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 2023 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 The discussion of financial results in this Form 10-Q 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, wars or other conflicts, impacts from inflation, supply chain 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 differ materially from those expressed in our prior forward-looking statements are detailed in ITEM 1A, Risk Factors section of our 2023 Form 10-K as filed with the SEC, and ITEM 1A Risk Factors herein. Forward-looking statements speak only as of the date they are made. Bancorp undertakes no obligation to release publicly the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances 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, Fair Value Measurements, and Goodwill. Page-28 Goodwill Goodwill arises from the acquisition method of accounting for business combinations and represents the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Our annual impairment assessment is performed in the fourth quarter. However, with triggering events occurring in the first quarter of 2024, including a persistent depressed stock price as a result of changes in macroeconomic conditions, market volatility resulting from rising interest rates and the failure of several regional banks in 2023, coupled with a revised five-year strategic forecast for the Bank, we performed a quantitative assessment in the first quarter of 2024, similar to the analysis performed in fourth quarter 2023. The results of this assessment indicated the value of goodwill was not impaired as of March 31, 2024. For a detailed discussion of goodwill accounting and impairment assessment methodology, refer to Note 1, Summary of Significant Accounting Policies, and the Critical Accounting Estimates section of our 2023 Form 10-K filed with the SEC on March 14, 2024. Executive Summary We generated earnings of $2.9 million for the first quarter of 2024, compared to $610 thousand for the fourth quarter of 2023 and $9.4 million for the first quarter of 2023. Diluted earnings per share were $0.18 for the first quarter of 2024, compared to $0.04 for the preceding quarter and $0.59 for the same quarter a year ago. Net interest margin compression due to the rapid rise in interest rates this cycle is clearly evident in the comparison of 2024 and 2023 first quarter earnings. In addition, prior quarter results reflected a $5.9 million pretax loss from balance sheet restructuring. 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 first quarter ta x-equivalent net interest margin stabilized at 2.50% from 2.53% the previous quarter. Climbing deposit rates continued to put pressure on the margin this quarter. While the average cost of deposits increas ed 23 basis points to 1.38% in the first quarter c ompared to a 21 basis point increase in the prior quarter, monthly trends since January show a clear slow down in the pace of increase. Although we reduced borrowings to zero and gained ground in higher yields on loans, the overall average earning asset balances decreased, limiting the positive impact on the margin. • A $350 thousand provision for credit losses on loans in the first quarter, compared to a provision of $1.3 million in the previous quarter, brought the allowance for credit losses to 1.24% of total loans, compared to 1.21% as of December 31, 2023. • Non-accrual loans declined to 0.31% of total loans at quarter end, from 0.39% at December 31, 2023, and net charge-offs were minimal. Classified loans increased to 2.67% of total loans from 1.56% last quarter, which we believe evidences our diligent monitoring of customers impacted by current economic conditions. • Loan balances of $2.055 billion as of March 31, 2024, were relatively stable from $2.074 billion as of December 31, 2023, reflecting originations of $12.4 million and payoffs of $21.8 million. During the quarter, interest rates on loan originations averaged approximately 266 basis points above those that paid off. Loan amortization from scheduled repayments, partially offset by a net increase in utilization of credit lines was $9.4 million during the quarter. • Total deposits of $3.284 billion as of March 31, 2024, were essentially flat, compared to $3.290 billion as of December 31, 2023 . Non-interest bearing depo sits increased $2.5 million representing 44.0% of total deposits as of March 31, 2024, compared to 43.8% as of December 31, 2023. • Total borrowings was reduced to zero representing a $26.0 million decrease from December 31, 2023 and a $97.5 million quarter-over-quarter decrease in average balances, resulting in a $1.3 million decline in interest expense. Net available funding sources of $1.905 billion provided 208% coverage of an estimated $915.4 million in uninsured deposits, representing only 28% of total deposits at March 31, 2024. • Return on average assets ("ROA") was 0.31% for the first quarter of 2024, compared to 