UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
FORM 10-Q
(Mark One)
 
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 20192020
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________________ to __________________
 
Commission File Number  001-33572
Bank of Marin Bancorp
(Exact name of Registrant as specified in its charter)
California20-8859754
(State or other jurisdiction of incorporation)  incorporation or organization)  (IRS Employer Identification No.)
504 Redwood Blvd. Suite 100NovatoCA94947
(Address of principal executive office)(Zip Code)
 
Registrant’s telephone number, including area code:  (415) (415) 763-4520

Not Applicable
(Former name, or former address and formal fiscal year, if changeschanged since last report)
Securities registered pursuant to 12(b) of the Act:

Title of each classTrading symbolName of each exchange on which registered
Common stock, no par value and attached Share Purchase RightsBMRCThe Nasdaq Stock Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ☒                  No  ☐
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ☒                  No ☐
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.   
Large accelerated filer☐Accelerated filer☒
Non-accelerated filer☐(Do not check if a smaller reporting company)Smaller reporting company☒☐
Emerging growth company☐
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark ifwhether the registrant is a shell company as(as defined in Rule 12b-2 of the Exchange Act.Act).
Yes   ☐    No  ☒ 

As of October 31, 2019,2020, there were 13,588,23413,615,563 shares of common stock outstanding.



TABLE OF CONTENTS
 
PART I
Page-33
ITEM 1.
Page-33
Consolidated Statements of Condition
Page-33
Consolidated Statements of Comprehensive Income
Page-44
Consolidated Statements of Changes in Stockholders' Equity
Page-55
Consolidated Statements of Cash Flows
Page-67
Notes to Consolidated Financial Statements
Page-78
ITEM 2.
Page-2931
ITEM 3.
Page-4344
ITEM 4.
Page-4445
PART II
Page-4446
ITEM 1.
Page-4446
ITEM 1A.
Page-4446
ITEM 2.
Page-4547
ITEM 3.
Page-4548
ITEM 4.
Page-4548
ITEM 5.
Page-4548
ITEM 6.
Page-4649




Page-2

PART I       FINANCIAL INFORMATION
 
ITEM 1.  Financial Statements
BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF CONDITION 
September 30, 20192020 and December 31, 20182019
(in thousands, except share data; unaudited)September 30, 2019
December 31, 2018
Assets 
 
Cash, cash equivalents and restricted cash$182,486
$34,221
Investment securities 
 
Held-to-maturity, at amortized cost142,213
157,206
Available-for-sale, at fair value358,724
462,464
Total investment securities500,937
619,670
Loans, net of allowance for loan losses of $16,240 and $15,821 at
September 30, 2019 and December 31, 2018, respectively		1,782,450
1,748,043
Bank premises and equipment, net6,474
7,376
Goodwill30,140
30,140
Core deposit intangible4,906
5,571
Operating lease right-of-use assets11,934
—
Interest receivable and other assets72,744
75,871
Total assets$2,592,071
$2,520,892
   
Liabilities and Stockholders' Equity 
 
Liabilities 
 
Deposits 
 
Non-interest bearing$1,101,288
$1,066,051
Interest bearing 
 
Transaction accounts162,015
133,403
Savings accounts170,007
178,429
Money market accounts693,137
679,775
Time accounts98,077
117,182
Total deposits2,224,524
2,174,840
Borrowings and other obligations255
7,000
Subordinated debentures2,691
2,640
Operating lease liabilities13,665
—
Interest payable and other liabilities17,871
20,005
Total liabilities2,259,006
2,204,485
   
Stockholders' Equity 
 
Preferred stock, no par value,
Authorized - 5,000,000 shares, none issued		—
—
Common stock, no par value,
Authorized - 30,000,000 shares;
Issued and outstanding - 13,608,525 and 13,844,353 at
September 30, 2019 and December 31, 2018, respectively		130,220
140,565
Retained earnings196,999
179,944
Accumulated other comprehensive income (loss), net of taxes5,846
(4,102)
Total stockholders' equity333,065
316,407
Total liabilities and stockholders' equity$2,592,071
$2,520,892
(in thousands, except share data; unaudited)September 30, 2020December 31, 2019
Assets  
Cash, cash equivalents and restricted cash$213,584 $183,388 
Investment securities 
Held-to-maturity, at amortized cost117,350 137,413 
Available-for-sale, at fair value413,464 432,260 
Total investment securities530,814 569,673 
Loans, net of allowance for loan losses of $22,113 and $16,677 at
September 30, 2020 and December 31, 2019, respectively
2,085,878 1,826,609 
Bank premises and equipment, net5,266 6,070 
Goodwill30,140 30,140 
Core deposit intangible4,045 4,684 
Operating lease right-of-use assets26,041 11,002 
Interest receivable and other assets79,457 75,714 
Total assets$2,975,225 $2,707,280 
Liabilities and Stockholders' Equity  
Liabilities  
Deposits  
Non-interest bearing$1,383,719 $1,128,823 
Interest bearing 
Transaction accounts156,061 142,329 
Savings accounts192,764 162,817 
Money market accounts738,661 804,710 
Time accounts98,084 97,810 
Total deposits2,569,289 2,336,489 
Borrowings and other obligations99 212 
Subordinated debenture2,760 2,708 
Operating lease liabilities27,527 12,615 
Interest payable and other liabilities17,980 18,468 
Total liabilities2,617,655 2,370,492 
Stockholders' Equity  
Preferred stock, no par value,
    Authorized - 5,000,000 shares, NaN issued
0 0 
Common stock, no par value,
    Authorized - 30,000,000 shares;
    Issued and outstanding - 13,605,363 and 13,577,008 at
    September 30, 2020 and December 31, 2019, respectively
129,284 129,058 
Retained earnings215,976 203,227 
Accumulated other comprehensive income, net of taxes12,310 4,503 
Total stockholders' equity357,570 336,788 
Total liabilities and stockholders' equity$2,975,225 $2,707,280 

The accompanying notes are an integral part of these consolidated financial statements (unaudited).


BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 Three months ended Nine months ended
(in thousands, except per share amounts; unaudited)September 30, 2019September 30, 2018 September 30, 2019September 30, 2018
Interest income  
   
Interest and fees on loans$21,525
$20,284
 $63,208
$58,795
Interest on investment securities3,382
3,524
 11,242
10,180
Interest on federal funds sold and due from banks425
400
 754
1,088
Total interest income25,332
24,208
 75,204
70,063
Interest expense 
 
  
 
Interest on interest-bearing transaction accounts101
58
 269
158
Interest on savings accounts17
18
 52
54
Interest on money market accounts855
337
 2,406
789
Interest on time accounts147
130
 441
426
Interest on borrowings and other obligations4
1
 75
2
Interest on subordinated debentures57
125
 175
362
Total interest expense1,181
669
 3,418
1,791
Net interest income24,151
23,539
 71,786
68,272
Provision for loan losses400
—
 400
—
Net interest income after provision for loan losses23,751
23,539
 71,386
68,272
Non-interest income 
   
 
Service charges on deposit accounts439
475
 1,403
1,407
Wealth Management and Trust Services495
490
 1,406
1,493
Debit card interchange fees, net406
402
 1,200
1,158
Merchant interchange fees, net79
99
 253
297
Earnings on bank-owned life insurance, net795
227
 970
685
Dividends on FHLB stock202
194
 591
582
(Losses) gains on investment securities, net—
(90) 55
(79)
Other income305
439
 888
1,173
Total non-interest income2,721
2,236
 6,766
6,716
Non-interest expense 
   
 
Salaries and related benefits8,412
8,069
 26,426
25,402
Occupancy and equipment1,507
1,444
 4,616
4,462
Depreciation and amortization573
532
 1,701
1,625
Federal Deposit Insurance Corporation insurance1
186
 354
568
Data processing923
950
 2,942
3,354
Professional services580
727
 1,701
2,836
Directors' expense189
173
 555
530
Information technology279
262
 822
795
Amortization of core deposit intangible222
230
 665
691
Provision for losses on off-balance sheet commitments—
—
 129
—
Other expense1,514
1,398
 4,733
4,298
Total non-interest expense14,200
13,971
 44,644
44,561
Income before provision for income taxes12,272
11,804
 33,508
30,427
Provision for income taxes2,824
3,124
 8,346
7,467
Net income$9,448
$8,680
 $25,162
$22,960
Net income per common share:1
 
   
 
Basic$0.70
$0.63
 $1.84
$1.66
Diluted$0.69
$0.62
 $1.82
$1.64
Weighted average shares:1
  
  
 
Basic13,571
13,900
 13,654
13,872
Diluted13,735
14,110
 13,825
14,062
Comprehensive income:    

Net income$9,448
$8,680
 $25,162
$22,960
Other comprehensive income (loss)



 



Change in net unrealized gains or losses on available-for-sale securities936
(2,120) 13,857
(9,421)
Reclassification adjustment for losses (gains) on available-for-sale securities in net income—
90
 (55)79
Net unrealized losses on securities transferred from available-for-sale to held-to-maturity—
—
 —
(278)
Amortization of net unrealized losses on securities transferred from available-for-sale to held-to-maturity123
128
 328
396
Subtotal1,059
(1,902) 14,130
(9,224)
Deferred tax expense (benefit)313
(562) 4,182
(2,730)
Other comprehensive income (loss), net of tax746
(1,340) 9,948
(6,494)
Comprehensive income$10,194
$7,340
 $35,110
$16,466
1 Share and per share data have been adjusted to reflect the 2-for-one stock split effective November 27, 2018.
The accompanying notes are an integral part of these consolidated financial statements (unaudited).

Page-3


BANK OF MARIN BANCORP

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the three and nine months ended September 30, 2019 and 2018COMPREHENSIVE INCOME
(in thousands, except share data; unaudited)Common Stock
Retained
Earnings

Accumulated Other
Comprehensive Income (Loss) ("AOCI"),
Net of Taxes

 Total
Shares1

Amount
 Three months ended September 30, 2019
Balance at July 1, 201913,659,143
$132,151
$190,416
$5,100
$327,667
Net income—
—
9,448
—
9,448
Other comprehensive income—
—
—
746
746
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings3,452
101
—
—
101
Stock issued under employee stock purchase plan265
10
—
—
10
Stock issued under employee stock ownership plan7,600
311
—
—
311
Stock-based compensation - stock options—
98
—
—
98
Stock-based compensation - restricted stock—
142
—
—
142
Cash dividends paid on common stock ($0.21 per share)—
—
(2,865)—
(2,865)
Stock purchased by directors under director stock plan392
16
—
—
16
Stock issued in payment of director fees2,800
117
—
—
117
Stock repurchased, net of commissions(65,127)(2,726)—
—
(2,726)
Balance at September 30, 201913,608,525
$130,220
$196,999
$5,846
$333,065
 Three months ended September 30, 2018
Balance at July 1, 201813,983,642
$146,195
$166,281
$(8,278)$304,198
Net income—
—
8,680
—
8,680
Other comprehensive loss—
—
—
(1,340)(1,340)
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings3,502
—
—
—
—
Stock issued under employee stock purchase plan242
9
—
—
9
Stock issued under employee stock ownership plan6,800
297
—
—
297
Stock-based compensation - stock options—
124
—
—
124
Stock-based compensation - restricted stock—
176
—
—
176
Cash dividends paid on common stock ($0.155 per share1)
—
—
(2,238)—
(2,238)
Stock purchased by directors under director stock plan478
19
—
—
19
Stock issued in payment of director fees2,784
113
—
—
113
Stock repurchased, net of commissions(33,090)(1,435)—
—
(1,435)
Balance at September 30, 201813,964,358
$145,498
$172,723
$(9,618)$308,603
Three months endedNine months ended
(in thousands, except per share amounts; unaudited)September 30, 2020September 30, 2019September 30, 2020September 30, 2019
Interest income   
Interest and fees on loans$21,776 $21,525 $63,880 $63,208 
Interest on investment securities3,343 3,382 11,249 11,242 
Interest on federal funds sold and due from banks50 425 421 754 
Total interest income25,169 25,332 75,550 75,204 
Interest expense    
Interest on interest-bearing transaction accounts41 101 146 269 
Interest on savings accounts17 17 50 52 
Interest on money market accounts377 855 1,731 2,406 
Interest on time accounts133 147 436 441 
Interest on borrowings and other obligations0 4 3 75 
Interest on subordinated debenture35 57 124 175 
Total interest expense603 1,181 2,490 3,418 
Net interest income24,566 24,151 73,060 71,786 
Provision for loan losses1,250 400 5,450 400 
Net interest income after provision for loan losses23,316 23,751 67,610 71,386 
Non-interest income   
Service charges on deposit accounts284 439 1,028 1,403 
Wealth Management and Trust Services450 495 1,375 1,406 
Debit card interchange fees, net383 406 1,051 1,200 
Merchant interchange fees, net63 79 183 253 
Earnings on bank-owned life insurance232 795 741 970 
Dividends on Federal Home Loan Bank stock149 202 503 591 
Gains on sale of investment securities, net0 0 915 55 
Other income229 305 927 888 
Total non-interest income1,790 2,721 6,723 6,766 
Non-interest expense   
Salaries and related benefits8,638 8,412 25,979 26,426 
Occupancy and equipment1,776 1,507 5,100 4,616 
Depreciation and amortization539 573 1,591 1,701 
Federal Deposit Insurance Corporation insurance181 1 299 354 
Data processing822 923 2,437 2,942 
Professional services655 580 1,749 1,701 
Directors' expense184 189 533 555 
Information technology256 279 758 822 
Amortization of core deposit intangible213 222 639 665 
Provision for losses on off-balance sheet commitments248 0 610 129 
Charitable contributions481 111 921 377 
Other expense1,245 1,403 4,232 4,356 
Total non-interest expense15,238 14,200 44,848 44,644 
Income before provision for income taxes9,868 12,272 29,485 33,508 
Provision for income taxes2,377 2,824 7,360 8,346 
Net income$7,491 $9,448 $22,125 $25,162 
Net income per common share:  
Basic$0.55 $0.70 $1.64 $1.84 
Diluted$0.55 $0.69 $1.62 $1.82 
Weighted average shares:   
Basic13,539 13,571 13,526 13,654 
Diluted13,610 13,735 13,617 13,825 
Comprehensive income:
Net income$7,491 $9,448 $22,125 $25,162 
Other comprehensive income
Change in net unrealized gains or losses on available-for-sale securities299 936 11,605 13,857 
Reclassification adjustment for gains on available-for-sale securities included in net income0 0 (915)(55)
Amortization of net unrealized losses on securities transferred from available-for-sale to held-to-maturity149 123 394 328 
Other comprehensive income, before tax448 1,059 11,084 14,130 
Deferred tax expense132 313 3,277 4,182 
Other comprehensive income, net of tax316 746 7,807 9,948 
Total comprehensive income$7,807 $10,194 $29,932 $35,110 
1
Share and per share data have been adjusted to reflect the 2-for-one stock split effective November 27, 2018.

