Bank of Marin Bancorp 10-Q

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Management's discussion of the financial condition and results of operations, which is unaudited, should be read in conjunction with the related unaudited consolidated financial statements in this Form 10-Q and with the audited consolidated financial statements and accompanying notes included in our 2022 Annual Report on Form 10-K. Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances. Forward-Looking Statements This discussion of financial results includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, (the "1933 Act") and Section 21E of the Securities Exchange Act of 1934, as amended, (the "1934 Act"). Those sections of the 1933 Act and 1934 Act provide a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about their financial performance so long as they provide meaningful, cautionary statements identifying important factors that could cause actual results to differ significantly from projected results. Our forward-looking statements include descriptions of plans or objectives of management for future operations, products or services, and forecasts of revenues, earnings or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include the words "believe," "expect," "intend," "estimate" or words of similar meaning, or future or conditional verbs preceded by "will," "would," "should," "could" or "may." Forward-looking statements are based on management's current expectations regarding economic, legislative, and regulatory issues that may impact Bancorp's earnings in future periods. Factors that could cause future results to vary materially from current management expectations include, but are not limited to, general economic conditions and the economic uncertainty in the United States and abroad, including economic or other disruptions to financial markets caused by acts of terrorism, war or other conflicts such as the war between Russia and Ukraine and more recently the war between Israel and Hamas, impacts from inflation, supply change disruptions, changes in interest rates (including the actions taken by the Federal Reserve to control inflation), California's unemployment rate, deposit flows, real estate values, and expected future cash flows on loans and securities; the impact of adverse developments at other banks, including bank failures, that impact general sentiment regarding the stability and liquidity of banks; costs or effects of acquisitions; competition; changes in accounting principles, policies or guidelines; changes in legislation or regulation; natural disasters (such as wildfires and earthquakes in our area); adverse weather conditions; interruptions of utility service in our markets for sustained periods; and other economic, competitive, governmental, regulatory and technological factors (including external fraud and cybersecurity threats) affecting our operations, pricing, products and services; and successful integration of acquisitions. Important factors that could cause results or performance to materially differ from those expressed in our prior forward-looking statements are detailed in ITEM 1A, Risk Factors section of our 2022 Form 10-K as filed with the SEC, and ITEM 1A Risk Factors herein, copies of which are available from us at no charge. Forward-looking statements speak only as of the date they are made. We do not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. Critical Accounting Estimates Critical accounting estimates are those estimates made in accordance with generally accepted accounting principles that involve a significant level of estimation and uncertainty and have had or are reasonably likely to have a material impact on our financial condition and results of operations. We consider accounting estimates to be critical to our financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain, (ii) management could have applied different assumptions during the reported period, and (iii) changes in the accounting estimate are reasonably likely to occur in the future and could have a material impact on our financial statements. Our critical estimates include: Allowance for Credit Losses on Loans and Unfunded Commitments, Income Taxes, Fair Value Measurements, and Business Combinations. For a detailed discussion, refer to the Critical Accounting Estimates section of our 2022 Form 10-K filed with the SEC on March 16, 2023. Page-30 Executive Summary We generated earnings of $5.3 million for the third quarter of 2023, compared to $4.6 million for the second quarter of 2023. Diluted earnings per share were $0.33 for the third quarter of 2023, compared to $0.28 for the preceding quarter. Earnings for the first nine months of 2023 totaled $19.3 million, compared to $33.7 million for the same period in 2022. Diluted earnings per share were $1.20 and $2.11 for the first nine months of 2023 and 2022, respectively. The 2023 earnings were impacted by the increased cost of interest bearing deposits catching up to market interest rates and higher average balances on borrowings. The following are highlights of our operating and financial performance for the periods presented. Additional performance details can be found in the pages that follow. • The third quarter tax-equi valent net interest margin increased 3 basis points to 2.48% from 2.45% in the previous quarter due primarily to higher rates on interest-bearing cash balances generated from securities sales. The tax-equivalent net interest margin for the nine months ended September 30, 2023 of 2.66% decreased 40 basis points fr om 3.06% for the same period in 2022, primarily due to higher deposit and borrowing costs, partially offset by higher interest rates on loans and investment securities. We continue to manage our balance sheet and interest rate risk position to the current interest rate environment, and sold an additional $55.0 million in available-for-sale securities in late October. The sales generated an after-tax loss of $1.5 million, which is expected to be earned back through incremental interest income and improvements to the net interest margin in less than one year. • Deposits totaled $3.444 billion as of September 30, 2023, a decrease of $129.7 million f rom $3.573 billion at December 31, 2022 . However, deposits increased $118.5 million over the prior quarter. Our experienced team of bankers continued to build upon our strong deposit franchise with consistent growth from proactive outreach to both existing and prospective customers in all of our markets. Average cost of deposits increased 25 basis points over the second quarter, from 0.69% to 0.94%. Average cost of deposits increased 55 basis points for the first nine months of 2023, compared to the same period in 2022, from 0.06% to 0.61%. We believe we are competitively aligned in regard to deposit pricing, helping to maintain deposit levels. • Non-interest bearing deposits made up 47.7% of total deposits at September 30, 2023, compared to 51.5% at December 31, 2022. We have successfully maintained non-interest bearing deposit percentages consistent with pre-pandemic levels, despite market and industry turbulence. Customer participation in the reciprocal deposit network program grew to $483.3 million maintaining estimated uninsured and/or uncollateralized deposits at 29% of total deposits as of September 30, 2023 . Our largest depositor represented 2.7% of total deposits as of September 30, 2023. • Borrowings totaled $120.0 million as of September 30, 2023, an $8.0 million increase from $112.0 million at December 31, 2022. However, total borrowings declined $52.2 million quarter-over-quarter from $172.2 million as a result of deposit growth and cash flows from investments and loans. Net available funding sources