What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-11-08 compared with 2023-08-08 · 206 added, 198 removed, 366 unchanged (52% of the section changed)

9 unchanged sentences

Forward-looking statements are based on management's current expectations regarding economic, legislative, and regulatory issues that may impact Bancorp's earnings in future periods.

Factors that could cause future results to vary materially from current management expectations include, but are not limited to, general economic conditions and the economic uncertainty in the United States and abroad, including economic or other disruptions to financial markets caused by acts of terrorism, war or other conflicts such as Russia's military action in Ukraine, impacts from inflation, supply change disruptions, changes in interest rates (including the actions taken by the Federal Reserve to control inflation), California's unemployment rate, deposit flows, real estate values, and expected future cash flows on loans and securities;

Factors that could cause future results to vary materially from current management expectations include, but are not limited to, general economic conditions and the economic uncertainty in the United States and abroad, including economic or other disruptions to financial markets caused by acts of terrorism, war or other conflicts such as the war between Russia and Ukraine and more recently the war between Israel and Hamas, impacts from inflation, supply change disruptions, changes in interest rates (including the actions taken by the Federal Reserve to control inflation), California's unemployment rate, deposit flows, real estate values, and expected future cash flows on loans and securities;

the impact of adverse developments at other banks, including bank failures, that impact general sentiment regarding the stability and liquidity of banks;

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Executive Summary

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.

We generated earnings of $5.3 million for the third quarter of 2023, compared to $4.6 million for the second quarter of 2023.

Diluted earnings per share were $0.33 for the third quarter of 2023, compared to $0.28 for the preceding quarter.

Earnings for the first nine months of 2023 totaled $19.3 million, compared to $33.7 million for the same period in 2022.

Diluted earnings per share were $1.20 and $2.11 for the first nine months of 2023 and 2022, respectively.

The 2023 earnings 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.

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.

• The third quarter tax-equi valent net interest margin increased 3 basis points to 2.48% from 2.45% in the previous quarter due primarily to higher rates on interest-bearing cash balances generated from securities sales.

The tax-equivalent net interest margin for the nine months ended September 30, 2023 of 2.66% decreased 40 basis points fr om 3.06% for the same period in 2022, primarily due to higher deposit and borrowing costs, partially offset by higher interest rates on loans and investment securities.

We continue to manage our balance sheet and interest rate risk position to the current interest rate environment, and sold an additional $55.0 million in available-for-sale securities in late October.

The sales generated an after-tax loss of $1.5 million, which is expected to be earned back through incremental interest income and improvements to the net interest margin in less than one year.

• Deposits totaled $3.444 billion as of September 30, 2023, a decrease of $129.7 million f rom $3.573 billion at December 31, 2022 .

However, deposits increased $118.5 million over the prior quarter.

Our experienced team of bankers continued to build upon our strong deposit franchise with consistent growth from proactive outreach to both existing and prospective customers in all of our markets.

Average cost of deposits increased 25 basis points over the second quarter, from 0.69% to 0.94%.

Average cost of deposits increased 55 basis points for the first nine months of 2023, compared to the same period in 2022, from 0.06% to 0.61%.

We believe we are competitively aligned in regard to deposit pricing, helping to maintain deposit levels.

• Non-interest bearing deposits made up 47.7% of total deposits at September 30, 2023, compared to 51.5% at December 31, 2022.

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

Customer participation in the reciprocal deposit network program grew to $483.3 million maintaining estimated uninsured and/or uncollateralized deposits at 29% of total deposits as of September 30, 2023 .

Our largest depositor represented 2.7% of total deposits as of September 30, 2023.

• Borrowings totaled $120.0 million as of September 30, 2023, an $8.0 million increase from $112.0 million at December 31, 2022.

However, total borrowings declined $52.2 million quarter-over-quarter from $172.2 million as a result of deposit growth and cash flows from investments and loans.

Net available funding sources of $2.1 billion provided 211% coverage of an estimated $989.8 million in uninsured deposits at September 30, 2023.

• Our loan portfolio continues to perform well with classified loans at 1.90% of total loans.

Non-owner-occupied commercial real estate loans made up $23.6 million or 59% of total classified loans as of September 30, 2023, compared to $22.0 million or 78% at December 31, 2022.