The accompanying notes are an integral part of these consolidated financial statements (unaudited).
Page-4

BANK OF MARIN BANCORP

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the three and nine months ended September 30, 20192020 and 20182019
(in thousands, except share data; unaudited)Common Stock
Retained
Earnings

Accumulated Other
Comprehensive Income (Loss) ("AOCI"),
Net of Taxes
 Total
(in thousands, except share data; unaudited)Common StockRetained
Earnings		Accumulated Other
Comprehensive Income (Loss),
Net of Taxes		 Total
Shares
Amount
SharesAmount
Nine months ended September 30, 2019Three months ended September 30, 2020
Balance at January 1, 201913,844,353
$140,565
$179,944
$(4,102)$316,407
Balance at July 1, 2020Balance at July 1, 202013,591,835 $128,633 $211,613 $11,994 $352,240 
Net income—
—
25,162
—
25,162
Net income— — 7,491 — 7,491 
Other comprehensive income—
—
—
9,948
9,948
Other comprehensive income— — — 316 316 
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings40,927
572
—
—
572
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings207 0 — — 0 
Stock issued under employee stock purchase plan1,016
40
—
—
40
Stock issued under employee stock purchase plan728 20 — — 20 
Stock issued under employee stock ownership plan23,200
935
—
—
935
Stock issued under employee stock ownership plan10,200 319 — — 319 
Restricted stock granted29,110
—
—
—
—
Restricted stock surrendered for tax withholdings upon vesting(5,240)(220)—
—
(220)
Restricted stock forfeited / cancelled(17,325)—
—
—
—
Restricted stock forfeited / cancelled(1,466)— — — — 
Stock-based compensation - stock options—
437
—
—
437
Stock-based compensation - stock options— 88 — — 88 
Stock-based compensation - restricted stock—
806
—
—
806
Stock-based compensation - restricted stock— 99 — — 99 
Cash dividends paid on common stock ($0.59 per share)—
—
(8,107)—
(8,107)
Cash dividends paid on common stock ($0.23 per share)Cash dividends paid on common stock ($0.23 per share)— — (3,128)— (3,128)
Stock purchased by directors under director stock plan591
24
—
—
24
Stock purchased by directors under director stock plan746 25 — — 25 
Stock issued in payment of director fees5,544
231
—
—
231
Stock issued in payment of director fees3,113 100 — — 100 
Stock repurchased, net of commissions(313,651)(13,170)—
—
(13,170)
Balance at September 30, 201913,608,525
$130,220
$196,999
$5,846
$333,065
Nine months ended September 30, 2018
Balance at January 1, 201813,843,084
$143,967
$155,544
$(2,486)$297,025
Balance at September 30, 2020Balance at September 30, 202013,605,363 $129,284 $215,976 $12,310 $357,570 
Three months ended September 30, 2019
Balance at July 1, 2019Balance at July 1, 201913,659,143 $132,151 $190,416 $5,100 $327,667 
Net income—
—
22,960
—
22,960
Net income— — 9,448 — 9,448 
Other comprehensive loss—
—
—
(6,494)(6,494)
Reclassification of stranded tax effects in AOCI—
—
638
(638)—
Other comprehensive incomeOther comprehensive income— — — 746 746 
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings103,652
534
—
—
534
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings3,452 101 — — 101 
Stock issued under employee stock purchase plan772
28
—
—
28
Stock issued under employee stock purchase plan265 10 — — 10 
Stock issued under employee stock ownership plan22,600
898
—
—
898
Stock issued under employee stock ownership plan7,600 311 — — 311 
Restricted stock granted37,040
—
—
—
—
Restricted stock surrendered for tax withholdings upon vesting(1,316)(45)—
—
(45)
Restricted stock forfeited / cancelled(12,056)—
—
—
—
Stock-based compensation - stock options—
566
—
—
566
Stock-based compensation - stock options— 98 — — 98 
Stock-based compensation - restricted stock—
848
—
—
848
Stock-based compensation - restricted stock— 142 — — 142 
Cash dividends paid on common stock ($0.46 per share1)
—
—
(6,419)—
(6,419)
Cash dividends paid on common stock ($0.21 per share)Cash dividends paid on common stock ($0.21 per share)— — (2,865)— (2,865)
Stock purchased by directors under director stock plan998
37
—
—
37
Stock purchased by directors under director stock plan392 16 — — 16 
Stock issued in payment of director fees5,470
204
—
—
204
Stock issued in payment of director fees2,800 117 — — 117 
Stock repurchased, net of commissions(35,886)(1,539)—
—
(1,539)Stock repurchased, net of commissions(65,127)(2,726)— — (2,726)
Balance at September 30, 201813,964,358
145,498
172,723
(9,618)308,603
Balance at September 30, 2019Balance at September 30, 201913,608,525 $130,220 $196,999 $5,846 $333,065 
1
Share and per share data have been adjusted to reflect the 2-for-one stock split effective November 27, 2018.

The accompanying notes are an integral part of these consolidated financial statements (unaudited).















BANK OF MARIN BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS
CHANGES IN STOCKHOLDERS' EQUITY
For the nine months ended September 30, 20192020 and 20182019
(in thousands; unaudited)September 30, 2019 September 30, 2018
Cash Flows from Operating Activities:   
Net income$25,162
 $22,960
Adjustments to reconcile net income to net cash provided by operating activities: 
  
Provision for loan losses400
 —
Provision for losses on off-balance sheet commitments129
 —
Noncash contribution expense to employee stock ownership plan935
 898
Noncash director compensation expense226
 219
Stock-based compensation expense1,243
 1,414
Amortization of core deposit intangible665
 691
Amortization of investment security premiums, net of accretion of discounts1,282
 2,172
Accretion of discount on acquired loans(208) (531)
Accretion of discount on subordinated debentures51
 92
Net change in deferred loan origination costs/fees(345) 114
(Gain) loss on sale of investment securities(55) 79
Depreciation and amortization1,701
 1,625
Earnings on bank-owned life insurance policies(970) (685)
Net change in operating assets and liabilities:   
Interest receivable and other assets2,287
 2,779
Interest payable and other liabilities(1,302) (543)
Total adjustments6,039
 8,324
Net cash provided by operating activities31,201
 31,284
Cash Flows from Investing Activities: 
  
Purchase of held-to-maturity securities—
 (1,988)
Purchase of available-for-sale securities(18,892) (174,617)
Proceeds from sale of available-for-sale securities66,081
 16,972
Proceeds from paydowns/maturities of held-to-maturity securities14,736
 15,947
Proceeds from paydowns/maturities of available-for-sale securities69,711
 45,917
Loans originated and principal collected, net(32,895) (50,315)
Purchase of bank-owned life insurance policies(1,892) —
Purchase of premises and equipment(419) (615)
Purchase of Federal Home Loan Bank stock(616) —
Cash paid for low-income housing tax credit investment(339) (389)
Net cash provided by (used in) investing activities95,475
 (149,088)
Cash Flows from Financing Activities: 
  
Net increase in deposits49,684
 64,176
Proceeds from stock options exercised572
 585
Payment of tax withholdings for stock options exercised and vesting of restricted stock(220) (96)
Proceeds from stock issued under employee and director stock purchase plans64
 65
Stock repurchased, net of commissions(13,279) (1,334)
Repayment of Federal Home Loan Bank borrowings(7,000) —
Repayment of finance lease obligations(125) —
Cash dividends paid on common stock(8,107) (6,419)
Net provided by financing activities21,589
 56,977
Net increase (decrease) in cash, cash equivalents and restricted cash148,265
 (60,827)
Cash, cash equivalents and restricted cash at beginning of period34,221
 203,545
Cash, cash equivalents and restricted cash at end of period$182,486
 $142,718
Supplemental disclosure of cash flow information:   
Cash paid in interest$3,351
 $1,737
Cash paid in income taxes$9,025
 $4,900
Supplemental disclosure of noncash investing and financing activities: 
  
Change in net unrealized gain or loss on available-for-sale securities$13,857
 $(9,421)
Securities transferred from available-for-sale to held-to-maturity$—
 $27,422
Amortization of net unrealized loss on available-for-sale securities transferred to held-to-maturity$328
 $396
Subscription in low-income housing tax credit investment$—
 $3,000
Stock issued to employee stock ownership plan$935
 $898
Stock issued in payment of director fees$231
 $204
Repurchase of stock not yet settled$34
 $205
Restricted cash:   
Federal Reserve Bank reserve requirements included in cash, cash equivalents and restricted cash$10,015
 $7,345
(in thousands, except share data; unaudited)Common StockRetained
Earnings		Accumulated Other
Comprehensive Income (Loss),
Net of Taxes		 Total
SharesAmount
Nine months ended September 30, 2020
Balance at January 1, 202013,577,008 $129,058 $203,227 $4,503 $336,788 
Net income— — 22,125 — 22,125 
Other comprehensive income— — — 7,807 7,807 
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings64,022 1,277 — — 1,277 
Stock issued under employee stock purchase plan1,812 53 — — 53 
Stock issued under employee stock ownership plan29,600 967 — — 967 
Restricted stock granted29,100 — — — 0 
Restricted stock surrendered for tax withholdings upon vesting(2,200)(73)— — (73)
Restricted stock forfeited / cancelled(8,184)— — — — 
Stock-based compensation - stock options— 299 — — 299 
Stock-based compensation - restricted stock— 673 — — 673 
Cash dividends paid on common stock ($0.69 per share)— — (9,376)— (9,376)
Stock purchased by directors under director stock plan1,146 43 — — 43 
Stock issued in payment of director fees5,723 217 — — 217 
Stock repurchased, net of commissions(92,664)(3,230)— — (3,230)
Balance at September 30, 202013,605,363 $129,284 $215,976 $12,310 $357,570 
Nine months ended September 30, 2019
Balance at January 1, 201913,844,353 $140,565 $179,944 $(4,102)$316,407 
Net income— — 25,162 — 25,162 
Other comprehensive income— — — 9,948 9,948 
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings40,927 572 — — 572 
Stock issued under employee stock purchase plan1,016 40 — — 40 
Stock issued under employee stock ownership plan23,200 935 — — 935 
Restricted stock granted29,110 — — — 0 
Restricted stock surrendered for tax withholdings upon vesting(5,240)(220)— — (220)
Restricted stock forfeited / cancelled(17,325)— — — — 
Stock-based compensation - stock options— 437 — — 437 
Stock-based compensation - restricted stock— 806 — — 806 
Cash dividends paid on common stock ($0.59 per share)— — (8,107)— (8,107)
Stock purchased by directors under director stock plan591 24 — — 24 
Stock issued in payment of director fees5,544 231 — — 231 
Stock repurchased, net of commissions(313,651)(13,170)— — (13,170)
Balance at September 30, 201913,608,525 $130,220 $196,999 $5,846 $333,065 

The accompanying notes are an integral part of these consolidated financial statements (unaudited).
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BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended September 30, 2020 and 2019
(in thousands; unaudited)September 30, 2020September 30, 2019
Cash Flows from Operating Activities:  
Net income$22,125 $25,162 
Adjustments to reconcile net income to net cash provided by operating activities:  
Provision for loan losses5,450 400 
Provision for losses on off-balance sheet commitments610 129 
Noncash contribution expense to employee stock ownership plan967 935 
Noncash director compensation expense226 226 
Stock-based compensation expense972 1,243 
Amortization of core deposit intangible639 665 
Amortization of investment security premiums (discounts), net864 1,282 
Amortization of acquired loan (discounts) premiums, net(101)(208)
Accretion of discount on subordinated debenture52 51 
Net change in deferred loan origination costs/fees6,132 (345)
Gain on sale of investment securities(915)(55)
Depreciation and amortization1,591 1,701 
Earnings on bank-owned life insurance policies(741)(970)
Net change in operating assets and liabilities:
Interest receivable and other assets(5,347)2,287 
Interest payable and other liabilities(1,207)(1,302)
Total adjustments9,192 6,039 
Net cash provided by operating activities31,317 31,201 
Cash Flows from Investing Activities:  
Purchase of available-for-sale securities(71,744)(18,892)
Proceeds from sale of available-for-sale securities33,756 66,081 
Proceeds from paydowns/maturities of held-to-maturity securities19,880 14,736 
Proceeds from paydowns/maturities of available-for-sale securities68,102 69,711 
Loans originated and principal collected, net(269,376)(32,895)
Purchase of bank-owned life insurance policies(941)(1,892)
Purchase of premises and equipment(769)(419)
Purchase of Federal Home Loan Bank stock0 (616)
Cash paid for low income housing tax credit investment(1,289)(339)
Net cash (used in) provided by investing activities(222,381)95,475 
Cash Flows from Financing Activities:  
Net increase in deposits232,800 49,684 
Proceeds from stock options exercised1,277 572 
Payment of tax withholdings for stock options exercised and vesting of restricted stock(73)(220)
Proceeds from stock issued under employee and director stock purchase plans96 64 
Stock repurchased, net of commissions(3,333)(13,279)
Repayment of Federal Home Loan Bank borrowings0 (7,000)
Repayment of finance lease obligations(131)(125)
Cash dividends paid on common stock(9,376)(8,107)
Net cash provided by financing activities221,260 21,589 
Net increase in cash, cash equivalents and restricted cash30,196 148,265 
Cash, cash equivalents and restricted cash at beginning of period183,388 34,221 
Cash, cash equivalents and restricted cash at end of period$213,584 $182,486 
Supplemental disclosure of cash flow information:
Cash paid in interest$2,450 $3,351 
Cash paid in income taxes$9,765 $9,025 
Supplemental disclosure of noncash investing and financing activities:  
Change in net unrealized gain or loss on available-for-sale securities$11,605 $13,857 
Amortization of net unrealized loss on available-for-sale securities transferred to held-to-maturity$394 $328 
Stock issued to employee stock ownership plan$967 $935 
Stock issued in payment of director fees$217 $231 
Repurchase of stock not yet settled$0 $34 
Restricted cash1
$0 $10,015 
1 Restricted cash includes reserve requirements held with the Federal Reserve Bank of San Francisco. In response to the COVID-19 pandemic, the Federal Reserve reduced the reserve requirement ratios to zero percent effective March 26, 2020.
The accompanying notes are an integral part of these consolidated financial statements (unaudited).

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
 
Note 1:  Basis of Presentation
 
The consolidated financial statements include the accounts of Bank of Marin Bancorp (“Bancorp”), a bank holding company, and its wholly-owned bank subsidiary, Bank of Marin (the “Bank”), a California state-chartered commercial bank. References to “we,” “our,” “us” mean Bancorp and the Bank that are consolidated for financial reporting purposes. The accompanying unaudited consolidated interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and note disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles ("GAAP") have been condensed or omitted pursuant to those rules and regulations. Although we believe that the disclosures are adequate and the information presented is not misleading, we suggest that these interim financial statements be read in conjunction with the annual financial statements and the notes thereto included in our 20182019 Annual Report on Form 10-K.  In the opinion of Management, the unaudited consolidated financial statements reflect all adjustments, which are necessary for a fair presentation of the consolidated financial position, the results of operations, changes in comprehensive income, changes in stockholders’ equity, and cash flows for the periods presented. All material intercompany transactions have been eliminated. The results of these interim periods may not be indicative of the results for the full year or for any other period.