of $2.1 billion provided 211% coverage of an estimated $989.8 million in uninsured deposits at September 30, 2023. • Our loan portfolio continues to perform well with classified loans at 1.90% of total loans. Non-owner-occupied commercial real estate loans made up $23.6 million or 59% of total classified loans as of September 30, 2023, compared to $22.0 million or 78% at December 31, 2022. Shortly after quarter-end three unsecured commercial substandard loans to one borrower totaling approximately $4.6 million paid off. • Non-accrual loans were 0.27% of total loans, or $5.7 million, at September 30, 2023, compared to 0.12%, or $2.4 million, at December 31, 2022. Of the seven loans totaling $5.3 million moved to non-accrual status during the year, one legacy acquired-bank agricultural loan totaling $3.8 million became current on outstanding payments shortly after quarter-end. Offsetting the additions were payoffs and paydowns of $1.8 million and two loans for $314 thousand that were moved to accrual status in the first quarter. All of the non-accrual loans are collateralized by real estate with no expected credit loss as of September 30, 2023. Page-31 • A $425 thousand provision for credit losses on loans in the third quarter brought the allowance for credit losses to 1.16% of total loans as of September 31, 2023. The provision was due primarily to qualitative risk factor adjustments as discussed further below and compared to a provision of $500 thousand in the previous quarter. For nine months ended September 30, 2023, we recorded a provision for credit losses on loans of $1.3 million , compared to a rev ersal of $63 thousand for the same period in 2022. • Loans totaled $2.087 billion at September 30, 2023, a decrease of $5.6 million from $2.093 billion at December 31, 2022 reflecting originations of $90.3 million and payoffs of $59.5 million (including PPP payoffs). L oan amortization from scheduled repayments totaling $60.6 million was partially offset by a $24.2 million net increase in utilization of credit lines in the nine months ended September 30, 2023. • Return on average assets ("ROA") was 0.52% for the third quarter of 2023, compared to 0.44% for the second quarter of 2023. Return on average equity ("ROE") was 4.94% for the third quarter of 2023 , compared to 4.25% for the prior quarter. ROA was 0.63% for the nine months ended September 30, 2023, compared to 1.04% in the same period in 2022. ROE was 6.07% for the nine months ended September 30, 2023, compared to 10.65% in the same period in 2022. The efficiency ratio for the third quarter of 2023 was 72.96% , compared to 76.91% for the prior quarter. The efficiency ratio was 69.37% for the nine months ended September 30, 2023, compared to 55.60% in the same period in 2022 . • All capital ratios were above well-capitalized regulatory requirements. The total risk-based capital ratios at September 30, 2023 for Bancorp and the Bank were 16.6% and 16.1%, respectively. Bancorp's tangible common equity to tangible assets ("TCE ratio") was 8.6% at September 30, 2023, compared to 8.2% as of December 31, 2022. As of September 30, 2023, Bancorp's TCE ratio, net of after tax unrealized losses on held-to-maturity securities, was 6.1%, compared to 6.2% at December 31, 2022 (ref er to page 46 for a dis cussion and reconciliation of this non-GAAP financial measure). • The Board of Directors declared a cash dividend of $0.25 per share on October 20, 2023, which represents the 74 th consecutive quarterly dividend paid by Bancorp. The dividend is payable on November 10, 2023, to shareholders of record at the close of business on November 3, 2023. • As previously announced, David Bloom, Executive Vice President and Head of Commercial Banking, joined the Bank on July 31 and is responsible for the direction, vision, growth, and performance of the Bank’s commercial banking division, including its eight regional offices located throughout northern California and its specialty wine business. He previously served as senior managing director of business banking in northern California and the Pacific Northwest at First Republic Ban k. Under David's direction we have alre ady approved for fu nding loan amounts exceeding third quarter originations since quarter end. • Also as previously announced, effective October 20, 2023, the Board of Directors for Bank of Marin Bancorp appointed Cigdem Gencer to its board, increasing its membership to thirteen directors. Gencer brings extensive leadership and financial services experience to the Board. Throughout her career, she has developed and executed transformative growth, expansion, and investment strategies for organizations, including international expansion efforts. For nearly two decades, Gencer served as executive vice president at a Fortune 500 financial institution where she served as head of international human resources, head of enterprise data strategy and analytics in the Chief Data Office, and chief financial officer, chief operating officer, and regional sales director for its Private Wealth division. Her experience also includes serving as a management consultant in the financial services sector and chief financial officer at Intrax, Inc. In 2021, she established Fazilet Consulting—an executive coaching and organizational consulting firm—in which she also serves as an executive coach. Page-32 RESULTS OF OPERATIONS Highlights of the financial results are presented in the following tables: Three months ended Nine months ended (dollars in thousands, except per share data) September 30, 2023 June 30, 2023 September 30, 2023 September 30, 2022 Selected operating data: Net interest income $ 24,469 $ 24,130 $ 78,497 $ 94,122 Provision for (reversal of) credit losses on loans 425 500 1,275 (63) Reversal of credit losses on unfunded loan commitments — (168) (342) (318) Non-interest income 2,598 2,739 8,272 8,318 Non-interest expense 19,747 20,665 60,192 56,959 Net income 5,295 4,551 19,285 33,705 Net income per common share: Basic $ 0.33 $ 0.28 $ 1.21 $ 2.12 Diluted $ 0.33 $ 0.28 $ 1.20 $ 2.11 Performance and other financial ratios: Return on average assets 0.52 % 0.44 % 0.63 % 1.04 % Return on average equity 4.94 % 4.25 % 6.07 % 10.65 % Tax-equivalent net interest margin 2.48 % 2.45 % 2.66 % 3.06 % Cost of deposits 0.94 % 0.69 % 0.61 % 0.06 % Efficiency ratio 72.96 % 76.91 % 69.37 % 55.60 % Net (recoveries) charge-offs $ (3) $ (2) $ (2) $ (3) Cash dividend payout ratio on common stock 1 75.76 % 89.29 % 61.98 % 34.43 % (dollars in thousands, except per share data) September 30, 2023 December 31, 2022 Selected financial condition data: Total assets $ 4,035,549 $ 4,147,464 Investment securities 1,593,957 1,774,303 Loans, net 2,062,682 2,069,563 Deposits 3,443,684 3,573,348 Short-term borrowings and other obligations 120,335 112,439 Stockholders' equity 418,618 412,092 Book value per share 25.94 25.71 Asset quality ratios: Allowance for credit losses on loans to total loans 1.16 % 1.10 % Allowance for credit losses on loans to non-performing loans 4.28x 9.45x Non-accrual loans to total loans 0.27 % 0.12 % Capital ratios: Equity to total assets ratio 10.37 % 9.94 % Tangible common equity to tangible assets 8.63 % 8.21 % Total capital (to risk-weighted assets) 16.56 % 15.90 % Tier 1 capital (to risk-weighted assets) 15.63 % 15.02 % Tier 1 capital (to average assets) 10.24 % 9.60 % Common equity Tier 1 capital (to risk weighted assets) 15.63 % 15.02 % 1 Calculated as dividends on common shares divided by basic net income per common share. Page-33 Net Interest Income Net interest income is the interest earned on loans, investments and other interest-earning assets minus the interest expense incurred on deposits and other interest-bearing liabilities. Net interest income is