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Item 2. Management’s Discussion and Analysis

2023-08-08 compared with 2023-05-09 · 271 added, 181 removed, 293 unchanged (61% of the section changed)

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management's discussion of the financial condition and results of operations, which is unaudited, should be read in conjunction with the related consolidated financial statements in this Form 10-Q and with the audited consolidated financial statements and accompanying notes included in our 2022 Annual Report on Form 10-K.

Management's discussion of the financial condition and results of operations, which is unaudited, should be read in conjunction with the related unaudited consolidated financial statements in this Form 10-Q and with the audited consolidated financial statements and accompanying notes included in our 2022 Annual Report on Form 10-K.

Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances.

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Executive Summary

We generated earnings of $9.4 million for the first quarter of 2023, compared to $12.9 million for the fourth quarter of 2022 and $10.5 million in the first quarter of 2022.

Diluted earnings per share were $0.59 for the first quarter of 2023, compared to $0.81 for the preceding quarter and $0.66 in the same quarter a year ago.

Earnings declined in the first quarter of 2023, as an increase in interest expense reflected market interest rate increases on a lagged basis.

We generated earnings of $4.6 million for the second quarter of 2023, compared to $9.4 million for the first quarter of 2023.

Diluted earnings per share were $0.28 for the second quarter of 2023, compared to $0.59 for the preceding quarter.

Earnings for the first six months of 2023 totaled $14.0 million, compared to $21.5 million in the same period last year.

Diluted earnings per share were $0.87 and $1.35 for the first six months of 2023 and 2022, respectively.

2023 earnings presented were impacted by the increased cost of interest bearing deposits catching up to market interest rates and higher average balances on borrowings.

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

• Following recent industry events, our deposit franchise remained strong at $3.251 billion on March 31, 2023, a decrease of $322.8 million from $3.573 billion at December 31, 2022.

While there have been some outflows related to industry concerns in March and pandemic surge deposits redeploying to money market funds, the largest transactions were related to the normal operating activities of our customers.

Those activities include vendor payments, taxes, payroll and singular events such as disbursement of proceeds from the sale of a business, real property acquisitions for cash, trust distributions or estate settlements.

The cost of deposits increased 12 basis points quarter over quarter due to targeted relationship-based pricing adjustments.

Non-interest bearing deposits made up 50.3% of total deposits at March 31, 2023, compared to 51.5% at December 31, 2022, and we estimated that 67% of total deposits were fully covered by FDIC insurance as of March 31, 2023.

• Liquidity is strong, providing 181% coverage of estimated uninsured deposits.

The Bank has long followed liquidity management practices similar to larger banks with robust liquidity requirements and regular liquidity stress testing.

While the Bank has the ability to utilize the Federal Reserve Bank Term Funding Program ("BTFP") and has tested it for contingency planning purposes, there has been no need to utilize the facility at this time.

• Loan balances of $2.112 billion at March 31, 2023, increased $19.8 million from $2.093 billion at December 31, 2022 reflecting originations of $44.9 million and payoffs of $22.2 million.

Utilization of credit lines was offset by loan amortization from scheduled repayments during the quarter and unfunded commitments declined $37.4 million from December 31, 2022 to $529.5 million at March 31, 2023.

• Non-accrual loans were only 0.10% of total loans as of March 31, 2023, compared to 0.12% at December 31, 2022.

We recorded a $350 thousand provision for credit losses on loans in the first quarter, compared to no provision in the previous quarter and a $485 thousand provision reversal in the same quarter of 2022.

The provision in the first quarter of 2023 was due primarily to qualitative risk factor adjustments.

• Credit quality remains sound notwithstanding the trends in the commercial real estate market.

Our loan po rtfolio continues to perform well, with classified loans at only 1.47% of total loans and manageable delinquencies.

Non-owner occupied commercial real estate loans made up 73% of total classified loans as of March 31, 2023, compared to 76% at December 31, 2022, and all are currently paying as agreed.

We continue to maintain diversity among property types and within our geographic footprint.

In particular, our offi ce commercial real estate portfolio in the City of San Francisco represents just 3% of our total loan portfolio and 6% of our total non-owner occupied commercial real estate portfolio.

As of the last measurement period, the average loan-to-value and debt-service coverage for the entire non-owner occupied office portfolio were 55% and 1.67x, respectively.

For the eleven non-owner occupied office loans in the City of San Francisco, the average loan-to-value and debt-service coverage were 60% and 1.20x, respectively.

More details are available in the supplementary earnings presentation filed as Exhibit 99.2 to our 8-K on April 24, 2023, and also available on our website.

• The first quarter tax-equivalent net interest margin decreased 22 basis points to 3.04% from 3.26% for the previous quarter due primarily to increased deposit costs and average borrowing balances, partially offset by higher loan yields.

The margin was up from 2.96% in the same period of 2022.

• Return on average assets ("ROA") was 0.92% for the first quarter of 2023, compared to 1.21% for the fourth quarter of 2022 and 0.98% for the first quarter of 2022, and return on average equity ("ROE") was 9.12%, compared to 12.77% for the prior quarter and 9.61% for the first quarter in the prior year.

The efficiency

ratio for the first quarter of 2023 was 60.24%, compared to 50.92% for the prior quarter and 59.13% for the first q uarter of 2022.

The sequential declines in ROA and ROE and increase in the efficiency ratio were due primarily to the $3.6 million increase in interest expense.

• The Bank finalized the closure of four branch locations which were announced in January 2023.

The acquisition of American River Bank ("ARB") 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 Marin and Amador counties were in close proximity to other branches fully able to meet our customers' needs.

These closures represented the remaining expense savings anticipated from the acquisition, optimizing efficiency and our ability to fund strategic initiatives going forward.

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

Additional performance details can be found in the pages that follow.

• Deposits totaled $3.325 billion as of June 30, 2023, a decrease of $248.1 million from $3.573 billion at December 31, 2022.

We are closing the gap on the deposit outflows experienced in the first quarter of 2023.

Our deposit franchise exhibited good growth in new and existing relationships in the second quarter of 2023 as a result of our extensive customer outreach, with the addition of over 1,400 new accounts in the quarter and over 2,400 new accounts year-to-date at average rates well below our cost of borrowing.

In fact, total deposits increased by $69 million post quarter-end through July 31, 2023, following a $75 million increase in second quarter as previously reported in our earnings release, and were less than $80 million below levels immediately preceding the first quarter bank failures that resulted in industry disruption.

• Non-interest bearing deposits made up 47.8% of total deposits at June 30, 2023, compared to 51.5% at December 31, 2022.

We have successfully maintained high non-interest bearing deposit balances consistent with pre-pandemic levels, despite market and industry turbulence.

Customer participation in the reciprocal deposit network program grew to $421.0 million, bringing estimated FDIC insured and/or collateralized deposits up to 71% of total deposits as of June 30, 2023.

Our largest depositor represented 1.3% of total deposits as of June 30, 2023.