The NorCal Community Bancorp Trusts I andTrust II respectively (the "Trusts""Trust") werewas formed for the sole purpose of issuing trust preferred securities. Bancorp is not considered the primary beneficiary of the Trusts (variableTrust (a variable interest entities)entity), therefore the Trusts areTrust is not consolidated in our consolidated financial statements, but rather the subordinated debentures aredebenture is shown as a liability on our consolidated statements of condition. Bancorp's investment in the securities of the TrustsTrust is accounted for under the equity method and is included in interest receivable and other assets on the consolidated statements of condition. Refer to Note 6, Borrowings, for detailadditional information on the early redemption on October 7, 2018 of one subordinated debenture due to NorCal Community Bancorp Trust I.II.
 
The following table shows: 1) weighted average basic shares, 2) potentially dilutive weighted average common shares related to stock options and unvested restricted stock awards, and 3) weighted average diluted shares. Basic earnings per share (“EPS”) are calculated by dividing net income by the weighted average number of common shares outstanding during each period, excluding unvested restricted stock awards. Diluted EPS are calculated using the weighted average number of potentially dilutive common shares. The number of potentially dilutive common shares included in the quarterly diluted EPS is computed using the average market prices during the three months included in the reporting period under the treasury stock method. The number of potentially dilutive common shares included in year-to-date diluted EPS is a year-to-date weighted average of potentially dilutive common shares included in each quarterly diluted EPS computation. In computing diluted EPS, we exclude anti-dilutive shares such as options whose exercise prices exceed the current common stock price, as they would not reduce EPS under the treasury method. We have two forms of outstanding common stock: common stock and unvested restricted stock awards. Holders of unvested restricted stock awards receive non-forfeitable dividends at the same rate as common shareholders and they both share equally in undistributed earnings. Under the two-class method, the difference in EPS is nominal for these participating securities.
Three months endedNine months ended
(in thousands, except per share data)September 30, 2020September 30, 2019September 30, 2020September 30, 2019
Weighted average basic shares outstanding13,539 13,571 13,526 13,654 
Potentially dilutive common shares related to:
Stock options53 141 71 146 
Unvested restricted stock awards18 23 20 25 
Weighted average diluted shares outstanding13,610 13,735 13,617 13,825 
Net income$7,491 $9,448 $22,125 $25,162 
Basic EPS$0.55 $0.70 $1.64 $1.84 
Diluted EPS$0.55 $0.69 $1.62 $1.82 
Weighted average anti-dilutive shares not included in the calculation of diluted EPS202 39 152 34 
 Three months ended Nine months ended
(in thousands, except per share data)1
September 30, 2019September 30, 2018 September 30, 2019September 30, 2018
Weighted average basic shares outstanding13,571
13,900
 13,654
13,872
Potentially dilutive common shares related to:     
Stock options141
177
 146
158
Unvested restricted stock awards23
33
 25
32
Weighted average diluted shares outstanding13,735
14,110
 13,825
14,062
Net income$9,448
$8,680
 $25,162
$22,960
Basic EPS$0.70
$0.63
 $1.84
$1.66
Diluted EPS$0.69
$0.62
 $1.82
$1.64
Weighted average anti-dilutive shares not included in the calculation of diluted EPS39
—
 34
2

1 Share and per share data have been adjusted to reflect the 2-for-one stock split effective November 27, 2018.

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Note 2: Recently Adopted and Issued Accounting Standards

Accounting Standards Adopted in 2019

2020
In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2016-02,
Leases (Topic 842) (the "new lease accounting standard"). The amendments in this ASU intend to increase transparency and comparability among organizations by recognizing an operating lease or finance lease right-of-use asset for the lease term, and a lease liability, which is a lessee's obligation to make lease payments, recorded based on discounting future lease payments under the lease terms. This ASU generally applies to leasing arrangements exceeding a twelve-month term. ASU 2016-02 is effective for annual periods, including interim periods within those annual periods beginning after December 15, 2018 and requires a modified retrospective method of adoption. In July 2018, the FASB issued two amendments to ASU 2016-02: ASU No. 2018-10, Codification Improvements to Topic 842, Leases, which provided various corrections and clarifications to ASU 2016-02; and ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which permitted optional transition methods and provided lessors with a practical expedient for separating lease and non-lease components of a lease. The ASU allowed entities to apply either a modified retrospective approach at the beginning of the earliest period presented or at the beginning of the period of adoption through a cumulative-effect adjustment to retained earnings, which we adopted.

As a result of the adoption of the ASU on January 1, 2019, we recorded operating and finance lease right-of-use assets totaling $13.4 million, net of deferred rent and unaccreted lease incentives, operating and finance lease liabilities totaling $15.4 million, and no cumulative-effect adjustments to retained earnings. Under the standard's transition guidance, we elected the package of practical expedients, which allowed us to carry forward existing lease classifications and did not require us to reassess initial direct costs for any existing leases. In addition, we elected the hindsight practical expedient when determining the lease term (i.e., considering whether we are reasonably certain to exercise options to extend or terminate the lease). We made accounting policy elections not to separate non-lease components from lease components and to exclude short-term leases (i.e., lease term of 12 months or less at the commencement date) from right-of-use assets and lease liabilities for all lease classifications. See Note 8, Commitments and Contingencies for further information.

In June 2018, the FASB issued ASU No. 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. This update simplifies the accounting for share-based payment transactions for acquiring goods and services from nonemployees, applying some of the same requirements as employee share-based payment transactions. The ASU will not affect the accounting for share-based payment awards to nonemployee directors, which will continue to be treated as employee share-based transactions under the current standards. ASU 2018-07 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. We adopted the requirements of this ASU effective January 1, 2019, which did not impact our financial condition or results of operations, as it is not our practice to issue stock-based awards to pay for goods and services from nonemployees, other than nonemployee directors.

In October 2018, the FASB issued ASU No. 2018-16, Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. This update adds an alternative fifth permissible U.S. benchmark rate to be used for hedge accounting purposes. As we have already adopted the amendments in ASU 2017-12, which changed both the designation and measurement guidance for qualifying hedging relationships, the amendments in ASU 2018-16 are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The amendments should be adopted on a prospective basis for qualifying new or re-designated hedging relationships entered into on or after the date of adoption. We adopted this ASU effective January 1, 2019, which did not impact our financial condition or results of operations, as we did not have new or re-designated hedging relationships since adoption.
Accounting Standards Not Yet Effective
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The standard will replace today's "incurred loss" model with a "current expected credit loss" ("CECL") model. The CECL model will apply to estimated credit losses on loans receivable, held-to-maturity debt securities, unfunded loan commitments, and certain other financial assets measured at amortized cost. The CECL model is based on lifetime expected losses, rather than incurred losses, and requires the recognition of credit loss expense in the consolidated statement of income and a related allowance for credit losses on the consolidated statement of condition at the time of origination or purchase of a loan receivable or held-to-maturity debt


security. Likewise, subsequent changes in this estimate are recorded through credit loss expense and related allowance. In addition, CECL will modify the accounting for purchased loans and will require that an allowance for credit losses be established at the date of acquisition. However, for purchased financial assets with a more­-than-insignificant amount of credit deterioration since origination (“PCD assets”) that are measured at amortized cost, the initial allowance for credit losses is added to the purchase price rather than being reported as a credit loss expense. Subsequent changes in the allowance for credit losses on PCD assets are recognized through credit loss expense. The CECL model requires the use of not only relevant historical experience and current conditions, but reasonable and supportable forecasts of future events and circumstances, incorporating a broad range of information in developing credit loss estimates, which could result in significant changes to both the timing and amount of credit loss expense and allowance. Under ASU 2016-13, available-for-sale debt securities are evaluated for impairment if fair value is less than amortized cost. Estimated credit losses are recorded through a credit loss expense and an allowance, rather than a write-down of the investment. Changes in fair value that are not credit-related will continue to be recorded in other comprehensive income. The ASU also expands the disclosure requirements regarding assumptions, models, and methods for estimating the allowance for loan losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.

While we believe the change from an incurred loss model to a CECL model has the potential to increase the allowance for credit losses, which will result in a one-time cumulative-effect adjustment to retained earnings at the adoption date, the full impact to our financial condition or results of operations cannot be quantified at this time as we continue to evaluate the applicability and validity of our methodologies and assumptions. In addition, any estimate could be significantly influenced by the composition and risk characteristics of the loan portfolio as well as prevailing economic conditions and forecasts as of the adoption date. Our cross-functional team and our third-party CECL model vendor continue to make progress and we will be ready for adoption on January 1, 2020. Early implementation activities focused on, among other things, capturing and validating data, segmenting the loan portfolio, evaluating various credit loss estimation methodologies, sourcing tools to forecast future economic conditions, and running multiple loan loss driver analyses that correlate our credit loss experience with one or more economic factors. Based on these activities, we determined that our primary credit loss methodology will utilize a discounted cash flow approach that considers the probability of default and loss given default. Continuing implementation activities include refining estimated credit loss model assumptions, model validation, evaluating the qualitative factor framework and assumptions, drafting policies and disclosures, and evaluating, documenting and testing internal controls. In addition, we will continue to run parallel tests throughout 2019 to identify opportunities for enhancing our assumptions as the processes, internal controls and policies are finalized.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this ASU remove, modify, and add disclosure requirements for the fair value reporting of assets and liabilities. The modifications and additions relate to Level 3 fair value measurements at the end of the reporting period. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Entities should disclose and describe the range and weighted-average of significant observableunobservable inputs used to develop Level 3 fair value measurements prospectively. Early adoption is permitted. Entities makingmeasurements. We adopted this election are permitted to early adopt the eliminated or modified disclosure requirements and delay the adoption of all the new disclosure requirements until the ASU'sASU prospectively effective date.January 1, 2020. As the ASU’s requirements only relate to disclosures, the amendments willdid not impact our financial condition or results of operations. Refer to Note 3, Fair Value of Assets and Liabilities, for additional disclosures.

In August 2018, the FASB issued ASU No. 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This standard aligns the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software regardless of whether they convey a license to the hosted software. The accounting for the service element of a hosting arrangement that is a service contract is not affected by this ASU. The amendments are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. An entity has the option to apply amendments in the ASU either retrospectively or prospectively to all implementation costs incurred after the date of adoption. Early adoption is permitted, including adoption in an interim period. We doadopted this ASU prospectively on January 1, 2020, which did not expect that the ASU will have a material impact on our financial condition orand results of operations.

Accounting Standards Not Yet Adopted
In March 2019,June 2016, the FASB issued ASU No. 2019-01,2016-13, LeasesFinancial Instruments - Credit Losses (Topic 842)326): Codification ImprovementsMeasurement of Credit Losses on Financial Instruments. ThisThe standard replaces the "incurred loss" model with a "current expected credit loss" ("CECL") model. The CECL model applies to estimated credit losses on loans receivable, held-to-maturity debt securities, unfunded loan commitments, and certain other financial assets measured at amortized cost. The CECL model is based on lifetime expected losses, rather than incurred losses, and requires the recognition of credit loss expense in the consolidated statement of income and a related allowance for credit losses on the consolidated statement of condition at the time of origination or purchase of a loan receivable or held-to-maturity debt security. In addition, the CECL standard modifies the accounting for purchased loans and requires that an allowance for credit losses be established at the date of acquisition. However, for purchased financial assets with a more-than-insignificant amount of credit deterioration since origination (“PCD assets”) that are measured at amortized cost, the initial allowance for credit losses is added to the purchase price rather than being reported as a credit loss expense. Subsequent changes in the allowance for credit losses on PCD assets are recognized through credit loss expense.

Under ASU addresses two lessor implementation issues2016-13, available-for-sale debt securities are evaluated for impairment if fair value is less than amortized cost. Estimated credit losses are recorded through a credit loss expense and clarifiesan allowance, rather than a write-down of the investment. Changes in fair value that lessees and lessors are exempt from certain interim


not credit-related will continue to be recorded in other comprehensive income. The ASU also expands the disclosure requirements associated with adoptingregarding assumptions, models, and methods for estimating the allowance for credit losses. In addition, entities will disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. ASU 2016-02. The amendments related to the lessor implementation issues are2016-13 is effective for public business entities for fiscal years beginning after December 15, 2019, andincluding interim periods within those fiscal years. Early application is permitted. AsHowever, in accordance with the ASU's amendments applicable to us only relate to disclosures,accounting relief provisions of the Coronavirus Aid, Relief and Economic Security ("CARES") Act passed in March 2020, we postponed the adoption of ASU 2019-01the CECL standard. Implementation is delayed until the end of the national emergency or December 31, 2020, whichever occurs first.

Early CECL implementation activities focused on, among other things, capturing and validating data, segmenting the loan portfolio, evaluating various credit loss estimation methodologies, sourcing tools to forecast future economic conditions, running multiple loan loss driver analyses that correlate our credit loss experience with one or more economic factors, and evaluating the qualitative factor framework and assumptions. Based on these activities, we determined that our primary credit loss methodology will not impactutilize a discounted cash flow approach that considers the probability of default and loss given default. Ongoing implementation activities included refining forecast methodologies, running parallel calculations, evaluating and validating results, and documenting internal controls.
Page-8


The Bank has continued to run the CECL model in parallel with the incurred loss model and will adopt the CECL standard as of December 31, 2020. Upon adoption of the CECL standard, we will record a cumulative adjustment to retained earnings in our financial condition or resultsstatements, net of operations.taxes, based on economic forecasts and other assumptions as of January 1, 2020. That adjustment will result in an increase to our allowance for credit losses of approximately $1.6 million and an increase to the allowance for off-balance sheet commitments of approximately $122 thousand. These adjustments do not include the subsequent COVID-19 pandemic-related impact. Upon adoption on December 31, 2020, we will recognize the difference between the allowance for credit losses calculated under the CECL model as of December 31, 2020 and the allowance for credit losses calculated under the incurred loss model as of September 30, 2020 as a provision for credit losses and a provision for credit losses on off-balance sheet commitments, as applicable. Based on information available at this time, we do not expect the fourth quarter provision for credit losses to exceed 10% of the September 30, 2020 allowance for credit losses. However, the exact amount will depend on certain forecasts, such as the California unemployment rate, and other assumptions available as of December 31, 2020, which could differ significantly from present levels.

In April 2019, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments that clarifies and improves areas of guidance related to recently issued standards on credit losses, hedging and recognition and measurement.standards. The provisions of this ASU are effective January 1, 2020 and contain various methodsunder Topic 326 will be evaluated in conjunction with the adoption of adoption. WeASU 2016-13, however, we do not expect that the ASU willit to have a material impact on our financial condition orand results of operations. All other provisions under this ASU were adopted as of January 1, 2020 and did not impact our financial condition and results of operations.

In May 2019, the FASB issued ASU No. 2019-05, Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief. This ASU allows an option for entities to irrevocably elect the fair value option on an instrument-by-instrument basis for eligible financial assets measured at amortized cost basis upon adoption of the credit loss standards. This amendment provides relief for those entities electing the fair value option on newly originated or purchased financial assets, while maintaining existing similar financial assets at amortized cost, avoiding the requirement to maintain dual measurement methods for similar assets. The fair value option does not apply to held-to-maturity debt securities. The effective date for this ASU is the same as for ASU 2016-13, as discussed above. We will evaluate this ASU in conjunction with the adoption of ASU 2016-13 to determine its impact on our financial condition and results of operations. However, at this time we do not expect to elect the fair value option for our financial assets.