Shortly after quarter-end three unsecured commercial substandard loans to one borrower totaling approximately $4.6 million paid off.

• Non-accrual loans were 0.27% of total loans, or $5.7 million, at September 30, 2023, compared to 0.12%, or $2.4 million, at December 31, 2022.

Of the seven loans totaling $5.3 million moved to non-accrual status during the year, one legacy acquired-bank agricultural loan totaling $3.8 million became current on outstanding payments shortly after quarter-end.

Offsetting the additions were payoffs and paydowns of $1.8 million and two loans for $314 thousand that were moved to accrual status in the first quarter.

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

• A $425 thousand provision for credit losses on loans in the third quarter brought the allowance for credit losses to 1.16% of total loans as of September 31, 2023.

The provision was due primarily to qualitative risk factor adjustments as discussed further below and compared to a provision of $500 thousand in the previous quarter.

For nine months ended September 30, 2023, we recorded a provision for credit losses on loans of $1.3 million , compared to a rev ersal of $63 thousand for the same period in 2022.

• Loans totaled $2.087 billion at September 30, 2023, a decrease of $5.6 million from $2.093 billion at December 31, 2022 reflecting originations of $90.3 million and payoffs of $59.5 million (including PPP payoffs).

L oan amortization from scheduled repayments totaling $60.6 million was partially offset by a $24.2 million net increase in utilization of credit lines in the nine months ended September 30, 2023.

• Return on average assets ("ROA") was 0.52% for the third quarter of 2023, compared to 0.44% for the second quarter of 2023.

Return on average equity ("ROE") was 4.94% for the third quarter of 2023 , compared to 4.25% for the prior quarter.

ROA was 0.63% for the nine months ended September 30, 2023, compared to 1.04% in the same period in 2022.

ROE was 6.07% for the nine months ended September 30, 2023, compared to 10.65% in the same period in 2022.

The efficiency ratio for the third quarter of 2023 was 72.96% , compared to 76.91% for the prior quarter.

The efficiency ratio was 69.37% for the nine months ended September 30, 2023, compared to 55.60% in the same period in 2022 .

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

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.

The total risk-based capital ratios at September 30, 2023 for Bancorp and the Bank were 16.6% and 16.1%, respectively.

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

As of September 30, 2023, Bancorp's TCE ratio, net of after tax unrealized losses on held-to-maturity securities, was 6.1%, compared to 6.2% at December 31, 2022 (ref er to page 46 for a dis cussion and reconciliation of this non-GAAP financial measure).

• The Board of Directors declared a cash dividend of $0.25 per share on October 20, 2023, which represents the 74 th consecutive quarterly dividend paid by Bancorp.

The dividend is payable on November 10, 2023, to shareholders of record at the close of business on November 3, 2023.

• As previously announced, David Bloom, Executive Vice President and Head of Commercial Banking, joined the Bank on July 31 and is responsible for the direction, vision, growth, and performance of the Bank’s commercial banking division, including its eight regional offices located throughout northern California and its specialty wine business.

He previously served as senior managing director of business banking in northern California and the Pacific Northwest at First Republic Ban k.

Under David's direction we have alre ady approved for fu nding loan amounts exceeding third quarter originations since quarter end.

• Also as previously announced, effective October 20, 2023, the Board of Directors for Bank of Marin Bancorp appointed Cigdem Gencer to its board, increasing its membership to thirteen directors.

Gencer brings extensive leadership and financial services experience to the Board.

Throughout her career, she has developed and executed transformative growth, expansion, and investment strategies for organizations, including international expansion efforts.

For nearly two decades, Gencer served as executive vice president at a Fortune 500 financial institution where she served as head of international human resources, head of enterprise data strategy and analytics in the Chief Data Office, and chief financial officer, chief operating officer, and regional sales director for its Private Wealth division.

Her experience also includes serving as a management consultant in the financial services sector and chief financial officer at Intrax, Inc.

In 2021, she established Fazilet Consulting—an executive coaching and organizational consulting firm—in which she also serves as an executive coach.