0.06% for the fourth quarter of 2023, and return on average equity ("ROE") was 2.70% , compared to 0.57% for the prior quarter. The efficiency ratio for the first quarter of 2024 was 83.18% , compared to 91.94% for the prior quarter. Page-29 • Bancorp's and the Bank's total risk-based capital ratios increased during the quarter to 17.05% and 16.71%, respectively, as of March 31, 2024, well above regulatory requirements. Bancorp's tangible common equity to tangible assets ("TCE ratio") increased to 9.76% as of March 31, 2024, and the Bank's TCE ratio was 9.53%, consistent with prior quarter. While we do not intend to sell our held-to-maturity securities, the TCE ratio, net of after-tax unrealized losses on held-to-maturity securities as if the losses were realized was 7.67% a s of March 31, 2024, compared to 7.80% as of December 31, 2023 (refer to the discussion and reconciliation of this non-GAAP financial measure in the section below entitled Statement Regarding Use of Non-GAAP Financial Measures ). • The Bank optimized its facilities by consolidating two commercial banking offices, closing the San Mateo office in April 2024. We expect the combination of both personnel and facilities pre-tax savings to total approximately $650 thousand in 2024 and $800 thousand in 2025. These savings will be deployed to self-fund talent acquisition aimed at loan growth initiatives. • The Board of Directors declared a cash dividend of $0.25 per share on April 25, 2024, which represents the 76 th consecutive quarterly dividend paid by Bancorp. The dividend is payable on May 16, 2024, to shareholders of record at the close of business on May 9, 2024. Page-30 RESULTS OF OPERATIONS Highlights of the financial results are presented in the following tables: Three months ended (dollars in thousands, except per share data) March 31, 2024 December 31, 2023 March 31, 2023 Selected operating data: Net interest income $ 22,694 $ 24,264 $ 29,899 Provision for credit losses on loans 350 1,300 350 Reversal of credit losses on unfunded loan commitments — — (174) Non-interest income 2,754 (3,283) 2,935 Non-interest expense 21,169 19,289 19,780 Net income 2,922 610 9,440 Net income per common share: Basic $ 0.18 $ 0.04 $ 0.59 Diluted $ 0.18 $ 0.04 $ 0.59 Performance and other financial ratios: Return on average assets 0.31 % 0.06 % 0.92 % Return on average equity 2.70 % 0.57 % 9.12 % Tax-equivalent net interest margin 2.50 % 2.53 % 3.04 % Cost of deposits 1.38 % 1.15 % 0.20 % Cost of funds 1.38 % 1.27 % 0.49 % Efficiency ratio 83.18 % 91.94 % 60.24 % Net charge-offs (recoveries) $ 21 $ 387 $ 3 Cash dividend payout ratio on common stock 1 138.89 % 625.00 % 42.37 % (dollars in thousands, except per share data) March 31, 2024 December 31, 2023 Selected financial condition data: Total assets $ 3,767,176 $ 3,803,903 Investment securities 1,451,433 1,477,226 Loans, net 2,029,462 2,048,548 Deposits 3,284,102 3,290,075 Short-term borrowings and other obligations 260 26,298 Stockholders' equity 436,680 439,062 Book value per share 26.81 27.17 Asset quality ratios: Allowance for credit losses on loans to total loans 1.24 % 1.21 % Allowance for credit losses on loans to non-performing loans 4.05x 3.15x Non-accrual loans to total loans 0.31 % 0.39 % Capital ratios: Equity to total assets ratio 11.59 % 11.54 % Tangible common equity to tangible assets 9.76 % 9.73 % Total capital (to risk-weighted assets) 17.05 % 16.89 % Tier 1 capital (to risk-weighted assets) 16.05 % 15.91 % Tier 1 capital (to average assets) 10.92 % 10.46 % Common equity Tier 1 capital (to risk weighted assets) 16.05 % 15.91 % 1 Calculated as dividends on common shares divided by basic net income per common share. Page-31 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 table compares 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 Three months ended March 31, 2024 December 31, 2023 March 31, 2023 Interest Interest Interest Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ (dollars in thousands) Balance Expense Rate Balance Expense Rate Balance Expense Rate Assets Interest-earning deposits with banks 1 $ 23,439 $ 321 5.42 % $ 84,864 $ 1,170 5.40 % $ 4,863 $ 56 4.58 % Investment securities 2, 3 1,529,985 8,880 2.32 % 1,625,084 9,368 2.31 % 1,851,743 10,194 2.20 % Loans 1, 3, 4, 5 2,067,431 25,130 4.81 % 2,072,654 25,081 4.73 % 2,121,718 24,415 4.60 % Total interest-earning assets 1 3,620,855 34,331 3.75 % 3,782,602 35,619 3.68 % 3,978,324 34,665 3.49 % Cash and non-interest-bearing due from banks 35,302 35,572 39,826 Bank premises and equipment, net 7,708 8,027 8,396 Interest receivable and other assets, net 147,405 128,587 137,114 Total assets $ 3,811,270 $ 3,954,788 $ 4,163,660 Liabilities and Stockholders' Equity Interest-bearing transaction accounts $ 215,001 $ 261 0.49 % $ 228,168 $ 278 0.48 % $ 272,353 $ 254 0.38 % Savings accounts 230,133 371 0.65 % 245,712 322 0.52 % 329,299 170 0.21 % Money market accounts 1,150,637 8,449 2.95 % 