In November 2019, the FASB issued ASU No. 2019-11, Codification Improvements to Topic 326, Financial Instruments - Credit Losses. This ASU, among other narrow-scope improvements, clarifies guidance around how to report expected recoveries. “Expected recoveries” describes a situation in which an organization recognizes a full or partial write-off of the amortized cost basis of a financial asset, but then later determines that the amount written off, or a portion of that amount, will in fact be recovered. This ASU permits organizations to record expected recoveries on PCD assets. Additionally, this ASU reinforces existing guidance that prohibits organizations from recording negative allowances for available-for-sale debt securities. ASU 2019-11 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The amendments should be applied on a modified retrospective basis by means of a cumulative-effect adjustment to the opening retained earnings balance in the statement of financial position as of the date of adoption. The effective date for this ASU is the same as for ASU 2016-13, as discussed above. We will evaluate this ASU in conjunction with the adoption of ASU 2016-13 to determine its impact on our financial condition and results of operations.

Accounting Standards Not Yet Effective
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This ASU is intended to reduce the cost and complexity related to accounting for income taxes by removing certain exceptions to the guidance in Topic 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and simplifying aspects of the accounting for franchise taxes and enacted changes in tax laws or rates. This ASU is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. As this ASU is narrow in scope and applicability to us will likely be minimal, we do not expect that the ASU will have a material impact on our financial condition or results of operations.
In January 2020, the FASB issued ASU No. 2020-01, Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) - Clarifying the
Page-9

Interactions between Topic 321, Topic 323, and Topic 815. Among other things, this ASU clarifies that a company should consider observable transactions that require a company to either apply or discontinue the equity method of accounting under Topic 323,for the purposes of applying the measurement alternative in accordance with Topic 321. This ASU is effective for fiscal years beginning after December 15, 2020. Early adoption is permitted. ASU No. 2020-01 should be applied prospectively at the beginning of the interim period that includes adoption. We do not expect that the ASU will have a material impact on our financial condition or results of operations.
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848). The amendments in this ASU are elective and provide optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform. The amendments in this ASU provide optional expedients and exceptions for applying generally accepted accounting principles (GAAP) to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The amendments in this ASU may be elected as of March 12, 2020 through December 31, 2022. An entity may choose to elect the amendments in this update at an interim period subsequent to March 12, 2020 with adoption methods varying based on transaction type. We have not elected to apply these amendments, however, we will assess the applicability of the ASU to us and continue to monitor guidance for reference rate reform from FASB and its impact on our financial condition and results of operations.

In October 2020, the FASB issued ASU No. 2020-08, Codification Improvements to Subtopic 310-20, Receivables—Nonrefundable Fees and Other Costs. This ASU was issued as part of the Board's ongoing project to improve codification or correct unintended application. This ASU adds clarification to ASU 2017-08, which the Bank early adopted in 2017, and delineates whether an entity with callable debt securities that have multiple call dates should amortize the amount above that which is repayable, to the next call date. This ASU is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years, on a prospective basis. Early adoption is not permitted. As this ASU is narrow in scope and for clarification purposes, we do not expect this ASU will have a material impact on our financial condition and results of operations.

Note 3:  Fair Value of Assets and Liabilities
 
Fair Value Hierarchy and Fair Value Measurement
 
We group our assets and liabilities that are measured at fair value in three levels within the fair value hierarchy, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
 
Level 1: Valuations are based on unadjusted quoted prices in active markets for identical assets or liabilities.
 
Level 2: Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data.
 
Level 3: Valuations are based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Values are determined using pricing models and discounted cash flow models and may include significant Management judgment and estimation.

Transfers between levels of the fair value hierarchy are recognized through our monthly and/or quarterly valuation process in the reporting period during which the event or circumstances that caused the transfer occurred. No such transfers occurred during the first nine months of 2019 or 2018.

The following table summarizes our assets and liabilities that were required to be recorded at fair value on a recurring basis.

Page-10

(in thousands)  
Description of Financial Instruments
Carrying Value
Quoted Prices in Active Markets for Identical Assets (Level 1)
Significant Other Observable Inputs
(Level 2)

Significant Unobservable Inputs 
(Level 3)

Measurement Categories: Changes in Fair Value Recorded In1
September 30, 2019 
  
 
 
Securities available-for-sale:     
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies$245,603
$—
$245,603
$—
OCI
SBA-backed securities36,943
—
36,943
—
OCI
Debentures of government sponsored agencies23,822
—
23,822
—
OCI
Privately-issued collateralized mortgage obligations119
—
119
—
OCI
Obligations of state and political subdivisions50,232
—
50,232
—
OCI
Corporate bonds2,005
—
2,005
—
OCI
Derivative financial assets (interest rate contracts)—
—
—
—
NI
Derivative financial liabilities (interest rate contracts)1,603
—
1,603
—
NI
December 31, 2018 
  
 
 
Securities available-for-sale: 
  
 
 
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies$278,403
$—
$278,403
$—
OCI
SBA-backed securities50,781
—
50,781
—
OCI
Debentures of government sponsored agencies53,018
—
53,018
—
OCI
Privately-issued collateralized mortgage obligations297
—
297
—
OCI
Obligations of state and political subdivisions77,960
—
77,960
—
OCI
Corporate bonds2,005
—
2,005
—
OCI
Derivative financial assets (interest rate contracts)161
—
161
—
NI
Derivative financial liabilities (interest rate contracts)375
—
375
—
NI

(in thousands)  
Description of Financial Instruments
Carrying ValueQuoted Prices in Active Markets for Identical Assets (Level 1)Significant Other Observable Inputs
(Level 2)		Significant Unobservable Inputs 
(Level 3)
Measurement Categories: Changes in Fair Value Recorded In1
September 30, 2020    
Securities available-for-sale:    
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies$241,189 $0 $241,189 $0 OCI
SBA-backed securities32,844 0 32,844 0 OCI
Debentures of government sponsored agencies45,688 0 45,688 0 OCI
Obligations of state and political subdivisions93,743 0 93,743 0 OCI
Derivative financial liabilities (interest rate contracts)2,529 0 2,529 0 NI
December 31, 2019    
Securities available-for-sale:   
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies$278,144 $0 $278,144 $0 OCI
SBA-backed securities36,286 0 36,286 0 OCI
Debentures of government sponsored agencies49,046 0 49,046 0 OCI
Obligations of state and political subdivisions67,282 0 67,282 0 OCI
Corporate bonds1,502 0 1,502 0 OCI
Derivative financial liabilities (interest rate contracts)1,178 0 1,178 0 NI
 1 Other comprehensive income ("OCI") or net income ("NI").

Securities available-for-saleAvailable-for-sale securities are recorded at fair value on a recurring basis. When available, quoted market prices (Level 1) are used to determine the fair value of securities available-for-sale.available-for-sale securities. If quoted market prices are not available, we obtain pricing information from a reputable third-party service provider, who may utilize valuation techniques that use current market-based or independently sourced parameters, such as bid/ask prices, dealer-quoted prices, interest rates, benchmark yield curves, prepayment speeds, probability of default, loss severity and credit spreads (Level 2).   Level 2 securities include obligations of state and political subdivisions, U.S. agencies or government-sponsored agencies' debt securities, mortgage-backed securities, government agency-issued, privately-issued collateralized mortgage obligations, and corporate bonds. As of September 30, 20192020 and December 31, 2018,2019, there were 0 Level 1 or Level 3 securities.


Securities held-to-maturityHeld-to-maturity securities may be written down to fair value (determined using the same techniques discussed above for securities available-for-sale) as a result of other-than-temporary impairment, and we did not0t record any write-downs during the nine months ended September 30, 20192020 or September 30, 2018.2019. Fair value of held-to-maturity securities is determined using the same techniques discussed above for available-for-sale securities.
 
On a recurring basis, derivative financial instruments are recorded at fair value, which is based on the income approach using observable Level 2 market inputs, reflecting market expectations of future interest rates as of the measurement date.  Standard valuation techniques are used to calculate the present value of the future expected cash flows assuming an orderly transaction.  Valuation adjustments may be made to reflect both our own credit risk and the counterparties’ credit risk in determining the fair value of the derivatives. Level 2 inputs for the valuations are limited to observable market prices for London Interbank Offered Rate ("LIBOR") and Overnight Index Swap ("OIS") rates (for the very short term), quoted prices for LIBOR futures contracts, observable market prices for LIBOR and OIS swap rates, and one-month and three-month LIBOR basis spreads at commonly quoted intervals.  Mid-market pricing of the inputs is used as a practical expedient in the fair value measurements.  We project spot rates at reset days specified by each swap contract to determine future cash flows, then discount to present value using either LIBOR or OIS curves depending


on whether the swap positions are fully collateralized as of the measurement date.  When the value of any collateral placed with counterparties is less than the interest rate derivative liability, a credit valuation adjustment ("CVA") is applied to reflect the credit risk we pose to counterparties.  We have used the spread between the Standard & Poor's BBB rated U.S. Bank Composite rate and LIBOR for the closest maturity term corresponding to the duration of the swaps to derive the CVA. A similar credit risk adjustment, correlated to the credit standing of the counterparty, is made
Page-11

when collateral posted by the counterparty does not fully cover their liability to us. For further discussion on our methodology in valuing our derivative financial instruments, refer to Note 9, Derivative Financial Instruments and Hedging Activities.

Certain financial assets may be measured at fair value on a non-recurring basis. These assets are subject to fair value adjustments that result from the application of the lower of cost or fair value accounting or write-downs of individual assets, such as impaired loans that are collateral dependent and other real estate owned ("OREO"). As of September 30, 20192020 and December 31, 2018,2019, we did not0t carry any assets measured at fair value on a non-recurring basis.

Disclosures about Fair Value of Financial Instruments
 
The table below is a summary of fair value estimates for financial instruments as of September 30, 20192020 and December 31, 2018,2019, excluding financial instruments recorded at fair value on a recurring basis (summarized in the first table in this note). The carrying amounts in the following table are recorded in the consolidated statements of condition under the indicated captions. Further, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements such as bank-owned life insurance policies ("BOLI") and non-maturity deposit liabilities. Additionally, we holdheld shares of FHLBFederal Home Loan Bank ("FHLB") of San Francisco stock and Visa Inc. Class B common stock, both recorded at cost, as there was no impairment or changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer as of September 30, 2019 and2020 or December 31, 2018.2019. The values are discussed in Note 4, Investment Securities.
 September 30, 2020December 31, 2019
(in thousands)Carrying AmountsFair ValueFair Value HierarchyCarrying AmountsFair ValueFair Value Hierarchy
Financial assets (recorded at amortized cost)  
Cash and cash equivalents$213,584 $213,584 Level 1$183,388 $183,388 Level 1
Investment securities held-to-maturity117,350 123,983 Level 2137,413 139,642 Level 2
Loans, net2,085,877 2,106,790 Level 31,826,609 1,839,666 Level 3
Interest receivable11,014 11,014 Level 27,732 7,732 Level 2
Financial liabilities (recorded at amortized cost)  
Time deposits98,084 98,495 Level 297,810 97,859 Level 2
Subordinated debenture2,760 2,994 Level 32,708 3,182 Level 3
Interest payable122 122 Level 2134 134 Level 2
 September 30, 2019 December 31, 2018
(in thousands)Carrying Amounts
Fair Value
Fair Value Hierarchy Carrying Amounts
Fair Value
Fair Value Hierarchy
Financial assets (recorded at amortized cost)      
Cash and cash equivalents$182,486
$182,486
Level 1 $34,221
$34,221
Level 1
Investment securities held-to-maturity142,213
145,118
Level 2 157,206
153,894
Level 2
Loans, net1,782,450
1,792,192
Level 3 1,748,043
1,700,971
Level 3
Interest receivable7,037
7,037
Level 2 8,292
8,292
Level 2
Financial liabilities (recorded at amortized cost) 
    
 
Time deposits98,077
97,150
Level 2 117,182
116,584
Level 2
Federal Home Loan Bank overnight borrowings—
—
Level 2 7,000
7,000
Level 2
Subordinated debentures2,691
3,094
Level 3 2,640
3,268
Level 3
Interest payable120
120
Level 2 104
104
Level 2


Fair value of loans is based on exit price techniques and obtained from an independent third-party that uses its proprietary valuation model and methodology and may not reflect actual or prospective market valuations. The discounted cash flow valuation approach reflects key inputs and assumptions such as loan probability of default, loss given default, prepayment speed, and market discount rates.
Fair value of fixed-rate time deposits is estimated by discounting future contractual cash flows using discount rates that reflect the current market rates offered for time deposits of similar remaining maturities.
Fair value of the subordinated debenture is estimated using a discounted cash flow approach based on current interest rates for similar financial instruments adjusted for credit and liquidity spreads.
Commitments
 -
The value of unrecognized financial instruments is estimated based on the fee income associated with the commitments which, in the absence of credit exposure, is considered to approximate their settlement value. The fair value of commitment fees was not material as of September 30, 20192020 or December 31, 2018.2019.


