Bank of Marin Bancorp 10-Q

ITEM 1. Financial Statements BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CONDITION (in thousands, except share data; unaudited) September 30, 2023 December 31, 2022 Assets Cash, cash equivalents and restricted cash $ 123,132 $ 45,424 Investment securities: Held-to-maturity, at amortized cost (net of zero allowance for credit losses at September 30, 2023 and December 31, 2022) 935,142 972,207 Available-for-sale, at fair value (net of zero allowance for credit losses at September 30, 2023 and December 31, 2022) 658,815 802,096 Total investment securities 1,593,957 1,774,303 Loans, at amortized cost 2,086,942 2,092,546 Allowance for credit losses on loans ( 24,260 ) ( 22,983 ) Loans, net of allowance for credit losses on loans 2,062,682 2,069,563 Goodwill 72,754 72,754 Bank-owned life insurance 67,738 67,066 Operating lease right-of-use assets 21,589 24,821 Bank premises and equipment, net 8,174 8,134 Core deposit intangible, net 4,096 5,116 Other real estate owned — 455 Interest receivable and other assets 81,427 79,828 Total assets $ 4,035,549 $ 4,147,464 Liabilities and Stockholders' Equity Liabilities Deposits: Non-interest bearing $ 1,642,244 $ 1,839,114 Interest bearing Transaction accounts 221,128 287,651 Savings accounts 257,754 338,163 Money market accounts 1,090,181 989,390 Time accounts 232,377 119,030 Total deposits 3,443,684 3,573,348 Short-term borrowings and other obligations 120,335 112,439 Operating lease liabilities 24,040 26,639 Interest payable and other liabilities 28,872 22,946 Total liabilities 3,616,931 3,735,372 Commitments and contingent liabilities (Note 8) Stockholders' Equity Preferred stock, no par value, Authorized - 5,000,000 shares, none issued — — Common stock, no par value, Authorized - 30,000,000 shares; issued and outstanding - 16,139,321 and 16,029,138 at September 30, 2023 and December 31, 2022, respectively 217,202 215,057 Retained earnings 277,996 270,781 Accumulated other comprehensive loss, net of taxes ( 76,580 ) ( 73,746 ) Total stockholders' equity 418,618 412,092 Total liabilities and stockholders' equity $ 4,035,549 $ 4,147,464 The accompanying notes are an integral part of these consolidated financial statements (unaudited). Page-3 BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME Three months ended Nine months ended (in thousands, except per share amounts; unaudited) September 30, 2023 June 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Interest income Interest and fees on loans $ 24,704 $ 24,579 $ 23,357 $ 73,541 $ 70,368 Interest on investment securities 9,345 9,994 9,674 29,371 24,640 Interest on federal funds sold and due from banks 1,055 48 546 1,159 832 Total interest income 35,104 34,621 33,577 104,071 95,840 Interest expense Interest on interest-bearing transaction accounts 270 234 121 758 230 Interest on savings accounts 229 146 32 545 93 Interest on money market accounts 5,988 4,292 268 11,365 1,184 Interest on time accounts 1,555 946 128 2,724 209 Interest on borrowings and other obligations 2,593 4,873 1 10,182 2 Total interest expense 10,635 10,491 550 25,574 1,718 Net interest income 24,469 24,130 33,027 78,497 94,122 Provision for (reversal of) credit losses on loans 425 500 422 1,275 ( 63 ) Reversal of credit losses on unfunded loan commitments — ( 168 ) — ( 342 ) ( 318 ) Net interest income after provision for (reversal of) credit losses 24,044 23,798 32,605 77,564 94,503 Non-interest income Wealth Management and Trust Services 515 559 507 1,585 1,737 Service charges on deposit accounts 508 520 535 1,561 1,488 Debit card interchange fees, net 456 555 502 1,458 1,538 Earnings on bank-owned life insurance, net 371 362 222 1,438 933 Dividends on Federal Home Loan Bank stock 324 290 251 916 759 Merchant interchange fees, net 117 127 141 377 430 Gains (losses) on sale of investment securities, net 14 — ( 63 ) 14 ( 63 ) Other income 293 326 628 923 1,496 Total non-interest income 2,598 2,739 2,723 8,272 8,318 Non-interest expense Salaries and related benefits 10,741 11,416 10,557 33,087 32,446 Occupancy and equipment 1,973 1,980 1,941 6,367 5,739 Data processing 1,009 922 1,093 2,976 3,569 Professional services 757 797 736 2,677 2,314 Depreciation and amortization 423 400 414 1,705 1,259 Federal Deposit Insurance Corporation insurance 469 666 300 1,424 886 Information technology 411 357 573 1,138 1,519 Amortization of core deposit intangible 335 340 370 1,020 1,124 Directors' expense 272 300 233 893 838 Charitable contributions 20 638 49 707 605 Other real estate owned — 44 350 48 355 Other expense 3,337 2,805 2,062 8,150 6,305 Total non-interest expense 19,747 20,665 18,678 60,192 56,959 Income before provision for income taxes 6,895 5,872 16,650 25,644 45,862 Provision for income taxes 1,600 1,321 4,476 6,359 12,157 Net income $ 5,295 $ 4,551 $ 12,174 $ 19,285 $ 33,705 Net income per common share: Basic $ 0.33 $ 0.28 $ 0.76 $ 1.21 $ 2.12 Diluted $ 0.33 $ 0.28 $ 0.76 $ 1.20 $ 2.11 Weighted average shares: Basic 16,028 16,009 15,939 16,002 15,912 Diluted 16,036 16,016 15,974 16,017 15,959 Comprehensive (loss) income: Net income $ 5,295 $ 4,551 $ 12,174 $ 19,285 $ 33,705 Other comprehensive (loss) income: Change in net unrealized gains or losses on available-for-sale securities ( 13,792 ) ( 10,928 ) ( 31,816 ) ( 8,507 ) ( 97,094 ) Reclassification adjustment for losses (gains) on available-for-sale securities included in net income 2,793 — 63 2,793 63 Reclassification adjustment for gains or losses for fair value hedge 367 — — 367 — Net unrealized losses on securities transferred from available-for-sale to held-to-maturity — — — — ( 14,847 ) Amortization of net unrealized losses on securities transferred from available-for-sale to held-to-maturity 411 451 510 1,325 1,126 Other comprehensive (loss) income, before tax ( 10,221 ) ( 10,477 ) ( 31,243 ) ( 4,022 ) ( 110,752 ) Deferred tax (benefit) expense ( 3,021 ) ( 3,097 ) ( 9,236 ) ( 1,188 ) ( 32,741 ) Other comprehensive (loss) income, net of tax ( 7,200 ) ( 7,380 ) ( 22,007 ) ( 2,834 ) ( 78,011 ) Total comprehensive (loss) income $ ( 1,905 ) $ ( 2,829 ) $ ( 9,833 ) $ 16,451 $ ( 44,306 ) The accompanying notes are an integral part of these consolidated financial statements (unaudited). Page-4 BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the three months ended September 30, 2023 and 2022 (in thousands, except share data; unaudited) Common Stock Retained Earnings Accumulated Other Comprehensive (Loss) Income, Net of Taxes Total Shares Amount Three months ended September 30, 2023 Balance at July 1, 2023 16,107,192 $ 216,589 $ 276,732 $ ( 69,380 ) $ 423,941 Net income — — 5,295 — 5,295 Other comprehensive loss, net of tax — — — ( 7,200 ) ( 7,200 ) Stock issued under employee stock purchase plan 879 15 — — 15 Stock issued under employee stock ownership plan 5,800 120 — — 120 Restricted stock granted 12,550 — — — — Restricted stock forfeited / cancelled ( 850 ) — — — — Stock-based compensation - stock options — 21 — — 21 Stock-based compensation - restricted stock — 209 — — 209 Cash dividends paid on common stock ($ 0.25 per share) — — ( 4,031 ) — ( 4,031 ) Stock issued in payment of director fees 13,750 248 — — 248 Balance at September 30, 2023 16,139,321 $ 217,202 $ 277,996 $ ( 76,580 ) $ 418,618 Three months ended September 30, 2022 Balance at July 1, 2022 16,009,600 $ 213,864 $ 253,737 $ ( 58,028 ) $ 409,573 Net income — — 12,174 — 12,174 Other comprehensive loss, net of tax — — — ( 22,007 ) ( 22,007 ) Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings 363 — — — — Stock issued under employee stock purchase plan 574 16 — — 16 Stock issued under employee stock ownership plan 13,000 404 — — 404 Stock-based compensation - stock options — 106 — — 106 Stock-based compensation - restricted stock — 151 — — 151 Cash dividends paid on common stock ($ 0.25 per share) — — ( 4,004 ) — ( 4,004 ) Stock purchased by directors under director stock plan 515 16 — — 16 Stock issued in payment of director fees 4,996 163 — — 163 Balance at September 30, 2022 16,029,048 $ 214,720 $ 261,907 $ ( 80,035 ) $ 396,592 The accompanying notes are an integral part of these consolidated financial statements (unaudited). BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the nine months ended September 30, 2023 and 2022 (in thousands, except share data; unaudited) Common Stock Retained Earnings Accumulated Other Comprehensive (Loss) Income, Net of Taxes Total Shares Amount Nine months ended September 30, 2023 Balance at January 1, 2023 16,029,138 $ 215,057 $ 270,781 $ ( 73,746 ) $ 412,092 Net income — — 19,285 — 19,285 Other comprehensive loss, net of tax — — — ( 2,834 ) ( 2,834 ) Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings 11,530 230 — — 230 Stock issued under employee stock purchase plan 2,035 36 — — 36 Stock issued under employee stock ownership plan 39,800 967 — — 967 Restricted stock granted 61,978 — — — — Restricted stock surrendered for tax withholdings upon vesting ( 2,498 ) ( 70 ) — — ( 70 ) Restricted stock forfeited / cancelled ( 21,024 ) — — — — Stock-based compensation - stock options — 159 — — 159 Stock-based compensation - restricted stock — 425 — — 425 Cash dividends paid on common stock ($ 0.75 per share) — — ( 12,070 ) — ( 12,070 ) Stock issued in payment of director fees 18,362 398 — — 398 Balance at September 30, 2023 16,139,321 $ 217,202 $ 277,996 $ ( 76,580 ) $ 418,618 Nine months ended September 30, 2022 Balance at January 1, 2022 15,929,243 $ 212,524 $ 239,868 $ ( 2,024 ) $ 450,368 Net income — — 33,705 — 33,705 Other comprehensive loss, net of tax — — — ( 78,011 ) ( 78,011 ) Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings 40,674 821 — — 821 Stock issued under employee stock purchase plan 1,510 46 — — 46 Stock issued under employee stock ownership plan 38,000 1,233 — — 1,233 Restricted stock granted 46,672 — — — — Restricted stock surrendered for tax withholdings upon vesting ( 1,169 ) ( 40 ) — — ( 40 ) Restricted stock forfeited / cancelled ( 13,267 ) — — — — Stock-based compensation - stock options — 221 — — 221 Stock-based compensation - restricted stock — 421 — — 421 Cash dividends paid on common stock ($ 0.73 per share) — — ( 11,666 ) — ( 11,666 ) Stock purchased by directors under director stock plan 515 16 — — 16 Stock issued in payment of director fees 10,145 355 — — 355 Stock repurchased, including commissions ( 23,275 ) ( 877 ) — — ( 877 ) Balance at September 30, 2022 16,029,048 $ 214,720 $ 261,907 $ ( 80,035 ) $ 396,592 The accompanying notes are an integral part of these consolidated financial statements (unaudited). Page-5 BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CASH FLOWS For the nine months ended September 30, 2023 and 2022 (in thousands; unaudited) 2023 2022 Cash Flows from Operating Activities: Net income $ 19,285 $ 33,705 Adjustments to reconcile net income to net cash provided by operating activities: Provision for (reversal of) credit losses on loans 1,275 ( 63 ) Reversal of credit losses on unfunded loan commitments ( 342 ) ( 318 ) Noncash contribution expense to employee stock ownership plan 967 1,233 Noncash director compensation expense 398 355 Stock-based compensation expense 584 642 Amortization of core deposit intangible 1,020 1,124 Amortization of investment security premiums, net of accretion of discounts 5,529 7,139 (Accretion of discounts) amortization of premiums on acquired loans, net ( 461 ) 143 Net change in deferred loan origination costs/fees ( 800 ) ( 2,484 ) Write-down of other real estate owned 40 345 (Gains) losses on sale of investment securities, net ( 14 ) 63 Depreciation and amortization 1,705 1,259 Earnings on bank-owned life insurance policies ( 1,438 ) ( 933 ) Net changes in interest receivable and other assets 196 2,230 Net changes in interest payable and other liabilities 6,928 ( 5,489 ) Total adjustments 15,587 5,246 Net cash provided by operating activities 34,872 38,951 Cash Flows from Investing Activities: Purchase of held-to-maturity securities — ( 293,720 ) Purchase of available-for-sale securities — ( 243,459 ) Proceeds from sale of available-for-sale securities 79,840 10,664 Proceeds from paydowns/maturities of held-to-maturity securities 37,046 33,198 Proceeds from paydowns/maturities of available-for-sale securities 50,749 112,793 Proceeds from sale of Visa Inc. Class B restricted common stock 2,807 — Decrease in loans receivable, net 6,634 