impacted by changes in general market interest rates and by changes in the composition of interest-earning assets and interest-bearing liabilities. Interest rate changes can create fluctuations in the net interest income and/or margin due to an imbalance in the timing of repricing and maturity of assets and liabilities. We manage interest rate risk exposure with the goal of minimizing the impact of interest rate volatility on net interest income. For more information, refer to Item 3. Quantitative and Qualitative Disclosure about Market Risk in this Form 10-Q. Net interest margin is expressed as net interest income divided by average interest-earning assets. Net interest rate spread is the difference between the average rate earned on total interest-earning assets and the average rate incurred on total interest-bearing liabilities. Both of these measures are reported on a taxable-equivalent basis. Net interest margin is the higher of the two because it reflects interest income earned on assets funded with non-interest-bearing sources of funds, which include demand deposits and stockholders’ equity. Average Statements of Condition and Analysis of Net Interest Income The following tables compare interest income, average interest-earning assets, interest expense, and average interest-bearing liabilities for the periods presented. The tables also present net interest income, net interest margin and net interest rate spread for each period reported. Three months ended Three months ended September 30, 2023 June 30, 2023 Interest Interest Average Income/ Yield/ Average Income/ Yield/ (dollars in thousands) Balance Expense Rate Balance Expense Rate Assets Interest-earning deposits with banks 1 $ 76,896 $ 1,055 5.37 % $ 3,578 $ 48 5.35 % Investment securities 2, 3 1,721,367 9,436 2.19 % 1,819,486 10,103 2.22 % Loans 1, 3, 4 2,096,814 24,823 4.63 % 2,108,260 24,700 4.63 % Total interest-earning assets 1 3,895,077 35,314 3.55 % 3,931,324 34,851 3.51 % Cash and non-interest-bearing due from banks 37,964 38,154 Bank premises and equipment, net 8,428 8,546 Interest receivable and other assets, net 134,075 141,130 Total assets $ 4,075,544 $ 4,119,154 Liabilities and Stockholders' Equity Interest-bearing transaction accounts $ 230,085 $ 270 0.47 % $ 232,090 $ 234 0.41 % Savings accounts 266,770 229 0.34 % 285,745 146 0.20 % Money market accounts 1,046,011 5,988 2.27 % 948,670 4,292 1.81 % Time accounts including CDARS 217,467 1,555 2.84 % 174,471 946 2.18 % Short-term borrowings and other obligations 1 188,415 2,593 5.39 % 372,308 4,873 5.18 % Total interest-bearing liabilities 1,948,748 10,635 2.17 % 2,013,284 10,491 2.09 % Demand accounts 1,649,691 1,627,730 Interest payable and other liabilities 52,067 49,116 Stockholders' equity 425,038 429,024 Total liabilities & stockholders' equity $ 4,075,544 $ 4,119,154 Tax-equivalent net interest income/margin 1 $ 24,679 2.48 % $ 24,360 2.45 % Reported net interest income/margin 1 $ 24,469 2.46 % $ 24,130 2.43 % Tax-equivalent net interest rate spread 1.38 % 1.42 % Page-34 Nine months ended Nine months ended September 30, 2023 September 30, 2022 Interest Interest Average Income/ Yield/ Average Income/ Yield/ (in thousands) Balance Expense Rate Balance Expense Rate Assets Interest-earning deposits with banks 1 $ 28,710 $ 1,159 5.32 % $ 140,114 $ 832 0.78 % Investment securities 2, 3 1,797,054 29,731 2.21 % 1,770,882 25,214 1.90 % Loans 1, 3, 4 2,108,840 73,938 4.62 % 2,196,173 70,944 4.26 % Total interest-earning assets 1 3,934,604 104,828 3.51 % 4,107,169 96,990 3.11 % Cash and non-interest-bearing due from banks 38,641 56,585 Bank premises and equipment, net 8,457 7,220 Interest receivable and other assets, net 137,428 159,994 Total assets $ 4,119,130 $ 4,330,968 Liabilities and Stockholders' Equity Interest-bearing transaction accounts $ 244,688 $ 758 0.41 % $ 296,239 $ 230 0.10 % Savings accounts 293,709 545 0.25 % 342,704 93 0.04 % Money market accounts 982,729 11,365 1.55 % 1,074,597 1,184 0.15 % Time accounts including CDARS 172,991 2,724 2.11 % 144,807 209 0.19 % Short-term borrowings and other obligations 1 260,973 10,182 5.14 % 368 2 0.71 % Total interest-bearing liabilities 1,955,090 25,574 1.75 % 1,858,715 1,718 0.12 % Demand accounts 1,689,615 1,999,433 Interest payable and other liabilities 49,819 49,747 Stockholders' equity 424,606 423,073 Total liabilities & stockholders' equity $ 4,119,130 $ 4,330,968 Tax-equivalent net interest income/margin 1 $ 79,254 2.66 % $ 95,272 3.06 % Reported net interest income/margin 1 $ 78,497 2.63 % $ 94,122 3.02 % Tax-equivalent net interest rate spread 1.76 % 2.99 % 1 Interest income/expense is divided by actual number of days in the period times 360 days to correspond to stated interest rate terms, where applicable. 2 Yields on available-for-sale securities are calculated based on amortized cost balances rather than fair value, as changes in fair value are reflected as a component of stockholders' equity. Investment security interest is earned on 30/360 day basis monthly. 3 Yields and interest income on tax-exempt securities and loans are presented on a taxable-equivalent basis using the Federal statutory rate of 21 percent in 2023 and 2022. 4 Average balances on loans outstanding include non-performing loans. The amortized portion of net loan origination fees is included in interest income on loans, representing an adjustment to the yield. The following table presents the effects of changes in average balances (volume) or changes in average rates on tax-equivalent net interest income for the periods indicated. Volume variances are equal to the increase or decrease in average balances multiplied by prior period rates. Rate variances are equal to the increase or decrease in rates multiplied by prior period average balances. Mix variances are attributable to the change in yields or rates multiplied by the change in average balances, including one more day in the three months ended September 30, 2023, compared to the three months ended June 30, 2023. Three months ended September 30, 2023 compared to three months ended June 30, 2023 Nine months ended September 30, 2023 compared to nine months ended September 30, 2022 (in thousands) Volume Yield/Rate Mix Total Volume Yield/Rate Mix Total Interest-earning deposits with banks $ 984 $ 1 $ 22 $ 1,007 $ (661) $ 4,825 $ (3,837) $ 327 Investment securities 1 (545) (129) 7 (667) 373 4,084 60 4,517 Loans 1 (134) (13) 270 123 (2,821) 6,056 (241) 2,994 Total interest-earning assets 305 (141) 299 463 (3,109) 14,965 (4,018) 7,838 Interest-bearing transaction accounts (2) 34 4 36 (40) 688 (120) 528 Savings accounts (10) 97 (4) 83 (13) 543 (78) 452 Money market accounts 440 1,080 176 1,696 (101) 11,243 (961) 10,181 Time accounts, including CDARS 233 288 88 609 41 2,071 403 2,515 Short-term borrowings and other obligations (2,407) 195 (68) (2,280) 1,416 12 8,752 10,180 Total interest-bearing liabilities (1,746) 1,694 196 144 1,303 14,557 7,996 23,856 Changes in tax-equivalent net interest income $ 2,051 $ (1,835) $ 103 $ 319 $ (4,412) $ 408 $ (12,014) $ (16,018) 1 Yields and interest income on tax-exempt securities and loans are presented on a taxable-equivalent basis using the federal statutory rate of 21%. Page-35 Third Quarter of 2023 Compared to the Second Quarter of 2023 Net interest income totaled $24.5 million for the third quarter of 2023, compared to $24.1 million for the prior quarter. The $339 thousand increase from the prior quarter was primarily related to an increase of approximately $358 thousand in interest income from the investment of securities sales proceeds into interest-bearing cash. The $2.3 million reduction in borrowing cost for the quarter was offset by rising deposit rates and higher average deposit balances that resulted in an additional $2.4 million in interest expense. The tax-equivalent net interest margin was 2.48% for the third quarter of 2023, compared to 2.45% for the prior quarter. The increase from prior quarter was primarily due to a $73.3 million increase in avera ge interest-bearing cash balances with an average yield of 5.37% from securities sales proceeds. During the third quarter n ew loans were originated at rates approximately 150 basis points above the rates on loans paid off, which will positively impact the margin in future periods. Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022 Net interest income totaled $78.5 million for the nine months ended September 30, 2023, compared to $94.1 million for the same period in the prior year. The $15.6 million decrease from prior year was primarily due to higher funding costs of $23.9 million, partially offset by higher average yields on earning assets. The tax-equivalent net interest margin was 2.66% for the nine months ended September 30, 2023, compared to 3.06% for the same period in the prior year. The decrease was primarily attributed to higher deposit and borrowing costs, partially offset by higher interest rates on loans and investment securities. Average interest-bearing deposits balances decreased by $164.2 million while the average cost increased by 55 basis points, mainly for money market and time deposit account types, decreasing the margin by 46 basis points. Average borrowings and other obligations increased by $260.6 million at an average cost of 5.14%, an increase of 4.43%, decreasing the margin by 34 basis points. Average loan balances decreased by $87.3 million while the average yield increased by 36 basis points, increasing the margin by 20 basis points. Average investment securities increased $26.2 million and their average yield increased 31 basis points, increasing the margin by 19 basis points. Market Interest Rates Market interest rates are, in part, based on the target federal funds interest rate (the interest rate banks charge each other for short-term borrowings) implemented by the Federal Reserve Open Market Committee ("FOMC"). In response to the evolving risks to economic activity caused by the COVID-19 pandemic, the FOMC made two emergency federal funds rate cuts totaling 150 basis points in March 2020. The federal funds rate range remained between 0.0% to 0.25% through the beginning of 2022, putting downward pressure on our asset yields and net interest margin. Beginning in March 2022, the FOMC began successive increases to the federal funds rate due to the evolving inflation risks, complicated by international political unrest and supply chain disruptions. As a result of seven rate adjustments during 2022, the federal funds target rate increased to a range of 4.25% to 4.50% at year-end 2022 and our net interest margin increased gradually over the course of the year. In 2023, on each of February 1 st , March 22 nd , May 3 rd , and July 26 th the FOMC increased the target rate by 25 basis points to a range of 5.25% to 5.50%. Rising interest rates and first quarter disruptions in the banking industry resulted in rapid increases in the cost of funds through rising deposit costs and increased borrowings, putting pressure on net interest margin in the second and third quarters. Federal Reserve policymakers continue to monitor inflation and economic developments throughout 2023. See ITEM 3. Quantitative and Qualitative Disclosure about Market Risk for further information. Provision for Credit Losses on Loans Management assesses the adequacy of the allowance for credit losses on loans quarterly based on several factors including growth of the loan portfolio, past events, current conditions, and reasonable and supportable forecasts to estimate expected losses over the contractual terms of our loans. The allowance for credit losses on loans is increased by provisions charged to expense and loss recoveries and decreased by loans charged off. Page-36 The following table shows the activity for the periods presented. Three months ended Nine months ended (dollars in thousands) September 30, 2023 June 30, 2023 September 30, 2023 September 30, 2022 Provision for (reversal of) credit losses on loans $ 425 $ 500 $ 1,275 $ (63) We recorded a $425 thousand provision for credit losses on loans in the third quarter. The provision was due primarily to increases in qualitative factors related to trends in adversely graded, non-owner-occupied commercial real estate loans and the potential impact of rapidly increasing interest rates and other external factors on both our non-owner-occupied commercial real estate and construction portfolios. These increases were partially offset by the impact of the decrease in loan balances. We recorded a $500 thousand provision for credit losses on loans in the second quarter. The provision was due primarily to increases in qualitative risk factors from continued negative trends in adversely graded loans and/or collateral values on our non-owner occupied commercial real estate office and multi-family real estate portfolios. These increases were partially offset by the impact of a decrease in loan balances. The provision totaling $1.3 million for the nine months ended September 30, 2023 primarily resulted from increases in qualitative risk factors from continued trends in adversely graded loans and/or collateral values not believed to be captured in the quantitative risk factors. The net provision reversal for the nine months ended September 30, 2022 primarily resulted from a provision reversal in the first quarter due to improvements in the economic forecasts, partially offset by the provision in the third quarter due primarily to an increase in qualitative factors to account for the ongoing deterioration in the economic outlook not captured in the quantitative portion of the allowance. For more information, refer to Note 5, Loans and Allowance for Credit Losses on Loans, to the consolidated financial statements in this Form 10-Q. Non-interest Income The following table details the components of non-interest income. Three months ended (dollars in thousands) September 30, 2023 June 30, 2023 Amount Change Percent Change Wealth Management and Trust Services $ 515 $ 559 $ (44) (7.9) % Service charges on deposit accounts 508 520 (12) (2.3) % Debit card interchange fees, net 456 555 (99) (17.8) % Earnings on bank-owned life insurance, net 371 $ 362 9 2.5 % Dividends on Federal Home Loan Bank stock 324 290 34 11.7 % Merchant interchange fees, net 117 127 (10) (7.9) % Other income 293 326 (33) (10.1) % Total non-interest income $ 2,598 $ 2,739 $ (141) (5.1) % Nine months ended Amount Change Percent Change (dollars in thousands) September 30, 2023 September 30, 2022 Wealth Management and Trust Services $ 1,585 $ 1,737 $ (152) (8.8) % Service charges on deposit accounts 1,561 1,488 73 4.9 % Debit card interchange fees, net 1,458 1,538 (80) (5.2) % Earnings on bank-owned life insurance, net 1,438 933 505 54.1 % Dividends on Federal Home Loan Bank stock 916 759 157 20.7 % Merchant interchange fees, net 377 430 (53) (12.3) % Gains (losses) on sale of investment securities, net 14 (63) 77 NM Other income 923 1,496 (573) (38.3) % Total non-interest income $ 8,272 $ 8,318 $ (46) (0.6) % Page-37 Third Quarter of 2023 Compared to the Second Quarter of 2023 Non-interest income totaled $2.6 million for the third quarter of 2023, compared to $2.7 million for the prior quarter. The $141 thousand decrease from the prior quarter was primarily related to the decrease in debit card interchange income. Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022 Non-interest income totaled $8.3 million for the nine months ended September 30, 2023, materially unchanged from the same period of the prior year. The $46 thousand decrease from the prior year period was mostly attributable to decreases in other income including one-way deposit and cash management fees and in wealth management and trust services income, partially offset by higher bank-owned life insurance benefit payments and balances and dividends on Federal Home Loan Bank stock. Non-interest Expense The following table details the components of non-interest expense. Three months ended (dollars in thousands) September 30, 2023 June 30, 2023 Amount Change Percent Change Salaries and related benefits $ 10,741 $ 11,416 $ (675) (5.9) % Occupancy and equipment 1,973 1,980 (7) (0.4) % Data processing 1,009 922 87 9.4 % Professional services 757 797 (40) (5.0) % Federal Deposit Insurance Corporation insurance 469 666 (197) (29.6) % Depreciation and amortization 423 400 23 5.8 % Information technology 411 357 54 15.1 % Amortization of core deposit intangible 335 340 (5) (1.5) % Directors' expense 272 300 (28) (9.3) % Charitable contributions 20 638 (618) (96.9) % Other real estate owned — 44 (44) (100.0) % Other non-interest expense Advertising 319 300 19 6.3 % Other expense 3,018 2,505 513 20.5 % Total other non-interest expense 3,337 2,805 532 19.0 % Total non-interest expense $ 19,747 $ 20,665 $ (918) (4.4) % Nine months ended Amount Change Percent Change (dollars in thousands) September 30, 2023 September 30, 2022 Salaries and related benefits $ 33,087 $ 32,446 $ 641 2.0 % Occupancy and equipment 6,367 5,739 628 10.9 % Data processing 2,976 3,569 (593) (16.6) % Professional services 2,677 2,314 363 15.7 % Depreciation and amortization 1,705 1,259 446 35.4 % Federal Deposit Insurance Corporation insurance 1,424 886 538 60.7 % Information technology 1,138 1,519 (381) (25.1) % Amortization of core deposit intangible 1,020 1,124 (104) (9.3) % Directors' expense 893 838 55 6.6 % Charitable contributions 707 605 102 16.9 % Other real estate owned 48 355 (307) NM Other non-interest expense Advertising 897 789 108 13.7 % Other expense 7,253 5,516 1,737 31.5 % Total other non-interest expense 8,150 6,305 1,845 29.3 % Total non-interest expense $ 60,192 $ 56,959 $ 3,233 5.7 % NM - Not Meaningful Page-38 Third Quarter of 2023 Compared to the Second Quarter of 2023 Non-interest expense totaled $19.7 million for the third quarter of 2023, compared to $20.7 million for the prior quarter. Th e $918 thousand decrease from the prior quarter primarily resulted from a $675 thousand decrease in salaries and related benefits mainly due to decreases in accrued incentive and profit sharing expenses and 401(k) contributio ns, $ 618 thousand less in charitable contributions as our annual grant program normally occurs in the second quarter, and a $197 thousand decrease related to a catch-up adjustment in the second quarter for increased FDIC assessments to strengthen the Deposit Insurance Fund. These decreases were partially offset by a $532 thousand net increase in other expense, primarily due to a $688 thousand increase in expenses and fees associated with our customers' participation in reciprocal deposit networks to bolster their FDIC insured balances. Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022 Non-interest expense totaled $60.2 million for the nine months ended September 30, 2023 , compared to $57.0 million for the nine months ended September 30, 2022, an increase of $3.2 million. Other expense increased by $1.8 million primarily due to a $1.5 million increase in expenses and fees associated with reciprocal deposits placed into deposit networks. Salaries and related benefits increased by $641 thousand primarily due to regularly scheduled annual merit and other increases, the hiring of several key employees and officers, and lower deferred loan origination costs, partially offset by a reduction in accrued incentive and profit sharing expenses. Occupancy and equipment and depreciation and amortization expenses rose $628 thousand and $446 thousand, respectively, mainly from the acceleration of lease-related costs for branch closures in the first quarter of 2 0 23. Beginning in 2024, the estimated annual pre-tax savings from branch closures are expected to be approximately $1.4 million. I n addition, the FDIC insurance assessment rose by $538 thousand due to the increased statutory rate. These increases were partially offset by a $593 thousand decrease in data processing expenses due to our core system contract renegotiation for the current period and because the prior year included data processing expenses largely eliminated after the systems conversion associated with the American River Bankshares merger. In addition, other real estate owned expenses decreased by $307 thousand due the write-down in the prior year of the asset that was sold in the third quarter of 2023. Provision for Income Taxes Income tax provisions reflect accruals for taxes at the applicable rates for federal income tax and California franchise tax based upon reported pre-tax income. Provisions also reflect permanent differences between income for tax and financial reporting purposes (such as earnings on tax exempt loans and municipal securities, bank-owned life insurance ("BOLI") income, low-income housing tax credits, and stock-based compensation from the exercise of stock options, disqualifying dispositions of incentive stock options and vesting of restricted stock awards). The provision for income taxes for the third quarter of 2023 totaled $1.6 million at an effective tax rate of 23.2%, compared to $1.3 million at an effective tax rate of 22.5% in the prior quarter. The increase in the provision for income taxes in the third quarter of 2023 reflected higher pre-tax income as compared to the prior quarter. The 70 basis point increase in the effective tax rate in the third quarter of 2023 was primarily due to the smaller proportional effect of permanent tax differences on higher pretax income. The provision for income taxes for the first nine months of 2023 totaled $6.4 million at an effective tax rate of 24.8%, compared to $12.2 million at an effective tax rate of 26.5% for the first nine months of 2022. The 170 basis point decrease in the effective tax rate in the first nine months of 2023, as compared to the same period a year ago, was primarily due to the larger proportional effect of permanent tax differences on lower pretax income and higher tax-exempt BOLI income. This decrease was partially offset by a reduction in the tax-exempt interest exclusion (due to a larger IRC Section 291(e) interest expense disallowance), compared to the prior period. We file a consolidated return in the U.S. Federal tax jurisdiction and a combined return in the State of California tax jurisdiction. There were no ongoing federal or state income tax examinations at the issuance of this report. At September 30, 2023, neither the Bank nor Bancorp had accruals for interest or penalties related to unrecognized tax benefits. Page-39 FINANCIAL CONDITION SUMMARY Cash, Cash Equivalents and Restricted Cash Total cash, cash equivalents and restricted cash were $123.1 million at September 30, 2023, compared to $45.4 million at December 31, 2022. The $77.7 million increase was due primarily to the sale of $82.7 million of available-for-sale securities in the third quarter, which resulted in 3 basis points of net interest margin expansion due to the higher interest rate earned on cash and provided diversification to our liquidity profile. Investment Securities The investment securities portfolio totaled $1.594 billion at September 30, 2023, a decrease of $180.3 million from $1.774 billion at December 31, 2022. The decrease was primarily the result of principal repayments and maturities totaling $87.7 million, sales of $82.7 million