Note 4:  Investment Securities
 
Our investment securities portfolio consists of obligations of state and political subdivisions, U.S. corporations, U.S. federal government agencies such as Government National Mortgage Association ("GNMA") and Small Business Administration ("SBA"), U.S. government-sponsored enterprise securitiesenterprises ("GSEs"), such as Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC"), Federal Farm Credit Banks Funding Corporation and FHLB. We also invest in residential and commercial mortgage-backed securities (“MBS”/"CMBS")
Page-12

and collateralized mortgage obligations (“CMOs”) issued or guaranteed by the GSEs, and privately issued CMOs, as reflected in the following table:

September 30, 2020December 31, 2019
AmortizedFairGross UnrealizedAmortizedFairGross Unrealized
(in thousands)CostValueGains(Losses)CostValueGains(Losses)
Held-to-maturity:
Securities of U.S. government-sponsored enterprises:
MBS pass-through securities issued by FHLMC and FNMA$69,797 $73,884 $4,087 $0 $80,451 $81,325 $1,018 $(144)
SBA-backed securities6,5496,979430 0 7,999 8,264 265 0 
CMOs issued by FNMA8,4408,834394 0 10,210 10,492 282 0 
CMOs issued by FHLMC29,65731,3311,674 0 31,477 32,157 685 (5)
CMOs issued by GNMA1,2301,2355 0 3,763 3,816 53 0 
Obligations of state and
political subdivisions		1,6771,72043 0 3,513 3,588 75 0 
Total held-to-maturity117,350123,9836,6330 137,413 139,642 2,378 (149)
Available-for-sale:
Securities of U.S. government-sponsored enterprises:
MBS pass-through securities issued by FHLMC and FNMA56,67959,4822,8030 98,502 100,071 1,617 (48)
SBA-backed securities31,05732,8441,844 (57)35,674 36,286 688 (76)
CMOs issued by FNMA18,28518,9616760 22,702 23,092 390 0 
CMOs issued by FHLMC144,600153,2558,656(1)139,398 143,226 3,892 (64)
CMOs issued by GNMA9,0649,491427 0 11,719 11,755 42 (6)
Debentures of government- sponsored agencies45,23945,688449 0 48,389 49,046 727 (70)
Obligations of state and
political subdivisions		89,51393,7434,2300 66,042 67,282 1,386 (146)
Corporate bonds0000 1,497 1,502 6 (1)
Total available-for-sale394,437413,46419,085(58)423,923 432,260 8,748 (411)
Total investment securities$511,787 $537,447 $25,718 $(58)$561,336 $571,902 $11,126 $(560)

 September 30, 2019 December 31, 2018
 AmortizedFairGross Unrealized AmortizedFairGross Unrealized
(in thousands)CostValueGains(Losses) CostValueGains(Losses)
Held-to-maturity:         
Securities of U.S. government-sponsored enterprises:         
MBS pass-through securities issued by FHLMC and FNMA$80,166
$81,308
$1,357
$(215)
$88,606
$85,804
$7
$(2,809)
SBA-backed securities8,001
8,360
359
—
 8,720
8,757
37
—
CMOs issued by FNMA10,679
10,981
302
—
 11,447
11,327
—
(120)
CMOs issued by FHLMC32,568
33,524
966
(10) 33,583
33,021
8
(570)
CMOs issued by GNMA3,757
3,810
53
—
 3,739
3,769
30
—
Obligations of state and
political subdivisions
7,042
7,135
93
—
 11,111
11,216
128
(23)
Total held-to-maturity142,213
145,118
3,130
(225)
157,206
153,894
210
(3,522)
Available-for-sale:         
Securities of U.S. government-sponsored enterprises:         
MBS pass-through securities issued by FHLMC and FNMA62,654
64,290
1,683
(47)
95,339
94,467
358
(1,230)
SBA-backed securities36,014
36,943
990
(61) 50,722
50,781
465
(406)
CMOs issued by FNMA24,168
24,560
392
—

28,275
28,079
134
(330)
CMOs issued by FHLMC138,731
144,067
5,374
(38)
145,979
144,836
454
(1,597)
CMOs issued by GNMA12,621
12,686
66
(1)
11,294
11,021
1
(274)
Debentures of government- sponsored agencies23,069
23,822
753
—

52,956
53,018
185
(123)
Privately issued CMOs120
119
—
(1)
295
297
2
—
Obligations of state and
political subdivisions
48,993
50,232
1,292
(53)
79,046
77,960
134
(1,220)
Corporate bonds1,999
2,005
7
(1)
2,004
2,005
15
(14)
Total available-for-sale348,369
358,724
10,557
(202)
465,910
462,464
1,748
(5,194)
Total investment securities$490,582
$503,842
$13,687
$(427)
$623,116
$616,358
$1,958
$(8,716)


The amortized cost andfair value of investment debt securities by contractual maturity at September 30, 20192020 and December 31, 20182019 are shown in the following table below. Expected maturities may differ from contractual maturities if the issuers of the securities have the right to call or prepay obligations with or without call or prepayment penalties.
 September 30, 2020December 31, 2019
 Held-to-MaturityAvailable-for-SaleHeld-to-MaturityAvailable-for-Sale
(in thousands)Amortized CostFair ValueAmortized CostFair ValueAmortized CostFair ValueAmortized CostFair Value
Within one year$247 $252 $14,235 $14,452 $1,807 $1,811 $6,699 $6,706 
After one but within five years8,974 9,539 60,958 64,559 2,256 2,296 48,706 49,619 
After five years through ten years52,373 56,139 164,815 174,439 56,221 57,544 208,806 214,277 
After ten years55,756 58,053 154,429 160,014 77,129 77,991 159,712 161,658 
Total$117,350 $123,983 $394,437 $413,464 $137,413 $139,642 $423,923 $432,260 
 September 30, 2019 December 31, 2018
 Held-to-Maturity Available-for-Sale Held-to-Maturity Available-for-Sale
(in thousands)Amortized CostFair Value Amortized CostFair Value Amortized CostFair Value Amortized CostFair Value
Within one year$5,327
$5,335
 $5,475
$5,478
 $6,194
$6,182
 $9,863
$9,795
After one but within five years2,269
2,318
 57,102
58,144
 5,481
5,492
 84,871
84,435
After five years through ten years56,183
58,018
 188,601
195,869
 59,231
58,120
 252,274
250,055
After ten years78,434
79,447
 97,191
99,233
 86,300
84,100
 118,902
118,179
Total$142,213
$145,118
 $348,369
$358,724
 $157,206
$153,894
 $465,910
$462,464


Sales of investment securities and gross gains and losses are shown in the following table.table:
 Three months endedNine months ended
(in thousands)September 30, 2020September 30, 2019September 30, 2020September 30, 2019
Available-for-sale:
Sales proceeds$0 $0 $33,756 $66,081 
Gross realized gains0 0 916 214 
Gross realized losses0 0 (1)(159)
 Three months ended Nine months ended
(in thousands)September 30, 2019September 30, 2018 September 30, 2019September 30, 2018
Available-for-sale:     
Sales proceeds$—
$11,966
 $66,081
$16,972
Gross realized gains—
—
 214
27
Gross realized losses—
(90) (159)(106)






Page-13


Pledged investment securities are shown in the following table.table:
(in thousands)September 30, 2020December 31, 2019
Pledged to the State of California:
Secure public deposits in compliance with the Local Agency Security Program$102,396 $126,598 
Collateral for trust deposits752 742 
Total investment securities pledged to the State of California103,148 127,340 
Collateral for Wealth Management and Trust Services checking account629 622 
Total pledged investment securities$103,777 $127,962 
(in thousands)September 30, 2019December 31, 2018
Pledged to the State of California:  
Secure public deposits in compliance with the Local Agency Security Program$84,574
$125,696
Collateral for trust deposits745
734
Total investment securities pledged to the State of California$85,319
$126,430
Collateral for Wealth Management and Trust Services checking account$625
$2,000


Other-Than-Temporarily Impaired ("OTTI") Debt Securities
 
There were 378 and 22940 securities in unrealized loss positions at September 30, 20192020 and December 31, 2018,2019, respectively. Those securities are summarized and classified according to the duration of the loss period in the tables below:
September 30, 2020< 12 continuous months≥ 12 continuous monthsTotal securities
in a loss position
(in thousands)Fair valueUnrealized lossFair valueUnrealized lossFair valueUnrealized loss
Available-for-sale:
SBA-backed securities$0 $0 $1,900 $(57)$1,900 $(57)
CMOs issued by FHLMC2,014 (1)0 0 2,014 (1)
Total available-for-sale2,014 (1)1,900 (57)3,914 (58)
Total temporarily impaired securities$2,014 $(1)$1,900 $(57)$3,914 $(58)
September 30, 2019< 12 continuous months ≥ 12 continuous months 
Total securities
 in a loss position
December 31, 2019December 31, 2019< 12 continuous months≥ 12 continuous monthsTotal securities
in a loss position
(in thousands)Fair valueUnrealized loss Fair valueUnrealized loss Fair valueUnrealized loss(in thousands)Fair valueUnrealized lossFair valueUnrealized lossFair valueUnrealized loss
Held-to-maturity:     Held-to-maturity:
MBS pass-through securities issued by FHLMC and FNMA$9,063
$(24) $23,799
$(191) $32,862
$(215)MBS pass-through securities issued by FHLMC and FNMA$14,203 $(60)$6,073 $(84)$20,276 $(144)
CMOs issued by FHLMC—
—
 1,866
(10) 1,866
(10)CMOs issued by FHLMC0 0 1,725 (5)1,725 (5)
Total held-to-maturity9,063
(24) 25,665
(201) 34,728
(225)Total held-to-maturity14,203 (60)7,798 (89)22,001 (149)
Available-for-sale:     Available-for-sale:
MBS pass-through securities issued by FHLMC and FNMA269
(1) 7,628
(46) 7,897
(47)MBS pass-through securities issued by FHLMC and FNMA4,367 (34)4,464 (14)8,831 (48)
SBA-backed securities—
—
 2,785
(61) 2,785
(61)SBA-backed securities9,227 (14)2,448 (62)11,675 (76)
CMOs issued by FNMA—
—
 —
—
 —
—
CMOs issued by FHLMC7,735
(13) 9,722
(25) 17,457
(38)CMOs issued by FHLMC14,918 (58)2,981 (6)17,899 (64)
CMOs issued by GNMA—
—
 130
(1) 130
(1)CMOs issued by GNMA7,139 (6)0 0 7,139 (6)
Privately issued CMOs79
(1) —
—
 79
(1)
Debentures of government- sponsored agenciesDebentures of government- sponsored agencies25,228 (70)0 0 25,228 (70)
Obligations of state and political subdivisions6,936
(49) 966
(4) 7,902
(53)Obligations of state and political subdivisions20,579 (145)659 (1)21,238 (146)
Corporate bonds—
—
 504
(1) 504
(1)
Corporate BondsCorporate Bonds500 (1)0 0 500 (1)
Total available-for-sale15,019
(64) 21,735
(138) 36,754
(202)Total available-for-sale81,958 (328)10,552 (83)92,510 (411)
Total temporarily impaired securities$24,082
$(88) $47,400
$(339) $71,482
$(427)Total temporarily impaired securities$96,161 $(388)$18,350 $(172)$114,511 $(560)


December 31, 2018< 12 continuous months ≥ 12 continuous months 
Total securities
 in a loss position
(in thousands)Fair valueUnrealized loss Fair valueUnrealized loss Fair valueUnrealized loss
Held-to-maturity:        
MBS pass-through securities issued by FHLMC and FNMA$198
$(9) $83,990
$(2,800) $84,188
$(2,809)
CMOs issued by FNMA—
—
 11,327
(120) 11,327
(120)
CMOs issued by FHLMC2,880
(3) 28,171
(567) 31,051
(570)
Obligations of state and political subdivisions—
—
 3,565
(23) 3,565
(23)
Total held-to-maturity3,078
(12) 127,053
(3,510) 130,131
(3,522)
Available-for-sale:



 



 



MBS pass-through securities issued by FHLMC and FNMA19,971
(128) 50,077
(1,102) 70,048
(1,230)
SBA-backed securities13,175
(122) 20,123
(284) 33,298
(406)
CMOs issued by FNMA2,345
(8) 16,138
(322) 18,483
(330)
CMOs issued by FHLMC24,094
(330) 74,243
(1,267) 98,337
(1,597)
CMOs issued by GNMA1,666
(7) 9,112
(267) 10,778
(274)
Debentures of government- sponsored agencies4,992
(8) 11,349
(115) 16,341
(123)
Obligations of state and political subdivisions15,290
(54) 52,804
(1,166) 68,094
(1,220)
Corporate Bonds—
—
 1,004
(14) 1,004
(14)
Total available-for-sale81,533
(657) 234,850
(4,537) 316,383
(5,194)
Total temporarily impaired securities$84,611
$(669) $361,903
$(8,047) $446,514
$(8,716)


As of September 30, 2019,2020, the investment portfolio included 255 investment securities that had been in a continuous loss position for twelve months or more and 123 investment securities that had been in a loss position for less than twelve months.

Securities issued by government-sponsored agencies, such as FNMA and FHLMC, usually have implicit credit support by the U.S. federal government. However, since 2008, FNMA and FHLMC have been under government conservatorship and, therefore, contractual cash flows for these investments carry explicit guarantees by the U.S. federal government. Securities issued by the SBA and GNMA have explicit credit guarantees by the U.S. federal government, which protects us from credit losses on the contractual cash flows of the securities.
Other temporarily impaired securities, including
Page-14

We routinely perform internal analyses of latest financial information of the issuers of obligations of state and political subdivisions, and corporate bonds, were deemed credit worthy after our internal analyses of the issuers’ latest financial information,their credit ratings by major credit agencies, and/or credit enhancements. Based on our comprehensive analyses, we determined that the decline in the fair values of these securities wasobligations of state and political subdivisions and corporate bonds as of December 31, 2019 were primarily driven by factors other than credit, such as changes in market interest rates and liquidity spreads subsequent to purchase. At September 30, 2019,2020, Management determined that it did not intend to sell any investment securities with unrealized losses, and it is more likely than not that we will not be required to sell any of the securities with unrealized losses before recovery of their amortized cost. Therefore, we do not consider these investment securities to be other-than-temporarily impaired at September 30, 2019.2020.
Non-Marketable Securities Included in Other Assets

As a member of the FHLB, we are required to maintain a minimum investment in FHLB capital stock determined by the Board of Directors of the FHLB. The minimum investment requirements can increase in the event we increase our total asset size or borrowings with the FHLB. Shares cannot be purchased or sold except between the FHLB and its members at the $100 per share par value. We held $11.7$11.9 million and $11.1$11.7 million of FHLB stock included in other assets on the consolidated statements of condition at September 30, 20192020 and December 31, 2018,2019, respectively. The carrying amounts of these investments are reasonable estimates of fair value because the securities are restricted to member banks and they do not have a readily determinable market value. Based on our analysis of FHLB's financial condition and certain qualitative factors, we determined that the FHLB stock was not impaired at September 30, 20192020 and December 31, 2018.2019. On October 24, 2019,29, 2020, FHLB announced a cash dividend for the secondthird quarter of 20192020 at an annualized dividend rate of 7.00%5.00% to be distributed in mid-November 2019.2020. Cash dividends paid on FHLB capital stock are recorded as non-interest income.



As a member bank of Visa U.S.A., we held 10,439 shares of Visa Inc. Class B common stock at September 30, 20192020 and December 31, 2018.2019. These shares have a carrying value of 0 and are restricted from resale to non-member banks of Visa U.S.A. until their conversion into Class A (voting) shares upon the termination of Visa Inc.'s Covered Litigation escrow account. Because of the restriction and the uncertainty on the conversion rate to Class A shares, these shares lack a readily determinable fair value. When converting this Class B common stock to Class A common stock based on the conversion rate of 1.6228 both at September 30, 20192020 and 1.6298 at December 31, 2018,2019, and the closing stock price of Class A shares at those respective dates, the converted value of our shares of Class B common stock would have been $2.9$3.4 million and $2.2$3.2 million at September 30, 20192020 and December 31, 2018,2019, respectively. The conversion rate is subject to further adjustment upon the final settlement of the covered litigation against Visa Inc. and its member banks. As such, the fair value of these Class B shares can differ significantly from their converted values. For further information, refer to Note 8, Commitments and Contingencies.

We invest in low-income housing tax credit funds as a limited partner, which totaled $4.2$3.7 million and $4.6$4.1 million recorded in other assets as of September 30, 20192020 and December 31, 2018,2019, respectively. In the first nine months of 2019,2020, we recognized $480$490 thousand of low-income housing tax credits and other tax benefits, offset by $381$412 thousand of amortization expense of low-income housing tax credit investment, as a component of income tax expense. As of September 30, 2019,2020, our unfunded commitments for these low-income housing tax credit funds totaled $2.8 million.$886 thousand. We did not0t recognize any impairment losses on these low-income housing tax credit investments during the first nine months of 20192020 or 2018,2019, as the value of the future tax benefits exceeds the carrying value of the investments.

