to the high credit quality of our loan portfolio experienced to date, net charge-offs have been minimal for the past several years.

Net recoveries totaled $23 thousand in 2022, compared to net recoveries of $93 thousand in 2021 and net charge-offs of $1 thousand in 2020.

The following table presents the allowance for credit losses on loans by loan class in accordance with the methodology described in Note 1 to the Consolidated Financial Statements in ITEM 8 of this report, as well as the per centage of total loans in each of the same loan classes as of December 31, 2022 and 2021.

Allocation of the Allowance for Credit Losses

(dollars in thousands;

unaudited) Allowance balance allocation Loans as a percent of total loans Allowance balance allocation Loans as a percent of total loans

Commercial and industrial $ 1,709 13.4 % $ 2,530 23.9 %

Commercial, owner-occupied 2,776 17.4 2,778 14.6

Commercial, investor-owned 12,739 52.7 12,682 46.0

Construction 1,653 5.3 1,557 3.5

Home Equity 595 3.9 738 5.0

Other residential 644 5.1 998 5.9

Installment and other consumer 621 2.2 291 1.1

Unallocated allowance 2,286 N/A 1,300 N/A

Total allowance for credit losses $ 23,023 $ 22,874

Total percent 100.0% 100.0%

The table below shows the activity in the allowance for credit losses for each of the five years presented below.

unaudited) Commercial and industrial Commercial real estate, owner-occupied Commercial real estate, investor-owned Construction Home equity Other residential Installment and other consumer Unallocated Total

December 31, 2022

Modeled expected credit losses $ 1,079 $ 1,497 $ 7,937 $ 453 $ 504 $ 571 $ 610 $ — $ 12,651

Qualitative adjustments 706 990 4,739 1,484 54 24 258 2,068 10,323

Specific allocations 9 — — — — — — — 9

Total $ 1,794 $ 2,487 $ 12,676 $ 1,937 $ 558 $ 595 $ 868 $ 2,068 $ 22,983

Loans as a percent of total loans 8.3 % 17.0 % 56.9 % 5.5 % 4.2 % 5.4 % 2.7 % N/A 100.0 %

December 31, 2021

Modeled expected credit losses $ 1,067 $ 2,045 $ 8,974 $ 503 $ 569 $ 642 $ 450 $ — $ 14,250

Qualitative adjustments 642 731 3,765 1,150 26 2 171 2,286 8,773

Specific allocations — — — — — — — — —

Total $ 1,709 $ 2,776 $ 12,739 $ 1,653 $ 595 $ 644 $ 621 $ 2,286 $ 23,023

Loans as a percent of total loans 13.4 % 17.4 % 52.7 % 5.3 % 3.9 % 5.1 % 2.2 % N/A 100.0 %

The table below shows the activity in the allowance for credit losses for each of the three years presented below.

Allowance for Credit Losses Rollforward

3 unchanged sentences

Impact of CECL adoption — — 1,604

Provision for (reversal of) credit losses (1,449) 4,594 900

(Reversal of) provision for credit losses (63) (1,449) 4,594

Initial allowance for PCD loans — 1,505 —

5 unchanged sentences

Commercial and industrial 22 14 27

Commercial, investor-owned — — 12

Construction 33 34 3

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Net charge-offs and recoveries for the years ended December 31, 2022, 2021 and 2020 were considered insignificant.

The following shows non-performing assets and loans modified in a troubled debt restructuring ("TDR") for each of the years in the five-year period ended December 31, 2021.

Non-Performing and Loans and Troubled Debt Restructurings

The following shows non-performing loans and loans modified in a TDR as of December 31, 2022 and 2021.

Non-Performing Loans and Troubled Debt Restructurings

(dollars in thousands;

unaudited) 2021 2020

unaudited) December 31, 2022 December 31, 2021

Non-accrual loans:

6 unchanged sentences

Commercial and industrial $ 900 $ 1,183

Commercial, owner-occupied — —

Commercial, investor-owned 160 179

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Non-Accrual and TDR

Non-accrual loans decreased by $857 thousand primarily due to $1.0 million in payoffs and paydowns, partially offset by a $114 thousand well-secured investor-owned commercial real estate loan assumed in the ARB acquisition and one $67 thousand home equity loan placed on non-accrual status in 2021.