1,105,286 7,188 2.58 % 952,479 1,085 0.46 % Time accounts including CDARS 264,594 2,280 3.47 % 244,661 1,991 3.23 % 126,030 223 0.72 % Borrowings and other obligations 1 7,323 91 4.93 % 104,855 1,380 5.15 % 222,571 2,716 4.88 % Total interest-bearing liabilities 1,867,688 11,452 2.47 % 1,928,682 11,159 2.30 % 1,902,732 4,448 0.95 % Demand accounts 1,458,686 1,556,437 1,792,998 Interest payable and other liabilities 48,923 48,322 48,233 Stockholders' equity 435,973 421,347 419,697 Total liabilities & stockholders' equity $ 3,811,270 $ 3,954,788 $ 4,163,660 Tax-equivalent net interest income/margin 1 $ 22,879 2.50 % $ 24,460 2.53 % $ 30,217 3.04 % Reported net interest income/margin 1 $ 22,694 2.48 % $ 24,264 2.51 % $ 29,899 3.01 % Tax-equivalent net interest rate spread 1.28 % 1.38 % 2.54 % 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. 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. 5 Net loan origination costs in interest income totaled $375 thousand, $324 thousand, and $190 thousand for the three months ended March 31, 2024, December 31, 2023 and March 31, 2023, respectively. 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 Page-32 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 day less in the three months ended March 31, 2024, compared to the three months ended December 31, 2023 and one day more in the three months ended March 31, 2024, compared to the same period in 2023. Three months ended March 31, 2024 compared to three months ended December 31, 2023 Three months ended March 31, 2024 compared to three months ended March 31, 2023 (in thousands) Volume Yield/Rate Mix Total Volume Yield/Rate Mix Total Interest-earning deposits with banks $ (847) $ 5 $ (7) $ (849) $ 214 $ 10 $ 41 $ 265 Investment securities 1 (548) 64 (4) (488) (1,771) 553 (96) (1,314) Loans 1 (63) 390 (278) 49 (625) 1,092 248 715 Total interest-earning assets (1,458) 459 (289) (1,288) (2,182) 1,655 193 (334) Interest-bearing transaction accounts (16) 3 (4) (17) (53) 73 (13) 7 Savings accounts (20) 78 (9) 49 (51) 355 (103) 201 Money market accounts 295 1,017 (51) 1,261 226 5,832 1,306 7,364 Time accounts, including CDARS 162 141 (14) 289 245 851 961 2,057 Borrowings and other obligations (1,284) (63) 58 (1,289) (2,627) 20 (18) (2,625) Total interest-bearing liabilities (863) 1,176 (20) 293 (2,260) 7,131 2,133 7,004 Changes in tax-equivalent net interest income $ (595) $ (717) $ (269) $ (1,581) $ 78 $ (5,476) $ (1,940) $ (7,338) 1 Yields and interest income on tax-exempt securities and loans are presented on a taxable-equivalent basis using the federal statutory rate of 21%. First Quarter of 2024 Compared to the Fourth Quarter of 2023 Net interest income totaled $22.7 million for the first quarter of 2024, compared to $24.3 million for the prior quarter. The $1.6 million decrease from the prior quarter was primarily related to an increase of $1.6 million in interest expense on deposits and a decrease of $1.3 million in interest on cash and investments. These were partially offset by a $1.3 million decrease in borrowing costs. Quarter-over-quarter, average interest-bearing deposit balances increased by $36.5 million to $1.860 billion, raising the cost of total deposits by 23 basis points to 1.38%. Average borrowings and other obligations decreased by $97.5 million to $7.3 million, and average investment security balances were down a similar amount. The tax-equivalent net interest margin was 2.50% for the first quarter of 2024, compared to 2.53% for the prior quarter. The higher cost of deposits reduced the margin by 23 basis points, while higher loan yields added 15 basis points. The effect of low er wholesale borrowing balances, partially offset by lower interest-earning deposits with banks, added 5 basis points. First Quarter of 2024 Compared to the First Quarter of 2023 Net interest income totaled $22.7 million for the three months ended March 31, 2024, compared to $29.9 million for the same period in the prior year. The $7.2 million decrease from the prior year was primarily due to a higher cost of deposits totaling $9.6 million, partially offset by lower borrowing costs of $2.6 million. The tax-equivalent net interest margin was 2.50% for the three months ended March 31, 2024, compared to 3.04% for the same period in the prior year. The decrease was primarily attributed to higher deposit costs, reducing the margin by 107 basis points, partially offset by higher yields on loans, adding 29 basis points, and decreases in borrowings contributing 26 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% and 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 evolving inflation risks, international political unrest, and oil and other supply chain disruptions. As a result of seven Page-33 rate adjustments during 2022, the federal funds target rate range increased to between 4.25% and 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 resulted in rapid increases in the cost of funds through rising deposit costs and increased average borrowings, putting pressure on the net interest margin. Federal Reserve policymakers continue to monitor inflation and economic developments and are considering rate changes during the balance of 2024. 