RESULTS OF OPERATIONS

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

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

Three months ended Nine months ended

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

Selected operating data:

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75.76 % 89.29 % 61.98 % 34.43 %

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

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

Selected financial condition data:

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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.

The tables also present 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

September 30, 2023 June 30, 2023

Interest Interest

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Tax-equivalent net interest rate spread 1.38 % 1.42 %

Six months ended Six months ended

June 30, 2023 June 30, 2022

Nine months ended Nine months ended

September 30, 2023 September 30, 2022

Interest Interest

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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

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 September 30, 2023, compared to the three months ended June 30, 2023.

Three months ended September 30, 2023 compared to three months ended

June 30, 2023

Nine months ended September 30, 2023 compared to nine months ended

September 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%.

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 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.

Third Quarter of 2023 Compared to the Second Quarter of 2023

Net interest income totaled $24.5 million for the third quarter of 2023, compared to $24.1 million for the prior quarter.

The $339 thousand increase from the prior quarter was primarily related to an increase of approximately $358 thousand in interest income from the investment of securities sales proceeds into interest-bearing cash.

The $2.3 million reduction in borrowing cost for the quarter was offset by rising deposit rates and higher average deposit balances that resulted in an additional $2.4 million in interest expense.

The tax-equivalent net interest margin was 2.48% for the third quarter of 2023, compared to 2.45% for the prior quarter.

The increase from prior quarter was primarily due to a $73.3 million increase in avera ge interest-bearing cash balances with an average yield of 5.37% from securities sales proceeds.

During the third quarter n ew loans were originated at rates approximately 150 basis points above the rates on loans paid off, which will positively impact the margin in future periods.

Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022

Net interest income totaled $78.5 million for the nine months ended September 30, 2023, compared to $94.1 million for the same period in the prior year.

The $15.6 million decrease from prior year was primarily due to higher funding costs of $23.9 million, partially offset by higher average yields on earning assets.

The tax-equivalent net interest margin was 2.66% for the nine months ended September 30, 2023, compared to 3.06% for the same period in the prior year.

The decrease was primarily attributed to higher deposit and borrowing costs, partially offset by higher interest rates on loans and investment securities.

Average interest-bearing deposits balances decreased by $164.2 million while the average cost increased by 55 basis points, mainly for money market and time deposit account types, decreasing the margin by 46 basis points.

Average borrowings and other obligations increased by $260.6 million at an average cost of 5.14%, an increase of 4.43%, decreasing the margin by 34 basis points.

Average loan balances decreased by $87.3 million while the average yield increased by 36 basis points, increasing the margin by 20 basis points.

Average investment securities increased $26.2 million and their average yield increased 31 basis points, increasing the margin by 19 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 seven rate adjustments during 2022, the federal funds target rate increased to a range of 4.25% to 4.50% at year-end 2022.

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 and our net interest margin increased gradually over the course of the year.

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%.

Rising interest rates and first quarter disruptions in the banking industry resulted in rapid increases in the cost of funds through rising deposit costs and increased borrowings, putting pressure on net interest margin in the second and third quarters.

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 Six months ended

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

Three months ended Nine months ended

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

Provision for (reversal of) credit losses on loans $ 425 $ 500 $ 1,275 $ (63)

We recorded a $425 thousand provision for credit losses on loans in the third quarter.

The provision was due primarily to increases in qualitative factors related to trends in adversely graded, non-owner-occupied commercial real estate loans and the potential impact of rapidly increasing interest rates and other external factors on both our non-owner-occupied commercial real estate and construction portfolios.

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

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

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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 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.

The provision totaling $1.3 million for the nine months ended September 30, 2023 primarily resulted from increases in qualitative risk factors from continued trends in adversely graded loans and/or collateral values not believed to be captured in the quantitative risk factors.

The net provision reversal for the nine months ended September 30, 2022 primarily resulted from a provision reversal in the first quarter due to improvements in the economic forecasts, partially offset by the provision in the third quarter due primarily to an increase in qualitative factors to account for the ongoing deterioration in the economic outlook not captured in the quantitative portion of the allowance.