• Contingent liquidity provided 209% coverage of estimated uninsured and/or uncollateralized deposits at June 30, 2023.

The Bank has long followed sound liquidity management practices similar to large banks with robust liquidity requirements and regular liquidity stress testing that have been enhanced subsequent to events of the first quarter.

• The credit quality of our loan portfolio remains strong with classified loans at only 1.81% of total loans and manageable delinquencies with no meaningful credit surprises during the first half of the year.

Non-accrual loans were 0.10% of total loans as of June 30, 2023, compared to 0.12% at December 31, 2022.

We recorded a $500 thousand provision for credit losses on loans in the second quarter, compared to a provision of $350 thousand in the previous quarter.

For six months ended June 30, 2023, we recorded a provision for credit losses on loans of $850 thousand, compared to a reversal of $485 thousand for the same period in 2022.

• Loan balances of $2.103 billion increased $10.3 million during the six months ended June 30, 2023.

Loan originations were $67.7 million and payoffs were $46.8 million for the six months ended June 30, 2023.

• The second quarter tax-equivalent net interest margin decreased 59 basis points to 2.45% from 3.04% for the previous quarter due primarily to increased deposit costs and average borrowing balances, partially offset by higher loan yields.

The tax-equivalent net interest margin for the first six months of 2023 of 2.74% decreased 27 basis points from 3.01% for the same period in 2022 for the same reasons mentioned above.

• Return on average assets ("ROA") was 0.44% for the second quarter of 2023, compared to 0.92% for the first quarter of 2023.

Return on average equity ("ROE") was 4.25% for the second quarter of 2023, compared to 9.12% for the prior quarter.

ROA was 0.68% for the six months ended June 30, 2023, compared to 1.00% in the same period of the prior year.

ROE was 6.65% for the six months ended June 30, 2023, compared to 10.16% in the same period of the prior year.

The efficiency ratio for the second quarter of 2023 was 76.91%, compared to 60.24% for the prior quarter.

The efficiency ratio was 67.74% for the six months ended June 30, 2023, compared to 57.40% in the same period of the prior year.

The sequential declines in ROA and ROE and increase in the efficiency ratio in the first six months of 2023 were due primarily to a $13.8 million increase in interest expense.

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

The total risk-based capital ratios at March 31, 2023 for Bancorp and the Bank were 16.2% and 15.6%, respectively.

Bancorp's tangible common equity to tangible assets ("TCE ratio") was 8.7% at March 31, 2023, and the Bank's TCE ratio was 8.3%.

• Given the strength and durability of the Bank's financial performance, the Board of Directors declared a cash dividend of $0.25 per share on April 21, 2023, which represents the 72 nd consecutive quarterly dividend paid by Bancorp.

The dividend is payable on May 12, 2023, to shareholders of record at the close of business on May 5, 2023.

The total risk-based capital ratios at June 30, 2023 for Bancorp and the Bank were 16.4% and 16.0%, respectively.

Bancorp's tangible common equity to tangible assets ("TCE ratio") was 8.6% at June 30, 2023, compared to 8.2% as of December 31, 2022.

As of June 30, 2023, Bancorp's TCE ratio, net of after tax unrealized losses on held-to-maturity securities, was 6.7%, compared to 6.2% at December 31, 2022 (ref er to page 45 for a dis cussion and reconciliation of this non-GAAP financial measure).

• On July 12, 2023, the Bank completed the sale of its only other real estate owned property, which was obtained in the 2021 merger with American River Bankshares.

After previously recorded write-downs totaling $385 thousand, including $40 thousand in the second quarter of 2023, the Bank realized a negligible gain after sales costs.

• On July 7, 2023, the Bank entered into various interest rate swap agreements with notional values totaling $101.8 million to hedge balance sheet interest rate sensitivity and protect selected securities in its available-for-sale portfolio against changes in fair value related to changes in the benchmark interest rate.

The interest rate swaps are expected to be immediately accretive to earnings.

• In July 2023, the Bank sold $82.7 million of available-for-sale securities for a net loss of $2.8 million.

We held the sales proceeds in cash as part of our liquidity strategy.

The loss was offset by a $2.8 million gain from the July 13, 2023 sale of our remaining investment in Visa Inc.

Class B restricted common stock, which had a zero carrying value.

• The Board of Directors declared a cash dividend of $0.25 per share on July 21, 2023, which represents the 73 rd consecutive quarterly dividend paid by Bancorp.

The dividend is payable on August 11, 2023, to shareholders of record at the close of business on August 4, 2023.

• On July 21, 2023, the Board of Directors approved the adoption of Bancorp's new share repurchase program for up to $25.0 million and expiring on July 31, 2025, replacing the program that expired on July 31, 2023.

RESULTS OF OPERATIONS

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

Three months ended

(dollars in thousands, except per share data) March 31, 2023 December 31, 2022 March 31, 2022

Three months ended Six months ended

(dollars in thousands, except per share data) June 30, 2023 March 31, 2023 June 30, 2023 June 30, 2022

Selected operating data:

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89.29 % 42.37 % 56.82 % 35.56 %

(dollars in thousands, except per share data) March 31, 2023 December 31, 2022

(dollars in thousands, except per share data) June 30, 2023 December 31, 2022

Selected financial condition data:

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Average Statements of Condition and Analysis of Net Interest Income

The following table compares interest income, average interest-earning assets, interest expense, and average interest-bearing liabilities for the periods presented.

The table also presents net interest income, net interest margin and net interest rate spread for each period reported.

Three months ended Three months ended Three months ended

March 31, 2023 December 31, 2022 March 31, 2022

Interest Interest Interest

Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/

(dollars in thousands) Balance Expense Rate Balance Expense Rate Balance Expense Rate

The following tables compare interest income, average interest-earning assets, interest expense, and average interest-bearing liabilities for the periods presented.

The tables also presents net interest income, net interest margin and net interest rate spread for each period reported.

Three months ended Three months ended

June 30, 2023 March 31, 2023

Interest Interest

Average Income/ Yield/ Average Income/ Yield/

(dollars in thousands) Balance Expense Rate Balance Expense Rate

Interest-earning deposits with banks 1

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Tax-equivalent net interest rate spread 1.42 % 2.54 %

Six months ended Six months ended

June 30, 2023 June 30, 2022

Interest Interest

Average Income/ Yield/ Average Income/ Yield/

(in thousands) Balance Expense Rate Balance Expense Rate

Interest-earning deposits with banks 1

$ 4,217 $ 104 4.91 % $ 163,064 $ 286 0.35 %

Investment securities 2, 3

1,835,525 20,297 2.21 % 1,717,624 15,340 1.79 %

Loans 1, 3, 4

2,114,952 49,115 4.62 % 2,211,062 47,403 4.26 %

Total interest-earning assets 1

3,954,694 69,516 3.50 % 4,091,750 63,029 3.06 %

Cash and non-interest-bearing due from banks 38,985 62,679

Bank premises and equipment, net 8,471 7,305

Interest receivable and other assets, net 139,134 167,265

Total assets $ 4,141,284 $ 4,328,999

Liabilities and Stockholders' Equity

Interest-bearing transaction accounts $ 252,110 $ 488 0.39 % $ 297,734 $ 109 0.07 %