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. The following table shows the activity for the periods presented. Three months ended (dollars in thousands) March 31, 2024 December 31, 2023 March 31, 2023 Provision for credit losses on loans $ 350 $ 1,300 $ 350 We recorded a $350 thousand provision for credit losses on loans in the first quarter. The provision was due primaril y to adjustments to certain qualitative risk factors to account for continued negative trends in adversely graded loans for our non-owner occupied commercial real estate and commercial and industrial portfolios, adjustments to the discounted cash flow modeling assumptions related to estimated default timing, and a slight increase in Moody's Analytics' Baseline Forecast of California's unemployment rates, partially offset by the impact of a decrease in pooled loans and changes in loan mix. We recorded a $1.3 million provision for credit losses on loans in the fourth quarter. The provision was due primari ly to an increase in specific allowances re lated to a few loans that exhibited certain credit risk characteristics over time that were not indicative of pooled loans. Of the specific allowances, a portion was related to two loans with existing substandard risk ratings and collateral valuation issues caused by persistently higher than average vacancy rates. In addition, a portion was related to two loans that were placed on non-accrual status during the fourth quarter, where the estimated credit losses were derived using either discounted expected cash flows or adjusted collateral values and loss rates. A large p ortion of these specific allowances was previously recognized in the quantitative and qualitative estimated credit losses for pooled loans and shifted to the allowance for individually evaluated loans in the fourth quarter. Other elements of the provision included a $406 thousand loss on the note sale of a loan to an unrelated third party that was charged to the allowance concurrent with the sale, a decrease in loans, and a stable California unemployment rate forecast for the next four quarters. Net adjustments to qualitative factors in the fourth quarter did not materially affect the provision. The provision totaling $350 thousand for the three months ended March 31, 2023 was due primarily to increases in qualitative risk factors to account for continued uncertainty about inflation and recession risks. Management believed that these risk factors were not adequately captured in the modeled quantitative portion of the allowance and took the more prudent approach to account for loan and collateral concentration risks, mainly in our construction and commercial real estate portfolios, and the need for heightened portfolio management in light of economic conditions at that time. In addition, a $19.8 million increase in loans contributed modestly to the provision. These increases were partially offset by the quantitative impact of an improvement in Moody's Analytics' baseline California unemployment rate forecasts at the time. For more information, refer to Note 5, Loans and Allowance for Credit Losses on Loans, to the consolidated financial statements in this Form 10-Q. Page-34 Non-interest Income The following table details the components of non-interest income. Three months ended Quarter over quarter Year over year (dollars in thousands) March 31, 2024 December 31, 2023 March 31, 2023 Amount Change Percent Change Amount Change Percent Change Wealth management and trust services $ 553 $ 560 511 $ (7) (1.3) % $ 42 8.2 % Service charges on deposit accounts 529 522 533 7 1.3 % (4) (0.8) % Earnings on bank-owned life insurance, net 435 $ 364 $ 705 71 19.5 % (270) (38.3) % Debit card interchange fees, net 408 373 447 35 9.4 % (39) (8.7) % Dividends on Federal Home Loan Bank stock 377 349 302 28 8.0 % 75 24.8 % Merchant interchange fees, net 167 119 133 48 40.3 % 34 25.6 % Losses on sale of investment securities, net — (5,907) — 5,907 — % — — % Other income 285 337 304 (52) (15.4) % (19) (6.3) % Total non-interest income $ 2,754 $ (3,283) $ 2,935 $ 6,037 (183.9) % $ (181) (6.2) % First Quarter of 2024 Compared to the Fourth Quarter of 2023 Non-interest income totaled $2.8 million for the first quarter of 2024, compared to a loss of $3.3 million for the prior quarter. The $6.0 million increase from the prior quarter was primarily attributed to a $5.9 million net loss on sale of available-for-sale investment securities in the prior quarter. First Quarter of 2024 Compared to the First Quarter of 2023 Non-interest income totaled $2.8 million for the first quarter of 2024, materially unchanged from the same period of the prior year. The $181 thousand