97,935 Proceeds from bank-owned life insurance policies 766 350 Purchase of premises and equipment ( 1,737 ) ( 762 ) Proceeds from sale of other real estate owned 420 — Cash paid for low income housing tax credit investment ( 39 ) ( 30 ) Net cash provided by (used in) investing activities 176,486 ( 283,031 ) Cash Flows from Financing Activities: Net (decrease) increase in deposits ( 129,664 ) 94,160 Proceeds from short-term borrowings, net 8,000 — Repayment of finance lease obligations ( 112 ) ( 96 ) Proceeds from stock options exercised 230 821 Restricted stock surrendered for tax withholdings upon vesting ( 70 ) ( 40 ) Cash dividends paid on common stock ( 12,070 ) ( 11,666 ) Stock repurchased, including commissions — ( 1,250 ) Proceeds from stock issued under employee and director stock purchase plans 36 62 Net cash (used in) provided by financing activities ( 133,650 ) 81,991 Net increase (decrease) in cash, cash equivalents and restricted cash 77,708 ( 162,089 ) Cash, cash equivalents and restricted cash at beginning of period 45,424 347,641 Cash, cash equivalents and restricted cash at end of period $ 123,132 185,552 Supplemental disclosure of cash flow information: Cash paid in interest $ 23,036 $ 1,716 Cash paid in income taxes $ — $ 11,075 Supplemental disclosure of noncash investing and financing activities: Change in net unrealized gains or losses on available-for-sale securities $ ( 8,140 ) $ ( 97,094 ) Securities transferred from available-for-sale to held-to-maturity, at fair value $ — $ 357,482 Amortization of net unrealized loss on available-for-sale securities transferred to held-to-maturity $ 1,325 $ 1,126 Stock issued to employee stock ownership plan $ 967 $ 1,233 Restricted cash 1 $ — $ 2,996 1 Restricted cash includes reserve requirements held with the Federal Reserve Bank of San Francisco and other cash pledged. In response to the COVID-19 pandemic, the Federal Reserve reduced the reserve requirement ratios to zero percent effective March 26, 2020. The accompanying notes are an integral part of these consolidated financial statements (unaudited). Page-6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1: Basis of Presentation The consolidated financial statements include the accounts of Bancorp, a bank holding company, and its wholly-owned bank subsidiary, Bank of Marin, a California state-chartered commercial bank. References to “we,” “our,” “us” mean Bancorp and the Bank that are consolidated for financial reporting purposes. The accompanying unaudited consolidated interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and note disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles ("GAAP") have been condensed or omitted pursuant to those rules and regulations. Although we believe that the disclosures are adequate and the information presented is not misleading, we suggest that these interim financial statements be read in conjunction with the annual financial statements and the notes thereto included in our 2022 Annual Report on Form 10-K. In the opinion of management, the unaudited consolidated financial statements reflect all adjustments, which are necessary for a fair presentation of the consolidated financial position, the results of operations, changes in comprehensive income (loss), changes in stockholders’ equity, and cash flows for the periods presented. All material intercompany transactions have been eliminated. The results of these interim periods may not be indicative of the results for the full year or for any other period. The following table shows: 1) weighted average basic shares, 2) potentially dilutive weighted average common shares related to stock options and unvested restricted stock awards, and 3) weighted average diluted shares. Basic earnings per share (“EPS”) are calculated by dividing net income by the weighted average number of common shares outstanding during each period, excluding unvested restricted stock awards. Diluted EPS are calculated using the weighted average number of potentially dilutive common shares. The number of potentially dilutive common shares included in the quarterly diluted EPS is computed using the average market prices during the three months included in the reporting period under the treasury stock method. The number of potentially dilutive common shares included in year-to-date diluted EPS is a year-to-date weighted average of potentially dilutive common shares included in each quarterly diluted EPS computation. In computing diluted EPS, we exclude anti-dilutive shares such as options whose exercise prices exceed the current common stock price, as they would not reduce EPS under the treasury method. We have two forms of outstanding common stock: common stock and unvested restricted stock awards. Holders of unvested restricted stock awards receive non-forfeitable dividends at the same rate as common shareholders and they both share equally in undistributed earnings. Under the two-class method, the difference in EPS is nominal for these participating securities. Three months ended Nine months ended (in thousands, except per share data) September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Weighted average basic common shares outstanding 16,028 15,939 16,002 15,912 Potentially dilutive common shares related to: Stock options — 22 5 33 Unvested restricted stock awards 8 13 10 14 Weighted average diluted common shares outstanding 16,036 15,974 16,017 15,959 Net income $ 5,295 $ 12,174 $ 19,285 $ 33,705 Basic EPS $ 0.33 $ 0.76 $ 1.21 $ 2.12 Diluted EPS $ 0.33 $ 0.76 $ 1.20 $ 2.11 Weighted average anti-dilutive common shares not included in the calculation of diluted EPS 362 237 368 213 Note 2: Recently Adopted and Issued Accounting Standards Accounting Standards Adopted in 2023 In March 2022, the FASB issued ASU No. 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures . The amendment eliminated the recognition measurement guidance for troubled debt restructured ("TDR") loans and instead enhanced disclosure requirements for certain loan modifications when a borrower is experiencing financial difficulty. In addition, the amendment required that an entity include in its vintage disclosures the current period gross loan charge-offs by year of origination. We early adopted the current period charge-off disclosures in the first quarter of 2022. We adopted the loan modification provisions as Page-7 of January 1, 2023 using a modified retrospective method. The cumulative-effect adjustment to retained earnings was considered immaterial. Refer to Note 5, Loans and Allowance for Credit Losses on Loans, for additional information. In March 2022, the FASB issued ASU No. 2022-01, Derivatives and Hedging (Topic 815): Fair Value Hedging - Portfolio Layer Method . Among other things, the ASU renamed the "last-of-layer" method to the "portfolio layer" method and made fair value hedging more accessible for hedge accounting of interest rate risk for portfolios and financial assets. For example, the guidance permits an entity to apply the same portfolio hedging method to both prepayable and non-prepayable financial assets, thereby providing for consistency between accounting for similar hedges. We adopted the amendments on January 1, 2023, which had no effect on our existing hedge accounting, disclosures, financial condition or results of operations. In March 2020, the FASB issued Accounting Standards Update ("ASU") No. 2020-04, Reference Rate Reform (Topic 848) . The amendments in this ASU are elective and provide optional guidance for a limited period of time to ease the potential burden of accounting for, or recognizing the effects of reference rate reform. The amendments in this ASU provide optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. Topic 848 was further amended in January 2021 with ASU No. 2021-01, which provided additional guidance on certain optional expedients and scope of derivative instruments, and in December 2022 with ASU 2022-06, which extended the sunset date of Topic 848 to December 31, 2024 given the UK Financial Conduct Authority ("FCA") March 2021 announcement that the intended cessation date of certain tenors of USD LIBOR would be June 30, 2023. An entity may elect the amendments in these updates at an interim period with adoption methods varying based on transaction type. As of September 30, 2023, we had four interest rate swap contracts with notional values totaling $ 11.3 million that were indexed to LIBOR, which transitioned to the Secured Overnight Financing Rate ("SOFR") effective July 1, 2023. The transition to SOFR did not have a material impact to either our financial condition or results of operations. Accounting Standards Not Yet Effective In June 2022, the FASB issued ASU No. 2022-03, Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions . The amendment reduces diversity in practice by clarifying that a separate contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. In addition, this ASU provided amended examples to illustrate that a restriction that is a characteristic of the equity security, which market participants would take into account when pricing them, would be considered in measuring fair value. This ASU also introduces new disclosure requirements. The amendments are effective prospectively for years beginning after December 15, 2023. Early adoption is permitted for both interim and annual financial statements. As discussed in Note 4, Investment Securities, on July 13, 2023 we sold our remaining shares of Visa Inc. Class B restricted common stock. As a result of the sale, this update will not impact our financial condition, results of operations or disclosures. In March 2023, the FASB issued ASU No. 2023-01, Leases (Topic 842): Common Control Arrangements . For public companies, the amendment requires entities to amortize leasehold improvements associated with common control lease arrangements over the useful life of the improvements to the common control group, as opposed to the shorter of the remaining lease term and the useful life of the improvements for all other operating leases. The amendments are effective for years beginning after December 15, 2023, and may be adopted either prospectively or retrospectively. Early adoption is permitted for both interim and annual financial statements. We currently do not have common control lease arrangements, and therefore do not anticipate that the amendments will impact our financial condition and results of operations. In March 2023, the FASB issued ASU No. 2023-02, Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method . Under current GAAP, an entity can only elect to apply the proportional amortization method to investments in low-income housing tax credit ("LIHTC") structures. The proportional amortization method results in the cost of the investment being amortized in proportion to the income tax credits and other income tax benefits received, with the amortization of the investment and the income tax credits being presented net in the consolidated statements of income as a component of income tax expense (benefit). The amendments will allow entities to elect to account for all other equity investments made primarily for the purpose of receiving income tax credits to using the proportional amortization method, regardless of the tax credit program through which the investment earns income tax credits, Page-8 when certain conditions are met. The amendments are effective for fiscal years beginning after December 15, 2023, and may be adopted either on a modified retrospective basis or retrospectively. Other than investments in LIHTC funds, as disclosed in Note 4, Investment Securities, we currently have no other equity investments made primarily for the purpose of receiving income tax credits, and therefore do not anticipate that the amendments will impact our financial condition and results of operations. Note 3: Fair Value of Assets and Liabilities Fair Value Hierarchy and Fair Value Measurement We group our assets and liabilities that are measured at fair value into three levels within the fair value hierarchy, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are: Level 1: Valuations are based on unadjusted quoted prices in active markets for identical assets or liabilities. Level 2: Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data. Level 3: Valuations are based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Values