Savings accounts 307,402 316 0.21 % 343,333 61 0.04 %

Money market accounts 950,564 5,377 1.14 % 1,099,439 916 0.17 %

Time accounts including CDARS 150,384 1,169 1.57 % 146,061 81 0.11 %

Short-term borrowings and other obligations 1

297,853 7,589 5.07 % 384 1 0.62 %

Total interest-bearing liabilities 1,958,313 14,939 1.54 % 1,886,951 1,168 0.12 %

Demand accounts 1,709,907 1,963,832

Interest payable and other liabilities 48,678 50,846

Stockholders' equity 424,386 427,370

Total liabilities & stockholders' equity $ 4,141,284 $ 4,328,999

Tax-equivalent net interest income/margin 1

$ 54,577 2.74 % $ 61,861 3.01 %

Reported net interest income/margin 1

$ 54,029 2.72 % $ 61,095 2.97 %

Tax-equivalent net interest rate spread 1.96 % 2.94 %

1 Interest income/expense is divided by actual number of days in the period times 360 days to correspond to stated interest rate terms, where applicable.

6 unchanged sentences

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

Rate variances are equal to the increase or

decrease in rates multiplied by prior period average balances.

Mix variances are attributable to the change in yields or rates multiplied by the change in average balances, including two fewer days in the three months ended March 31, 2023 compared to December 31, 2022.

Three Months Ended March 31, 2023 Compared to Three Months Ended

December 31, 2022 Three Months Ended March 31, 2023 Compared to Three Months Ended

March 31, 2022

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

Mix variances are attributable to the change in yields or rates multiplied by the change in average balances, including one more day in the three months ended June 30, 2023, compared to March 31, 2023.

Three Months Ended June 30, 2023 Compared to Three Months Ended

March 31, 2023 Six Months Ended June 30, 2023 Compared to Six Months Ended

June 30, 2022

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

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

First Quarter of 2023 Compared to the Fourth Quarter of 2022

Net interest income totaled $29.9 million in the first quarter of 2023, compared to $33.4 million in the fourth quarter of 2022.

Second Quarter of 2023 Compared to the First Quarter of 2023

Net interest income totaled $24.1 million in the second quarter of 2023, compared to $29.9 million in the first quarter of 2023.

The $5.8 million decrease from the prior quarter was primarily related to an increase in the cost of deposits and higher average borrowing balances.

The tax-equivalent net interest margin was 3.04% in the first quarter of 2023, compared to 3.26% in the fourth quarter of 2022.

The decline from prior quarter was primarily due to higher borrowing and deposit costs partially offset by higher interest rates on loans.

The tax-equivalent yield on interest-earning assets was 3.49% in the first quarter of 2023, an increase of 15 basis points over the fourth quarter of 2022.

For the first quarter of 2023, interest-bearing liabilities costs were 0.95%, which was a 77 basis point increase over the fourth quarter of 2022.

First Quarter of 2023 Compared to the First Quarter of 2022

Net interest income totaled $29.9 million for the first quarter of 2023, largely unchanged compared to the first quarter of 2022, as the increase in interest income on loans and investments offset the increases in interest expense on deposits and borrowings.

The tax-equivalent net interest margin was 3.04% in the first quarter of 2023, compared to 2.96% in the same period in the prior year.

The increase over the same quarter last year was primarily due to higher yields on loans and investments partially offset by higher deposit and borrowing costs.

The tax-equivalent net interest margin was 2.45% in the second quarter of 2023, compared to 3.04% in the first quarter of 2023.

The decline from prior quarter was primarily due to higher deposit and borrowing costs slightly offset by higher yields on loans.

Average interest-bearing deposit balances decreased by $39.2 million while the cost increased by 95 basis points.

Average borrowing balances increased by $149.7 million and the cost of borrowings increased by 30 basis points.

Average loan balances decreased by $13.5 million while the average yield increased by 3 basis points.

First Six Months of 2023 Compared to the First Six Months of 2022

Net interest income totaled $54.0 million for the six months ended June 30, 2023, a decrease of $7.1 million, compared to the six months ended June 30, 2022.

The decrease was primarily due to higher deposit costs resulting in an incremental $6.2 million in interest expense, and borrowing costs of $7.6 million.

These decreases were partially offset by higher average balances and yields on the investment portfolio, generating incremental income of $5.1 million, and higher yields on loans, adding $1.8 million.

The tax-equivalent net interest margin was 2.74% in the six months ended June 30, 2023, compared to 3.01% in the same period in the prior year.

The decrease was primarily attributed to higher borrowing and deposit costs partially offset by higher yields on investments and loans.

Average interest-bearing deposits balances decreased by $226.1 million while the cost increased by 77 basis points, mainly for money market and time deposit account types.

Average borrowing balances increased by $297.5 million at an average cost of 4.45%.

Average loan balances decreased by $96.1 million while the average yield increased by 36 basis points.

Market Interest Rates

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

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

In 2023, on both February 1 st and March 2 nd , the FOMC increased the target rate by 25 basis points to a range of 4.75% to 5.00%.

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

In 2023, on each of February 1 st , March 22 nd , May 3 rd , and July 26 th the FOMC increased the target rate by 25 basis points to a range of 5.25% to 5.50%.

Federal Reserve policymakers continue to monitor inflation and economic developments throughout 2023.

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The following table shows the activity for the periods presented.

Three months ended

(dollars in thousands) March 31, 2023 December 31, 2022 March 31, 2022

Three months ended Six months ended

(dollars in thousands) June 30, 2023 March 31, 2023 June 30, 2023 June 30, 2022

Provision for (reversal of) credit losses on loans $ 500 $ 350 $ 850 $ (485)

We recorded a $500 thousand provision for credit losses on loans in the second quarter.

The provision was due primarily to increases in qualitative risk factors from continued negative trends in adversely graded loans and/or collateral values on our non-owner occupied commercial real estate office and multi-family real estate portfolios.

These increases were partially offset by the impact of a decrease in loan balances.

We recorded a $350 thousand provision for credit losses on loans in the first quarter.

The provision was due primarily to increases in qualitative risk factors to account for continued uncertainty about inflation and recession risks.

Management believed that these risk factors were not adequately captured in the modeled quantitative portion of the allowance and took the more prudent approach to account for loan and collateral concentration risks, mainly in our construction and commercial real estate portfolios, and the need for heightened portfolio management in light of current economic conditions.

In addition, the $19.8 million increase in loans contributed modestly to the provision.

These increases were partially offset by the quantitative impact of an improvement in Moody's Analytics' baseline California unemployment rate forecasts over the next four quarters.

There was no provision in the prior quarter and a $485 thousand provision reversal in the first quarter of 2022, due primarily to an improvement in underlying economic forecasts at the time.

The provision was due primarily t o increases in qualitative risk factors to account for continued uncertainty about inflation and recession risks.