Note 5:  Loans and Allowance for Loan Losses

Credit Quality of Loans
 
The following table shows outstanding loans by class and payment aging as of September 30, 2019 and December 31, 2018.
Loan Aging Analysis by Class
(in thousands)Commercial and industrial
Commercial real estate, owner-occupied
Commercial real estate, investor
Construction
Home equity
Other residential
Installment and other consumer
Total
September 30, 2019 
 
 
 
 
 
 
 
 30-59 days past due$—
$—
$—
$—
$440
$—
$153
$593
 60-89 days past due—
—
—
—
94
—
—
94
 90 days or more past due20
—
—
—
73
—
—
93
Total past due20
—
—
—
607
—
153
780
Current260,808
310,486
896,066
50,254
121,207
130,781
28,308
1,797,910
Total loans 2
$260,828
$310,486
$896,066
$50,254
$121,814
$130,781
$28,461
$1,798,690
Non-accrual loans 1
$195
$—
$—
$—
$167
$—
$60
$422
December 31, 2018 
 
 
 
 
 
 
 
 30-59 days past due$5
$—
$1,004
$—
$—
$—
$112
$1,121
 60-89 days past due—
—
—
—
—
—
—
—
 90 days or more past due—
—
—
—
—
—
—
—
Total past due5
—
1,004
—
—
—
112
1,121
Current230,734
313,277
872,406
76,423
124,696
117,847
27,360
1,762,743
Total loans 2
$230,739
$313,277
$873,410
$76,423
$124,696
$117,847
$27,472
$1,763,864
Non-accrual loans 1
$319
$—
$—
$—
$313
$—
$65
$697

1 Includes 0 purchased credit impaired ("PCI") loans at September 30, 20192020 and December 31, 2018. Amounts exclude accreting PCI loans with carrying values totaling $2.1 million at September 30, 2019 and December 31, 2018, as we have a reasonable expectation about future cash flows to be collected and we continue to recognize accretable yield on these loans in interest income. There were 0 accruing loans past due more than ninety days at September 30, 2019 or December 31, 2018.2019.
Page-15

Loan Aging Analysis by Class
(in thousands)Commercial and industrialCommercial real estate, owner-occupiedCommercial real estate, investor-ownedConstructionHome equityOther residentialInstallment and other consumerTotal
September 30, 2020        
 30-59 days past due$198 $0 $0 $0 $217 $0 $0 $415 
 60-89 days past due0 0 0 0 276 — 7 283 
 90 days or more past due0 0 0 0 0 0 0 0 
Total past due198 0 0 0 493 0 7 698 
Current512,775 299,754 966,517 66,663 106,871 130,915 23,798 2,107,293 
Total loans 1
$512,973 $299,754 $966,517 $66,663 $107,364 $130,915 $23,805 $2,107,991 
Non-accrual loans 2
$0 $0 $886 $0 $532 $0 $24 $1,442 
December 31, 2019        
 30-59 days past due$1 $0 $1,001 $0 $279 $0 $7 $1,288 
 60-89 days past due0 0 0 0 98 0 95 193 
 90 days or more past due0 0 0 0 167 0 0 167 
Total past due1 0 1,001 0 544 0 102 1,648 
Current246,686 308,824 945,316 61,095 115,480 136,657 27,580 1,841,638 
Total loans 1
$246,687 $308,824 $946,317 $61,095 $116,024 $136,657 $27,682 $1,843,286 
Non-accrual loans 2
$0 $0 $0 $0 $168 $0 $58 $226 
21 Amounts include net deferred loan origination (fees) costs of $980 thousand$(5.1) million (including $6.5 million in deferred SBA PPP loan fees, net of costs) and $635$983 thousand at September 30, 20192020 and December 31, 2018,2019, respectively. Amounts are also net of unaccreted purchase discounts on non-PCI loans of $669 thousand and $708$878 thousand at September 30, 20192020 and $983 thousand at December 31, 2018, respectively.2019.
2 There were 0 loans past due more than ninety days accruing interest at September 30, 2020 or December 31, 2019.

We generally make commercial loans to established small and mid-sized businesses to provide financing for their growth and working capital needs, equipment purchases and acquisitions.  Management examines historical, current, and projected cash flows to determine the ability of the borrower to repay obligations as agreed. Commercial loans are made based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral and guarantor support. The cash flows of borrowers, however, may not occur as expected, and the collateral securing


these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed, such as accounts receivable and inventory, and typically include personal guarantees. We target stable businesses with guarantors who provide additional sources of repayment and have proven to be resilient in periods of economic stress.

Pursuant to the CARES Act, the Bank funded over 1,800 loans to eligible small businesses and non-profit organizations who participated in the Paycheck Protection Program (“PPP”) administered by the U.S. Small Business Administration (“SBA”). PPP loans have terms of two to five years and earn interest at 1%. In addition, the Bank received a fee of 1%-5% from the SBA depending on the loan amount, which was netted with loan origination costs and amortized into interest income under the effective yield method over the contractual life of the loan. The recognition of fees and costs is accelerated when the loan is forgiven by the SBA and/or paid off prior to maturity. PPP loans are fully guaranteed by the SBA and are expected to be forgiven by the SBA if they meet the requirements of the program. PPP loans totaling $301.7 million at September 30, 2020 are included in commercial and industrial loan balances. The Bank ended its origination of new PPP loans on June 30, 2020. On June 5, 2020, the PPP Flexibility Act was signed into law that modified, among other things, rules governing the PPP payment deferral period. In October 2020, due to the continued delay in the PPP forgiveness process, the Bank modified the first payment due dates for PPP loans that originated prior to June 5, 2020 and extended the payment deferral period from six to sixteen months. The extended payment deferral period will affect the timing over which the accretion of PPP net loan origination fees are recognized.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans discussed above. We underwrite these loans to be repaid from cash flow and to be supported by real property collateral. Underwriting standards for commercial real estate loans include, but are not limited to, debt coverage and loan-to-value ratios. Furthermore, a large majority of our loans are guaranteed by the owners of the properties. Conditions in the real estate markets or in the general economy may adversely affect our commercial real estate loans. In the event of a vacancy, we expect guarantors to carry the loans until they find a replacement tenant.  The owner's substantial equity investment provides a strong economic incentive to continue to support the commercial real estate projects. As such, we have generally experienced a relatively low level of loss and delinquencies in this portfolio.
Page-16


Construction loans are generally made to developers and builders to finance construction, renovation and occasionally land acquisitions in anticipation of near-term development. Construction loan borrowers provide forloans include interest reserves that are used for the payment of interest during the development and marketing periods.periods and are capitalized as part of the loan balance. When a construction loan is placed on nonaccrual status before the depletion of the interest reserve, we apply the interest funded by the interest reserve against the loan's principal balance. These loans are underwritten after evaluation of the borrower's financial strength, reputation, prior track record, and independent appraisals. We monitor all construction projects to determine whether they are on schedule, completed as planned and in accordance with the approved construction budgets. Significant events can affect the construction industry, including: the inherent volatility of real estate markets and vulnerability to delays due to weather, change orders, inability to obtain construction permits, labor or material shortages, and price changes. Estimates of construction costs and value associated with the completed project may be inaccurate. Repayment of construction loans is largely dependent on the ultimate success of the project.
 
Consumer loans primarily consist of home equity lines of credit, other residential loans and floating homes, along with a small number of installment loans. Our other residential loans include tenancy-in-common fractional interest loans ("TIC") located almost entirely in San Francisco County. We originate consumer loans utilizing credit score information, debt-to-income ratio and loan-to-value ratio analysis. Diversification among consumer loan types, coupled with relatively small loan amounts that are spread across many individual borrowers, mitigates risk. We do not originate sub-prime residential mortgage loans, nor is it our practice to underwrite loans commonly referred to as "Alt-A mortgages," the characteristics of which are reduced documentation, borrowers with low FICO scores or collateral with high loan-to-value ratios.

We use a risk rating system to evaluate asset quality, and to identify and monitor credit risk in individual loans, and in the loan portfolio. Our definitions of “Special Mention” risk graded loans, or worse, are consistent with those used by the Federal Deposit Insurance Corporation ("FDIC").  Our internally assigned grades are as follows:
 
Pass and Watch: Loans to borrowers of acceptable or better credit quality. Borrowers in this category demonstrate fundamentally sound financial positions, repayment capacity, credit history, and management expertise.  Loans in this category must have an identifiable and stable source of repayment and meet the Bank’s policy regarding debt-service-coverage ratios.  These borrowers are capable of sustaining normal economic, market or operational setbacks without significant financial consequences.  Negative external industry factors are generally not present.  The loan may be secured, unsecured or supported by non-real estate collateral for which the value is more difficult to determine and/or marketability is more uncertain. This category also includes “Watch” loans, where the primary source of repayment has been delayed. “Watch” is intended to be a transitional grade, with either an upgrade or downgrade within a reasonable period.
 
Special Mention: Potential weaknesses that deserve close attention. If left uncorrected, those potential weaknesses may result in deterioration of the payment prospects for the asset. Special Mention assets do not present sufficient risk to warrant adverse classification.
 
Substandard: Inadequately protected by either the current sound worth and paying capacity of the obligor or the collateral pledged, if any. A Substandard asset has a well-defined weakness or weaknesses that jeopardize(s) the liquidation of the debt. Substandard assets are characterized by the distinct possibility that we will sustain some loss if such weaknesses or deficiencies are not corrected. Well-defined weaknesses include adverse trends or developments of the borrower’s financial condition, managerial weaknesses and/or significant collateral deficiencies.


 
Doubtful: Critical weaknesses that make collection or liquidation in full improbable. There may be specific pending events that work to strengthen the asset; however, the amount or timing of the loss may not be determinable. Pending events generally occur within one year of the asset being classified as Doubtful. Examples include: merger, acquisition, or liquidation; capital injection; guarantee; perfecting liens on additional collateral; and refinancing. Such loans are placed on non-accrual status and usually are collateral-dependent.

We regularly review our credits for accuracy of risk grades whenever we receive new information. Borrowers are generally required to submit financial information at regular intervals. Typically, commercial borrowers with lines of credit are required to submit financial information with reporting intervals ranging from monthly to annually depending on credit size, risk and complexity. In addition, investor commercial real estate borrowers with loans exceeding a certain dollar threshold are usually required to submit rent rolls or property income statements annually.
Page-17

We monitor construction loans monthly. We review home equity and other consumer loans based on delinquency. We also review loans graded “Watch” or worse, regardless of loan type, no less than quarterly.

The following table represents an analysis of the carrying amount in loans, net of deferred fees and costs and purchase premiums or discounts, by internally assigned risk grades, including PCI loans, at September 30, 20192020 and December 31, 2018.2019.
Credit Risk Profile by Internally Assigned Risk Grade
(in thousands)Commercial and industrial
Commercial real estate, owner-occupied
Commercial real estate, investor
Construction
Home equity
Other residential
Installment and other consumer
Purchased credit-impaired
Total
September 30, 2019         
Pass$219,346
$290,074
$893,574
$50,254
$120,400
$130,781
$28,313
$2,059
$1,734,801
Special Mention41,092
10,198
1,664
—
1,000
—
—
—
53,954
Substandard386
9,061
—
—
340
—
148
—
9,935
Total loans$260,824
$309,333
$895,238
$50,254
$121,740
$130,781
$28,461
$2,059
$1,798,690
December 31, 2018 
 
 
 
 
 
 
 
 
Pass$219,625
$299,998
$870,443
$73,735
$122,844
$117,847
$27,312
$2,112
$1,733,916
Special Mention9,957
4,106
2,156
—
1,121
—
—
—
17,340
Substandard1,126
7,986
—
2,688
648
—
160
—
12,608
Total loans$230,708
$312,090
$872,599
$76,423
$124,613
$117,847
$27,472
$2,112
$1,763,864

Credit Risk Profile by Internally Assigned Risk Grade
(in thousands)Commercial and industrialCommercial real estate, owner-occupiedCommercial real estate, investor-ownedConstructionHome equityOther residentialInstallment and other consumerTotal
September 30, 2020        
Pass$484,305 $251,741 $946,166 $66,663 $105,824 $130,915 $23,665 $2,009,279 
Special Mention28,544 41,010 17,359 0 800 0 0 87,713 
Substandard124 7,003 2,992 0 740 0 140 10,999 
Total loans$512,973 $299,754 $966,517 $66,663 $107,364 $130,915 $23,805 $2,107,991 
December 31, 2019        
Pass$209,213 $264,766 $945,757 $61,095 $114,935 $136,657 $27,538 $1,759,961 
Special Mention37,065 35,016 560 0 750 0 0 73,391 
Substandard409 9,042 0 0 339 0 144 9,934 
Total loans$246,687 $308,824 $946,317 $61,095 $116,024 $136,657 $27,682 $1,843,286 
 
Troubled Debt Restructuring
 
Our loan portfolio includes certain loans modified in a troubled debt restructuring (“TDR”), where we have granted economic concessions to borrowers experiencing financial difficulties. These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. TDRs on non-accrual status at the time of restructure may be returned to accruing status after Management considers the borrower’s sustained repayment performance for a reasonable period, generally nine months, and obtains reasonable assurance of repayment and performance.
 
We may remove a loan from TDR designation if it meets all of the following conditions:
•The loan is subsequently refinanced or restructured at current market interest rates and the new terms are consistent with the treatment of creditworthy borrowers under regular underwriting standards;
•The borrower is no longer considered to be in financial difficulty;
•Performance on the loan is reasonably assured; and
•Existing loan did not have any forgiveness of principal or interest.

The same Management level that approved the loan classification upgrade must approve the removal of TDR status. After meeting all ofThere were 0 loans removed from TDR designation during the conditions above, therenine months ended September 30, 2020. There was 1 commercial loan with a recorded investment of $3 thousand removed from TDR designation during the nine months ended September 30, 2019. There were2019 after meeting all of the conditions above.

Section 4013 of the CARES Act provided optional, temporary relief from evaluating loans that may have been considered TDRs under GAAP. This relief applies to loan modifications executed between March 1, TIC2020 and the earlier of 60 days after the national emergency is terminated or December 31, 2020. The Bank elected to apply these temporary accounting provisions to payment relief loans beginning in March 2020. The Bank approved 264 loan modifications for full payment deferral or interest-only payments for up to 120 days on loan balances exceeding $388.5 million. As of October 19, 2020, 20 loans totaling $47.2 million had either requested additional payment relief or the relief period had not expired. We accrue and 1 home equity loan with recorded investments totaling $247 thousand removed from TDR designation duringrecognize interest income on loans under payment relief based on the nine months ended September 30, 2018.original contractual interest rates. When payments resume at the end of the relief period, the payments will generally be applied to accrued interest due until accrued interest is fully paid.