are determined using pricing models and discounted cash flow models and may include significant management judgment and estimation. Transfers between levels of the fair value hierarchy are recognized through our monthly and/or quarterly valuation process in the reporting period during which the event or circumstances that caused the transfer occurred. No such transfers occurred in the years presented. The following table summarizes our assets and liabilities that were required to be recorded at fair value on a recurring basis. Page-9 (in thousands) Description of Financial Instruments Carrying Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Measurement Categories: Changes in Fair Value Recorded In 1 September 30, 2023 Securities available-for-sale: Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies $ 384,933 $ — $ 384,933 $ — OCI SBA-backed securities $ 28,223 $ — $ 28,223 $ — OCI Debentures of government sponsored agencies $ 117,166 $ — $ 117,166 $ — OCI U.S. Treasury securities $ 10,215 $ 10,215 $ — $ — OCI Obligations of state and political subdivisions $ 83,722 $ — $ 83,722 $ — OCI Corporate bonds $ 34,556 $ — $ 34,556 $ — OCI Derivative financial assets (interest rate contracts - loans) $ 854 $ — $ 854 $ — NI Derivative financial assets (interest rate contracts - AFS securities) $ 367 $ — $ 367 $ — NI December 31, 2022 Securities available-for-sale: Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies $ 475,505 $ — $ 475,505 $ — OCI SBA-backed securities $ 44,355 $ — $ 44,355 $ — OCI Debentures of government sponsored agencies $ 135,106 $ — $ 135,106 $ — OCI U.S. Treasury securities $ 10,269 $ 10,269 $ — $ — OCI Obligations of state and political subdivisions $ 102,123 $ — $ 102,123 $ — OCI Corporate bonds $ 33,276 $ — $ 33,276 $ — OCI Asset-backed securities $ 1,462 $ — $ 1,462 $ — OCI Derivative financial assets (interest rate contracts - loans) $ 602 $ — $ 602 $ — NI 1 Other comprehensive income ("OCI") or net income ("NI"). Available-for-sale securities are recorded at fair value on a recurring basis. When available, quoted market prices (Level 1) are used to determine the fair value of available-for-sale securities. Level 1 securities include U.S. Treasury securities. If quoted market prices are not available, we obtain pricing information from a reputable third-party service provider, who may utilize valuation techniques that use current market-based or independently sourced parameters, such as bid/ask prices, dealer-quoted prices, interest rates, benchmark yield curves, prepayment speeds, probability of default, loss severity and credit spreads (Level 2). Level 2 securities include asset-backed securities, obligations of state and political subdivisions, U.S. agencies or government-sponsored agencies' debt securities, mortgage-backed securities, government agency-issued, and corporate bonds. As of September 30, 2023 and December 31, 2022, there were no Level 3 securities. Held-to-maturity securities may be subject to an allowance for credit losses as a result of our evaluation of expected losses due to credit quality factors. We did not record any credit loss expense on held-to-maturity securities during the nine months ended September 30, 2023 or September 30, 2022. Fair value of held-to-maturity securities is determined using the same techniques discussed above for available-for-sale securities. On a recurring basis, derivative financial instruments are recorded at fair value, which is based on the income approach using observable Level 2 market inputs, reflecting market expectations of future interest rates as of the measurement date. Standard valuation techniques are used to calculate the present value of the future expected cash flows assuming an orderly transaction. Valuation adjustments may be made to reflect both our own credit risk and the counterparties’ credit risk in determining the fair value of the derivatives. These unobservable inputs are not considered significant inputs to the fair value measurement overall. Level 2 inputs for the valuations are limited to observable market prices for Secured Overnight Financing Rate ("SOFR") and Overnight Index Swap ("OIS") rates (for the very short term), quoted prices for SOFR futures contracts, observable market prices for SOFR and OIS swap rates, and one-month and three-month SOFR basis spreads at commonly quoted intervals. Mid-market pricing of the inputs is used as a practical expedient in the fair value measurements. We project spot rates at reset days specified by each swap contract to determine future cash flows, then discount to present value using OIS curves as of the measurement date. When the value of any collateral placed with counterparties is less than the interest rate derivative liability, a credit valuation adjustment ("CVA") is applied to reflect the credit risk we pose to counterparties. We have used the spread between the Standard & Poor's BBB rated U.S. Bank Composite rate and Page-10 SOFR for the closest maturity term corresponding to the duration of the swaps to derive the CVA. Because there is little to no counterparty risk, we did not incorporate credit adjustments from our assessment of the counterparty credit risk in determining fair value. For further discussion on our methodology in valuing our derivative financial instruments, refer to Note 9, Derivative Financial Instruments and Hedging Activities. Certain financial assets may be measured at fair value on a non-recurring basis. These assets are subject to fair value adjustments that result from the application of the lower of cost or fair value accounting or write-downs of individual assets, such as individually analyzed loans that are collateral dependent and other real estate owned ("OREO"). OREO is classified as Level 3 and represents collateral acquired through foreclosure and is initially recorded at fair value as established by a current appraisal of the collateral. Subsequent to foreclosure, OREO is carried at the lower of cost or fair value, less estimated costs to sell. On July 12, 2023, the Bank completed the sale of its only OREO property. The following table presents the carrying value of assets measured at fair value on a non-recurring basis and that were held in the consolidated statements of condition at each respective period end, by level within the fair value hierarchy as of September 30, 2023 and December 31, 2022. (in thousands) Carrying Value Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) September 30, 2023 Other real estate owned $ — $ — $ — $ — December 31, 2022 Other real estate owned $ 455 $ — $ — $ 455 Disclosures about Fair Value of Financial Instruments The table below is a summary of fair value estimates for financial instruments as of September 30, 2023 and December 31, 2022, excluding financial instruments recorded at fair value on a recurring basis (summarized in the first table in this note). The carrying amounts in the following table are recorded in the consolidated statements of condition under the indicated captions. Further, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements such as bank-owned life insurance policies ("BOLI"), lease obligations and non-maturity deposit liabilities. Additionally, we held shares of Federal Home Loan Bank ("FHLB") of San Francisco stock at cost as of September 30, 2023 and December 31, 2022, and Visa Inc. Class B common stock with no carrying value, as of December 31, 2022, which was sold entirely in July of 2023. There were no impairment or changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer as of September 30, 2023 or December 31, 2022. The values are discussed in Note 4, Investment Securities. September 30, 2023 December 31, 2022 (in thousands) Carrying Amounts Fair Value Fair Value Hierarchy Carrying Amounts Fair Value Fair Value Hierarchy Financial assets (recorded at amortized cost): Cash and cash equivalents $ 123,132 $ 123,132 Level 1 $ 45,424 $ 45,424 Level 1 Investment securities held-to-maturity 935,142 783,216 Level 2 972,207 845,239 Level 2 Loans, net 2,062,682 1,949,647 Level 3 2,069,563 1,993,866 Level 3 Interest receivable 11,714 11,714 Level 2 13,069 13,069 Level 2 Financial liabilities (recorded at amortized cost): Time deposits 232,377 233,757 Level 2 119,030 118,333 Level 2 Federal Home Loan Bank short-term borrowings — — Level 2 112,000 112,000 Level 2 Federal Reserve Bank - Bank Term Funding Program ("BTFP") 120,000 119,882 Level 2 — — Level 2 Interest payable 1,643 1,643 Level 2 75 75 Level 2 Fair value of loans is based on exit price techniques and obtained from an independent third-party that uses its proprietary valuation model and methodology and may differ from actual price from a prospective buyer. The Page-11 discounted cash flow valuation approach reflects key inputs and assumptions that are unobservable, such as loan probability of default, loss given default, prepayment speed, and market discount rates. Fair value of fixed-rate time deposits is estimated by discounting future contractual cash flows using discount rates that reflect the current observable market rates offered for time deposits of similar remaining maturities. Due to the short-term nature of the FHLB borrowings outstanding as of December 31, 2022, the carrying value approximated fair value. The fair value of the borrowings under the BTFP is estimated by discounting the contractual cash flow using the program's period end financing rate. The value of off-balance-sheet financial instruments is estimated based on the fee income associated with the commitments, which in the absence of credit exposure, is considered to approximate their settlement value. The fair value of commitment fees was not material as of September 30, 2023 or December 31, 2022. Note 4: Investment Securities Our investment securities portfolio consists of U.S. Treasury securities, obligations of state and political subdivisions, U.S. federal government agencies such as Government National Mortgage Association ("GNMA") and Small Business Administration ("SBA"), U.S. government-sponsored enterprises ("GSEs"), such as Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC"), Federal Farm Credit Banks Funding Corporation and FHLB and U.S. Corporations. We also invest in residential and commercial mortgage-backed securities (“MBS”/"CMBS") and collateralized mortgage obligations (“CMOs”) issued or guaranteed by the GSEs, as reflected in the following table. A summary of the amortized cost, fair value and allowance for credit losses related to securities held-to-maturity as of September 30, 2023 and December 31, 2022 is presented below. Held-to-maturity: Amortized Cost 1 Allowance for Credit Losses Net Carrying Amount Gross Unrealized Fair Value (in thousands) Gains (Losses) September 30, 2023 Securities of U.S. government-sponsored enterprises: MBS pass-through securities issued by FHLMC, FNMA and GNMA $ 311,595 $ — $ 311,595 $ — $ ( 61,870 ) $ 249,725 CMOs issued by FHLMC 228,194 — 228,194 71 ( 33,448 ) 194,817 CMOs issued by FNMA 104,031 — 104,031 — ( 9,125 ) 94,906 CMOs issued by GNMA 51,268 — 51,268 155 ( 4,816 ) 46,607 SBA-backed securities 1,853 — 1,853 — ( 140 ) 1,713 Debentures of government-sponsored agencies 146,050 — 146,050 — ( 28,893 ) 117,157 Obligations of state and political subdivisions 62,151 — 62,151 — ( 12,066 ) 50,085 Corporate bonds 30,000 — 30,000 — ( 1,794 ) 28,206 Total held-to-maturity $ 935,142 $ — $ 935,142 $ 226 $ ( 152,152 ) $ 783,216 December 31, 2022 Securities of U.S. government-sponsored enterprises: MBS pass-through securities issued by FHLMC, FNMA and GNMA $ 331,281 $ — $ 331,281 $ — $ ( 50,147 ) $ 281,134 CMOs issued by FHLMC 235,971 — 235,971 59 ( 29,503 ) 206,527 CMOs issued by FNMA 111,904 — 111,904 — ( 5,419 ) 106,485 CMOs issued by GNMA 52,356 — 52,356 11 ( 3,076 ) 49,291 SBA-backed securities 2,372 — 2,372 — ( 133 ) 2,239 Debentures of government-sponsored agencies 145,823 — 145,823 — ( 26,467 ) 119,356 Obligations of state and political subdivisions 62,500 — 62,500 — ( 10,741 ) 51,759 Corporate bonds 30,000 — 30,000 — ( 1,552 ) 28,448 Total held-to-maturity $ 972,207 $ — $ 972,207 $ 70 $ ( 127,038 ) $ 845,239 1 Amortized cost and fair values exclude accrued interest receivable of $ 2.6 million and $ 3.7 million at September 30, 2023 and December 31, 2022, respectively, which is included in interest receivable and other