available-for-sale securities, an increase of $5.7 million in pre-tax unrealized losses on available-for-sale investment securities, and $4.2 million in net amortization in the first nine months of 2023. The securities sales and $102 million fair value hedge reduced the impact of interest rate increases on tangible capital over the quarter by approximately 7 basis points. The $2.8 million net loss on the sale of securities was offset by a $2.8 million gain from the sale of our remaining investment in Visa Inc. Class B restricted common stock, which had a zero carrying value. B oth the available-for-sale and held-to-maturity portfolios are eligible for pledging to either the FHLB or the Federal Reserve as collateral for borrowing. The portfolios are comprised of high credit quality investments with average effective durations of 4.07 on available-for-sale securities and 5.95 on held-to-maturity securities. Both portfolios generate cash inflows monthly from interest, principal amortization and payoffs, which supports the Bank's liquidity . Those cash inflows t otaled $123.9 million in the first nine months of 2023 . The following table summarizes our investment in obligations of state and political subdivisions at September 30, 2023 and December 31, 2022. September 30, 2023 December 31, 2022 (dollars in thousands) Amortized Cost Fair Value % of Total State and Political Subdivisions Amortized Cost Fair Value % of Total State and Political Subdivisions Within California: General obligation bonds $ 24,216 $ 18,867 14.7 % $ 25,806 $ 20,768 14.4 % Revenue bonds 3,510 2,775 2.1 3,719 2,987 2.1 Total within California 27,726 21,642 16.8 29,525 23,755 16.5 Outside California: General obligation bonds 109,167 89,863 66.3 121,908 106,375 68.0 Revenue bonds 27,751 22,303 16.9 27,922 23,752 15.5 Total outside California 136,918 112,166 83.2 149,830 130,127 83.5 Total obligations of state and political subdivisions $ 164,644 $ 133,808 100.0 % $ 179,355 $ 153,882 100.0 % Percent of investment portfolio 9.7 % 9.3 % 9.6 % 9.3 % Of the total investment in obligations of state and political subdivisions, the largest concentrations outside of California are in Texas (37.1%), Washington (15.4%) and Wisconsin (9.0%). Our investment in obligations issued by municipal issuers in Texas are either guaranteed by the AAA rated Texas Permanent School Fund ("PSF") or backed by revenue sources from essential services (such as utilities and transportation). Investments in states, municipalities and political subdivisions are subject to an initial pre-purchase credit assessment and ongoing monitoring. Key considerations include: • The soundness of a municipality’s budgetary position and stability of its tax revenues • Debt profile and level of unfunded liabilities, diversity of revenue sources, taxing authority of the issuer • Local demographics/economics including unemployment data, largest taxpayers and local employers, income indices and home values Page-40 • For revenue bonds, the source and strength of revenue for municipal authorities including the obligor’s financial condition and reserve levels, annual debt service and debt coverage ratio, and credit enhancement (such as insurer’s strength and collateral in escrow accounts) • Credit ratings by major credit rating agencies Loans and Credit Quality During the first nine months of 2023, loans decreased by $5.6 million and totaled $2.087 billion at September 30, 2023, compared to $2.093 billion at December 31, 2022. During the same period in 2022, loans decreased $97.3 million to $2.158 billion at September 30, 2022 from $2.256 billion at December 31, 2021. Loan originations were $90.3 million for the nine months ended September 30, 2023, compared to $204.1 million for the first nine months of 2022. Excluding PPP loans, payoffs were $57.7 million for the nine months ended September 30, 2023, compared to $204.2 million for the same period in 2022. PPP loan payoffs during the nine months ended September 30, 2023 and 2022 were $1.8 million and $103.6 million, respectively. In addition, loan amortization from scheduled repayments totaling $60.6 million was partially offset by a $24.2 million net increase in utilization of credit lines for the nine months ended September 30, 2023. While Bank of Marin has continued its usual steadfast conservative underwriting practices and has not changed its credit standards or policies in reaction to current market conditions, our portfolio management and credit teams are exercising heightened awareness of the potential for credit quality deterioration. The Bank continues to focus on extending credit within the markets we know best and serving the needs of our existing clients while ensuring new opportunities present the appropriate levels of risk and return. The ratio of allowance for credit losses on loans to total loans was 1.16% at September 30, 2023, compared to 1.10% at December 31, 2022. Non-accrual loans increased $3.3 million to $5.7 million, or 0.27% of the loan portfolio at September 30, 2023 from $2.4 million, or 0.12% at December 31, 2022. All of the non-accrual loans are collateralized by real estate with no expected credit loss as of September 30, 2023. Accruing loans past due 30 to 89 days totaled $2.2 million at September 30, 2023, compared to $664 thousand at December 31, 2022. Classified loans with risk ratings of substandard or doubtful totaled $39.7 million at September 30, 2023, compared to $28.1 million at December 31, 2022. Increases in 2023 were primarily due to the addition of eleven loans to ten borrowers totaling $13.4 million, mostly within the commercial real estate (both owner-occupied and non-owner occupied) and the commercial and industrial portfolios. Partially offsetting the additions were $939 thousand in upgrades to pass risk rating and $905 thousand in payoffs and paydowns, net of balance increases of $3.4 million. Shortly after quarter-end three unsecured commercial substandard loans to one borrower totaling approximately $4.6 million paid off. Loans designated special mention, which are not considered adversely classified, increased by $52.2 million to $112.4 million at September 30, 2023 from $60.2 million at December 31, 2022. The increase was largely due to $66.0 million in downgrades from pass risk ratings, mostly concentrated in the commercial real estate non-owner-occupied portfolio, which were partially offset by $5.9 million in downgrades from special mention to substandard, $4.9 million in paydowns and payoffs and $3.1 million in upgrades to pass risk ratings. With the heightened market concern about non-owner-occupied commercial real estate, and in particular the office sector, we are providing the following additional information. We continue to maintain diversity among property types and within our geographic footprint. In particular, our office commercial real estate portfolio in the City of San Francisco represents just 3% of our total loan portfolio and 6% of our total non-owner occupied commercial real estate portfolio. As of the last measurement period (generally December 2022), the weighted average loan-to-value and weighted average debt-service coverage ratios for the entire non-owner-occupied office portfolio were 56% and 1.68x, respectively. For the eleven non-owner-occupied office loans in the City of San Francisco, the weighted average loan-to-value and debt-service coverage ratios were 66% (61% unweighted) and 1.07x (1.34x unweighted), respectively. During the quarter we conducted a review of the refinance risk in our non-owner-occupied commercial real estate portfolio. We evaluated 36 loans with commitments of $1.0 million or more totaling $97.4 million that mature or reprice in 2023 or 2024 and determined that the refina nce risk on