Management believed that these risk factors were not adequately captured in the modeled quantitative portion of the allowance and took a more prudent approach to account for loan and collateral concentration risks, mainly in our construction and commercial real estate portfolios and the need for heightened portfolio management in light of current economic conditions.

In additio n, the $19.8 million increase in loans contrib uted modestly to the provision in the first quarter.

These increases were partially offset by the quantitative impact of an improvement in Moody's Analytics' baseline California unemployment rate forecasts over the next four quarters at the time.

The reversal of the allowance for credit losses on loans for the six months ended June 30, 2022 primarily resulted from improved unemployment rate forecasts at the time.

For more information, refer to Note 5, Loans and Allowance for Credit Losses on Loans, to the consolidated financial statements in this Form 10-Q.

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

Three months ended Quarter over quarter Year over year

(dollars in thousands) March 31, 2023 December 31, 2022 March 31, 2022 Amount Change Percent Change Amount Change Percent Change

Three months ended

(dollars in thousands) June 30, 2023 March 31, 2023 Amount Change Percent Change

Wealth Management and Trust Services $ 559 $ 511 $ 48 9.4 %

Earnings on bank-owned life insurance, net 362 $ 705 (343) (48.7) %

Service charges on deposit accounts 520 533 (13) (2.4) %

Debit card interchange fees, net 555 447 108 24.2 %

Dividends on Federal Home Loan Bank stock 290 302 (12) (4.0) %

Merchant interchange fees, net 127 133 (6) (4.5) %

Other income 326 304 22 7.2 %

Total non-interest income $ 2,739 $ 2,935 $ (196) (6.7) %

Six months ended Amount Change Percent Change

(dollars in thousands) June 30, 2023 June 30, 2022

Wealth Management and Trust Services $ 1,070 $ 1,230 $ (160) (13.0) %

Earnings on bank-owned life insurance, net 1,067 711 356 50.1 %

Service charges on deposit accounts 1,053 953 100 10.5 %

Debit card interchange fees, net 1,002 1,036 (34) (3.3) %

3 unchanged sentences

Total non-interest income $ 5,674 $ 5,595 $ 79 1.4 %

First Quarter of 2023 Compared to the Fourth Quarter of 2022

Non-interest income totaled $2.9 million in the first quarter of 2023, compared to $2.6 million in the prior quarter.

The $348 thousand increase from the prior quarter was primarily related to the recognition of a death benefit on bank-owned life insurance, partially offset by decreases in debit card interchange fees and other income.

First Quarter of 2023 Compared to the First Quarter of 2022

Non-interest income totaled $2.9 million in the first quarter of 2023, compared to $2.9 million in the same period of the prior year.

The $68 thousand improvement from the first quarter of 2022, was primary due to the death benefit, partially offset by decreases in wealth management and trust services income and other income.

Second Quarter of 2023 Compared to the First Quarter of 2023

Non-interest income totaled $2.7 million for the second quarter of 2023, compared to $2.9 million for the prior quarter.

The $196 thousand decrease from the prior quarter was primarily related to the recognition of a bank-owned life insurance benefit payment in the prior quarter, partially offset by increases in ATM and debit card interchange fees.

First Six Months of 2023 Compared to the First Six Months of 2022

Non-interest income totaled $5.7 million for the six months ended June 30, 2023, compared to $5.6 million for the same period of the prior year.

The $79 thousand increase from the prior year period was mostly attributable to the

higher bank-owned life insurance balances and benefit payments, partially offset by decreases in wealth management and trust services income and other income including one-way deposit and cash management fees.

Non-interest Expense

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

Three months ended Quarter over quarter Year over year

(dollars in thousands) March 31, 2023 December 31, 2022 March 31, 2022 Amount Change Percent Change Amount Change Percent Change

Three months ended

(dollars in thousands) June 30, 2023 March 31, 2023 Amount Change Percent Change

Salaries and related benefits $ 11,416 $ 10,930 $ 486 4.4 %

Occupancy and equipment 1,980 2,414 (434) (18.0) %

Professional services 1,123 985 913 138 14.0 % 210 23.0 %

Data processing 922 1,045 (123) (11.8) %

Professional services 797 1,123 (326) (29.0) %

Depreciation and amortization 400 882 (482) (54.6) %

Federal Deposit Insurance Corporation insurance 666 289 377 130.4 %

Information technology 357 370 (13) (3.5) %

Charitable contributions 638 49 589 1,202.0 %

Amortization of core deposit intangible 340 345 (5) (1.4) %

Directors' expense 300 321 (21) (6.5) %

Other real estate owned 44 4 40 1,000.0 %

Other non-interest expense

Advertising 300 278 22 7.9 %

Other expense 2,505 1,730 775 44.8 %

Total other non-interest expense 2,805 2,008 797 39.7 %

Total non-interest expense $ 20,665 $ 19,780 $ 885 4.5 %

Six months ended Amount Change Percent Change

(dollars in thousands) June 30, 2023 June 30, 2022

Salaries and related benefits $ 22,346 $ 21,889 $ 457 2.1 %

Occupancy and equipment 4,394 3,798 596 15.7 %

Data processing 1,967 2,476 (509) (20.6) %

Professional services 1,920 1,578 342 21.7 %

Depreciation and amortization 1,282 845 437 51.7 %

Federal Deposit Insurance Corporation insurance 955 586 369 63.0 %

Information technology 727 946 (219) (23.2) %

Charitable contributions 687 556 131 23.6 %

Other real estate owned 4 4 2 — — % 2 100.0 %

Amortization of core deposit intangible 685 754 (69) (9.2) %

Directors' expense 621 605 16 2.6 %

Other real estate owned 48 5 43 NM

Other non-interest expense

3 unchanged sentences

Total non-interest expense $ 40,445 $ 38,281 $ 2,164 5.7 %

First Quarter of 2023 Compared to the Fourth Quarter of 2022

Non-interest expense totaled $19.8 million in the first quarter of 2023, compared to $18.3 million in the prior quarter.

The $1.5 million increase from the prior quarter included $417 thousand in adjustments to estimated incentive and supplemental executive retirement plan accruals, and $432 thousand from accelerated amortization and lease costs associated with branch closures.

Other increases to salaries and related benefits included $389 thousand in 401(k) matching contributions, which is typically higher in the first quarter, and $383 thousand of additional salaries, insurance and payroll taxes.

Meaningful decreases in expenses included $343 thousand in information technology and data processing costs due largely to timing of purchases and the renegotiation of our data processing contract.

First Quarter of 2023 Compared to the First Quarter of 2022

Non-interest expense totaled $19.8 million in the first quarter of 2023, compared to $19.4 million in the first quarter of 2022.

The $405 thousand increase from the first quarter of 2022 was primarily related to $646 thousand in accelerated amortization and lease costs for branches closed and a $210 thousand increase in professional services fees from the completion of multiple internal audit and consulting engagements.