assets in the consolidated statements of condition. Management measures expected credit losses on held-to-maturity securities collectively by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. With regard to MBSs and CMOs issued or Page-12 guaranteed by the GSEs, and SBA-backed securities, we expect to receive all the contractual principal and interest on these securities as such securities are backed by the full faith and credit of and/or guaranteed by the U.S. government. Accordingly, no allowance for credit losses has been recorded for these securities. With regard to securities issued by states and political subdivisions and corporate bonds, management considers: (i) issuer and/or guarantor credit ratings, (ii) historical probability of default and loss given default rates for given bond ratings and remaining maturity, (iii) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities, (iv) internal credit review of the financial information, and (v) whether or not such securities have credit enhancements such as guarantees, contain a defeasance clause, or are pre-refunded by the issuers. Based on our comprehensive anal ysis, no cred it losses are expected. The following table summarizes the amortized cost of our portfolio of held-to-maturity securities issued by states and political subdivisions and corporate bonds by Moody's and/or Standard & Poor's bond ratings as of September 30, 2023 and December 31, 2022. Moody's / S&P Obligations of state and political subdivisions Corporate bonds (in thousands) September 30, 2023 December 31, 2022 September 30, 2023 December 31, 2022 Aaa / AAA $ 42,680 $ 42,986 $ — $ — Aa2 / AA 19,471 19,514 — — A2 / A — — 30,000 30,000 Total $ 62,151 $ 62,500 $ 30,000 $ 30,000 A summary of the amortized cost, fair value and allowance for credit losses related to securities available-for-sale as of September 30, 2023 and December 31, 2022 is presented below. Available-for-sale: Amortized Cost 1 Gross Unrealized Allowance for Credit Losses Fair Value (in thousands) Gains (Losses) September 30, 2023 Securities of U.S. government-sponsored enterprises: MBS pass-through securities issued by FHLMC, FNMA and GNMA $ 84,654 $ 2 $ ( 13,263 ) $ — $ 71,393 CMOs issued by FHLMC 307,119 — ( 37,236 ) — 269,883 CMOs issued by FNMA 30,832 — ( 4,012 ) — 26,820 CMOs issued by GNMA 20,505 — ( 3,668 ) — 16,837 SBA-backed securities 31,389 — ( 3,166 ) — 28,223 Debentures of government- sponsored agencies 129,137 — ( 11,971 ) — 117,166 U.S. Treasury securities 11,918 — ( 1,703 ) — 10,215 Obligations of state and political subdivisions 102,493 — ( 18,771 ) — 83,722 Corporate bonds 36,991 — ( 2,435 ) — 34,556 Total available-for-sale $ 755,038 $ 2 $ ( 96,225 ) $ — $ 658,815 December 31, 2022 Securities of U.S. government-sponsored enterprises: MBS pass-through securities issued by FHLMC, FNMA and GNMA $ 109,736 $ 3 $ ( 12,133 ) $ — $ 97,606 CMOs issued by FHLMC 347,437 — ( 33,682 ) — 313,755 CMOs issued by FNMA 36,172 — ( 3,852 ) — 32,320 CMOs issued by GNMA 35,120 — ( 3,296 ) — 31,824 SBA-backed securities 47,724 2 ( 3,371 ) — 44,355 Debentures of government- sponsored agencies 149,114 — ( 14,008 ) — 135,106 U.S. Treasury securities 11,904 — ( 1,635 ) 10,269 Obligations of state and political subdivisions 116,855 29 ( 14,761 ) — 102,123 Corporate bonds 36,990 — ( 3,714 ) — 33,276 Asset-backed securities 1,553 — ( 91 ) — 1,462 Total available-for-sale $ 892,605 $ 34 $ ( 90,543 ) $ — $ 802,096 1 Amortized cost and fair value exclude accrued interest receivable of $ 2.7 million and $ 3.2 million at September 30, 2023 and December 31, 2022, respectively, which is included in interest receivable and other assets in the consolidated statements of condition. As part of our ongoing review of our investment securities portfolio, we reassessed the classification of certain securities issued by government sponsored agencies. In March 2022, we transferred $ 357.5 million of these securities from available-for-sale to held-to-maturity at fair value. We intend and have the ability to hold these securities to maturity. The net unrealized pre-tax loss of $ 14.8 million that remained and the related accumulated other comprehensive loss are accreted to interest income over the remaining lives of the securities. Because these entries offset each other, there was no impact to net income. Page-13 The amortized cost a nd fair value of investment debt securities by contractual maturity at September 30, 2023 and December 31, 2022 are shown below. Expected maturities may differ from contractual maturities if the issuers of the securities have the right to call or prepay obligations with or without call or prepayment penalties. September 30, 2023 December 31, 2022 Held-to-Maturity Available-for-Sale Held-to-Maturity Available-for-Sale (in thousands) Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost Fair Value Within one year $ — $ — $ 25,103 $ 24,205 $ 450 $ 446 $ 1,254 $ 1,239 After one but within five years 88,242 83,291 327,723 297,206 87,418 83,663 335,813 307,843 After five years through ten years 304,952 247,742 99,406 85,685 262,072 222,280 185,997 166,273 After ten years 541,948 452,183 302,806 251,719 622,267 538,850 369,541 326,741 Total $ 935,142 $ 783,216 $ 755,038 $ 658,815 $ 972,207 $ 845,239 $ 892,605 $ 802,096 Sales of investment securities and gross gains and losses are shown in the following table: Three months ended Nine months ended (in thousands) September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Available-for-sale: Sales proceeds $ 79,840 $ 10,664 $ 79,840 $ 10,664 Gross realized gains 5 17 5 17 Gross realized losses ( 2,798 ) ( 80 ) ( 2,798 ) ( 80 ) Sale of equity securities: 1 Sales proceeds 2,807 — 2,807 — Gross realized gain 2,807 — 2,807 — 1 Refer to VISA Inc. Class B Common Stock section below for more information. In October 2023, the Bank sold $ 55.0 million of available-for-sale securities for a pretax net loss of $ 2.1 million (or $ 1.5 million after tax). Management did not have the intent and was not required to sell these securities at the reporting date. Therefore, no impairment loss was recognized in the third quarter of 2023. The carrying values of pledged investment securities are shown in the following table: (in thousands) September 30, 2023 December 31, 2022 Pledged to the State of California: Secure public deposits in compliance with the Local Agency Security Program $ 203,936 $ 231,307 Collateral for trust deposits 649 669 Collateral for Wealth Management and Trust Services checking account 547 564 Total investment securities pledged to the State of California 205,132 232,540 Bankruptcy trustee deposits pledged with Federal Reserve Bank 1,321 1,686 Pledged to FHLB Securities-Backed Credit Program 386,713 — Pledged to the Federal Reserve BTFP 269,961 — Total pledged investment securities $ 863,127 $ 234,226 Page-14 There were 331 and 407 securities in unrealized loss positions at September 30, 2023 and December 31, 2022, respectively. Those securities are summarized and classified according to the duration of the loss period in the tables below: September 30, 2023 < 12 continuous months ≥ 12 continuous months Total securities in a loss position (in thousands) Fair value Unrealized loss Fair value Unrealized loss Fair value Unrealized loss Held-to-maturity: MBS pass-through securities issued by FHLMC, FNMA and GNMA $ — $ — $ 249,726 $ ( 61,870 ) $ 249,726 $ ( 61,870 ) CMOs issued by FHLMC 4,311 ( 68 ) 181,530 ( 33,380 ) 185,841 ( 33,448 ) CMOs issued by FNMA 41,398 ( 2,413 ) 53,508 ( 6,712 ) 94,906 ( 9,125 ) CMOs issued by GNMA 11,481 ( 154 ) 25,859 ( 4,662 ) 37,340 ( 4,816 ) SBA-backed securities — — 1,713 ( 140 ) 1,713 ( 140 ) Debentures of government-sponsored agencies — — 117,157 ( 28,893 ) 117,157 ( 28,893 ) Obligations of state and political subdivisions 3,034 ( 43 ) 47,051 ( 12,023 ) 50,085 ( 12,066 ) Corporate bonds — — 28,206 ( 1,794 ) 28,206 ( 1,794 ) Total held-to-maturity 60,224 ( 2,678 ) 704,750 ( 149,474 ) 764,974 ( 152,152 ) Available-for-sale: MBS pass-through securities issued by FHLMC, FNMA and GNMA — — 70,980 ( 13,263 ) 70,980 ( 13,263 ) CMOs issued by FHLMC — — 269,883 ( 37,236 ) 269,883 ( 37,236 ) CMOs issued by FNMA — — 26,820 ( 4,012 ) 26,820 ( 4,012 ) CMOs issued by GNMA — — 16,837 ( 3,668 ) 16,837 ( 3,668 ) SBA-backed securities — — 28,223 ( 3,166 ) 28,223 ( 3,166 ) Debentures of government- sponsored agencies — — 117,166 ( 11,971 ) 117,166 ( 11,971 ) U.S. Treasury securities — — 10,215 ( 1,703 ) 10,215 ( 1,703 ) Obligations of state and political subdivisions 1,196 ( 36 ) 82,526 ( 18,735 ) 83,722 ( 18,771 ) Corporate bonds — — 34,556 ( 2,435 ) 34,556 ( 2,435 ) Asset-backed securities — — — — — — Total available-for-sale 1,196 ( 36 ) 657,206 ( 96,189 ) 658,402 ( 96,225 ) Total securities at loss position $ 61,420 $ ( 2,714 ) $ 1,361,956 $ ( 245,663 ) $ 1,423,376 $ ( 248,377 ) Page-15 December 31, 2022 < 12 continuous months ≥ 12 continuous months Total securities in a loss position (in thousands) Fair value Unrealized loss Fair value Unrealized loss Fair value Unrealized loss Held-to-maturity: MBS pass-through securities issued by FHLMC, FNMA and GNMA $ 62,627 $ ( 5,960 ) $ 218,507 $ ( 44,187 ) $ 281,134 $ ( 50,147 ) CMOs issued by FHLMC 78,144 ( 5,874 ) 113,796 ( 23,629 ) 191,940 ( 29,503 ) CMOs issued by FNMA 106,485 ( 5,419 ) — — 106,485 ( 5,419 ) CMOs issued by GNMA 27,570 ( 1,676 ) 10,331 ( 1,400 ) 37,901 ( 3,076 ) SBA-backed securities 2,239 ( 133 ) — — 2,239 ( 133 ) Debentures of government- sponsored agencies 38,645 ( 2,530 ) 80,711 ( 23,937 ) 119,356 ( 26,467 ) Obligations of state and political subdivisions 15,155 ( 589 ) 36,603 ( 10,152 ) 51,758 ( 10,741 ) Corporate Bonds 28,448 ( 1,552 ) — — 28,448 ( 1,552 ) Total held-to-maturity 359,313 ( 23,733 ) 459,948 ( 103,305 ) 819,261 ( 127,038 ) Available-for-sale: MBS pass-through securities issued by FHLMC, FNMA and GNMA 44,630 ( 4,501 ) 52,235 ( 7,632 ) 96,865 ( 12,133 ) CMOs issued by FHLMC 169,760 ( 15,144 ) 143,995 ( 18,538 ) 313,755 ( 33,682 ) CMOs issued by FNMA 4,790 ( 235 ) 27,529 ( 3,617 ) 32,319 ( 3,852 ) CMOs issued by GNMA 8,214 ( 374 ) 23,612 ( 2,922 ) 31,826 ( 3,296 ) SBA-backed securities 37,845 ( 3,228 ) 6,133 ( 143 ) 43,978 ( 3,371 ) Debentures of government- sponsored agencies 19,054 ( 946 ) 116,052 ( 13,062 ) 135,106 ( 14,008 ) U.S. Treasury securities — — 10,269 ( 1,635 ) 10,269 ( 1,635 ) Obligations of state and political subdivisions 70,402 ( 9,459 ) 28,711 ( 5,302 ) 99,113 ( 14,761 ) Corporate Bonds — — 33,276 ( 3,714 ) 33,276 ( 3,714 ) Asset-backed securities — — 1,462 ( 91 ) 1,462 ( 91 ) Total available-for-sale 354,695 ( 33,887 ) 443,274 ( 56,656 ) 797,969 ( 90,543 ) Total securities at loss position $ 714,008 $ ( 57,620 ) $ 903,222 $ ( 159,961 ) $ 1,617,230 $ ( 217,581 ) As of September 30, 2023, the investment portfolio included 323 investment securities that had been in a continuous loss position for twelve months or more and 8 investment securities that had been in a loss position for less than twelve months. Securities issued by government-sponsored enterprises, such as FNMA and FHLMC, usually have implicit credit support by the U.S. federal government. However, since 2008, FNMA and FHLMC have been under government conservatorship and, therefore, contractual cash flows for these investments carry explicit guarantees by the U.S. federal government. Securities issued by the SBA and GNMA have explicit credit guarantees by the U.S. federal government, which protects us from credit losses on the contractual cash flows of the securities. Our investment in obligations of state and political subdivisions bonds are deemed credit worthy after our comprehensive analysis of the issuers' latest financial information, credit ratings by major credit agencies, and/or credit enhancements. No allowances for credit losses have been recognized on available-for-sale securities in an unrealized loss position, as management did not believe any of the securities were impaired due to credit risk factors at either September 30, 2023 or December 31, 2022. In addition, for any available-for-sale securities in an unrealized loss position at September 30, 2023 and December 31, 2022, the Bank assessed whether it intended to sell the securities, or if it was more likely than not that it would be required to sell the securities before recovery of its amortized cost basis, which would require a write-down to fair value through net income. Because the Bank did not intend to sell those securities that were in an unrealized loss position, and it was not more-likely-than-not that the Bank would be required to sell the securities before recovery of their amortized cost bases, the Bank determined that no write-down was necessary as of the reporting date. 