these loans is expected to be manageable with weighted average debt service coverage ratios ranging from 1.28 to 2.01 times based on current interest rates. Page-41 For more information, refer to Note 5, Loans and Allowance for Credit Losses on Loans, to the consolidated financial statements in this Form 10-Q. Liabilities - Deposits and Borrowings During the first nine months of 2023, total liabilities decreased by $118.4 million to $3.617 billion. Deposits totaled $3.444 billion at September 30, 2023, a decrease of $129.7 million compared to $3.573 billion at December 31, 2022. Borrowings increased $8.0 million to $120.0 million at September 30, 2023 from $112.0 million at December 31, 2022. We have seen stability in deposit trends since the first quarter, including the utilization of our available deposit networks. That stability extended to our mix in deposits, new account activity and overall growth. Non-interest bearing deposits made up 47.7% of total deposits at September 30, 2023, compared to 51.5% at year-end 2022, while money market deposits rose to 31.7% from 27.7%, and time deposits rose to 6.7% from 3.3% in the same period. Additionally, the Bank's competitive and balanced approach to relationship management and focused outreach supported the growth adding over 1,200 new accounts during the third quarter, 38% of which were new relationships, bringing the total to over 3,600 new accounts in 2023 (excluding new reciprocal accounts). As a result, we are closing the gap on the deposit outflows experienced in the first quarter of 2023 without accessing brokered deposit markets. As of September 30, 2023, 61% of deposit balances were held in business accounts with average balances of $130 thousand per account. The remaining 39% were consumer accounts with average balances of $41 thousand per account. The largest depositor represented 2.7% of total deposits and the four largest depositors combined represented 5.3% of total deposits. Our liquidity policies require that compensating cash or investment security balances be held against concentrations over a certain level. At September 30, 2023, the Bank had $120.0 million outstanding in short term borrowings from the Federal Reserve Bank's "BTFP" facility at a rate of 5.42%, an increase of $8.0 million, compared to $112.0 million in overnight borrowings at December 31, 2022 at a rate of 4.65%. The Bank is actively evaluating strategies for reducing borrowings in the current environment and as market conditions change. Total immediate contingent funding sources, including unrestricted cash, unencumbered available-for-sale securities, and remaining borrowing capacity was $2.086 billion, or 61% of total deposits and 211% of estimated uninsured and/or uncollateralized deposits as of September 30, 2023. Capital Adequacy We are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements as set forth in the following tables can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on our consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and the Bank’s prompt corrective action classification are also subject to qualitative judgments by the regulators about components of capital, risk weightings and other factors. Management reviews capital ratios on a regular basis and produces a five-year capital plan semi-annually to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet our anticipated future needs. Stress tests are performed on capital ratios and include scenarios such as additional unrealized losses on the investment portfolio, additional deposit growth and potential share repurchases. For all periods presented, the Bank’s ratios exceed the regulatory definition of “well capitalized” under the regulatory framework for prompt corrective action and Bancorp’s ratios exceed the required minimum ratios to be considered a well-capitalized bank holding company. In addition, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action as of September 30, 2023. There are no conditions or events since that notification that management believes have changed the Bank’s categories and we expect the Bank to remain well capitalized for prompt corrective action purposes. Page-42 Bancorp's TCE ratio was 8.6% at September 30, 2023, compared to 8.2% at December 31, 2022. Bancorp's TCE ratio, net of after tax unrealized losses on held-to-maturity securities, was 6.1%, compared to 6.2% at December 31, 2022. Management believes this non-GAAP measure is important because it reflects the level of capital available to withstand drastic changes in market conditions (ref er to page 46 for a dis cussion and reconciliation of this non-GAAP financial measure). The Bancorp’s and Bank’s capital adequacy ratios as of September 30, 2023 and December 31, 2022 are presented in the following tables. Bancorp Capital Ratios (dollars in thousands) Actual Adequately Capitalized Threshold 1 Threshold to be a Well Capitalized Bank Holding Company September 30, 2023 Amount Ratio Amount Ratio Amount Ratio Total Capital (to risk-weighted assets) $ 442,947 16.56 % $ 280,854 10.50 % $ 267,480 10.00 % Tier 1 Capital (to risk-weighted assets) $ 418,088 15.63 % $ 227,358 8.50 % $ 213,984 8.00 % Tier 1 Leverage Capital (to average assets) $ 418,088 10.24 % $ 163,362 4.00 % $ 204,203 5.00 % Common Equity Tier 1 (to risk-weighted assets) $ 418,088 15.63 % $ 187,236 7.00 % $ 173,862 6.50 % December 31, 2022 Total Capital (to risk-weighted assets) $ 431,667 15.90 % $ 285,079 10.50 % $ 271,504 10.00 % Tier 1 Capital (to risk-weighted assets) $ 407,912 15.02 % $ 230,778 8.50 % $ 217,203 8.00 % Tier 1 Leverage Capital (to average assets) $ 407,912 9.60 % $ 169,948 4.00 % $ 212,435 5.00 % Common Equity Tier 1 (to risk-weighted assets) $ 407,912 15.02 % $ 190,053 7.00 % $ 176,478 6.50 % Bank Capital Ratios (dollars in thousands) Actual Adequately Capitalized Threshold 1 Threshold to be Well Capitalized under Prompt Corrective Action Provisions September 30, 2023 Amount Ratio Amount Ratio Amount Ratio Total Capital (to risk-weighted assets) $ 431,389 16.13 % $ 280,848 10.50 % $ 267,474 10.00 % Tier 1 Capital (to risk-weighted assets) $ 406,530 15.20 % $ 227,353 8.50 % $ 213,980 8.00 % Tier 1 Leverage Capital (to average assets) $ 406,530 9.95 % $ 163,359 4.00 % $ 204,199 5.00 % Common Equity Tier 1 (to risk-weighted assets) $ 406,530 15.20 % $ 187,232 7.00 % $ 173,858 6.50 % December 31, 2022 Total Capital (to risk-weighted assets) $ 427,108 15.73 % $ 285,052 10.50 % $ 271,478 10.00 % Tier 1 Capital (to risk-weighted assets) $ 403,352 14.86 % $ 230,757 8.50 % $ 217,183 8.00 % Tier 1 Leverage Capital (to average assets) $ 403,352 9.49 % $ 169,940 4.00 % $ 212,425 5.00 % Common Equity Tier 1 (to risk-weighted assets) $ 403,352 14.86 % $ 190,035 7.00 % $ 176,461 6.50 % 1 Except for Tier 1 Leverage Capital, the adequately capitalized thresholds reflect the regulatory minimum plus a 2.5% capital conservation buffer as required under the Basel III Capital Standards in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses. Liquidity and Capital Resources The goal of liquidity management is to provide adequate funds to meet loan demand and to fund operating activities and deposit withdrawals. We accomplish this goal by maintaining an appropriate level of liquid assets and formal lines of credit with the FHLB, FRBSF and correspondent banks that enable us to borrow funds as seen in the table below and discussed in Note 6 to the Consolidated Financial Statements in ITEM 1 of this report. Our Asset Liability Management Committee ("ALCO"), which is comprised of Bank directors and the Bank's Chief Executive Officer, is responsible for approving and monitoring our liquidity targets and strategies. The Bank has long-established minimum liquidity and diversification