These increases were partially offset by $466 thousand in net changes to estimated incentive, vacation and retirement plan accruals included within salaries and related benefits expense and acquisition costs included within data processing expense.

NM - Not Meaningful

Second Quarter of 2023 Compared to the First Quarter of 2023

Non-interest expense totaled $20.7 million for the three months ended June 30, 2023, compared to $19.8 million for the prior quarter.

Th e $885 thousand increase from the prior quarter included $589 thousand in charitable contributions as part of our annual grant program, $486 thousand in salaries and related benefits, which included annual merit increases, and $393 thousand in expenses and fees associated with an increase in our customers' participation in reciprocal deposit networks to bolster their FDIC insured balances.

In addition, our FDIC insurance expense increased by $377 thousand as the statutory rates increased uniformly by 2 basis points for all depository institutions effective January 1, 2023 in order to strengthen the FDIC's Deposit Insurance Fund.

These and other lesser increases were partially offset by a $482 thousand reduction in depreciation and amortization expense and $434 thousand decrease in occupancy and equipment expense, primarily due to the acceleration of lease-related costs for branches closed in the first quarter.

These branch closures also reduced maintenance, janitorial and

utilities expenses for the quarter.

In addition, professional services decreased by $326 thousand, mainly due to timing of audit work performed.

First Six Months of 2023 Compared to the First Six Months of 2022

Non-interest expense totaled $40.4 million for the six months ended June 30, 2023 , compared to $38.3 million for the six months ended June 30, 2022, an increase of $2.2 million.

The most significant increases over prior year came from occupancy and equipment and depreciation and amortization expenses, which rose $596 thousand and $437 thousand, respectively, from branch closures in the first quarter of 2023.

In addition, expenses associated with reciprocal deposits placed into deposit networks included in other expenses increased $497 thousand due to higher average balances and fees.

Salaries and related benefits increased by $457 thousand primarily due to regularly scheduled annual merit and other increases and lower deferred origination costs, which were partially offset by an adjustment to our incentive bonus accrual.

The FDIC insurance assessment and professional services also increased by $369 thousand and $342 thousand, resp ectively, for the same reasons mentioned above.

These increases were partially offset by a $509 thousand decrease in data processing expenses due to our core system contract renegotiation for the current period and because the prior year included data processing expenses largely eliminated after the systems conversion associated with the American River Bankshares merger.

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

Provision for Income Taxes

Income tax provisions reflect accruals for taxes at the applicable rates for federal income tax and California franchise tax based upon reported pre-tax income.

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

The provision for income taxes for the first quarter of 2023 totaled $3.4 million at an effective tax rate of 26.7%, compared to $4.8 million at an effective tax rate of 27.0% in the prior quarter and $3.7 million at an effective tax rate of 26.3% in the same quarter last year.

The decrease in the provision in the first quarter of 2023 reflected lower pre-tax income as compared to the prior quarter and the same quarter a year ago.

The 30 basis point decrease in the effective tax rate in the first quarter of 2023 as compared to the prior quarter was primarily due to higher nontaxable BOLI income in 2023.

The 40 basis point increase in the effective tax rate in the first quarter of 2023 as compared to the same quarter a year ago was primarily due to lower income from tax exempt loans and municipal securities

and a higher level of tax benefits in 2022 from the exercise of stock options and disqualifying dispositions of incentive stock options.

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

The provision for income taxes for the second quarter of 2023 totaled $1.3 million at an effective tax rate of 22.5%, compared to $3.4 million at an effective tax rate of 26.7% in the prior quarter.

The decrease in the provision for income taxes in the second quarter of 2023 reflected lower pre-tax income.

The 420 basis point decrease in the effective tax rate in the second quarter of 2023 was primarily due to the larger proportional effect of permanent tax differences on lower pretax income.

This decrease was partially offset by a reduction in the tax-exempt interest exclusion (due to a larger IRC Section 291(e) interest expense disallowance) and lower tax-exempt BOLI income in the second quarter, compared to the prior quarter.

The provision for income taxes for the first half of 2023 totaled $4.8 million at an effective tax rate of 25.4%, compared to $7.7 million at an effective tax rate of 26.3% for the first half of 2022.

The 90 basis point decrease in the effective tax rate in the first half of 2023, as compared to the same period a year ago, was primarily due the larger proportional effect of permanent tax differences on lower pretax income and higher tax-exempt BOLI income.

We file a consolidated return in the U.S.

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

At March 31, 2023, neither the Bank nor Bancorp had accruals for interest nor penalties related to unrecognized tax benefits.

At June 30, 2023, neither the Bank nor Bancorp had accruals for interest or penalties related to unrecognized tax benefits.

FINANCIAL CONDITION SUMMARY

Cash, Cash Equivalents and Restricted Cash

Total cash, cash equivalents and restricted cash were $38.0 million at March 31, 2023, compared to $45.4 million at December 31, 2022.

Total cash, cash equivalents and restricted cash were $39.7 million at June 30, 2023, compared to $45.4 million at December 31, 2022.

The $5.8 million decrease was due primarily to increases in loans and decreases in deposits, partially offset by cash flows from investment securities and increased borrowings.

Investment Securities

The investment securities portfolio totaled $1.756 billion at March 31, 2023, a decrease of $18.2 million from December 31, 2022.

The decrease was primarily the result of principal repayments totaling $32.9 million, partially offset by a $16.2 million reduction in pre-tax unrealized losses on available-for-sale investment securities.

The portfolio is comprised of high credit quality investments with average effective durations of approximately 3.8 on available-for-sale securities and 5.9 on held-to-maturity securities.

Both portfolios generate cash flow monthly from interest, principal amortization and payoffs, which supports the Bank's liquidity.

In the first quarter investment cash flows totaled $46.2 million.

The investment securities portfolio totaled $1.718 billion at June 30, 2023, a decrease of $56.6 million from $1.774 billion at December 31, 2022.

The decrease was primarily the result of principal repayments and maturities totaling

$58.9 million, partially offset by a $5.3 million decrease in pre-tax unrealized losses on available-for-sale investment securities, along with $2.9 million in net amortization in the first half of 2023.

Both the available-for-sale and held-to maturity portfolios are eligible for pledging to either the FHLB or the Federal Reserve as collateral for borrowing.

The portfolios are comprised of high credit quality investments with average effective duratio ns of 3.8 on available-for-sale securities and 5.8 on held-to-maturity securities.

Both portfolios generate cash inflows monthly from interest, principal amortization and payoffs, which supports the Bank's liquidity .

Those cash inflows totaled $82.9 million in the first six months of 2023.

Subsequent to quarter end, the Bank sold $82.7 million of available-for-sale securities and recognized a $2.8 million net loss.

We held the sales proceeds in cash as part of our liquidity strategy.

The net loss was offset with the $2.8 million gain from the July 13, 2023 sale of the Bank's remaining investment in Visa Inc.

Class B restricted common stock, which had a zero carrying value.

See Note 4, Investment Securities, for additional information.

The following table summarizes our investment in obligations of state and political subdivisions at March 31, 2023 and December 31, 2022.