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 Page-16 portfolio against changes in fair value related to changes in the benchmark interest rate. For additional details, refer to Note 9, Derivative Financial Instruments and Hedging Activities. Non-Marketable Securities Included in Other Assets FHLB Capital Stock As a member of the FHLB, we are required to maintain a minimum investment in FHLB capital stock determined by the Board of Directors of the FHLB. The minimum investment requirements can increase in the event we increase our total asset size or borrowings with the FHLB. Shares cannot be purchased or sold except between the FHLB and its members at the $ 100 per share par value. We held $ 16.7 million of FHLB stock included in other assets on the consolidated statements of condition at both September 30, 2023 and December 31, 2022. The carrying amounts of these investments are reasonable estimates of fair value because the securities are restricted to member banks and they do not have a readily determinable market value. Based on our analysis of FHLB's financial condition and certain qualitative factors, we determined that the FHLB stock w as not im paired at September 30, 2023 and December 31, 2022. On October 26, 2023, FHLB announced a cash dividend for the third quarter of 2023 at an annualized dividend rate of 8.25 % to be distributed on Novembe r 9, 20 23. Cash dividends paid on FHLB capital stock are recorded as non-interest income. VISA Inc. Class B Common Stock As a member bank of Visa U.S.A., we held 10,439 shares of Visa Inc. Class B common stock at December 31, 2022. These shares had a carrying value of zero and were restricted from resale to non-member banks of Visa U.S.A. until their conversion into Class A (voting) shares upon the termination of Visa Inc.'s Covered Litigation escrow account. Because of the restriction and the uncertainty on the conversion rate to Class A shares, these shares lacked a readily determinable fair value. On July 13, 2023, the Bank sold the entirety of its remaining investment in Visa Inc. Class B restricted common stock for a $ 2.8 million gain. For further information on the Covered Litigation, refer to Note 8, Commitments and Contingencies. Low Income Housing Tax Credits We invest in low-income housing tax credit funds as a limited partner, which totaled $ 2.1 million and $ 2.5 million recorded in other assets as of September 30, 2023 and December 31, 2022, respectively. In the first nine months of 2023, we recognized $ 450 thousand of low-income housing tax credits and other tax benefits, offset by $ 377 thousand of amortization expense of low-income housing tax credit investment, as a component of income tax expense. As of September 30, 2023, our unfunded commitments for these low-income housing tax credit funds totaled $ 346 thousand. We did not recognize any impairment losses on these low-income housing tax credit investments during the first nine months of 2023 or 2022, as the value of the future tax benefits exceeds the carrying value of the investments. Note 5: Loans and Allowance for Credit Losses on Loans The following table presents the amortized cost of loans by portfolio class as of September 30, 2023 and December 31, 2022. (in thousands) September 30, 2023 December 31, 2022 Commercial and industrial $ 174,096 $ 173,547 Real estate: Commercial owner-occupied 346,307 354,877 Commercial non-owner occupied 1,190,813 1,191,889 Construction 109,305 114,373 Home equity 83,267 88,748 Other residential 116,674 112,123 Installment and other consumer loans 66,480 56,989 Total loans, at amortized cost 1 2,086,942 2,092,546 Allowance for credit losses on loans ( 24,260 ) ( 22,983 ) Total loans, net of allowance for credit losses on loans $ 2,062,682 $ 2,069,563 Page-17 1 Amortized cost includes net deferred loan origination costs of $ 2.6 million and $ 1.8 million at September 30, 2023 and December 31, 2022, respectively. Amounts are also net of unrecognized purchase discounts of $ 2.2 million and $ 2.6 million at September 30, 2023 and December 31, 2022, respectively. Amortized cost excludes accrued interest, which totaled $ 6.3 million and $ 6.1 million at September 30, 2023 and December 31, 2022, respectively, and is included in interest receivable and other assets in the consolidated statements of condition. Lending Risks Commercial and Industrial Loans - Commercial loans are generally made to established small and mid-sized businesses to provide financing for their growth and working capital needs, equipment purchases and acquisitions. Management examines historical, current, and projected cash flows to determine the ability of the borrower to repay obligations as agreed. Commercial loans are made based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral and guarantor support. The cash flows of borrowers, however, may not occur as expected, and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed, such as accounts receivable and inventory, and typically include personal guarantees. We target stable businesses with guarantors who provide additional sources of repayment and have proven to be resilient in periods of economic stress. A weakened economy, and resultant decreased consumer and/or business spending, may have an effect on the credit quality of commercial loans. Commercial Real Estate Loans - Commercial real estate loans, which include income producing investment properties and owner-occupied real estate used for business purposes, are subject to underwriting standards and processes similar to commercial loans discussed above. We underwrite these loans to be repaid from cash flow from either the business or investment property and supported by real property collateral. Underwriting standards for commercial real estate loans include, but are not limited to, debt coverage and loan-to-value ratios. Furthermore, a large majority of our loans are guaranteed by the owners of the properties. Conditions in the real estate markets or downturn in the general economy may adversely affect our commercial real estate loans. In the event of a vacancy, we expect guarantors to carry the loans until they find a replacement tenant. The owner's substantial equity investment provides a strong economic incentive to continue to support the commercial real estate projects. As such, we have generally experienced a relatively low level of loss and delinquencies in this portfolio. Construction Loans - Construction loans are generally made to developers and builders to finance construction, renovation and occasionally land acquisitions in anticipation of near-term development. Construction loans include interest reserves that are used for the payment of interest during the development and marketing periods and are capitalized as part of the loan balance. When a construction loan is placed on nonaccrual status before the depletion of the interest reserve, we apply the interest funded by the interest reserve against the loan's principal balance. These loans are underwritten after evaluation of the borrower's financial strength, reputation, prior track record, and independent appraisals. We monitor all construction projects to determine whether they are on schedule, completed as planned and in accordance with the approved construction budgets. Significant events can affect the construction industry, including: the inherent volatility of real estate markets and vulnerability to delays due to weather, change orders, inability to obtain construction permits, labor or material shortages, and price changes. Estimates of construction costs and value associated with the completed project may be inaccurate. Repayment of construction loans is largely dependent on the ultimate success of the project. Consumer Loans - Consumer loans primarily consist of home equity lines of credit, other residential loans, floating homes, and indirect luxury auto loans, along with a small number of installment loans. Our other residential loans include tenancy-in-common fractional interest loans ("TIC") located almost entirely in San Francisco County. We originate consumer loans utilizing credit score information, debt-to-income ratio and loan-to-value ratio analysis. Diversification among consumer loan types, coupled with relatively small loan amounts that are spread across many individual borrowers, mitigates risk. We do not originate sub-prime residential mortgage loans, nor is it our practice to underwrite loans commonly referred to as "Alt-A mortgages," the characteristics of which are reduced documentation, borrowers with low FICO scores or collateral with high loan-to-value ratios. Credit Quality Indicators We use a risk rating system to evaluate asset quality, and to identify and monitor credit risk in individual loans, and in the loan portfolio. Our definitions of “Special Mention” risk graded loans, or worse, are consistent with those used by the Federal Deposit Insurance Corporation ("FDIC"). Our internally assigned grades are as follows: Pass and Watch - Loans to borrowers of acceptable or better credit quality. Borrowers in this category demonstrate fundamentally sound financial positions, repayment capacity, credit history and management Page-18 expertise. Loans in this category must have an identifiable and stable source of repayment and meet the Bank’s policy regarding debt-service-coverage ratios. These borrowers are capable of sustaining normal economic, market or operational setbacks without significant financial consequences. Negative external industry factors are generally not present. The loan may be secured, unsecured or supported by non-real estate collateral for which the value is more difficult to determine and/or marketability is more uncertain. This category also includes “Watch” loans, where the primary source of repayment has been delayed. “Watch” is intended to be a transitional grade, with either an upgrade or downgrade within a reasonable period. Special Mention - Potential weaknesses that deserve close attention. If left uncorrected, those potential weaknesses may result in deterioration of the payment prospects for the asset. Special Mention assets do not present sufficient risk to warrant adverse classification. Substandard - Inadequately protected by either the current sound worth and paying capacity of the obligor or the collateral pledged, if any. A Substandard asset has a well-defined weakness or weaknesses that jeopardize(s) the liquidation of the debt. Substandard assets are characterized by the distinct possibility that we will sustain some loss if such weaknesses or deficiencies are not corrected. Well-defined weaknesses include adverse trends or developments of the borrower’s financial condition, managerial weaknesses and/or significant collateral deficiencies. Doubtful - Critical weaknesses that make collection or liquidation in full improbable. There may be specific pending events that work to strengthen the asset; however, the amount or timing of the loss may not be determinable. Pending events generally occur within one year of the asset being classified as Doubtful. Examples include: merger, acquisition, or liquidation; capital injection; guarantee; perfecting liens on additional collateral; and refinancing. Such loans are placed on non-accrual status and usually are collateral-dependent. We regularly review our credits for accuracy of risk grades whenever we receive new information and at each quarterly and year-end reporting period. Borrowers are generally required to submit financial information at regular intervals. Typically, commercial borrowers with lines of credit are required to submit financial information with reporting intervals ranging from monthly to annually depending on credit size, risk and complexity. In addition, investor commercial real estate borrowers with loans exceeding a certain dollar threshold are usually required to submit rent rolls or property income statements annually. We monitor construction loans monthly. We review home equity