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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Three months ended

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

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

Wealth Management and Trust Services $ 515 $ 559 $ (44) (7.9) %

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

Service charges on deposit accounts 508 520 (12) (2.3) %

Debit card interchange fees, net 456 555 (99) (17.8) %

Earnings on bank-owned life insurance, net 371 $ 362 9 2.5 %

Dividends on Federal Home Loan Bank stock 324 290 34 11.7 %

2 unchanged sentences

Total non-interest income $ 2,598 $ 2,739 $ (141) (5.1) %

Six months ended Amount Change Percent Change

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

Nine months ended Amount Change Percent Change

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

Wealth Management and Trust Services $ 1,585 $ 1,737 $ (152) (8.8) %

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

Service charges on deposit accounts 1,561 1,488 73 4.9 %

Debit card interchange fees, net 1,458 1,538 (80) (5.2) %

Earnings on bank-owned life insurance, net 1,438 933 505 54.1 %

Dividends on Federal Home Loan Bank stock 916 759 157 20.7 %

Merchant interchange fees, net 377 430 (53) (12.3) %

Gains (losses) on sale of investment securities, net 14 (63) 77 NM

Other income 923 1,496 (573) (38.3) %

Total non-interest income $ 8,272 $ 8,318 $ (46) (0.6) %

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.

Third Quarter of 2023 Compared to the Second Quarter of 2023

Non-interest income totaled $2.6 million for the third quarter of 2023, compared to $2.7 million for the prior quarter.

The $141 thousand decrease from the prior quarter was primarily related to the decrease in debit card interchange income.

Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022

Non-interest income totaled $8.3 million for the nine months ended September 30, 2023, materially unchanged from the same period of the prior year.

The $46 thousand decrease from the prior year period was mostly attributable to decreases in other income including one-way deposit and cash management fees and in wealth management and trust services income, partially offset by higher bank-owned life insurance benefit payments and balances and dividends on Federal Home Loan Bank stock.

Non-interest Expense

1 unchanged sentence

Three months ended

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

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

Salaries and related benefits $ 10,741 $ 11,416 $ (675) (5.9) %

2 unchanged sentences

Professional services 757 797 (40) (5.0) %

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

Federal Deposit Insurance Corporation insurance 469 666 (197) (29.6) %

Depreciation and amortization 423 400 23 5.8 %

Information technology 411 357 54 15.1 %

Charitable contributions 638 49 589 1,202.0 %

Amortization of core deposit intangible 335 340 (5) (1.5) %

Directors' expense 272 300 (28) (9.3) %

Charitable contributions 20 638 (618) (96.9) %

Other real estate owned — 44 (44) (100.0) %

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Total non-interest expense $ 19,747 $ 20,665 $ (918) (4.4) %

Six months ended Amount Change Percent Change

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

Nine months ended Amount Change Percent Change

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

Salaries and related benefits $ 33,087 $ 32,446 $ 641 2.0 %

5 unchanged sentences

Information technology 1,138 1,519 (381) (25.1) %

Charitable contributions 687 556 131 23.6 %

Amortization of core deposit intangible 1,020 1,124 (104) (9.3) %

Directors' expense 893 838 55 6.6 %

Charitable contributions 707 605 102 16.9 %

Other real estate owned 48 355 (307) NM

5 unchanged sentences

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.

Third Quarter of 2023 Compared to the Second Quarter of 2023

Non-interest expense totaled $19.7 million for the third quarter of 2023, compared to $20.7 million for the prior quarter.

Th e $918 thousand decrease from the prior quarter primarily resulted from a $675 thousand decrease in salaries and related benefits mainly due to decreases in accrued incentive and profit sharing expenses and 401(k) contributio ns, $ 618 thousand less in charitable contributions as our annual grant program normally occurs in the second quarter, and a $197 thousand decrease related to a catch-up adjustment in the second quarter for increased FDIC assessments to strengthen the Deposit Insurance Fund.

These decreases were partially offset by a $532 thousand net increase in other expense, primarily due to a $688 thousand increase in expenses and fees associated with our customers' participation in reciprocal deposit networks to bolster their FDIC insured balances.

Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022

Non-interest expense totaled $60.2 million for the nine months ended September 30, 2023 , compared to $57.0 million for the nine months ended September 30, 2022, an increase of $3.2 million.