March 31, 2023 December 31, 2022

The following table summarizes our investment in obligations of state and political subdivisions at June 30, 2023 and December 31, 2022.

June 30, 2023 December 31, 2022

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

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Loans and Credit Quality

During the first three months of 2023, loans increased by $19.8 million and totaled $2.112 billion at March 31, 2023, compared to $2.093 billion at December 31, 2023.

Loan originations for the first quarter of 2023 were $44.9 million, compared to $36.1 million for the fourth quarter of 2022 and $49.8 million for the first quarter of 2022.

Loan payoffs were $22.2 million for the first quarter, compared to $55.3 million for the fourth quarter of 2022 and $119.7 million for the first quarter of 2022, which included $70.4 million in PPP loan payoffs.

First quarter 2023 loan payoffs were the lowest first quarter payoffs since 2017 and consisted mainly of a large construction project completed.

The ratio of allowance for credit losses on loans to total loans remained at 1.10% at March 31, 2023 and December 31, 2022.

Net charge-offs for the first quarter of 2023 totaled $3 thousand, compared to net recoveries of $20 thousand for the fourth quarter of 2022 and net recoveries of $9 thousand for the first quarter of 2022.

Non-accrual loans decreased $406 thousand to $2.0 million, or 0.10% of the loan portfolio at March 31, 2023 from $2.4 million, or 0.12% at December 31, 2022.

Non-accrual loans at March 31, 2023 included the addition of six loans totaling $1.4 million in the first quarter, 68% of which were well-secured by commercial real estate, offset by decreases due to payoffs of $1.4 million, upgrades of $413 thousand, and paydowns of $27 thousand.

Over 99% of the non-accrual loans were collateralized by real estate with no expected credit loss as of March 31, 2023.

Accruing loans past due 30 to 89 days totaled $1.2 million at March 31, 2023, compared to $664 thousand at December 31, 2022.

Classified loans with risk ratings of substandard or doubtful totaled $31.0 million at March 31, 2023, compared to $28.1 million at December 31, 2022, increasing primarily due to higher usage of a revolving line of credit already graded substandard.

Other increases included $1.4 million in downgrades, partially offset by $1.7 million in payoffs and paydowns and $314 thousand in upgrades to pass risk rating.

All of the downgrades in the first quarter were for loans that are secured by real estate collateral.

Loans designated special mention, which are not considered adversely classified, increased year-to-date by $2.9 million to $63.1 million at March 31, 2023 from $60.2 million at December 31, 2022.

The increase was largely due to $3.0 million in downgrades from pass risk ratings and balance increases of $550 thousand, which were partially offset by $630 thousand in paydowns and payoffs.

During the first half of 2023, loans increased by $10.3 million and totaled $2.103 billion at June 30, 2023, compared to $2.093 billion at December 31, 2022.

Loan originations wer e $67.7 million for the six months ended June 30, 2023, compared to $152.0 million for the first six months of 2022.

Excluding PPP loans, payoffs were $45.0 mill ion in the six months ended June 30, 2023, compared to $159.1 million for the same period in 2022.

PPP loan payoffs during the six months ended June 30, 2023 and 2022 were $1.8 million and $94.2 million, respectively.

In addition, l oan amortization from scheduled repayments totaling $39.9 million was partially offset by a net increase in

utilization of credit lines of $29.7 million for the six months ended June 30, 2023.

Bank of Marin has continued its usual steadfast conservative underwriting practices, and has not changed its credit standards or policies specifically in reaction to the current market conditions.

The Bank continues to be focused on achieving risk-adjusted returns.

The ratio of allowance for credit losses on loans to total loans was 1.13% at June 30, 2023 compared to 1.10% at December 31, 2022.

Non-accrual loans decreased $320 thousand to $2.1 million, or 0.10% of the loan portfolio at June 30, 2023 from $2.4 million, or 0.12% at December 31, 2022.

All of the non-accrual loans are collateralized by real estate with no expected credit loss as of June 30, 2023.

Accruing loans past due 30 to 89 days totaled $1.0 million at June 30, 2023, compared to $664 thousand at December 31, 2022.

Classified loans with risk ratings of substandard or doubtful totaled $38.1 million at June 30, 2023, compared to $28.1 million at December 31, 2022.

Increases in 2023 were primarily due to a $5.8 million increase in the usage of a revolving line of credit that was previously downgraded and the addition of eight loans to seven borrowers totaling $7.4 million.

Approximately 90% of the additions were comprised of one commercial loan and two non-owner occupied commercial real estate loans.

Partially offsetting the additions were $2.3 million in payoffs and paydowns and $939 thousand in upgrades to pass risk rating.

Loans designated special mention, which are not considered adversely classified, increased by $26.3 million to $86.5 million at June 30, 2023 from $60.2 million at December 31, 2022.

The increase was largely due to $35.9 million in downgrades from pass risk ratings and balance increases of $548 thousand, which were partially offset by $5.9 million in downgrades from special mention to substandard and $4.2 million in paydowns and payoffs.

With the heightened market concern about non-owner occupied commercial real estate, and in particular the office portfolios, we are providing the following additional information.

Non-owner occupied commercial real estate loans made up 64% of total classified loans as of June 30, 2023, compared to 88% at December 31, 2022 and all are currently paying in accordance with loan terms.

We continue to maintain diversity among property types and within our geographic footprint.

Specifically, our office commercial real estate portfolio in the City of San Francisco represents just 3% of our total loan portfolio and 6% of our total non-owner occupied commercial real estate portfolio.

As of the last annual review period (generally December 2022), the average loan-to-value and debt-service coverage for the entire non-owner occupied office portfolio were 55% and 1.67x, respectively.

For the eleven non-owner occupied office loans in the City of San Francisco totaling $71.4 with an average loan balance of $6.5 million, the average loan-to-value and debt-service coverage ratios were 63% and 1.20x, respectively.

For more information, refer to Note 5, Loans and Allowance for Credit Losses on Loans, to the consolidated financial statements in this Form 10-Q.

Liabilities - Deposits and Borrowings

During the first three months of 2023, total liabilities decreased by $30.3 million to $3.705 billion.

Deposits totaled $3.251 billion at March 31, 2023, a decrease of $322.8 million, compared to $3.573 billion at December 31, 2022.

Federal Home Loan Bank borrowings increased $293.4 million to $405.4 million in the first quarter of 2023.

Up until the regulatory closures of Silicon Valley Bank on March 10, 2023 and Signature Bank on March 12, 2023, deposit fluctuations were fairly consistent with prior years' first quarter customer activity with some additional outflows to alternative investments observed.

In 2022, the Bank maintained excess liquidity in anticipation of planned customer activities and expected outflows from pandemic surge deposits received in 2020 and 2021.

As outflows materialized, our low cost of funds relative to the industry provided an opportunity to balance deposit levels against costs.

Early in the first quarter of 2023, our bankers engaged in discussions with clients about account structure and pricing, which positioned the Bank well to navigate uncertainty in the marketplace later in the quarter.