decrease from the prior year period was mostly attributable to a decrease in bank-owned life insurance benefit payments due to the recognition of a death benefit in 2023, partially offset by higher dividend rates paid on Federal Home Loan Bank stock and higher wealth management and trust services income in 2024. Non-interest Expense The following table details the components of non-interest expense. Three months ended Quarter over quarter Year over year (dollars in thousands) March 31, 2024 December 31, 2023 March 31, 2023 Amount Change Percent Change Amount Change Percent Change Salaries and related benefits $ 12,084 $ 10,361 $ 10,930 $ 1,723 16.6 % $ 1,154 10.6 % Occupancy and equipment 1,969 1,939 2,414 30 1.5 % (445) (18.4) % Professional services 1,078 921 1,123 157 17.0 % (45) (4.0) % Data processing 1,070 1,081 1,045 (11) (1.0) % 25 2.4 % Deposit network fees 845 940 96 (95) (10.1) % 749 780.2 % Federal Deposit Insurance Corporation insurance 435 454 289 (19) (4.2) % 146 50.5 % Information technology 402 431 370 (29) (6.7) % 32 8.6 % Depreciation and amortization 388 393 882 (5) (1.3) % (494) (56.0) % Directors' expense 317 319 321 (2) (0.6) % (4) (1.2) % Amortization of core deposit intangible 251 330 345 (79) (23.9) % (94) (27.2) % Other real estate owned — — 4 — N/A (4) (100.0) % Other non-interest expense Advertising 296 347 278 (51) (14.7) % 18 6.5 % Other expense 2,034 1,773 1,683 261 14.7 % 351 20.9 % Total other non-interest expense 2,330 2,120 1,961 210 9.9 % 369 18.8 % Total non-interest expense $ 21,169 $ 19,289 $ 19,780 $ 1,880 9.7 % $ 1,389 7.0 % Page-35 First Quarter of 2024 Compared to the Fourth Quarter of 2023 Non-interest expense totaled $21.2 million for the first quarter of 2024, compared to $19.3 million for the prior quarter, an increase of $1.9 million. Salaries and related benefits increased $1.7 million largely due to various factors, both in prior and current quarter. Last quarter, profit sharing, supplemental executive retirement plan and stock-based compensation accrual adjustments reduced expenses. In the first quarter of 2024, there were lower deferred loan origination costs, an increase to the 401(k) contribution matching associated with the usual reset and bonus payments at the beginning of the year, and increased salary costs due to new talent acquisition, partially offset by incentive adjustments. In addition, professional services expenses from certain legal, accounting, and consulting costs increased by $157 thousand. First Quarter of 2024 Compared to the First Quarter of 2023 Non-interest expense totaled $21.2 million for the first quarter of 2024 , compared to $19.8 million for the first quarter of 2023, an increase of $1.4 million. Significant fluctuations were as follows: • Salaries and related benefits increased by $1.2 million largely due to the increase in full time equivalent employees to 330 from 311 at the same time in prior year. • Deposit network fees increased by $749 thousand as customers sought additional FDIC insurance protection through reciprocal deposit networks. • These increases were partially offset by decreases in occupancy and equipment and depreciation and amortization expenses of $445 thousand and $494 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. 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"), low-income housing tax credits, and stock-based compensation from the exercise of stock options, disqualifying dispositions of incentive stock options and vesting of restricted stock awards). The provision for income taxes for the first quarter of 2024 totaled $1.0 million at an effective tax rate of 25.6%, compared to provision reversal of $218 thousand at a negative effective tax rate of (55.6)% in the prior quarter and $3.4 million at an effective tax rate of 26.7% in the same quarter last year. The increase in the p rovision for income taxes in the first quarter of 2024 reflected higher pre-tax income as compared to the prior quarter. The increase in the effective tax rate in the first quarter of 2024 was primarily due to the tax provision reversal recorded in the prior quarter that primarily resulted from a $5.9 million pre-tax loss on the sale of available-for-sale investment securities. The 110 basis point decrease in the effective tax rate in the first quarter of 2024, as compared to the same quarter a year ago, was primarily due to the larger proportional effect of permanent tax differences on lower pretax income. This decrease was partially offset by a reduction in the tax-exempt interest exclusion (due to a larger IRC Section 291(e) interest expense disallowance), 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 time of the issuance of this report. As of March 31, 2024, neither the Bank nor Bancorp had accruals for interest or penalties related to unrecognized tax benefits. Page-36 FINANCIAL CONDITION SUMMARY Cash, Cash Equivalents and Restricted Cash Total cash, cash equivalents