Other expense increased by $1.8 million primarily due to a $1.5 million increase in expenses and fees associated with reciprocal deposits placed into deposit networks.

Salaries and related benefits increased by $641 thousand primarily due to regularly scheduled annual merit and other increases, the hiring of several key employees and officers, and lower deferred loan origination costs, partially offset by a reduction in accrued incentive and profit sharing expenses.

Occupancy and equipment and depreciation and amortization expenses rose $628 thousand and $446 thousand, respectively, mainly from the acceleration of lease-related costs for branch closures in the first quarter of 2 0 23.

Beginning in 2024, the estimated annual pre-tax savings from branch closures are expected to be approximately $1.4 million.

I n addition, the FDIC insurance assessment rose by $538 thousand due to the increased statutory rate.

These increases were partially offset by a $593 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.

In addition, other real estate owned expenses decreased by $307 thousand due the write-down in the prior year of the asset that was sold in the third quarter of 2023.

Provision for Income Taxes

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Provisions also reflect permanent differences between income for tax and financial reporting purposes (such as earnings on tax exempt loans and municipal securities, 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.

The provision for income taxes for the third quarter of 2023 totaled $1.6 million at an effective tax rate of 23.2%, compared to $1.3 million at an effective tax rate of 22.5% in the prior quarter.

The increase in the provision for income taxes in the third quarter of 2023 reflected higher pre-tax income as compared to the prior quarter.

The 70 basis point increase in the effective tax rate in the third quarter of 2023 was primarily due to the smaller proportional effect of permanent tax differences on higher pretax income.

The provision for income taxes for the first nine months of 2023 totaled $6.4 million at an effective tax rate of 24.8%, compared to $12.2 million at an effective tax rate of 26.5% for the first nine months of 2022.

The 170 basis point decrease in the effective tax rate in the first nine months of 2023, as compared to the same period a year ago, was primarily due to the larger proportional effect of permanent tax differences on lower pretax income and higher tax-exempt BOLI 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), compared to the prior period.

We file a consolidated return in the U.S.

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

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

At September 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 $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.

Total cash, cash equivalents and restricted cash were $123.1 million at September 30, 2023, compared to $45.4 million at December 31, 2022.

The $77.7 million increase was due primarily to the sale of $82.7 million of available-for-sale securities in the third quarter, which resulted in 3 basis points of net interest margin expansion due to the higher interest rate earned on cash and provided diversification to our liquidity profile.

Investment Securities

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.

The investment securities portfolio totaled $1.594 billion at September 30, 2023, a decrease of $180.3 million from $1.774 billion at December 31, 2022.

The decrease was primarily the result of principal repayments and maturities totaling $87.7 million, sales of $82.7 million available-for-sale securities, an increase of $5.7 million in pre-tax unrealized losses on available-for-sale investment securities, and $4.2 million in net amortization in the first nine months of 2023.

The securities sales and $102 million fair value hedge reduced the impact of interest rate increases on tangible capital over the quarter by approximately 7 basis points.

The $2.8 million net loss on the sale of securities was offset by a $2.8 million gain from the sale of our 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 June 30, 2023 and December 31, 2022.

June 30, 2023 December 31, 2022

B oth 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 durations of 4.07 on available-for-sale securities and 5.95 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 t otaled $123.9 million in the first nine months of 2023 .

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

September 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 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.

During the first nine months of 2023, loans decreased by $5.6 million and totaled $2.087 billion at September 30, 2023, compared to $2.093 billion at December 31, 2022.

During the same period in 2022, loans decreased $97.3 million to $2.158 billion at September 30, 2022 from $2.256 billion at December 31, 2021.

Loan originations were $90.3 million for the nine months ended September 30, 2023, compared to $204.1 million for the first nine months of 2022.

Excluding PPP loans, payoffs were $57.7 million for the nine months ended September 30, 2023, compared to $204.2 million for the same period in 2022.

PPP loan payoffs during the nine months ended September 30, 2023 and 2022 were $1.8 million and $103.6 million, respectively.

In addition, loan amortization from scheduled repayments totaling $60.6 million was partially offset by a $24.2 million net increase in utilization of credit lines for the nine months ended September 30, 2023.