and other consumer loans based on delinquency. We also review loans graded “Watch” or worse, regardless of loan type, no less than quarterly. The following tables present the loan portfolio by loan portfolio class, origination year and internal risk rating as of September 30, 2023 and December 31, 2022. The current year vintage table reflects gross charge-offs by loan portfolio class and year of origination. Generally, existing term loans that were re-underwritten are reflected in the table in the year of renewal. Lines of credit that have a conversion feature at the time of origination, such as construction to perm loans, are presented by year of origination. (in thousands) Term Loans - Amortized Cost by Origination Year Revolving Loans Amortized Cost September 30, 2023 2023 2022 2021 2020 2019 Prior Total Commercial and industrial: Pass and Watch $ 31,632 $ 9,235 $ 3,360 $ 4,644 $ 16,222 $ 23,223 $ 67,670 $ 155,986 Special Mention 391 — — — 1,687 269 8,172 10,519 Substandard — 273 — 918 — 2,735 3,665 7,591 Total commercial and industrial $ 32,023 $ 9,508 $ 3,360 $ 5,562 $ 17,909 $ 26,227 $ 79,507 $ 174,096 Gross current period charge-offs $ — $ — $ — $ — $ ( 3 ) $ ( 3 ) $ ( 1 ) $ ( 7 ) Commercial real estate, owner-occupied: Pass and Watch $ 10,374 $ 48,054 $ 50,265 $ 38,176 $ 40,211 $ 118,370 $ — $ 305,450 Special Mention 1,056 4,547 15,779 825 289 10,463 — 32,959 Substandard — 2,260 — — 3,834 1,804 — 7,898 Total commercial real estate, owner-occupied $ 11,430 $ 54,861 $ 66,044 $ 39,001 $ 44,334 $ 130,637 $ — $ 346,307 Commercial real estate, non-owner occupied: Pass and Watch $ 30,200 $ 174,327 $ 198,342 $ 152,318 $ 144,112 $ 399,022 $ — $ 1,098,321 Special Mention — 2,802 9,545 11,857 15,801 28,881 — 68,886 Substandard — — 2,209 — — 21,397 — 23,606 Total commercial real estate, non-owner occupied $ 30,200 $ 177,129 $ 210,096 $ 164,175 $ 159,913 $ 449,300 $ — $ 1,190,813 Page-19 (in thousands) Term Loans - Amortized Cost by Origination Year Revolving Loans Amortized Cost September 30, 2023 2023 2022 2021 2020 2019 Prior Total Construction: Pass and Watch $ 17,173 $ 44,236 $ 18,827 $ 29,069 $ — $ — $ — $ 109,305 Total construction $ 17,173 $ 44,236 $ 18,827 $ 29,069 $ — $ — $ — $ 109,305 Home equity: Pass and Watch $ — $ — $ — $ — $ — $ 711 $ 81,954 $ 82,665 Substandard — — — — — 189 413 602 Total home equity $ — $ — $ — $ — $ — $ 900 $ 82,367 $ 83,267 Other residential: Pass and Watch $ 13,224 $ 20,218 $ 13,673 $ 26,487 $ 21,075 $ 21,997 $ — $ 116,674 Total other residential $ 13,224 $ 20,218 $ 13,673 $ 26,487 $ 21,075 $ 21,997 $ — $ 116,674 Installment and other consumer: Pass and Watch $ 18,666 $ 15,071 $ 11,374 $ 4,971 $ 5,483 $ 9,930 $ 985 $ 66,480 Total installment and other consumer $ 18,666 $ 15,071 $ 11,374 $ 4,971 $ 5,483 $ 9,930 $ 985 $ 66,480 Gross current period charge-offs $ ( 7 ) $ ( 5 ) $ — $ ( 4 ) $ — $ ( 1 ) $ ( 5 ) $ ( 22 ) Total loans: Pass and Watch $ 121,269 $ 311,141 $ 295,841 $ 255,665 $ 227,103 $ 573,253 $ 150,609 $ 1,934,881 Total Special Mention $ 1,447 $ 7,349 $ 25,324 $ 12,682 $ 17,777 $ 39,613 $ 8,172 $ 112,364 Total Substandard $ — $ 2,533 $ 2,209 $ 918 $ 3,834 $ 26,125 $ 4,078 $ 39,697 Totals $ 122,716 $ 321,023 $ 323,374 $ 269,265 $ 248,714 $ 638,991 $ 162,859 $ 2,086,942 Total gross current period charge-offs $ ( 7 ) $ ( 5 ) $ — $ ( 4 ) $ ( 3 ) $ ( 4 ) $ ( 6 ) $ ( 29 ) (in thousands) Term Loans - Amortized Cost by Origination Year Revolving Loans Amortized Cost December 31, 2022 2022 2021 2020 2019 2018 Prior Total Commercial and industrial: Pass and Watch $ 15,349 $ 6,679 $ 7,603 $ 19,982 $ 5,362 $ 24,954 $ 84,655 $ 164,584 Special Mention 275 — — 2,272 3,836 — 402 6,785 Substandard — — 1,252 — — 625 301 2,178 Total commercial and industrial $ 15,624 $ 6,679 $ 8,855 $ 22,254 $ 9,198 $ 25,579 $ 85,358 $ 173,547 Commercial real estate, owner-occupied: Pass and Watch $ 54,188 $ 52,080 $ 40,369 $ 44,798 $ 29,856 $ 104,377 $ — $ 325,668 Special Mention — 16,199 — 304 5,255 4,493 — 26,251 Substandard — — — 1,160 — 1,699 — 2,859 Doubtful — — 99 — — — — 99 Total commercial real estate, owner-occupied $ 54,188 $ 68,279 $ 40,468 $ 46,262 $ 35,111 $ 110,569 $ — $ 354,877 Commercial real estate, non-owner occupied: Pass and Watch $ 177,822 $ 211,228 $ 155,278 $ 160,670 $ 129,166 $ 308,509 $ 57 $ 1,142,730 Special Mention — 1,172 12,097 3,934 678 9,290 — 27,171 Substandard — 2,264 — — — 19,724 — 21,988 Total commercial real estate, non-owner occupied $ 177,822 $ 214,664 $ 167,375 $ 164,604 $ 129,844 $ 337,523 $ 57 $ 1,191,889 Construction: Pass and Watch $ 49,262 $ 19,393 $ 28,861 $ 7,745 $ 9,112 $ — $ — $ 114,373 Total construction $ 49,262 $ 19,393 $ 28,861 $ 7,745 $ 9,112 $ — $ — $ 114,373 Home equity: Pass and Watch $ — $ — $ — $ — $ — $ 883 $ 86,971 $ 87,854 Substandard — — — — — 480 414 894 Total home equity $ — $ — $ — $ — $ — $ 1,363 $ 87,385 $ 88,748 Other residential: Pass and Watch $ 21,154 $ 14,547 $ 29,018 $ 21,890 $ 11,064 $ 14,450 $ — $ 112,123 Total other residential $ 21,154 $ 14,547 $ 29,018 $ 21,890 $ 11,064 $ 14,450 $ — $ 112,123 Installment and other consumer: Pass and Watch $ 20,054 $ 13,022 $ 5,727 $ 6,492 $ 4,181 $ 6,478 $ 944 $ 56,898 Substandard — — — — — 91 — 91 Total installment and other consumer $ 20,054 $ 13,022 $ 5,727 $ 6,492 $ 4,181 $ 6,569 $ 944 $ 56,989 Total loans: Pass and Watch $ 337,829 $ 316,949 $ 266,856 $ 261,577 $ 188,741 $ 459,651 $ 172,627 $ 2,004,230 Total Special Mention $ 275 $ 17,371 $ 12,097 $ 6,510 $ 9,769 $ 13,783 $ 402 $ 60,207 Total Substandard $ — $ 2,264 $ 1,252 $ 1,160 $ — $ 22,619 $ 715 $ 28,010 Total Doubtful $ — $ — $ 99 $ — $ — $ — $ — $ 99 Totals $ 338,104 $ 336,584 $ 280,304 $ 269,247 $ 198,510 $ 496,053 $ 173,744 $ 2,092,546 Page-20 The following table shows the amortized cost of loans by portfolio class, payment aging and non-accrual status as of September 30, 2023 and December 31, 2022. Loan Aging Analysis by Class (in thousands) Commercial and industrial Commercial real estate, owner-occupied Commercial real estate, non-owner occupied Construction Home equity Other residential Installment and other consumer Total September 30, 2023 30-59 days past due $ 1,321 $ — $ 797 $ — $ — $ — $ 97 $ 2,215 60-89 days past due — — 901 — 196 — 1 1,098 90 days or more past due — 3,992 — — 4 — — 3,996 Total past due 1,321 3,992 1,698 — 200 — 98 7,309 Current 172,775 342,315 1,189,115 109,305 83,067 116,674 66,382 2,079,633 Total loans 1 $ 174,096 $ 346,307 $ 1,190,813 $ 109,305 $ 83,267 $ 116,674 $ 66,480 $ 2,086,942 Non-accrual loans 2 $ — $ 4,281 $ 901 $ — $ 490 $ — $ — $ 5,672 Non-accrual loans with no allowance $ — $ 4,281 $ 901 $ — $ 490 $ — $ — $ 5,672 December 31, 2022 30-59 days past due $ 3 $ — $ — $ — $ 319 $ 93 $ 5 $ 420 60-89 days past due — — — — 244 — — 244 90 days or more past due 264 — — — 414 — — 678 Total past due 267 — — — 977 93 5 1,342 Current 173,280 354,877 1,191,889 114,373 87,771 112,030 56,984 2,091,204 Total loans 1 $ 173,547 $ 354,877 $ 1,191,889 $ 114,373 $ 88,748 $ 112,123 $ 56,989 $ 2,092,546 Non-accrual loans 2 $ — $ 1,563 $ — $ — $ 778 $ — $ 91 $ 2,432 Non-accrual loans with no allowance $ — $ 1,563 $ — $ — $ 778 $ — $ 91 $ 2,432 1 There were no non-performing loans past due more than ninety days and accruing interest as of September 30, 2023 and December 31, 2022. 2 None of the non-accrual loans as of September 30, 2023 or December 31, 2022 were earning interest on a cash or accrual basis. We reversed $ 131 thousand and $ 158 thousand in accrued interest income for loans that were placed on non-accrual status for the three and nine months ended September 30, 2023. We reversed accrued interest income of $ 39 thousand and $ 47 thousand for loans that were placed on non-accrual status during the three and nine months ended September 30, 2022, respectively. Collateral Dependent Loans The following table presents the amortized cost basis of individually analyzed collateral-dependent loans, which are all on non-accrual status, by portfolio class at September 30, 2023 and December 31, 2022. Amortized Cost by Collateral Type (in thousands) Commercial Real Estate Residential Real Estate Other Total 1 Allowance for Credit Losses September 30, 2023 Commercial real estate, owner-occupied $ 4,281 $ — $ — $ 4,281 $ — Commercial real estate, non-owner occupied 901 — — 901 — Home equity — 490 — 490 — Total $ 5,182 $ 490 $ — $ 5,672 $ — December 31, 2022 Commercial real estate, owner-occupied $ 1,563 $ — $ — $ 1,563 $ — Home equity — 778 — 778 — Installment and other consumer — — 91 91 — Total $ 1,563 $ 778 $ 91 $ 2,432 $ — 1 There were no collateral-dependent residential real estate mortgage loans in process of foreclosure or in substance repossessed at September 30, 2023 and December 31, 2022. The weighted average loan-to-value of collateral dependent loans was approximately 61 % at September 30, 2023 and 42 % at December 31, 2022. Loan Modifications to Borrowers Experiencing Financial Difficulty We adopted ASU No. 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures on January 1, 2023, as described in Note 2, Recently Adopted and Issued Accounting Standards. The amendments eliminated the accounting guidance for troubled debt restructurings and enhanced disclosures related to certain types of loan modifications for borrowers experiencing financial difficulty, including principal forgiveness, interest rate reductions, other-than-insignificant payment delays, and/or term extensions which are intended to minimize the economic loss and avoid foreclosure or repossession of collateral. Page-21 The following table summarizes the amortized cost of loans as of September 30, 2023 that were modified during the three and nine months ended September 30, 2023 by portfolio class and type of modification granted. (in thousands) Term Extension Percent of Portfolio Class Total Three months ended September 30, 2023 Commercial and industrial $ 391 0.2 % Commercial owner-occupied 1,056 0.3 % Total $ 1,447 Nine months ended September 30, 2023 Commercial and industrial $ 391 0.2 % Commercial owner-occupied 1,056 0.3 % Total $ 1,447 As of September 30, 2023, there were no unfunded loan commitments for loans that were modified during the periods presented. The following table summarizes the financial effect of loan modifications presented in the table above during the three and nine months ended September 30, 2023 by portfolio class. (in thousands) Weighted-Average Term Extension (in years) Three months ended September 30, 2023 Commercial and industrial 2.3 Commercial owner-occupied 2.5 Nine months ended September 30, 2023 Commercial and industrial 2.3 Commercial owner-occupied 2.5 The loan modifications did not significantly impact the determination of the allowance for credit losses on loans during the three and nine months ended September 30, 2023. The Bank closely monitors the performance of the modified loans to understand the effectiveness of its modification efforts. The following table summarizes the amortized cost and payment status of loans as of September 30, 2023 that were modified during the three and nine months ended September 30, 2023 by portfolio class. (in thousands) Current 30-59 Days Past Due 60-89 Days Past Due 90 Days or More Past Due Total Non-Accrual Three months ended September 30, 2023 Commercial and industrial $ 391 $ — $ — $ — $ 391 $ — Commercial owner-occupied 1,056 — — — 1,056 — Total $ 1,447 $ — $ — $ — $ 1,447 $ — Nine months ended September 30, 2023 Commercial and industrial $ 391 $ — $ — $ — $ 391 $ — Commercial owner-occupied 1,056 — — — 1,056 — Total $ 1,447 $ — $ — $ — $ 1,447 $ — There were no loans that defaulted (fully or partially charged-off or became 90 days or more past due) that were modified during the nine months ended September 30, 2023. Page-22 Allocation of the Allowance for Credit Losses on Loans The following table presents the details of the allowance for credit losses on loans segregated by loan portfolio class as of September 30, 2023 and December 31, 2022 . Allocation of the Allowance for Credit Losses on Loans (in thousands) Commercial and industrial Commercial real estate, owner-occupied Commercial real estate, non-owner occupied Construction Home equity Other residential Installment and other consumer Unallocated Total September 30, 2023 Modeled expected credit losses $ 1,042 $ 1,315 $ 7,324 $ 213 $ 494 $ 566 $ 613 $ — $ 11,567 Qualitative adjustments 761 1,214 