Page-18

The following table summarizes the carrying amount of TDR loans by loan class as of September 30, 20192020 and December 31, 2018.2019.
(in thousands) (in thousands)
Recorded Investment in Troubled Debt Restructurings 1
September 30, 2019
December 31, 2018
Recorded Investment in Troubled Debt Restructurings 1
September 30, 2020December 31, 2019
Commercial and industrial$1,139
$1,506
Commercial and industrial$1,017 $1,223 
Commercial real estate, owner-occupied6,999
6,993
Commercial real estate, owner-occupied7,003 6,998 
Commercial real estate, investor1,786
1,821
Construction880
2,688
Commercial real estate, investor-ownedCommercial real estate, investor-owned3,309 1,770 
Home equity251
251
Home equity527 251 
Other residential454
462
Other residential0 452 
Installment and other consumer653
685
Installment and other consumer769 639 
Total$12,162
$14,406
Total$12,625 $11,333 
1There was 1 acquired home equity TDR loan with a recorded investment of $276 thousand as of September 30, 2020. There were 0 acquired TDR loans as of September 30, 2019 or December 31, 2018.2019. TDR loans on non-accrual status totaled $233$300 thousand and $65$58 thousand at September 30, 20192020 and December 31, 2018,2019, respectively.

The following table presents information for loans modified in a TDR during the presented periods, including the number of modified contracts, the recorded investment in the loans prior to modification, and the recorded investment in the loans at period end after being restructured. The table excludes fully charged-off TDR loans and loans modified in a TDR and subsequently paid-off during the years presented.presented, if applicable.
(dollars in thousands)Number of Contracts ModifiedPre-Modification Outstanding Recorded InvestmentPost-Modification Outstanding Recorded InvestmentPost-Modification Outstanding Recorded Investment at Period End
TDRs during the three months ended September 30, 2020:   
Commercial real estate, investor-owned1$1,553 $1,553 $1,553 
TDRs during the three months ended September 30, 2019:   
None0$0 $0 $0 
TDRs during the nine months ended September 30, 2020:
Commercial and industrial1$170 $162 $125 
Commercial real estate, investor-owned11,553 1,553 1,553 
Home equity1276 276 276 
Installment and other consumer3211 211 209 
6$2,210 $2,202 $2,163 
TDRs during the nine months ended September 30, 2019:
Commercial and industrial1$298 $298 $173 
(dollars in thousands)Number of Contracts Modified
Pre-Modification Outstanding Recorded Investment
Post-Modification Outstanding Recorded Investment
Post-Modification Outstanding Recorded Investment at Period End
TDRs during the three months ended September 30, 2019:
None—
$—
$—
$—
TDRs during the three months ended September 30, 2018:




None—
$—

$—
$—
TDRs during the nine months ended September 30, 2019:    
Commercial and industrial1
$298
$298
$173
TDRs during the nine months ended September 30, 2018: 
 
 
 
Commercial and industrial2
$254
$245
$235

The loans modified in 2020 reflected debt consolidation, interest rate concessions, and/or other loan term and payment modifications. The loan modified during the first nine months ended September 30,of 2019 reflected a maturity extension and interest rate concession. The 2 loans modified duringDuring the nine months ended September 30, 2018 were to the same borrower2020 and included maturity extensions and other changes in loan terms. During the nine months ended September 30, 2019, and 2018, there were 0 defaults on loans that had been modified in a TDR within the prior twelve-month period. We report defaulted TDRs based on a payment default definition of more than ninety days past due.

Page-19

Impaired Loans

The following tables summarize information by class on impaired loans and their related allowances. Total impaired loans include non-accrual loans and accruing TDR loansloans.
(in thousands)Commercial and industrialCommercial real estate, owner-occupiedCommercial real estate, investor-ownedConstructionHome equityOther residentialInstallment and other consumerTotal
September 30, 2020       
Recorded investment in impaired loans:      
With no specific allowance recorded$291 $0 $885 $0 $532 $0 $89 $1,797 
With a specific allowance recorded726 7,003 3,310 0 251 0 680 11,970 
Total recorded investment in impaired loans$1,017 $7,003 $4,195 $0 $783 $0 $769 $13,767 
Unpaid principal balance of impaired loans$1,012 $6,993 $4,187 $0 $801 $0 $767 $13,760 
Specific allowance19 225 697 0 4 0 161 1,106 
Average recorded investment in impaired loans during the quarter ended
September 30, 2020		798 7,002 3,430 0 829 0 774 12,833 
Interest income recognized on impaired loans during the quarter ended
September 30, 20201
11 64 30 0 3 0 7 115 
Average recorded investment in impaired loans during the nine months ended
September 30, 2020		948 7,000 2,832 0 740 225 730 12,475 
Interest income recognized on impaired loans during the nine months ended
September 30, 20201
32 197 68 0 10 4 22 333 
Average recorded investment in impaired loans during the quarter ended
September 30, 2019		1,324 7,000 1,791 684 413 456 659 12,327 
Interest income recognized on impaired loans during the quarter ended
September 30, 20191
16 67 20 400 9 4 6 522 
Average recorded investment in impaired loans during the nine months ended
September 30, 2019		1,495 6,998 1,804 1,687 497 458 670 13,609 
Interest income recognized on impaired loans during the nine months ended September 30, 20191
56 199 59 456 42 14 18 844 
1 NaN interest income was recognized on a cash basis during the three and accreting PCI loans that have experienced post-acquisition declines in cash flows expected to be collected.


(in thousands)Commercial and industrial
Commercial real estate, owner-occupied
Commercial real estate, investor
Construction
Home equity
Other residential
Installment and other consumer
Total
September 30, 2019 
 
 
 
 
 
 
Recorded investment in impaired loans:      
With no specific allowance recorded$375
$—
$—
$—
$168
$454
$101
$1,098
With a specific allowance recorded785
6,999
1,786
880
251
—
552
11,253
Total recorded investment in impaired loans$1,160
$6,999
$1,786
$880
$419
$454
$653
$12,351
Unpaid principal balance of impaired loans$1,140
$6,993
$1,776
$876
$417
$453
$652
$12,307
Specific allowance183
85
45
12
5
—
59
389
Average recorded investment in impaired loans during the quarter ended September 30, 20191,324
7,000
1,791
684
413
456
659
12,327
Interest income recognized on impaired loans during the quarter ended September 30, 20191
16
67
20
400
9
4
6
522
Average recorded investment in impaired loans during the nine months ended
September 30, 2019		1,495
6,998
1,804
1,687
497
458
670
13,609
Interest income recognized on impaired loans during the nine months ended
September 30, 20191
56
199
59
456
42
14
18
844
Average recorded investment in impaired loans during the quarter ended
September 30, 2018		1,840
7,000
1,837
2,690
651
987
700
15,705
Interest income recognized on impaired loans during the quarter ended
September 30, 20181
31
67
20
39
5
13
7
182
Average recorded investment in impaired loans during the nine months ended
September 30, 2018		2,019
7,002
1,925
2,831
698
1,029
708
16,212
Interest income recognized on impaired loans during the nine months ended
September 30, 20181
214
199
63
114
15
38
22
665
1 nine months ended September 30, 2020. Interest income recognized on a cash basis of $393 thousand and $416 thousand during the respective three and nine months ended September 30, 2019 was related to a principal payment applied to interest collected but unrecognized on a former non-accrual land development loan and the pay-off of 3 non-accruals. Interest income recognized on a cash basis of $6 thousand and $134 thousand during the three and nine months ended September 30, 2018 was related to the pay-off of 3 non-accrual commercial PCI loans.
(in thousands)Commercial and industrialCommercial real estate, owner-occupiedCommercial real estate, investor-ownedConstructionHome equityOther residentialInstallment and other consumerTotal
December 31, 2019       
Recorded investment in impaired loans:      
With no specific allowance recorded$349 $0 $0 $0 $167 $452 $98 $1,066 
With a specific allowance recorded874 6,998 1,770 0 251 0 541 10,434 
Total recorded investment in impaired loans$1,223 $6,998 $1,770 $0 $418 $452 $639 $11,500 
Unpaid principal balance of impaired loans$1,209 $6,992 $1,764 $0 $417 $451 $638 $11,471 
Specific allowance$103 $195 $41 $0 $5 $0 $53 $397 
(in thousands)Commercial and industrial
Commercial real estate, owner-occupied
Commercial real estate, investor
Construction
Home equity
Other residential
Installment and other consumer
Total
December 31, 2018 
 
 
 
 
 
 
Recorded investment in impaired loans: 
 
 
 
 
 
With no specific allowance recorded$303
$—
$—
$2,688
$313
$462
$111
$3,877
With a specific allowance recorded1,522
6,993
1,821
—
251
—
574
11,161
Total recorded investment in impaired loans$1,825
$6,993
$1,821
$2,688
$564
$462
$685
$15,038
Unpaid principal balance of impaired loans$1,813
$6,993
$1,812
$2,688
$562
$461
$684
$15,013
Specific allowance$466
$189
$45
$—
$5
$—
$73
$778


Management monitors delinquent loans continuously and identifies problem loans generally loans graded Substandard or worse, loans(loans on non-accrual status and loans modified in a TDR,TDR) to be evaluatedevaluate individually for impairment testing.impairment. Generally, the recorded investment in impaired loans is net of any charge-offs from estimated losses related to specifically-identified impaired loans when they are deemed uncollectible. There were 0 charged-off amounts on impaired loans at September 30, 20192020 or December 31, 2018.2019. In addition, the recorded investment in impaired loans is net of purchase discounts or premiums on acquired loans and deferred fees and costs. At September 30, 20192020 and December 31, 2018,2019, unused commitments to extend credit on impaired loans, including performing loans to borrowers whose terms have been modified in TDRs, totaled $699$500 thousand and $1.1 million,$534 thousand, respectively.

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The following tables disclose activity in the allowance for loan losses ("ALLL") and the recorded investment in loans by class, as well as the related ALLL disaggregated by impairment evaluation method.

Allowance for Loan Losses Rollforward for the Period
(in thousands)Commercial and industrialCommercial real estate, owner-occupiedCommercial real estate, investor-ownedConstructionHome equityOther residentialInstallment and other consumerUnallocatedTotal
Three months ended September 30, 2020
Beginning balance$2,609 $2,910 $10,403 $836 $1,044 $1,266 $426 $1,374 $20,868 
Provision (reversal)(79)225 1,221 24 (6)(6)(20)(109)1,250 
Charge-offs(10)0 0 0 0 0 0 0 (10)
Recoveries5 0 0 0 0 0 0 0 5 
Ending balance$2,525 $3,135 $11,624 $860 $1,038 $1,260 $406 $1,265 $22,113 
Three months ended September 30, 2019
Beginning balance$2,368 $2,321 $7,721 $619 $907 $849 $323 $727 $15,835 
Provision (reversal)326 21 211 (117)(28)56 (28)(41)400 
Charge-offs0 0 0 0 0 0 0 0 0 
Recoveries5 0 0 0 0 0 0 0 5 
Ending balance$2,699 $2,342 $7,932 $502 $879 $905 $295 $686 $16,240 

Allowance for Loan Losses Rollforward for the Period
(in thousands)Commercial and industrialCommercial real estate, owner-occupiedCommercial real estate, investorConstructionHome equityOther residentialInstallment and other consumerUnallocatedTotal
Nine months ended September 30, 2020
Beginning balance$2,334 $2,462 $8,483 $638 $850 $973 $284 $653 $16,677 
Provision (reversal)208 673 3,141 219 188 287 122 612 5,450 
Charge-offs(30)0 0 0 0 0 0 0 (30)
Recoveries13 0 0 3 0 0 0 0 16 
Ending balance$2,525 $3,135 $11,624 $860 $1,038 $1,260 $406 $1,265 $22,113 
Nine months ended September 30, 2019
Beginning balance$2,436 $2,407 $7,703 $756 $915 $800 $310 $494 $15,821 
Provision (reversal)256 (65)217 (254)(36)105 (15)192 400 
Charge-offs(9)0 0 0 0 0 0 0 (9)
Recoveries16 0 12 0 0 0 0 0 28 
Ending balance$2,699 $2,342 $7,932 $502 $879 $905 $295 $686 $16,240 
Allowance for Loan Losses Rollforward for the Period
(in thousands)Commercial and industrial
Commercial real estate, owner-occupied
Commercial real estate, investor
Construction
Home equity
Other residential
Installment and other consumer
Unallocated
Total
Three months ended September 30, 2019






Beginning balance$2,368
$2,321
$7,721
$619
$907
$849
$323
$727
$15,835
Provision (reversal)326
21
211
(117)(28)56
(28)(41)400
Charge-offs—
—
—
—
—
—
—
—
—
Recoveries5
—
—
—
—
—
—
—
5
Ending balance$2,699
$2,342
$7,932
$502
$879
$905
$295
$686
$16,240
Three months ended September 30, 2018       
Beginning balance$2,597
$2,339
$7,390
$508
$952
$746
$325
$956
$15,813
Provision (reversal)(245)83
46
157
(39)35
5
(42)—
Charge-offs—
—
—
—
—
—
—
—
—
Recoveries4
—
—
—
—
—
—
—
4
Ending balance$2,356
$2,422
$7,436
$665
$913
$781
$330
$914
$15,817
Allowance for Loan Losses Rollforward for the Period
(in thousands)Commercial and industrial
Commercial real estate, owner-occupied
Commercial real estate, investor
Construction
Home equity
Other residential
Installment and other consumer
Unallocated
Total
Nine months ended September 30, 2019       
Allowance for loan losses:       
Beginning balance$2,436
$2,407
$7,703
$756
$915
$800
$310
$494
$15,821
Provision (reversal)256
(65)217
(254)(36)105
(15)192
400
Charge-offs(9)—
—
—
—
—
—
—
(9)
Recoveries16
—
12
—
—
—
—
—
28
Ending balance$2,699
$2,342
$7,932
$502
$879
$905
$295
$686
$16,240
Nine months ended September 30, 2018       
Allowance for loan losses:       
Beginning balance$3,654
$2,294
$6,475
$681
$1,031
$536
$378
$718
$15,767
Provision (reversal)(1,308)128
961
(16)(118)245
(88)196
—
Charge-offs(3)—
—
—
—
—
(2)—
(5)
Recoveries13
—
—
—
—
—
42
—
55
Ending balance$2,356
$2,422
$7,436
$665
$913
$781
$330
$914
$15,817
Allowance for Loan Losses and Recorded Investment in Loans
(dollars in thousands)Commercial and industrial
Commercial real estate, owner-occupied
Commercial real estate, investor
Construction
Home equity
Other residential
Installment and other consumer
Unallocated
Total
September 30, 2019
Ending ALLL related to loans collectively evaluated for impairment$2,516
$2,257
$7,887
$490
$874
$905
$236
$686
$15,851
Ending ALLL related to loans individually evaluated for impairment183
85
45
12
5
—
59
—
389
Ending ALLL related to PCI loans—
—
—
—
—
—
—
—
—
Ending balance$2,699
$2,342
$7,932
$502
$879
$905
$295
$686
$16,240
Recorded Investment: 
 
 
 
 
  
Collectively evaluated for impairment$259,664
$302,334
$893,452
$49,374
$121,321
$130,327
$27,808
$—
$1,784,280
Individually evaluated for impairment1,160
6,999
1,786
880
419
454
653
—
12,351
PCI loans4
1,153
828
—
74
—
—
—
2,059
Total$260,828
$310,486
$896,066
$50,254
$121,814
$130,781
$28,461
$—
$1,798,690
Ratio of allowance for loan losses to total loans1.03%0.75%0.89%1.00%0.72%0.69%1.04%NM
0.90%
Allowance for loan losses to non-accrual loans1,384%NM
NM
NM
526%NM
492%NM
3,848%