While Bank of Marin has continued its usual steadfast conservative underwriting practices and has not changed its credit standards or policies in reaction to current market conditions, our portfolio management and credit teams are exercising heightened awareness of the potential for credit quality deterioration.

The Bank continues to focus on extending credit within the markets we know best and serving the needs of our existing clients while ensuring new opportunities present the appropriate levels of risk and return.

The ratio of allowance for credit losses on loans to total loans was 1.16% at September 30, 2023, compared to 1.10% at December 31, 2022.

Non-accrual loans increased $3.3 million to $5.7 million, or 0.27% of the loan portfolio at September 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 September 30, 2023.

Accruing loans past due 30 to 89 days totaled $2.2 million at September 30, 2023, compared to $664 thousand at December 31, 2022.

Classified loans with risk ratings of substandard or doubtful totaled $39.7 million at September 30, 2023, compared to $28.1 million at December 31, 2022.

Increases in 2023 were primarily due to the addition of eleven loans to ten borrowers totaling $13.4 million, mostly within the commercial real estate (both owner-occupied and non-owner occupied) and the commercial and industrial portfolios.

Partially offsetting the additions were $939 thousand in upgrades to pass risk rating and $905 thousand in payoffs and paydowns, net of balance increases of $3.4 million.

Shortly after quarter-end three unsecured commercial substandard loans to one borrower totaling approximately $4.6 million paid off.

Loans designated special mention, which are not considered adversely classified, increased by $52.2 million to $112.4 million at September 30, 2023 from $60.2 million at December 31, 2022.

The increase was largely due to $66.0 million in downgrades from pass risk ratings, mostly concentrated in the commercial real estate non-owner-occupied portfolio, which were partially offset by $5.9 million in downgrades from special mention to substandard, $4.9 million in paydowns and payoffs and $3.1 million in upgrades to pass risk ratings.

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

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.

In particular, 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 measurement period (generally December 2022), the weighted average loan-to-value and weighted average debt-service coverage ratios for the entire non-owner-occupied office portfolio were 56% and 1.68x, respectively.

For the eleven non-owner-occupied office loans in the City of San Francisco, the weighted average loan-to-value and debt-service coverage ratios were 66% (61% unweighted) and 1.07x (1.34x unweighted), respectively.

During the quarter we conducted a review of the refinance risk in our non-owner-occupied commercial real estate portfolio.

We evaluated 36 loans with commitments of $1.0 million or more totaling $97.4 million that mature or reprice in 2023 or 2024 and determined that the refina nce risk on these loans is expected to be manageable with weighted average debt service coverage ratios ranging from 1.28 to 2.01 times based on current interest rates.

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 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%.

During the first nine months of 2023, total liabilities decreased by $118.4 million to $3.617 billion.

Deposits totaled $3.444 billion at September 30, 2023, a decrease of $129.7 million compared to $3.573 billion at December 31, 2022.

Borrowings increased $8.0 million to $120.0 million at September 30, 2023 from $112.0 million at December 31, 2022.

We have seen stability in deposit trends since the first quarter, including the utilization of our available deposit networks.

That stability extended to our mix in deposits, new account activity and overall growth.

Non-interest bearing deposits made up 47.7% of total deposits at September 30, 2023, compared to 51.5% at year-end 2022, while money market deposits rose to 31.7% from 27.7%, and time deposits rose to 6.7% from 3.3% in the same period.

Additionally, the Bank's competitive and balanced approach to relationship management and focused outreach supported the growth adding over 1,200 new accounts during the third quarter, 38% of which were new relationships, bringing the total to over 3,600 new accounts in 2023 (excluding new reciprocal accounts).

As a result, we are closing the gap on the deposit outflows experienced in the first quarter of 2023 without accessing brokered deposit markets.

As of September 30, 2023, 61% of deposit balances were held in business accounts with average balances of $130 thousand per account.

The remaining 39% were consumer accounts with average balances of $41 thousand per account.

The largest depositor represented 2.7% of total deposits and the four largest depositors combined represented 5.3% of total deposits.

Our liquidity policies require that compensating cash or investment security balances be held against concentrations over a certain level.