The Bank experien ced a $203.6 million decline in dep osits between March 10 th and March 31 st .

Of the 100 relationships with the largest net outflows totaling approximat ely $206.4 million, 83% was attributed to normal business activities including vendor payments, taxes, payroll and singular events such as estate settlements and sales of businesses, 14% moved to outside brokerage firms or other financial institutions, and the remaining 3% move d to assets under management of our Wealth Management and Trust Service s department.

From March 31 st

through May 5 th deposits have been relatively stable.

Daily balances have not fluctuated up or down more than 0.70% when compared to total deposits as of March 31 st .

We believe that our customer outreach has been effective, and it has resulted in a 48 basis point increase in the cost of our deposits to 56 basis points in the month of April from 8 basis points in the month of December, as we balanced the level of deposits against cost.

Additionally, we opened over 1,000 accounts in the first quarter with $60 million in new deposits.

Non-interest bearing deposits decreased $202.5 million, money market deposits decreased $78.2 million while time deposits increased $25.0 million in the first three months of 2023.

Non-interest bearing deposits represented 50.3% of total deposits at March 31, 2023, compared to 51.5% at December 31, 2022.

The average cost of deposits was 0.20% in the first quarter of 2023 compared to 0.06% in the same period of 2022.

At March 31, 2023, the Bank had $155.4 million outstanding in overnight borrowings and $250.0 million outstanding in short-term borrowings from the Federal Home Loan Bank at rates of 5.11% and 5.21%, respectively.

This compared to $112.0 million i n overnight borrowings at December 31, 2022 at a rate of 4.65%.

During the first six months of 2023, total liabilities decreased by $67.2 million to $3.668 billion.

Deposits totaled $3.325 billion at June 30, 2023, a decrease of $248.1 million compared to $3.573 billion at December 31, 2022.

Federal Home Loan Bank borrowings increased $180.2 million to $292.2 million at June 30, 2023 from $112.0 million at December 31, 2022.

Post quarter end, we reduced borrowings by another $92 million through July 31, 2023 and maintained excess cash, mostly from the sale of available-for-sale securities mentioned above, that is available for further reductions.

Non-interest bearing deposits decreased $250.4 million, while money market deposits increased $39.7 million and time deposits increased $84.4 million in the first six months of 2023.

There was a small shift in deposit composition in the first half of 2023, droppin g non-interest bearing deposits from 51.5% of total deposits to 47.8%, and raising money markets from 27.7% to 30.9% and time deposits from 3.3% to 6.1%.

While there was some runoff in the first quarter attributed to industry disruptions and bank deposits moving to money market funds, the Bank experienced a modest recovery and gained deposit growth momentum in the second quarter.

Additionally, the Bank's competitive and balanced approach to relationship management and focused outreach supported the growth adding over 1,400 new accounts during the second quarter, bringing the total to over 2,400 new accounts in 2023 (excluding new reciprocal accounts).

Of those, approximately 40% were new relationships to the Bank.

The average cost of deposits was 0.44% in the first half of 2023, compared to 0.06% in the same period of 2022.

At June 30, 2023, the Bank had $292.2 million outstanding in overnight borrowings from the Federal Home Loan Bank at a rate of 5.28%, an increase of $180.2 million, compared to $112.0 million i n overnight borrowings at December 31, 2022 at a rate of 4.65%.

The Bank is actively evaluating strategies for reducing borrowings in the current environment and as market conditions change.

Total immediate contingent funding sources, including unrestricted cash, unencumbered available-for-sale securities, and remaining borrowing capacity was $1.932 billion, or 59% of total deposits a nd 181% of estimated uninsured deposits as of March 31, 2023.

Total immediate contingent funding sources, including unrestricted cash, unencumbered available-for-sale securities, and remaining borrowing capacity was $1.992 billion, or 60% of total deposits a nd 209% of estimated uninsured and/or uncollateralized deposits as of June 30, 2023.

Capital Adequacy

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

In addition, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action as of March 31, 2023.

In addition, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action as of June 30, 2023.

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

Bancorp's tangible common equity to tangible assets was 8.7% at March 31, 2023, compared to 8.2% at December 31, 2022.

The Bank's tangible common equity to tangible assets was 8.3% at March 31, 2023, compared to 8.1% at December 31, 2022 for the Bank.

The pro forma TCE ratio if held-to-maturity securities were treated the same as available-for-sale securities at March 31, 2023 would have been 6.9% (refer to page 41 for a discussion and reconciliation of this non-GAAP financial measure).

Management believes this non-GAAP measure is important because it reflects the level of capital available to withstand drastic changes in market conditions.

Contingent funding sources, such as the Federal Home Loan Bank and the Federal Reserve BTFP facility, ensure that banks have immediate access to liquidity and alleviate the need to sell securities in an unrealized loss position.

The Bancorp’s and Bank’s capital adequacy ratios as of March 31, 2023 and December 31, 2022 are presented in the following tables.

Bancorp's TCE ratio was 8.6% at June 30, 2023, compared to 8.2% at December 31, 2022.

Bancorp's TCE ratio, net of after tax unrealized losses on held-to-maturity securities, was 6.7%, compared to 6.2% at December 31, 2022.

Management believes this non-GAAP measure is important because it reflects the level of capital available to withstand drastic changes in market conditions (ref er to page 45 for a dis cussion and reconciliation of this non-GAAP financial measure).

The Bancorp’s and Bank’s capital adequacy ratios as of June 30, 2023 and December 31, 2022 are presented in the following tables.

Bancorp Capital Ratios

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Threshold to be a Well Capitalized Bank Holding Company

March 31, 2023 Amount Ratio Amount Ratio Amount Ratio

June 30, 2023 Amount Ratio Amount Ratio Amount Ratio

Total Capital (to risk-weighted assets) $ 440,340 16.36 % $ 282,667 10.50 % $ 269,207 10.00 %

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Threshold to be Well Capitalized under Prompt Corrective Action Provisions

March 31, 2023 Amount Ratio Amount Ratio Amount Ratio

June 30, 2023 Amount Ratio Amount Ratio Amount Ratio

Total Capital (to risk-weighted assets) $ 430,491 15.99 % $ 282,659 10.50 % $ 269,199 10.00 %

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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 seen in the table below and discussed in Note 6 to the Consolidated Financial Statements in ITEM 1 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 Bank directors and the Bank's Chief Executive Officer, is responsible for approving and monitoring our liquidity targets and strategies.

The Bank has long-established minimum liquidity and diversification requirements using tools similar to larger banks such as the Liquidity Coverage Ratio and multi-scenario, long-horizon stress testing.

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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.

We maintained $2.2 million in one-way-sale deposits off-balance sheet with deposit networks at March 31, 2023 and 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.

In addition, under the Federal Reserve’s new BTFP facility, we added $283.6 million to our borrowing capacity.

Net available contingent funding sources, including unrestricted cash, unencumbered available-for-sale securities and total available borrowing capacity was $1.932 billion, or 181% of estimated uninsured deposits as of March 31, 2023.