and restricted cash were $36.3 million at March 31, 2024, an increase of $5.9 million compared to $30.5 million at December 31, 2023. Investment Securities The investment securities portfolio totaled $1.451 billion at March 31, 2024, a decrease of $25.8 million from $1.477 billion at December 31, 2023. The decrease was primarily the result of principal repayments totaling $20.3 million, a $4.6 million increase in pre-tax unrealized losses on available-for-sale investment securities, and $900 thousand in net amortization. Both the available-for-sale and held-to-maturity portfolios are eligible for pledging to FHLB or the Federal Reserve as collateral for borrowings. The portfolios are comprised of high credit quality investments with average effective durations of 4.41 on available-for-sale securities and 5.66 on held-to-maturity securities. Both portfolios generate cash flows monthly from interest, principal amortization and payoffs, which supports the Bank's liquidity. Those cash flows totaled $31.3 million in the first quarter of 2024. See Note 4, Investment Securities, for additional information. The following table summarizes our investment in obligations of state and political subdivisions at March 31, 2024 and December 31, 2023. March 31, 2024 December 31, 2023 (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 $ 24,165 $ 19,964 14.8 % $ 24,191 $ 20,009 14.7 % Revenue bonds 3,504 2,926 2.1 3,507 2,917 2.1 Total within California 27,669 22,890 16.9 27,698 22,926 16.8 Outside California: General obligation bonds 108,523 96,700 66.2 108,846 98,139 66.3 Revenue bonds 27,635 24,652 16.9 27,692 25,014 16.9 Total outside California 136,158 121,352 83.1 136,538 123,153 83.2 Total obligations of state and political subdivisions $ 163,827 $ 144,242 100.0 % $ 164,236 $ 146,079 100.0 % Percent of investment portfolio 10.8 % 10.8 % 10.7 % 10.7 % Of the total investment in obligations of state and political subdivisions, the largest concentrations outside of California are in Texas (37.1%), Washington (15.3%) 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 • 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 Page-37 Loans and Credit Quality During the first three months of 2024, loans decreased by $18.8 million and totaled $2.055 billion as of March 31, 2024, compared to $2.074 billion as of December 31, 2023. Loan originations were $12.4 million for the three months ended March 31, 2024, compared to $53.8 million for the fourth quarter of 2023. While originations were muted, the pipeline has grown, and key opportunistic hires and new compensation plans have already accelerated calling activity, pipeline growth and diversification. Loan payoffs were $21.8 million for the three months ended March 31, 2024, compared to $50.3 million for the fourth quarter of 2023. The largest portion of payoffs were the result of construction project completions, followed by refinances of loans not meeting our strategic and risk profile standards, and cash payoffs. There was no dominant overlying trend noted in the quarter. Non-accrual loans totaled $6.3 million, or 0.31% of the loan portfolio, at March 31, 2024, compared to $8.0 million, or 0.39% at December 31, 2023. The $1.7 million decrease resulted from various payoffs and paydowns. Three loan relationships totaling $370 thousand moved to non-accrual status in the first quarter, partially offsetting the decrease. Of the total non-accrual loans as of March 31, 2024 approximately 50% were paying as agreed, with the remaining 50% closely monitored for payments, and 63% were real estate secured. While Bank of Marin has continued its 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 weakening. Classified loans totaled $54.8 million as of March 31, 2024, compared to $32.3 million as of December 31, 2023. The increase of $22.5 million was due primarily to a migration of $24.4 million in loans from special mention to substandard risk ratings. The majority of these downgrades were due to protracted issues, therefore, these borrowers' financial conditions merit extra attention and proactive management. The three significant relationships downgraded are of different types and geographies. Two of these are commercial real estate loans that are fully secured and supported with owner-level personal guarantees that have ample liquidity, and we believe there is minimal loss potential in these credits. Only 1% of the additions were on non-accrual status as of March 31, 2024, with 11% of all classified loans on non-accrual status. Excluding the accruing loan over 90 days past due mentioned below, 98% of all classified loans were current on their payments as of March 31, 2024. Additions to classified loans were offset by $2.9 million in payoffs and paydowns. Accruing loans past due 30 to 89 days totaled $1.9 million as of March 31, 2024, compared to $1.0 million as of December 31, 2023. We had one accruing non-owner-occupied commercial real estate