requirements using tools similar to larger banks such as the Liquidity Coverage Ratio and multi-scenario, long-horizon stress testing. Our c on tingency funding plan provides for early detection of potential liquidity issues in the market or the Bank and institutes prompt responses that may prevent or alleviate a potential liquidity crisis. Management monitors liquidity daily and regularly adjusts our position based on current and future liquidity needs. We also have relationships with third-party deposit networks and can adjust the placement of our deposits via reciprocal or one-way sales as part of our cash management strategy. We maintained $2.2 million in off-balance sheet one-way deposit sales with our deposit networks at both September 30, 2023 and December 31, 2022. Net available contingent funding sources, including unrestricted cash, unencumbered available-for-sale securities and total available borrowing capacity was $2.086 billion, or 211% of estimated uninsured and/or uncollateralized deposits as of September 30, 2023. The Federal Reserve's BTFP facility offers borrowing capacity based on par values of securities pledged making it less sensitive to changes in market rates. The following table details the components of our contingent liquidity sources as of September 30, 2023. Page-43 (in thousands) Total Available Amount Used Net Availability Internal Sources Unrestricted cash 1 $ 102,581 N/A $ 102,581 Unencumbered securities at market value 613,684 N/A 613,684 External Sources FHLB line of credit 1,023,197 $ — 1,023,197 FRB line of credit and BTFP facility 331,907 (120,000) 211,907 Lines of credit at correspondent banks 135,000 — 135,000 Total Liquidity $ 2,206,369 $ (120,000) $ 2,086,369 1 Excludes cash items in transit. Note: Brokered deposits available through third party networks are not included above. We obtain funds from the repayment and maturity of loans, deposit inflows, investment securities sales, maturities and paydowns, federal funds purchases, FHLB advances, other borrowings, and cash flow from operations. Our primary uses of funds are the origination of loans, the purchase of investment securities, withdrawals of deposits, maturity of certificates of deposit, repayment of borrowings, dividends to common stockholders, and operating expenses. Customer deposits are a significant component of our daily liquidity position. The attraction and retention of new deposits depend upon the variety and effectiveness of our customer account products, service and convenience, rates paid to customers, and our financial strength. The cash cycles and unique business activities of some of our large commercial depositors may cause short-term fluctuations in their deposit balances held with us. Our cash and cash equivalents increased $77.7 million in the first nine months of 2023. The most significant sources of liquidity during the first nine months of 2023 were proceeds from principal paydowns and maturities of investment securities of $87.8 million, proceeds from the sales of $82.7 million of available-for-sale securities and the remaining Visa Inc. Class B restricted common stock in the third quarter, and $34.9 million in net cash provided by operating activities. Refer to the Consolidated Statement of Cash Flows in this Form 10-Q for additional information on our sources and uses of liquidity. Management anticipates that our current strong liquidity position, as detailed in this report, and contingent funding sources outlined in the table above are adequate to support our operational needs. Significant uses of liquidity during 2023 were $129.7 million in net withdrawals of deposits and $12.1 million in cash dividends paid on common stock to our shareholders. Unfunded loan commitments, as discussed in Note 8 to the Consolidated Financial Statements in this Form 10-Q, totaled $510.2 million at September 30, 2023. We expect to fund these commitments to the extent utilized primarily through the repayment of existing loans, principal paydowns of investment securities, and liquid assets. Over the next twelve months, $210.2 million of time deposits will mature. We expect to replace these funds with new deposits or excess liquidity. We believe our emphasis on local deposits, combined with our immediately available funding sources, provides a very stable base for our liquidity needs. We had borrowings under our credit facilities of $120.0 million at September 30, 2023, and $112.0 million at December 31, 2022, as discussed in Note 6 to the Consolidated Financial Statements in ITEM 1 of this report. Because Bancorp is a holding company and does not conduct regular banking operations, its primary sources of liquidity are dividends from the Bank. Under the California Financial Code, payment of a dividend from the Bank to Bancorp without advance regulatory approval is restricted to the lesser of the Bank’s retained earnings or the amount of the Bank’s net profits from the previous three fiscal years less the amount of dividends paid during that period. The primary uses of funds for Bancorp are shareholder dividends and ordinary operating expenses. Bancorp held $11.5 million in cash at September 30, 2023 and management anticipates that there will be sufficient earnings at the Bank to provide dividends to Bancorp to meet its funding requirements for the foreseeable future. Page-44 Statement Regarding use of Non-GAAP Financial Measures Results for 2022 we re impacted by costs associated with our 2021 acquisition of American River Bankshares, which we considered immaterial to discuss in this report. For additional information regarding the impact of non-GAAP adjustments to our third quarter and year-to-date 2022 performance measures, refer to Form 10-Q filed on November 8, 2022. Financial results are presented in accordance with GAAP and with reference to certain non-GAAP financial measures. Management believes that, given recent industry turmoil, the presentation of Bancorp's non-GAAP TCE ratio reflecting the after-tax impact of unrealized losses on held-to-maturity securities provides useful supplemental information to investors because it reflects the level of capital available to withstand drastic changes in market conditions. Because there are limits to the usefulness of this measure to investors, Bancorp encourages readers to consider its annual and quarterly consolidated financial statements and notes related thereto in their entirety, as filed with the Securities and Exchange Commission, and not to rely on any single financial measure. A reconciliation of the non-GAAP TCE ratio is presented below. Reconciliation of GAAP and Non-GAAP Financial Measures (in thousands, unaudited) September 30, 2023 December 31, 2022 Tangible Common Equity - Bancorp Total stockholders' equity $ 418,618 412,092 Goodwill and core deposit intangible (76,850) (77,870) Total TCE a 341,768 334,222 Unrealized losses on HTM securities, net of tax 1 (107,011) (89,432) TCE, net of unrealized losses on HTM securities (non-GAAP) b $ 234,757 244,790 Total assets $ 4,035,549 4,147,464 Goodwill and core deposit intangible (76,850) (77,870) Total tangible assets c 3,958,699 4,069,594 Unrealized losses on HTM securities, net of tax 1 (107,011) (89,432) Total tangible assets, net of unrealized losses on HTM securities (non-GAAP) d $ 3,851,688 3,980,162 Bancorp TCE ratio a / c 8.6 % 8.2 % Bancorp TCE ratio, net of unrealized losses on HTM securities (non-GAAP) b / d 6.1 % 6.2 % 1 Net unrealized losses on held-to-maturity securities as of September 30, 2023 and December 31, 2022 of $151.9 million and $127.0, respectively, as shown in Note 4, net of an estimated $44.9 million and $37.5, respectively, in deferred tax benefits based on a blended state and federal statutory tax rate of 29.56%.