The Federal Reserve BTFP facility offers borrowing capacity

based on par values of securities pledged and attractive borrowing rates.

While the Bank has pledged securities and tested the facility, there has been no need to use it.

The following table details the components of liquidity as of March 31, 2023.

We maintained $2.2 million in off-balance sheet one-way deposit sales with our deposit networks at both June 30, 2023 and December 31, 2022.

Net available contingent funding sources, including unrestricted cash, unencumbered available-for-sale securities and total available borrowing capacity was $1.992 billion, or 209% of estimated uninsured and/or uncollateralized deposits as of June 30, 2023.

The Federal Reserve's new BTFP facility offers borrowing capacity based on par values of securities pledged making it less sensitive to changes in market rates.

The following table details the components of our contingent liquidity sources as of June 30, 2023.

(in thousands) Total Available Amount Used Net Availability

Internal Sources

Unrestricted cash $ 37,993 N/A $ 37,993

Unrestricted cash 1

$ 16,705 N/A $ 16,705

Unencumbered securities at market value 761,472 N/A 761,472

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Total Liquidity $ 2,284,016 $ (292,200) $ 1,991,816

Access to brokered deposit purchases through networks such as Intrafi and Reich & Tang and brokered CD sales is not included above.

1 Excludes cash items in transit.

Brokered deposits available through third party networks are not included above.

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

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

Customer deposits are a significant component of our daily liquidity position.

The attraction and retention of new deposits depends upon the variety and effectiveness of our customer account products, service and convenience, rates paid to customers, and our financial strength.

The attraction and retention of new deposits depend upon the variety and effectiveness of our customer account products, service and convenience, rates paid to customers, and our financial strength.

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

Our cash and cash equivalents decreased $7.4 million in the first three months of 2023.

Our cash and cash equivalents decreased $5.8 million in the first half of 2023.

Significant uses of liquidity during 2023 were $248.1 million in withdrawals of deposits, $9.3 million in loan originations and advances, net of principal collected, and $8.0 million in cash dividends paid on common stock to our shareholders.

The most significant sources of liquidity during the first three months of 2023 were increased Federal Home Loan Bank borrowings of $293.4 million, proceeds from principal paydowns of investment securities of $32.9 million, and $13.4 million in net cash provided by operating activities.

The most significant sources of liquidity during the first half of 2023 were increased Federal Home Loan Bank borrowings of $180.2 million, proceeds from principal paydowns and maturities of investment securities of $59.0 million, and $21.5 million in net cash provided by operating activities.

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

Management anticipates that our current strong liquidity position as detailed in the table above is adequate to fund our operations.

Undrawn credit commitments, as discussed in Note 8 to the Consolidated Financial Statements in this Form 10-Q, totaled $529.5 million at March 31, 2023.

Management anticipates that our current strong liquidity position, as detailed in this report, and contingent funding sources outlined in the table above are adequate to support our operational needs.

Unfunded loan commitments, as discussed in Note 8 to the Consolidated Financial Statements in this Form 10-Q, totaled $489.6 million at June 30, 2023.

We expect to fund these commitments to the extent utilized primarily through the repayment of existing loans, principal paydowns of investment securities, and liquid assets.

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Our emphasis on local deposits, combined with our immediately available funding sources, provides a very stable base for our liquidity needs.

We had borrowings under our credit facilities of $405.4 million at March 31, 2023, and $112.0 million at December 31, 2022, as discussed in Note 6 to the Consolidated Financial Statements in ITEM 1 of this report.

We had borrowings under our credit facilities of $292.2 million at June 30, 2023, and $112.0 million at December 31, 2022, as discussed in Note 6 to the Consolidated Financial Statements in ITEM 1 of this report.

Since Bancorp is a holding company and does not conduct regular banking operations, its primary sources of liquidity are dividends from the Bank.

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

Bancorp held $14.1 million in cash at March 31, 2023, which is expected to be sufficient to cover Bancorp's operational needs and cash dividends to shareholders through 2023.

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

Bancorp held $9.7 million in cash at June 30, 2023 and management anticipates that there will be sufficient earnings at the Bank to provide dividends to Bancorp to meet its funding requirements for the foreseeable future.

Statement Regarding use of Non-GAAP Financial Measures

Our first quarter 2022 was impacted by costs associated with our acquisition of American River Bank ("ARB"), which we considered immaterial to discuss in this release.

For additional information regarding the impact of non-GAAP adjustments to our first quarter 2022 performance measures, refer to Form 10-Q filed on May 9, 2022.

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

Management believes that, given recent industry turmoil, the presentation of Bancorp's non-GAAP TCE ratio reflecting the after tax impact of unrealized losses on HTM securities provides useful supplemental information to investors because it reflects the level of capital available to withstand drastic changes in market conditions.

Our first half of 2022 was impacted by costs associated with our 2021 acquisition of American River Bankshares, which we considered immaterial to discuss in this report.

For additional information regarding the impact of non-GAAP adjustments to our first half of 2022 performance measures, refer to Form 10-Q filed on August 8, 2022.

In this report, financial results are presented in accordance with GAAP and with reference to certain non-GAAP financial measures.

Management believes that, given recent industry turmoil, the presentation of Bancorp's non-GAAP TCE ratio reflecting the after-tax impact of unrealized losses on held-to-maturity securities provides useful supplemental information to investors because it reflects the level of capital available to withstand drastic changes in market conditions.

Because there are limits to the usefulness of this measure to investors, Bancorp encourages readers to consider its annual and quarterly consolidated financial statements and notes related thereto in their entirety, as filed with the Securities and Exchange Commission, and not to rely on any single financial measure.

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Reconciliation of GAAP and Non-GAAP Financial Measures

(in thousands, unaudited) March 31, 2023

(in thousands, unaudited) June 30, 2023 December 31, 2022

Tangible Common Equity - Bancorp

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Unrealized losses on HTM securities, net of tax 1

(85,046) (89,432)

TCE, net of unrealized losses on HTM securities (non-GAAP) b $ 261,710 244,790

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Unrealized losses on HTM securities, net of tax 1

(85,046) (89,432)

Total tangible assets, net of unrealized losses on HTM securities (non-GAAP) e $ 3,929,902 3,980,162

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Bancorp TCE ratio, net of unrealized losses on HTM securities (non-GAAP) b / e 6.7 % 6.2 %

1 Net unrealized losses on held-to-maturity securities as of March 31, 2023 of $108.4 million, as shown in Note 4, net of an estimated $32.0 million in deferred tax benefits based on a blended state and federal statutory tax rate of 29.56%.

1 Net unrealized losses on held-to-maturity securities as of June 30, 2023 and December 31, 2022 of $120.7 million and $127.0, respectively, as shown in Note 4, net of an estimated $35.7 million and $37.5, respectively, in deferred tax benefits based on a blended state and federal statutory tax rate of 29.56%.

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What changed 10-Q

Item 2. Management’s Discussion and Analysis