loan over 90 days past due as of March 31, 2024 totaling $8.1 million that has been in extended renewal negotiations, but it is well-secured and expected to be restored to a current payment status in the near future. Loans designated special mention, which are not considered adversely classified, decreased by $34.3 million to $100.9 million as of March 31, 2024, from $135.2 million as of December 31, 2023. The decrease was largely due to $24.4 million in downgrades from special mention to substandard mentioned above, $10.5 million in upgrades to pass risk ratings, and $1.8 million in net paydowns and payoffs, partially offset by $2.0 million in downgrades from pass risk ratings and $443 thousand in balance increases. Of the loans designated special mention, 98% were real estate secured. All but one of the loans, outside of not-for-profits, are guaranteed by owners or sponsors. Net charge-offs for the first quarter of 2024 totaled $21 thousand, compared to net charge-offs of $387 thousand for the fourth quarter of 2023. The ratio of allowance for credit losses to total loans was 1.24% at March 31, 2024, compared to 1.21% at December 31, 2023. For more information, refer to Note 5, Loans and Allowance for Credit Losses on Loans, to the consolidated financial statements in this Form 10-Q. Liabilities - Deposits and Borrowings During the first three months of 2024, total liabilities decreased by $34.3 million to $3.330 billion. Deposits totaled $3.284 billion at March 31, 2024, a decrease of $6.0 million, compared to $3.290 billion at December 31, 2023. The Bank had zero outstanding borrowings at March 31, 2024, compared to $26.0 million at December 31, 2023. Page-38 Non-interest bearing deposits made up 44.0% of total deposits at March 31, 2024 , compared to 43.8% at December 31, 2023 . Money market balances remained constant at 34.6% and time deposits increased from 7.6% to 8.1% of total deposits with a weighted average rate of 3.17% and average term of six months. Additionally, the Bank's competitive and balanced approach to relationship management and focused outreach supported the addition of nearly 1,200 new accounts during the first quarter , 34% of w hich were new relationships (excluding new reciprocal accounts). During the first quarter of 2024, outstanding borrowings decreased by $26.0 million to zero at March 31, 2024, resulting from investment and loan cash flows. Although available as a liquidity source, we have not utilized brokered deposits. Net available funding sources, including unrestricted cash, unencumbered available-for-sale securities, and remaining borrowing capacity was $1.905 billion, or 58% of total deposits and 208% of estimated uninsured and/or uncollateralized deposits as of March 31, 2024. 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 March 31, 2024. There are no conditions or events since that notification that management believes have changed the Bank’s categories and we expect the Bank to remain well capitalized for prompt corrective action purposes. Bancorp's TCE ratio was 9.76% at March 31, 2024, compared to 9.73% at December 31, 2023. Bancorp's TCE ratio, net of after tax unrealized losses on held-to-maturity securities, was 7.67%, compared to 7.80% at December 31, 2023. Management believes this non-GAAP measure is important because it reflects the level of capital available to withstand drastic changes in market conditions (refer to the discussion and reconciliation of this non-GAAP financial measure in the section below entitled Statement Regarding Use of Non-GAAP Financial Measures ). The Bancorp’s and Bank’s capital adequacy ratios as of March 31, 2024 and December 31, 2023 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 March 31, 2024 Amount Ratio Amount Ratio Amount Ratio Total Capital (to risk-weighted assets) $ 441,181 17.05 % $ 271,680 10.50 % $ 258,743 10.00 % Tier 1 Capital (to risk-weighted assets) $ 415,157 16.05 % $ 219,931 8.50 % $ 206,994 8.00 % Tier 1 Leverage Capital (to average assets) $ 415,157 10.92 % $ 152,035 4.00 % $ 190,043 5.00 % Common Equity Tier 1 (to risk-weighted assets) $ 415,157 16.05 % $ 181,120 7.00 % $ 168,183 6.50 % December 31, 2023 Total Capital (to risk-weighted assets) $ 440,842 16.89 % $ 274,002 10.50 % $ 260,954 10.00 % Tier 1 Capital (to risk-weighted assets) $ 415,224 15.91 % $ 221,811 8.50 % $ 208,763 8.00 % Tier 1 Leverage Capital (to average assets) $ 415,224 10.46 % $ 158,771 4.00 % $ 198,464 5.00 % Common Equity Tier 1 (to risk-weighted assets) $ 415,224 15.91 % $ 182,668 7.00 % $ 169,620 6.50 % Page-39 Bank Capital Ratios (dollars in thousands) Actual Adequately Capitalized Threshold 1 Threshold to be Well Capitalized under Prompt Corrective Action Provisions March 31, 2024 Amount Ratio Amount Ratio Amount Ratio Total Capital (to risk-weighted assets) $ 432,306 16.71 % $ 271,640 10.50 % $ 258,705 10.00 % Tier 1 Capital (to risk-weighted assets) $ 406,282 15.70 % $ 219,899 