Non-accrual loans increased $9.0 million in 2020, primarily due to the placement of two existing well-secured owner-occupied commercial real estate TDR loans, secured by one property, totaling $7.1 million on non-accrual, as well as two well-secured investor-owned commercial loans totaling $1.6 million that were placed on non-accrual in 2020.

In addition, we designated five loans totaling $2.1 million as TDRs during 2020, resulting in an overall increase of $2.8 million in total non-accrual and accruing TDR loans from 2019 to 2020.

These increases were partially offset by approximately $1.0 million in paydowns and payoffs of non-accrual and TDR loans.

Non-accrual loans decreased by $5.9 million in 2022, primarily due to the payoff of two owner-occupied commercial real estate loans totaling $7.1 million and paydowns and the upgrade of a $695 thousand loan to accrual status as a result of improved financial condition and performance, partially offset by $2.0 million in loans designated as non-accrual in 2022.

Over 96% of the non-accrual loans as of December 31, 2022 were well-secured by either commercial or residential real estate.

Non-accrual loans decreased by $857 thousand in 2021, primarily due to $1.0 million in payoffs and paydowns, partially offset by a $114 thousand well-secured investor-owned commercial real estate loan assumed in the AMRB acquisition and one $67 thousand home equity loan placed on non-accrual status in 2021.

Total accruing TDR loans were $1.8 million and $2.1 million as of December 31, 2022 and 2021, respectively.

The $327 thousand decrease in 2022 was primarily due to $425 thousand in paydowns, partially offset by one loan totaling $98 thousand that was designated as TDR during 2022.

The $3.0 million decrease in 2021 was primarily due to $4.0 million in paydowns and payoffs, partially offset by two loans totaling $1.0 million that were designated as TDRs during 2021.

The $6.2 million decrease from 2019 to 2020 primarily related to the two existing well-secured commercial real estate TDR loans totaling $7.1 million that were transferred to non-accrual status coupled with payoffs and paydowns, partially offset by the $2.1 million in new TDR loans mentioned above.

For information regarding temporary relief from TDR accounting afforded by the CARES Act, refer to the Executive Summary section above and Note 3 to the Consolidated Financial Statements in ITEM 8, under “Troubled Debt Restructuring."

Criticized and Classified Loans

Loans designated as special mention decreased by $13.6 million in 2021, primarily due to $18.9 million in paydowns and payoffs, $33.1 million in upgrades to a pass risk rating and two loans that were downgraded from special mention to substandard totaling $5.4 million.

These decreases were partially offset by $17.2 million in loans that were downgraded from pass/watch, $13.5 million in loans assumed in the ARB acquisition, and $13.2 million in loans that were upgraded from substandard to special mention during 2021.

Of the $17.2 million in downgrades, $13.2 million were well-secured by commercial real estate and the remaining $4.0 million in commercial loans had strong support.

Loans designated special mention increased by $13.5 million in 2020, driven by loan downgrades

totaling $31.0 million.

Of these downgrades, approximately $24.5 million were loans to borrowers that were impacted by the pandemic, all of which were well-secured by commercial real estate.

These additions to special mention were mostly offset by $15.8 million in upgrades to pass risk ratings, paydowns and payoffs, and $2.2 million in loans downgraded from special mention to substandard in 2020.

Loans designated as special mention decreased by $13.1 million in 2022, primarily due to $30.2 million in upgrades to a pass risk rating, $7.7 million in paydowns and payoffs, and $3.6 million in downgrades from special mention to substandard.

These decreases were partially offset by $27.8 million in downgrades from pass to special mention and $695 thousand in upgrades from substandard to special mention during 2022.

Of the $27.8 million in

downgrades to special mention, $22.5 million (or 81%) was well-secured by commercial real estate and the remaining $5.3 million commercial loans had strong support .