6,300 1,805 71 38 338 2,159 12,686 Specific allocations 5 1 — — — 1 — — 7 Total $ 1,808 $ 2,530 $ 13,624 $ 2,018 $ 565 $ 605 $ 951 $ 2,159 $ 24,260 December 31, 2022 Modeled expected credit losses $ 1,079 $ 1,497 $ 7,937 $ 453 $ 504 $ 571 $ 610 $ — $ 12,651 Qualitative adjustments 706 990 4,739 1,484 54 24 258 2,068 10,323 Specific allocations 9 — — — — — — — 9 Total $ 1,794 $ 2,487 $ 12,676 $ 1,937 $ 558 $ 595 $ 868 $ 2,068 $ 22,983 Allowance for Credit Losses on Loans Rollforward The following table discloses activity in the allowance for credit losses on loans for the periods presented. Allowance for Credit Losses on Loans Rollforward (in thousands) Commercial and industrial Commercial real estate, owner-occupied Commercial real estate, non-owner occupied Construction Home equity Other residential Installment and other consumer Unallocated Total Three months ended September 30, 2023 Beginning balance $ 1,831 $ 2,589 $ 13,201 $ 1,942 $ 561 $ 599 $ 940 $ 2,169 $ 23,832 (Reversal) Provision ( 20 ) ( 59 ) 423 68 4 6 13 ( 10 ) 425 (Charge-offs) ( 4 ) — — — — — ( 2 ) — ( 6 ) Recoveries 1 — — 8 — — — — 9 Ending balance $ 1,808 $ 2,530 $ 13,624 $ 2,018 $ 565 $ 605 $ 951 $ 2,159 $ 24,260 Three months ended September 30, 2022 Beginning balance $ 1,699 $ 2,617 $ 12,439 $ 1,737 $ 530 $ 585 $ 733 $ 2,199 $ 22,539 Provision (Reversal) 265 ( 81 ) 299 38 12 5 83 ( 199 ) 422 (Charge-offs) ( 9 ) — — — — — ( 1 ) — ( 10 ) Recoveries 3 — — 9 — — — — 12 Ending balance $ 1,958 $ 2,536 $ 12,738 $ 1,784 $ 542 $ 590 $ 815 $ 2,000 $ 22,963 Allowance for Credit Losses on Loans Rollforward (in thousands) Commercial and industrial Commercial real estate, owner-occupied Commercial real estate, investor Construction Home equity Other residential Installment and other consumer Unallocated Total Nine months ended September 30, 2023 Beginning balance $ 1,794 $ 2,487 $ 12,676 $ 1,937 $ 558 $ 595 $ 868 $ 2,068 $ 22,983 Provision (Reversal) 16 43 948 56 7 10 104 91 1,275 Charge-offs ( 7 ) — — — — — ( 22 ) — ( 29 ) Recoveries 5 — — 25 — — 1 — 31 Ending balance $ 1,808 $ 2,530 $ 13,624 $ 2,018 $ 565 $ 605 $ 951 $ 2,159 $ 24,260 Nine months ended September 30, 2022 Beginning balance $ 1,709 $ 2,776 $ 12,739 $ 1,653 $ 595 $ 644 $ 621 $ 2,286 $ 23,023 Provision (Reversal) 248 ( 240 ) ( 1 ) 106 ( 53 ) ( 54 ) 217 ( 286 ) ( 63 ) Charge-offs ( 9 ) — — — — — ( 23 ) — ( 32 ) Recoveries 10 — — 25 — — — — 35 Ending balance $ 1,958 $ 2,536 $ 12,738 $ 1,784 $ 542 $ 590 $ 815 $ 2,000 $ 22,963 Page-23 Pledged Loans Our FHLB line of credit is secured under terms of a blanket collateral agreement by a pledge of certain qualifying loans with unpaid principal balances of $ 1.299 billion and $ 1.298 billion at September 30, 2023 and December 31, 2022, respectively. In addition, we pledge eligible TIC loans, which totaled $ 108.5 million and $ 105.0 million at September 30, 2023 and December 31, 2022, respectively, to secure our borrowing capacity with the Federal Reserve Bank ("FRB"). For additional information, see Note 6, Borrowings. Related Party Loans The Bank has, and expects to have in the future, banking transactions in the ordinary course of its business with directors, officers, principal shareholders and their businesses or associates. These transactions, including loans, are granted on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with persons not related to us. Likewise, these transactions do not involve more than the normal risk of collectability or present other unfavorable features. Related party loans totaled $ 6.3 million at September 30, 2023 and $ 6.4 million at December 31, 2022. In addition, undisbursed commitments to related parties totaled $ 562 thousand at both September 30, 2023 and December 31, 2022. Note 6: Short-Term Borrowings and Other Obligations Federal Home Loan Bank – As of September 30, 2023 and December 31, 2022, the Bank had total lines of credit with the FHLB totaling $ 1.023 billion and $ 711.6 million, respectively, based on eligible collateral of certain loans and investment securities. Federal Funds Lines of Credit – The Bank had unsecured lines of credit with correspondent banks for overnight borrowings totaling $ 135.0 million and $ 150.0 million at September 30, 2023 and December 31, 2022, respectively. In general, interest rates on these lines approximate the federal funds target rate. Federal Reserve Bank – The Bank has a line of credit with the Federal Reserve Bank of San Francisco ("FRBSF") secured by certain residential loans. At September 30, 2023 and December 31, 2022, the Bank had total borrowing capacity under this line of $ 57.3 million and $ 58.7 million, respectively. In addition, under the Federal Reserve’s BTFP facility, the Bank could borrow up to an additional $ 274.6 million based on the par value of pledged investment securities as of September 30, 2023 . Other Obligations – Finance lease liabilities totaling $ 335 thousand and $ 439 thousand at September 30, 2023 and December 31, 2022, respectively, are included in short-term borrowings and other obligations in the consolidated statements of condition. See Note 8, Commitments and Contingencies, for additional information. Outstanding balances and weighted average interest rates on short-term borrowings and other obligations as of September 30, 2023 and December 31, 2022 are summarized in the following table. September 30, 2023 December 31, 2022 (dollars in thousands) Outstanding Balance Weighted Average Rate Outstanding Balance Weighted Average Rate FHLB - short-term borrowings $ — — % $ 112,000 4.65 % Federal funds lines of credit — — % — — % FRBSF - federal funds purchased — — % — — % FRBSF - short-term borrowings under the BTFP 120,000 5.42 % — — % Other obligations (finance leases) 335 2.01 % 439 1.86 % Total short-term borrowings and other obligations $ 120,335 5.41 % $ 112,439 4.64 % Note 7: Stockholders' Equity Dividends On July 21, 2023, Bancorp declared a $ 0.25 per share cash dividend, paid August 11, 2023 to shareholders of record at the close of business on August 4, 2023. Subsequent to quarter end on October 20, 2023, Bancorp declared a $ 0.25 per share cash dividend, payable on November 10, 2023 to shareholders of record at the close of business on November 3, 2023. Page-24 Share-Based Payments The fair value of stock options as of the grant date is recorded as stock-based compensation expense in the consolidated statements of comprehensive income (loss) over the requisite service period, which is generally the vesting period, with a corresponding increase in common stock. Stock-based compensation also includes compensation expense related to the issuance of restricted stock awards. The grant-date fair value of the restricted stock awards, which equals the grant date price, is recorded as compensation expense over the requisite service period with a corresponding increase in common stock as the shares vest. Beginning in 2018, stock option and restricted stock awards issued include a retirement eligibility clause whereby the requisite service period is satisfied at the retirement eligibility date. For those awards, we accelerate the recording of stock-based compensation when the award holder is eligible to retire. However, retirement eligibility does not affect the vesting of restricted stock or the exercisability of the stock options, which are based on the scheduled vesting period. Performance-based stock awards (restricted stock) are issued to a selected group of employees. Stock award vesting is contingent upon the achievement of pre-established long-term performance goals set by the Compensation Committee of the Board of Directors. Performance is measured over a three-year period and cliff vested. These performance-based stock awards were granted at a maximum opportunity level, and based on the achievement of the pre-established goals, the actual payouts can range from 0 % to 200 % of the target award. For performance-based stock awards, an estimate is made of the number of shares expected to vest based on the probability that the performance criteria will be achieved to determine the amount of compensation expense to be recognized. The estimate is re-evaluated quarterly and total compensation expense is adjusted for any change in the current period. We record excess tax benefits (deficiencies) resulting from the exercise of non-qualified stock options, the disqualifying disposition of incentive stock options and vesting of restricted stock awards as income tax benefits (expense) in the consolidated statements of comprehensive income with a corresponding decrease (increase) to current taxes payable. The holders of unvested restricted stock awards are entitled to dividends on the same per-share ratio as holders of common stock. Tax benefits for dividends paid on unvested restricted stock awards are recorded as tax benefits in the consolidated statements of comprehensive income with a corresponding decrease to current taxes payable. Dividends on forfeited awards are included in stock-based compensation expense. Stock options and restricted stock may be net settled in a cashless exercise by a reduction in the number of shares otherwise deliverable upon exercise or vesting in satisfaction of the exercise payment and/or applicable tax withholding requirements. During the nine months ended September 30, 2023, we withheld 3,132 shares totaling $ 86 thousand at a weighted-average price of $ 27.57 for cashless exercises. During the nine months ended September 30, 2022, we withheld 11,505 shares totaling $ 393 thousand at a weighted-average price of $ 34.13 for cashless exercises. Shares withheld under net settlement arrangements are available for future grants. Share Repurchase Program Bancorp had an approved share repurchase program with $ 34.7 million remaining that expired on July 31, 2023. On July 21, 2023, the Board of Directors approved the adoption of Bancorp's new share repurchase program, which replaced the existing one at that time, for up to $ 25.0 million and expiring on July 31, 2025. There have been no repurchases in 2023. Note 8: Commitments and Contingent Liabilities Financial Instruments with Off-Balance Sheet Risk We make commitments to extend credit in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because various commitments will expire without being fully drawn, the total commitment amount does not necessarily represent future cash requirements. Page-25 Our credit loss exposure is equal to the contractual amount of the commitment in the event of nonperformance by the borrower. We use the same credit underwriting criteria for all credit exposure. The amount of collateral obtained, if deemed necessary by us, is based on management's credit evaluation of the borrower. Collateral types pledged may include accounts receivable, inventory, other personal property and real property. The contractual amount of unfunded loan commitments and standby letters of credit not reflected in the consolidated statements of condition are as follows: (in thousands) September 30, 2023 December 31, 2022 Commercial lines of credit $ 260,117 $ 292,204 Revolving home equity lines 220,148 218,907 Undisbursed construction loans 17,881 43,179 Personal and other lines of credit 9,268 10,842 Standby letters of credit 2,757 1,738 Total unfunded loan commitments and standby letters of credit $ 510,171 $ 566,870 We record an allowance for credit losses on unfunded loan commitments at the balance sheet date based on estimates of the probability that these commitments will be drawn upon according to historical utilization experience of the different types of commitments and expected loss rates determined for pooled funded loans. The allowance for credit losses on unfunded commitments totaled $ 1.1 million and $ 1.5 million as of September 30, 2023 and December 31, 2022, respectively, which is included in interest payable and other liabilities in the consolidated statements of condition. We recorded no provision for credit losses on unfunded loan commitments in the third quarters of 2023 and 2022. The $ 342 thousand reversal of the provision for credit losses on unfunded loan commitments in the nine months of 2023 was due primarily to a decrease in total unfunded commitments, compared to a $ 318 thousand provision reversal in the nine months of 2022, due to improved economic forecasts at the time. Leases We lease premises under long-term non-cancelable operating leases with remaining terms of 7 months to 18 years, 8 months , most of which include escalation clauses and one or more options to extend the lease term, and some of which contain lease termination clauses. Lease terms may include certain renewal options that were considered reasonably certain to be exercised. We lease certain equipment under finance leases with initial terms of 3 years to 5 years. The equipment finance leases do not contain renewal options, bargain purchase options or residual value guarantees. The following table shows the balances of operating and finance lease right-of-use assets and lease liabilities. (in thousands) September 30, 2023 December 31, 2022 Operating leases: Operating lease right-of-use assets $ 21,589 $ 24,821 Operating lease liabilities $ 24,040 $ 26,639 Finance leases: Finance lease right-of-use assets $ 608 $ 616 Accumulated amortization ( 282 ) ( 187 ) Finance lease right-of-use assets, net 1 $ 326 $ 429 Finance lease liabilities 2 $ 335 $ 439 1 Included in premises and equipment in the consolidated statements of condition. 