At September 30, 2023, the Bank had $120.0 million outstanding in short term borrowings from the Federal Reserve Bank's "BTFP" facility at a rate of 5.42%, an increase of $8.0 million, compared to $112.0 million in 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 $1.992 billion, or 60% of total deposits a nd 209% of estimated uninsured and/or uncollateralized deposits as of June 30, 2023.

Total immediate contingent funding sources, including unrestricted cash, unencumbered available-for-sale securities, and remaining borrowing capacity was $2.086 billion, or 61% of total deposits and 211% of estimated uninsured and/or uncollateralized deposits as of September 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 June 30, 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 September 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 TCE ratio was 8.6% at June 30, 2023, compared to 8.2% at December 31, 2022.

Bancorp's TCE ratio was 8.6% at September 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 6.1%, 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 46 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.

The Bancorp’s and Bank’s capital adequacy ratios as of September 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

June 30, 2023 Amount Ratio Amount Ratio Amount Ratio

September 30, 2023 Amount Ratio Amount Ratio Amount Ratio

Total Capital (to risk-weighted assets) $ 442,947 16.56 % $ 280,854 10.50 % $ 267,480 10.00 %

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Threshold to be Well Capitalized under Prompt Corrective Action Provisions

June 30, 2023 Amount Ratio Amount Ratio Amount Ratio

September 30, 2023 Amount Ratio Amount Ratio Amount Ratio

Total Capital (to risk-weighted assets) $ 431,389 16.13 % $ 280,848 10.50 % $ 267,474 10.00 %

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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 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.

We maintained $2.2 million in off-balance sheet one-way deposit sales with our deposit networks at both September 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 $2.086 billion, or 211% of estimated uninsured and/or uncollateralized deposits as of September 30, 2023.

The Federal Reserve's 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 September 30, 2023.

(in thousands) Total Available Amount Used Net Availability

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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.

We obtain funds from the repayment and maturity of loans, deposit inflows, investment securities sales, 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, dividends to common stockholders, and operating expenses.

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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.

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 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.

Our cash and cash equivalents increased $77.7 million in the first nine months of 2023.

The most significant sources of liquidity during the first nine months of 2023 were proceeds from principal paydowns and maturities of investment securities of $87.8 million, proceeds from the sales of $82.7 million of available-for-sale securities and the remaining Visa Inc.

Class B restricted common stock in the third quarter, and $34.9 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 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.

Significant uses of liquidity during 2023 were $129.7 million in net withdrawals of deposits and $12.1 million in cash dividends paid on common stock to our shareholders.

Unfunded loan commitments, as discussed in Note 8 to the Consolidated Financial Statements in this Form 10-Q, totaled $510.2 million at September 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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We expect to replace these funds with new deposits or excess liquidity.

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 $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.

We believe 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 $120.0 million at September 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.

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

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 shareholder dividends and ordinary operating expenses.

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.

Bancorp held $11.5 million in cash at September 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 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.

Results for 2022 we re 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 third quarter and year-to-date 2022 performance measures, refer to Form 10-Q filed on November 8, 2022.

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.

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Reconciliation of GAAP and Non-GAAP Financial Measures

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

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

Tangible Common Equity - Bancorp

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Goodwill and core deposit intangible (76,850) (77,870)

Total tangible assets d 4,014,948 4,069,594

Total tangible assets c 3,958,699 4,069,594

Unrealized losses on HTM securities, net of tax 1

(107,011) (89,432)

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

Bancorp TCE ratio a / d 8.6 % 8.2 %

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 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%.

Total tangible assets, net of unrealized losses on HTM securities (non-GAAP) d $ 3,851,688 3,980,162

Bancorp TCE ratio a / c 8.6 % 8.2 %

Bancorp TCE ratio, net of unrealized losses on HTM securities (non-GAAP) b / d 6.1 % 6.2 %

1 Net unrealized losses on held-to-maturity securities as of September 30, 2023 and December 31, 2022 of $151.9 million and $127.0, respectively, as shown in Note 4, net of an estimated $44.9 million and $37.5, respectively, in deferred tax benefits based on a blended state and federal statutory tax rate of 29.56%.

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

What changed 10-Q

Item 2. Management’s Discussion and Analysis