Loans designated as special mention decreased by $13.6 million in 2021, primarily due to $33.1 million in upgrades to a pass risk rating, $ 18.9 million in paydowns and payo ffs, and two loans that were downgraded from special mention to substandard totaling $5.4 million.

These decreases were partially offset by $17.2 million in loans that were downgraded from pass/watch, $13.5 million in loans assumed in the AMRB acquisition, and $13.2 million in loans that were upgraded from substandard to special mention during 2021.

Of the $17.2 million in downgrades to special mention, $13.2 million (or 77%) was well-secured by commercial real estate and the remaining $4.0 million in commercial loans had strong support.

Loans designated as special mention exhibit potential weakness that deserve close attention.

Loans classified substandard increased by $13.3 million in 2021, primarily due to downgrades totaling $25.4 million and $2.3 million in substandard loans assumed in the ARB acquisition.

Loans classified substandard decreased by $8.1 million in 2022, primarily due to $16.1 million in paydowns and payoffs and $871 thousand in upgrades to special mention or pass, partially offset by downgrades totaling $8.8 million.

Of the downgraded loans, $4.7 million (or 53%) was secured by commercial real estate and $3.6 million (or 41%) was to commercial borrowers.

In addition, of the $16.1 million in paydowns and payoffs, $2.7 million was from loans downgraded in 2022.

Loans classified substandard increased by $13.3 million in 2021, prim arily due to downgrades totaling $25.4 million and $2.3 million in substandard loans assumed in the AMRB acquisition.

Of the downgraded loans, $24.2 million were secured by commercial real estate.

The downgrades were partially offset by $13.2 million in upgrades to special mention and $4.2 million in paydowns and payoffs.

Loans classified substandard increased by $15.9 million in 2020, primarily due to downgrades totaling $18.5 million.

Of these loans, $13.4 million were to borrowers that requested payment relief due to the pandemic, all of which were well-secured by commercial real estate.

These downgrades to substandard were partially offset by approximately $2.8 million in payoffs and risk rating upgrades.

Loans classified substandard decreased by $2.7 million during 2019 primarily due to the payoff of a land development loan.

Refer to Note 3 to the Consolidated Financial Statements in ITEM 8 of this report for an allocation of criticized and classified loans by loan class.

BOLI totaled $61.5 million at December 31, 2021, compared to $43.6 million at December 31, 2020, and is recorded in other assets.

The increase of $17.9 million was primarily due to the acquisition of $15.7 million in ARB policies and the purchase of $1.9 million in new policies.

BOLI totaled $67.1 million at December 31, 2022, compared to $61.5 million at December 31, 2021.

The increase of $5.6 million was primarily due to the purchase of $4.7 million in new policies and an increase in the cash surrender value from net investment earnings.

Interest receivable and other assets totaled $79.8 million and $51.4 million at December 31, 2022 and 2021, respectively.

The $14.9 million increase was primarily due to a $6.4 million increase in net deferred tax assets, a $4.9 million increase in FHLB stock and a $2.6 million increase in accrued interest on investment securities as discussed below.

The $28.4 million increase was primarily due to a $30.5 million increase in net deferred tax assets as discussed below.

Net deferred tax assets totaled $43.9 million and $13.3 million at December 31, 2022 and 2021, respectively.

Deferred tax assets consist primarily of tax benefits expected to be realized in future periods related to temporary differences such as the allowances for credit losses and unfunded loan commitments, net operating loss carryforwards, and deferred compensation and salary continuation plans.

The $6.4 million increase in net deferred tax assets in 2021 was primarily due to a $4.5 million decrease in deferred tax liabilities related to changes in unrealized gains on available-for-sale investment securities, a $1.6 million increase in deferred tax assets related to the change in deferred compensation plan and salary continuation plan, a $781 thousand increase in deferred tax assets related to accrued but unpaid expenses and a $640 thousand increase in deferred tax assets related to fair value adjustments on acquired loans.

These increases were partially offset by a $820 thousand increase in deferred tax liabilities related to the increase in core deposit intangibles.