2 Included in borrowings and other obligations in the consolidated statements of condition. The following table shows supplemental disclosures of noncash investing and financing activities for the periods presented. Nine months ended (in thousands) September 30, 2023 September 30, 2022 Right-of-use assets obtained in exchange for operating lease liabilities, net of tenant improvement allowances received $ 572 $ 4,989 Right-of-use assets obtained in exchange for finance lease liabilities $ 7 $ 41 Page-26 The following table shows components of operating and finance lease cost. Three months ended Nine months ended (in thousands) September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Operating lease cost $ 1,289 $ 1,328 $ 4,221 $ 3,907 Variable lease cost — — — — Total operating lease cost 1 $ 1,289 $ 1,328 $ 4,221 $ 3,907 Finance lease cost: Amortization of right-of-use assets 2 $ 37 $ 31 $ 111 $ 93 Interest on finance lease liabilities 3 2 1 5 2 Total finance lease cost $ 39 $ 32 $ 116 $ 95 Total lease cost $ 1,328 $ 1,360 $ 4,337 $ 4,002 1 Included in occupancy and equipment expense in the consolidated statements of comprehensive income. 2 Included in depreciation and amortization in the consolidated statements of comprehensive income. 3 Included in interest on borrowings and other obligations in the consolidated statements of comprehensive income. The following table shows the future minimum lease payments, weighted average remaining lease terms, and weighted average discount rates under operating and finance lease arrangements as of September 30, 2023. The discount rates used to calculate the present value of lease liabilities were based on the collateralized FHLB borrowing rates that were commensurate with lease terms and minimum payments on the lease commencement date. (in thousands) September 30, 2023 Year Operating Leases Finance Leases 2023 $ 1,268 $ 39 2024 4,753 155 2025 4,112 108 2026 3,373 38 2027 3,097 5 Thereafter 10,017 — Total minimum lease payments 26,620 345 Amounts representing interest (present value discount) ( 2,580 ) ( 10 ) Present value of net minimum lease payments (lease liability) $ 24,040 $ 335 Weighted average remaining term (in years) 7.4 2.4 Weighted average discount rate 2.38 % 2.01 % Litigation Matters Bancorp may be party to legal actions that arise from time to time in the normal course of business. Bancorp's management is not aware of any pending legal proceedings to which either it or the Bank may be a party or has recently been a party that will have a material adverse effect on the financial condition or results of operations of Bancorp or the Bank. The Bank is responsible for a proportionate share of certain litigation indemnifications provided to Visa U.S.A. ("Visa") by its member banks in connection with Visa's lawsuits related to anti-trust charges and interchange fees ("Covered Litigation"). We sold our remaining shares on July 13, 2023, however our proportionate share of the litigation indemnification liability does not change or transfer upon the sale of our Class B Visa shares to member banks or, per the terms of the sale, to the recent purchaser of our shares. Visa established an escrow account for the Covered Litigation that it periodically funds, which is expected to cover the settlement payment obligations. Litigation is ongoing and until the court approval process is complete, there is no assurance that Visa will resolve the claims as contemplated by the amended class settlement agreement, and additional lawsuits may arise from individual merchants who opted out of the class settlement. However, until the escrow account is fully depleted and the conversion rate of Class B to Class A common stock is reduced to zero, no future cash settlement payments are required by the member banks, such as us, on the Covered Litigation. Therefore, we are not required to record any contingent liabilities for the indemnification related to the Covered Litigation, as we consider the probability of losses to be remote. Page-27 Note 9: Derivative Financial Instruments and Hedging Activities The Bank is exposed to certain risks from both its business operations and changes in economic conditions. As part of our asset/liability and interest rate risk management strategy, we may enter into interest rate derivative contracts to modify the repricing characteristics of certain of our interest-earning assets and interest-bearing liabilities. The Bank generally designates interest rate hedging agreements utilized in the management of interest rate risk as either fair value hedges or cash flow hedges. Our credit exposure, if any, on interest rate swap asset positions is limited to the fair value (net of any collateral pledged to us) and interest payments of all swaps by each counterparty. Conversely, when an interest rate swap is in a liability position exceeding a certain threshold, we may be required to post collateral to the counterparty in an amount determined by the agreements. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values. On July 7, 2023, the Bank entered into various interest rate swap agreements with notional values totaling $ 101.8 million split evenly between terms of 2.5 and 3.0 years to hedge balance sheet interest rate sensitivity and protect certain of our fixed rate available-for-sale securities against changes in fair value related to changes in the benchmark interest rate. The interest rate swaps involve the receipt of floating rate interest from a counterparty in exchange for us making fixed-rate interest payments over the lives of the agreements, without the exchange of the underlying notional values. The transactions were designated as partial term fair value hedges and structured such that the changes in fair value of the interest rate swaps are expected to be perfectly effective in offsetting the changes in the fair value of the hedged items attributable to changes in the SOFR OIS swap rate, the designated benchmark interest rate. Because the hedges met the criteria for using the shortcut method, there is no need to periodically reassess effectiveness during the term of the hedges. For fair value designated hedges, the gain or loss on the hedging instruments as well as the offsetting loss or gain on the hedged items, are recognized in current earnings as fair values change. In addition, we had four interest rate swap agreements on certain loans with our customers, which are scheduled to mature at various dates ranging from January 2026 to October 2037. The loan interest rate swaps were designated as fair value hedges and allowed us to offer long-term fixed-rate loans to customers without assuming the interest rate risk of a long-term asset. Converting our fixed-rate interest payments to floating-rate interest payments, generally benchmarked to the one-month U.S. dollar SOFR index, protects us against changes in the fair value of our loans associated with fluctuating interest rates. The notional amounts of the interest rate contracts are equal to the notional amounts of the hedged loans. Information on our derivatives follows: Asset Derivatives Liability Derivatives (in thousands) September 30, 2023 December 31, 2022 September 30, 2023 December 31, 2022 Available-for-sale securities: Interest rate swaps - notional amount $ 101,770 $ — $ — $ — Interest rate swaps - fair value 1 $ 367 $ — $ — $ — Loans receivable: Interest rate contracts - notional amount $ 11,277 $ 12,046 $ — $ — Interest rate contracts - fair value 1 $ 854 $ 602 $ — $ — 1 See Note 3, Fair Value of Assets and Liabilities, for valuation methodology. The following table presents the carrying amount and associated cumulative basis adjustment related to the application of fair value hedge accounting that is included in the carrying amount of hedged assets as of September 30, 2023 and December 31, 2022. Page-28 Carrying Amounts of Hedged Assets Cumulative Amounts of Fair Value Hedging Adjustments Included in the Carrying Amounts of the Hedged Assets (in thousands) September 30, 2023 December 31, 2022 September 30, 2023 December 31, 2022 Available-for-sale securities 1 $ 108,444 $ — $ ( 367 ) $ — Loans receivable 2 $ 10,266 $ 11,319 $ ( 960 ) $ ( 726 ) 1 Carrying value equals the amortized cost basis of the securities underlying the hedge relationship, which is the book value net of the fair value hedge adjustment. Amortized cost excludes accrued interest totaling $ 136 thousand as of September 30, 2023. 2 Carrying value equals the amortized cost basis of the loans underlying the hedge relationship, which is the loan balance net of deferred loan origination fees and cost and the fair value hedge adjustment. Amortized cost excludes accrued interest, which was not material. The following table presents the pretax net gains (losses) recognized in interest income related to our fair value hedges. Three months ended Nine months ended (in thousands) September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 Interest on investment securities 1 Increase (decrease) in fair value of interest rate swaps hedging available-for-sale securities $ 367 $ — $ 367 $ — Receivable (payment) on interest rate swaps 162 — 162 — (Decrease) increase in carrying value included in the hedged available-for-sale securities ( 367 ) — ( 367 ) — Net gain (loss) recognized in interest income on investment securities $ 162 $ — $ 162 $ — Interest and fees on loans 1 Increase (decrease) in fair value of interest rate swaps hedging loans receivable $ 223 $ 547 $ 252 $ 1,734 Receivable (payment) on interest rate swaps 74 ( 19 ) 192 ( 169 ) (Decrease) increase in carrying value included in the hedged loans ( 211 ) ( 538 ) ( 233 ) ( 1,718 ) Decrease in value of yield maintenance agreement ( 2 ) ( 3 ) ( 7 ) ( 8 ) Net gain (loss) recognized in interest income on loans $ 84 $ ( 13 ) $ 204 $ ( 161 ) 1 Represents the income line item in the statement of comprehensive income in which the effects of fair value hedges are recorded. Our derivative transactions with the counterparty are under an International Swaps and Derivative Association (“ISDA”) master agreement that includes “right of set-off” provisions. “Right of set-off” provisions are legally enforceable rights to offset recognized amounts and there may be an intention to settle such amounts on a net basis. We do not offset such financial instruments for financial reporting purposes. Information on financial instruments that are eligible for offset in the consolidated statements of condition follows: Offsetting of Financial Assets and Derivative Assets Gross Amounts Net Amounts of Gross Amounts Not Offset in Gross Amounts Offset in the Assets Presented the Statements of Condition of Recognized Statements of in the Statements Financial Cash Collateral ( in thousands) Assets 1 Condition of Condition 1 Instruments Received Net Amount September 30, 2023 Counterparty $ 1,221 $ — $ 1,221 $ — $ — $ 1,221 Total $ 1,221 $ — $ 1,221 $ — $ — $ 1,221 December 31, 2022 Counterparty $ 602 $ — $ 602 $ — $ — $ 602 Total $ 602 $ — $ 602 $ — $ — $ 602 1 Amounts exclude accrued interest on swaps. For more information on how we account for our interest rate swaps, refer to Note 1 to the Consolidated Financial Statements included in our 2022 Form 10-K filed with the SEC on March 16, 2023. Page-29