8.50 % $ 206,964 8.00 % Tier 1 Leverage Capital (to average assets) $ 406,282 10.69 % $ 152,026 4.00 % $ 190,033 5.00 % Common Equity Tier 1 (to risk-weighted assets) $ 406,282 15.70 % $ 181,094 7.00 % $ 168,158 6.50 % December 31, 2023 Total Capital (to risk-weighted assets) $ 433,598 16.62 % $ 273,986 10.50 % $ 260,939 10.00 % Tier 1 Capital (to risk-weighted assets) $ 407,981 15.64 % $ 221,798 8.50 % $ 208,751 8.00 % Tier 1 Leverage Capital (to average assets) $ 407,981 10.28 % $ 158,767 4.00 % $ 198,459 5.00 % Common Equity Tier 1 (to risk-weighted assets) $ 407,981 15.64 % $ 182,657 7.00 % $ 169,610 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 requirements that are regularly monitored using metrics and tools similar to those used by larger banks, such as the liquidity coverage ratio, and multi-scenario, long-horizon stress tests. 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 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. Net available contingent funding sources, including unrestricted cash, unencumbered available-for-sale securities and total available borrowing capacity was $1.905 billion, or 208% of estimated uninsured and/or uncollateralized deposits as of March 31, 2024. The following table details the components of our contingent liquidity sources as of March 31, 2024. (in thousands) Total Available Amount Used Net Availability Internal Sources Unrestricted cash 1 $ 13,452 N/A $ 13,452 Unencumbered securities at market value 464,959 N/A 464,959 External Sources FHLB line of credit 951,238 $ — 951,238 FRB line of credit 349,991 — 349,991 Lines of credit at correspondent banks 125,000 — 125,000 Total Liquidity $ 1,904,640 $ — $ 1,904,640 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, FRB and FHLB advances, other borrowings, and cash flow from operations. Although available as a liquidity source, we have not needed to utilize brokered deposits. 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. Page-40 Our cash and cash equivalents increased $5.9 million in the first three months of 2024. The most significant sources of liquidity during the first three months of 2024 were proceeds from principal paydowns and maturities of investment securities of $20.3 million, and proceeds from loans collected net of originations totaling $18.7 million. In addition, $4.3 million in net cash was provided by operating activities. Significant uses of liquidity during the first three months of 2024 were $26.0 million in repayments of short-term borrowings, $6.0 million in net withdrawals of deposits and $4.0 million in cash dividends paid on common stock to our shareholders. Refer to the Consolidated Statement of Cash Flows in this Form 10-Q for additional information on our sources and uses of liquidity. Management anticipates that our current strong liquidity position, as detailed in this report, and contingent funding sources outlined in the table above are adequate to support our operational needs. Unfunded loan commitments, as discussed in Note 8 to the Consolidated Financial Statements in this Form 10-Q, totaled $489.4 million at March 31, 2024. 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, $251.4 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 no borrowings under our credit facilities of at March 31, 2024, and $26.0 million at December 31, 2023, 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 $8.6 million in cash at March 31, 2024 and management anticipates that there will be sufficient capacity at the Bank to provide dividends to Bancorp to meet its funding requirements for the foreseeable future. Statement Regarding use of Non-GAAP Financial Measures 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 remaining after a hypothetical liquidation of the entire securities portfolio . 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) March 31, 2024 December 31, 2023 Tangible Common Equity - Bancorp Total stockholders' equity $ 436,680 439,062 Goodwill and core deposit intangible (76,269) (76,520) Total TCE a 360,411 362,542 Unrealized losses on HTM securities, net of tax 1 (83,931) (77,739) TCE, net of unrealized losses on HTM securities (non-GAAP) b $ 276,480 284,803 Total assets $ 3,767,176 3,803,903 Goodwill and core deposit intangible (76,269) (76,520) Total tangible assets c 3,690,907 3,727,383 Unrealized losses on HTM securities, net of tax 1 (83,931) (77,739) Total tangible assets, net of unrealized losses on HTM securities (non-GAAP) d $ 3,606,976 3,649,644 Bancorp TCE ratio a / c 9.8 % 9.7 % Bancorp TCE ratio, net of unrealized losses on HTM securities (non-GAAP) b / d 7.7 % 7.8 % 1 Net unrealized losses on held-to-maturity securities as of March 31, 2024 and December 31, 2023 of $119.2 million and $110.4 million, respectively, as shown in Note 4, net of an estimated $35.2 million and $32.6 million, respectively, in deferred tax benefits based on a blended state and federal statutory tax rate of 29.56%. Page-41