The $30.5 million increase in 2022 was primarily due to a $30.2 million increase in deferred tax assets related to changes in unrealized losses on available-for-sale investment securities, a $466 thousand increase in deferred tax assets related to state franchise tax and a $441 thousand decrease in deferred tax liabilities related to core deposit intangibles.

These increases to net deferred tax assets were partially offset by a $430 thousand decrease in deferred tax assets related to the decrease in deferred compensation and salary continuation plans.

Management believes deferred tax assets will be realizable due to our consistent record of earnings and the expectation that earnings will continue at a level adequate to realize such benefits.

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For additional information, refer to Note 11 to the Consolidated Financial Statements in ITEM 8 of this report.

We held $ 16.7 million and $11.9 million of FHLB stock recorded at cost in other assets at December 31, 2021 and 2020, respectively.

The increase in 2021 resulted from the acquisition of $4.9 million of ARB's FHLB stock.

The FHLB paid $760 thousand, $654 thousand and $799 thousand in cash dividends in 2021, 2020 and 2019, respectively.

We held $16.7 million of FHLB stock recorded at cost in other assets at December 31, 2022 and 2021.

The FHLB paid $1.0 million, $760 thousand and $654 thousand in cash dividends in 2022, 2021 and 2020, respectively.

For additional information, refer to Note 2 to the Consolidated Financial Statements in ITEM 8 of this report.

Accrued interest on investment securities totaled $6.9 million and $4.8 million at December 31, 2022 and 2021, respectively.

The increase was primarily due to purchases of $925.6 million in securities and acquisition of $297.8 million in securities from ARB.

Deposits grew b y $1.304 billion, to $3.809 billion at December 31, 2021, compared to $2.504 billion at December 31, 2020.

Non-interest bearing deposits grew by $555.6 million in 2021 and made up 50% of total

deposits at year-end.

See ITEM 1A, Risk Factors, for a discussion of potential risks associated with concentrations and volatility due to activity of our large deposit customers and impact of the SBA PPP loans.

The increase was due to purchases of $563.4 million in securities.

Deposits decreased by $235.2 million, to $3.573 billion at December 31, 2022, compared to $3.809 billion at December 31, 2021.

Non-interest bearing deposits decreased by $71 million in 2022 and made up 51% of total deposits at year-end.

The decline was a result of anticipated outflows due to planned business activities by a few large clients, some customers moving into alternative investments and normal year-end fluctuations.

See ITEM 1A, Risk Factors, for a discussion of potential risks associated with concentrations and volatility due to activity of our large deposit customers.

Our relationship banking model is the foundation for the strong deposit base and allows us to proactively and strategically address changes in the interest rate environment and technology adoption by our customers.

With our low cost of deposits, the Bank is well-positioned to implement deposit retention strategies.

Distribution of Average Deposits

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Total $ 44,609 $ 23,359

As of December 31, 2021 and 2020, respectively, our available borrowing capacity included $820.5 million and $642.5 million in secured lines of credit with FHLB and $70.8 million and $78.7 million with the Federal Reserve Bank of San Francisco (“FRBSF”).

We also had $150.0 million and $135.0 million in unsecured lines with correspondent banks to cover any short or long-term borrowing needs at December 31, 2021 and 2020, respectively.

There were no FHLB overnight borrowings at December 31, 2021 or 2020.

The FRBSF and correspondent bank lines were not utilized at December 31, 2021 or 2020.

As part of a bank acquisition in 2013, we assumed a subordinated debenture due to the NorCal Community Bancorp Trust II with a contractual balance of $4.1 million.

As of December 31, 2022 and 2021, respectively, our total borrowing capacity included $711.6 million and $820.5 million in secured lines of credit with FHLB and $58.7 million and $70.8 million with the Federal Reserve Bank of San Francisco (“FRBSF”).

We also had $150.0 million in unsecured lines with correspondent banks to cover any short-term borrowing needs at December 31, 2022 and 2021.

FHLB overnight borrowings at December 31, 2022 were $112.0 million for a net available balance of $599.6 million.

There were no overnight borrowings at December 31, 2021.

The FRBSF and other correspondent bank lines were not utilized at December 31, 2022 or 2021.

In February 2023, we increased our borrowing capacity at the FHLB by pledging certain held-to-maturity securities to the Securities-Backed Credit Program, which increased our total FHLB borrowing capacity to $1.0372 billion as of February 28, 2023 from $711.6 million as of December 31, 2022.

As part of a bank acquisition, we assumed a subordinated debentur e due to the NorCal Community Bancorp Trust II with a contractual balance of $4.1 million.

On March 15, 2021, we redeemed the $2.8 million subordinated debenture (accreted value), which carried an average interest rate of 5.68% in 2020.

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We maintain a non-qualified, unfunded deferred compensation plan for certain key management personnel.

Under this plan, participating employees may defer compensation, which will entitle them to receive certain payments for

up to fifteen years commencing upon retirement, death, disability or termination of employment.

Under this plan, participating employees may defer compensation, which will entitle them to receive certain payments for up to fifteen years commencing upon retirement, death, disability or termination of employment.

The participating employee may elect to receive payments over periods not to exceed fifteen years.

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The Plan is unfunded and non-qualified for tax purposes and for purposes of Title I of the Employee Retirement Income Security Act of 1974.

Increases in obligations under both the deferred compensation plan and SERP in 2021 were due to the assumption of the liabilities from the ARB acquisition.

Decreases in both the deferred compensation plan and SERP liabilities in 2022 mainly resulted from increases in benefit payments to retired employees.

In addition, we increased the discount rate on the SERP payments to reflect market conditions, which reduced the present value of the SERP obligation.

For additional information, see Note 10 to the Consolidated Financial Statements in ITEM 8 of this report.

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For further discussion of bank capital requirements, refer to the SUPERVISION AND REGULATION section in ITEM 1 of this report.

The Bank's total risk-based capital ratio decreased from 15.8% at December 31, 2020 to 14.4% at December 31, 2021, primarily due to $64.0 million in dividends paid to Bancorp to cover share repurchases, quarterly common stock dividends, and operating costs, partially offset by the Bank's $37.4 million net income in 2021.

The Bank's total risk-based capital ratio increased from 14.4% at December 31, 2021 to 15.7% at December 31, 2022, primarily due to capital creation from net income, partially offset by a $16.2 million dividend to the Holding Company to cover dividends to shareholders and Holding Company operating costs.

Bancorp's total risk-based capital ratio was 14.6% at December 31, 2021 and 15.9% at December 31, 2022.

Bancorp's 2020 Tier 1 capital included a subordinated debenture due to NorCal Community Bancorp Trust II, which was recorded only at the parent company level and accounted for approximately 18 basis points of the total risk-based capital ratio as of December 31, 2020.

This subordinated debenture was early redeemed on March 15, 2021.

Bancorp's share repurchase program and activity are discussed in detail in ITEM 5 and in Note 8 to the Consolidated Financial Statements in ITEM 8 of this report.

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We accomplish this goal by maintaining an appropriate level of liquid assets and formal lines of credit with the FHLB, FRBSF and correspondent banks that enable us to borrow funds as discussed in Note 7 to the Consolidated Financial Statement in ITEM 8 of this report.

Our Asset Liability Management Committee ("ALCO"), which is comprised of independent Bank directors and the Bank's Chief Executive Officer, is responsible for approving and monitoring our liquidity targets and strategies.

Our Asset Liability Management Committee

("ALCO"), which is comprised of independent Bank directors and the Bank's Chief Executive Officer, is responsible for approving and monitoring our liquidity targets and strategies.

ALCO has adopted a contingency funding plan that provides early detection of potential liquidity issues in the market or the Bank and institutes prompt responses that may prevent or alleviate a potential liquidity crisis.

Management monitors liquidity daily and regularly adjusts our position based on current and future liquidity needs.

We also have relationships with third-party deposit networks and can adjust the placement of our deposits via reciprocal or one-way sales as part of our cash management strategy, as discussed in Note 6 to the consolidated financial statements in ITEM 8 of this report.

We obtain funds from the repayment and maturity of loans, deposit inflows, investment security maturities and paydowns, federal funds purchases, FHLB advances, other borrowings, and cash flow from operations.

We also have relationships with third-party deposit networks and can adjust the placement of our deposits via reciprocal or one-way sales as part of our cash management strategy, as discussed in Note 6 to the Consolidated Financial Statement in ITEM 8 of this report.

We obtain funds from the repayment and maturity of loans, deposit inflows, investment security maturities, sales and paydowns, federal funds purchases, FHLB advances, other borrowings, and cash flow from operations.

Our primary uses of funds are the origination of loans, the purchase of investment securities, withdrawals of deposits, maturity of certificates of deposit, repayment of borrowings, and dividends to common stockholders.

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The cash cycles and unique business activities of some of our large commercial depositors may cause short-term fluctuations in their deposit balances held with us.

Since 2020 the banking industry has experienced abundant liquidity driven by pandemic-related government programs such as PPP and stimulus checks as well as an elevated savings rate system-wide.

Our cash and cash equivalents increased $147.3 million from December 31, 2020.

The most significant source of liquidity during 2021 was deposit growth of $514.3 million (exclusive of deposits added through the ARB acquisition).

Proceeds from loans collected net of origination was $256.9 million, mainly due to SBA PPP loan forgiveness.

Proceeds from principal paydowns, maturities and sales of investment securities totaled $188.4 million.

In addition, $140.6 million of cash was acquired from ARB, and $45.3 million in net cash was provided by operating activities.

Significant uses of liquidity during 2021 were $925.6 million in investment securities purchased, $40.8 million in common stock repurchases, 13.9 million for a repayment of an FHLB loan acquired from ARB, $13.1 million in cash dividends paid on common stock to our shareholders, and $4.1 million in repayment of a subordinated debenture.

Our cash and cash equivalents decreased by $302.2 million to $45.4 million at December 31 2022 from $347.6 million at December 31, 2021.

Significant uses of liquidity during 2022 were $563.4 million in investment securities purchased, $235.2 million in withdrawals of deposits, $15.7 million in cash dividends paid on common stock to our shareholders, $4.7 million in purchase of bank owned life insurance policies and $1.2 million in common stock repurchases.

The most significant sources of liquidity during 2022 were proceeds from loans collected net of originations totaling $164.0 million, proceeds from principal paydowns, maturities and sales of investment securities totaled $187.9 million and Federal Home Loan Bank borrowings of $112.0 million.

In addition, $55.3 million in net cash was provided by operating activities.

Refer to the Consolidated Statement of Cash Flows in this Form 10-K for additional information on our sources and uses of liquidity.

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

Undrawn credit commitments, as discussed in Note 16 to the Consolidated Financial Statements in ITEM 8 of this report, totaled $634.2 million at December 31, 2021.

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

Total immediate contingent funding sources, including unrestricted cash, unencumbered available-for-sale securities and total borrowing capacity was $1.7 billion, or 49% of total deposits as of December 31, 2022.

In February 2023, we enhanced our borrowing capacity at the FHLB by pledging certain held-to-maturity securities to the Securities-Backed Credit Program, increasing the Bank's total immediate contingent funding sources to approximately $2.0 billion, or 59% of deposits as of February 28, 2023.

In addition, under the Federal Reserve’s new BTFP facility, the the Bank has the option to add approximately $267 million to its borrowing capacity.

Undrawn credit commitments, as discussed in Note 16 to the Consolidated Financial Statements in ITEM 8 of this rep ort, totaled $566.9 million at December 31, 2022.

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

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Under the California Financial Code, payment of a dividend from the Bank to Bancorp without advance regulatory approval is restricted to the lesser of the Bank’s retained earnings or the amount of the Bank’s net profits from the previous three fiscal years less the amount of dividends paid during that period.

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

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

Bancorp held $4.5 million of cash at December 31, 2022 .

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

What changed 10-K

Item 7. Management’s Discussion and Analysis