Allowance for Loan Losses and Recorded Investment in Loans
(dollars in thousands)Commercial and industrialCommercial real estate, owner-occupiedCommercial real estate, investor-ownedConstructionHome equityOther residentialInstallment and other consumerUnallocatedTotal
September 30, 2020
Ending ALLL related to loans collectively evaluated for impairment$2,506 $2,910 $10,927 $860 $1,034 $1,260 $245 $1,265 $21,007 
Ending ALLL related to loans individually evaluated for impairment19 225 697 0 4 0 161 0 1,106 
Ending balance$2,525 $3,135 $11,624 $860 $1,038 $1,260 $406 $1,265 $22,113 
Recorded Investment:      
Collectively evaluated for impairment$511,956 $292,751 $962,322 $66,663 $106,581 $130,915 $23,036 $0 $2,094,224 
Individually evaluated for impairment1,017 7,003 4,195 0 783 0 769 0 13,767 
Total$512,973 $299,754 $966,517 $66,663 $107,364 $130,915 $23,805 $0 $2,107,991 
Ratio of allowance for loan losses to total loans0.49 %1.05 %1.20 %1.29 %0.97 %0.96 %1.71 %NM1.05 %
Allowance for loan losses to non-accrual loansNMNM1,312 %NM195 %NM1,692 %NM1,533 %
NM - Not Meaningful
Page-21


Allowance for Loan Losses and Recorded Investment in Loans
(dollars in thousands)Commercial and industrial
Commercial real estate, owner-occupied
Commercial real estate, investor
Construction
Home equity
Other residential
Installment and other consumer
Unallocated
Total
December 31, 2018
Ending ALLL related to loans collectively evaluated for impairment$1,970
$2,218
$7,658
$756
$910
$800
$237
$494
$15,043
Ending ALLL related to loans individually evaluated for impairment466
189
45
—
5
—
73
—
778
Ending ALLL related to purchased credit-impaired loans—
—
—
—
—
—
—
—
—
Ending balance$2,436
$2,407
$7,703
$756
$915
$800
$310
$494
$15,821
Recorded Investment: 
 
 
 
 
 
 
Collectively evaluated for impairment$228,883
$305,097
$870,778
$73,735
$124,049
$117,385
$26,787
$—
$1,746,714
Individually evaluated for impairment1,825
6,993
1,821
2,688
564
462
685
—
15,038
Purchased credit-impaired31
1,187
811
—
83
—
—
—
2,112
Total$230,739
$313,277
$873,410
$76,423
$124,696
$117,847
$27,472
$—
$1,763,864
Ratio of allowance for loan losses to total loans1.06%0.77%0.88%0.99%0.73%0.68%1.13%NM
0.90%
Allowance for loan losses to non-accrual loans764%NM
NM
NM
292%NM
NM
NM
2,270%

Allowance for Loan Losses and Recorded Investment in Loans
(dollars in thousands)Commercial and industrialCommercial real estate, owner-occupiedCommercial real estate, investor-ownedConstructionHome equityOther residentialInstallment and other consumerUnallocatedTotal
December 31, 2019
Ending ALLL related to loans collectively evaluated for impairment$2,231 $2,267 $8,442 $638 $845 $973 $231 $653 $16,280 
Ending ALLL related to loans individually evaluated for impairment103 195 41 0 5 0 53 0 397 
Ending balance$2,334 $2,462 $8,483 $638 $850 $973 $284 $653 $16,677 
Recorded Investment:       
Collectively evaluated for impairment$245,464 $301,826 $944,547 $61,095 $115,606 $136,205 $27,043 $0 $1,831,786 
Individually evaluated for impairment1,223 6,998 1,770 0 418 452 639 0 11,500 
Total$246,687 $308,824 $946,317 $61,095 $116,024 $136,657 $27,682 $0 $1,843,286 
Ratio of allowance for loan losses to total loans0.95 %0.80 %0.90 %1.04 %0.73 %0.71 %1.03 %NM0.90 %
Allowance for loan losses to non-accrual loansNMNMNMNM506 %NM490 %NM7,379 %
NM - Not Meaningful

Purchased Credit-Impaired Loans
Acquired loans are considered credit-impaired if there is evidence of significant deterioration of credit quality since origination and it is probable, at the acquisition date, that we will be unable to collect all contractually required payments receivable. Management has determined certain loans purchased in our 3 bank acquisitions to be PCI loans based on credit indicators such as non-accrual status, past due status, loan risk grade, loan-to-value ratio, etc. Revolving credit agreements (e.g., home equity lines of credit and revolving commercial loans) are not considered PCI loans as cash flows cannot be reasonably estimated.

The following table reflects the unpaid principal balance and related carrying value of PCI loans.
PCI LoansSeptember 30, 2019December 31, 2018

(in thousands)
Unpaid Principal Balance
Carrying Value
Unpaid Principal Balance
Carrying Value
Commercial and industrial$48
$4
$89
$31
Commercial real estate, owner occupied1,208
1,153
1,247
1,187
Commercial real estate, investor1,009
828
1,033
811
Home equity194
74
210
83
Total purchased credit-impaired loans$2,459
$2,059
$2,579
$2,112

The activities in the accretable yield, or income expected to be earned over the remaining lives of the PCI loans were as follows:
Accretable YieldThree months endedNine months ended
(in thousands)September 30, 2019September 30, 2018September 30, 2019September 30, 2018
Balance at beginning of period$819
$1,059
$934
$1,254
Accretion(55)(63)(170)(258)
Balance at end of period$764
$996
$764
$996


Pledged Loans

Our FHLB line of credit is secured under terms of a blanket collateral agreement by a pledge of certain qualifying loans with unpaid principal balances of $1,083.2$1,149.5 million and $1,027.4$1,133.4 million at September 30, 20192020 and December 31, 2018,2019, respectively. In addition, we pledge eligible TIC loans, which totaled $111.5$120.4 million and $94.5$115.7 million at September 30,


2019 2020 and December 31, 2018,2019, respectively, to secure our borrowing capacity with the Federal Reserve Bank ("FRB"). Also, see Note 6, Borrowings.

Related Party Loans
 
The Bank has, and expects to have in the future, banking transactions in the ordinary course of its business with directors, officers, principal shareholders and their businesses or associates. These transactions, including loans are granted on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with persons not related to us. Likewise, these transactions do not involve more than the normal risk of collectability or present other unfavorable features. Related party loans totaled $9.0$7.2 million at September 30, 2019, compared to $10.62020 and $8.3 million at December 31, 2018.2019. In addition, undisbursed commitments to related parties totaled $9.1$8.7 million at September 30, 20192020 and $9.2 million at December 31, 2018.2019.

Note 6: Borrowings and Other Obligations
 
Federal Funds Purchased – The Bank had unsecured lines of credit with correspondent banks for overnight borrowings totaling $92.0$135.0 million at September 30, 20192020 and $92.0 million at December 31, 2018.2019.  In general, interest rates on these lines approximate the federal funds target rate. We had 0 overnight borrowings under these credit facilities at September 30, 20192020 or December 31, 20182019.
 
Federal Home Loan Bank Borrowings – As of September 30, 20192020 and December 31, 2018,2019, the Bank had lines of credit with the FHLB totaling $615.9$696.2 million and $629.4$648.0 million, respectively, based on eligible collateral of certain loans. There were 0 FHLB overnight borrowings at September 30, 2019. There were $7.0 million FHLB overnight borrowings at an overnight rate of 2.56% on2020 or December 31, 2018.2019.

Federal Reserve Line of Credit – The Bank has a line of credit with the FRBSF secured by certain residential loans.  At September 30, 20192020 and December 31, 2018,2019, the Bank had borrowing capacity under this line totaling $76.5$83.1 million and $69.7$80.3 million, respectively, and had 0 outstanding borrowings with the FRBSF.

Subordinated DebenturesDebenture – As part of an acquisition in 2013, Bancorp assumed a subordinated debenturesdebenture due to NorCal Community Bancorp Trusts I andTrust II (the "Trust"), established for the sole purpose of issuing trust preferred securities. The trust preferred securities were sold and issued in private transactions pursuant to an exemption from registration under the Securities Act of 1933, as amended. On October 7, 2018, Bancorp redeemed in full theThe subordinated debentures due to NorCal Community Bancorp Trust I, resulting in $916 thousand accelerated accretion. The Trust II subordinated debentures weredebenture was recorded at fair
Page-22

value totaling $2.14 million at the acquisition date with a contractual balance of $4.12 million. The difference between the contractual balance and the fair value at the acquisition date is accreted into interest expense over the life of the debentures.debenture. Accretion on the subordinated debenturesdebenture totaled $52 thousand and $51 thousand (Trust II) and $92 thousand (Trusts I and II) for the nine months ended September 30, 20192020 and 2018,2019, respectively. Bancorp has the option to defer payment of the interest on the subordinated debenturesdebenture for a period of up to five years, as long as there is no event of default. In the event of interest deferral, dividends to Bancorp common stockholders are prohibited. Bancorp has guaranteed, on a subordinated basis, distributions and other payments due on trust preferred securities totaling $4.0 million issued by the Trust, II, which have identical maturity, repricing and payment terms as the subordinated debentures. Subordinated debenturesdebenture. The subordinated debenture due to NorCal Community Bancorp Trust II on March 15, 2036 with interest payable quarterly (repricing quarterly, based on 3-month LIBOR plus 1.40%, or 3.52%1.65% as of September 30, 2019), are2020) is redeemable in whole or in part on any interest payment date.

Other Obligations – The Bank leases certain equipment under financesfinance leases, which are included in borrowings and other obligations in the consolidated statementstatements of conditions.condition. See Note 8, CommitmentCommitments and Contingencies, for additional information.

Note 8:  Commitments and Contingencies
Financial Instruments with Off-Balance Sheet Risk
We make commitments to extend credit in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because various commitments will expire without being fully drawn, the total commitment amount does not necessarily represent future cash requirements.
Our credit loss exposure is equal to the contractual amount of the commitment in the event of nonperformance by the borrower. We use the same credit underwriting criteria for all credit exposure. The amount of collateral obtained, if deemed necessary by us, is based on Management's credit evaluation of the borrower. Collateral types pledged may include accounts receivable, inventory, other personal property and real property.
The contractual amount of undrawn loan commitments and standby letters of credit not reflected in the consolidated statements of condition are as follows:
(in thousands)September 30, 2020December 31, 2019
Commercial lines of credit$301,107 $287,533 
Revolving home equity lines193,364 189,035 
Undisbursed construction loans59,548 41,033 
Personal and other lines of credit10,923 9,567 
Standby letters of credit2,572 1,964 
   Total commitments and standby letters of credit$567,514 $529,132 

We record an allowance for losses on these off-balance sheet commitments based on an estimate of probabilities of the utilization of these commitments according to our historical experience on different types of commitments and expected loss. The allowance for losses on off-balance sheet commitments totaled $1.7 million and $1.1 million as of September 30, 2020 and December 31, 2019, respectively, which is recorded in interest payable and other liabilities in the consolidated statements of condition.

Leases

We lease premises under long-term non-cancelable operating leases with remaining terms of 1 year to 12 years, most of which include escalation clauses and one or more options to extend the lease term, and some of which contain lease termination clauses. Lease terms may include certain renewal options that were considered reasonably certain to be exercised.

Page-23

We lease certain equipment under finance leases with initial terms of 3 years to 5 years. The equipment finance leases do not contain renewal options, bargain purchase options or residual value guarantees.

The following table shows the balances of operating and finance lease right-of-use assets and lease liabilities as of September 30, 2020.
(in thousands)September 30, 2020December 31, 2019
Operating leases:
Operating lease right-of-use assets$26,041 $11,002 
Operating lease liabilities$27,527 $12,615 
Finance leases:
Finance lease right-of-use assets$365 $379 
Accumulated amortization(267)(170)
Finance lease right-of-use assets, net1
$98 $209 
Finance lease liabilities2
$99 $212 
1 Included in premises and equipment in the consolidated statements of condition.
2 Included in borrowings and other obligations in the consolidated statements of condition.

The following table shows supplemental disclosures of noncash investing and financing activities for the period presented.
Nine months ended
(in thousands)September 30, 2020September 30, 2019
Right-of-use assets obtained in exchange for operating lease liabilities$18,021 $1,661 
Right-of-use assets obtained in exchange for finance lease liabilities$18 $31 
Reclassification of deferred rent and unamortized lease incentives from other liabilities to operating lease right-of-use assets upon adoption of ASC 842$0 $1,967 


Page-24

The following table shows components of operating and finance lease cost.
Three months endedNine months ended
(in thousands)September 30, 2020September 30, 2019September 30, 2020September 30, 2019
Operating lease cost$1,165 $1,051 $3,334 $3,123 
Variable lease cost1 0 4 0 
Total operating lease cost1
$1,166 $1,051 $3,338 $3,123 
Finance lease cost:
Amortization of right-of-use assets2
$41 $43 $129 $128 
Interest on finance lease liabilities3
1 2 3 $7 
Total finance lease cost42 45 $132 $135 
Total lease cost$1,208 $1,096 $3,470 $3,258 
1 Included in occupancy and equipment expense in the consolidated statements of comprehensive income.
2 Included in depreciation and amortization in the consolidated statements of comprehensive income.
3 Included in interest on borrowings and other obligations in the consolidated statements of comprehensive income.

The following table shows the future minimum lease payments, weighted average remaining lease terms, and weighted average discount rates under operating and finance lease arrangements as of September 30, 2020. The discount rates used to calculate the present value of lease liabilities were based on the collateralized FHLB borrowing rates that were commensurate with lease terms and minimum payments on the later of the date we adopted the new lease accounting standards or lease commencement date.
(in thousands)September 30, 2020
YearOperating LeasesFinance Leases
2020$1,199 $41 
20214,592 42 
20224,318 13 
20233,893 4 
20243,187 0 
Thereafter12,475 0 
Total minimum lease payments29,664 100 
Amounts representing interest (present value discount)(2,137)(1)
Present value of net minimum lease payments (lease liability)$27,527 $99 
Weighted average remaining term (in years)8.01.2
Weighted average discount rate1.84 %2.55 %

Litigation Matters

Bancorp may be party to legal actions that arise from time to time in the normal course of business. Bancorp's Management is not aware of any pending legal proceedings to which either it or the Bank may be a party or has recently been a party that will have a material adverse effect on the financial condition or results of operations of Bancorp or the Bank.

The Bank is responsible for a proportionate share of certain litigation indemnifications provided to Visa U.S.A. ("Visa") by its member banks in connection with Visa's lawsuits related to anti-trust charges and interchange fees ("Covered Litigation"). Our proportionate share of the litigation indemnification liability does not change or transfer upon the sale of our Class B Visa shares to member banks. Visa established an escrow account to pay for settlements or judgments in the Covered Litigation. Under the terms of the U.S. retrospective responsibility plan, when Visa funds the litigation escrow account, it triggers a conversion rate reduction of the Class B common stock to shares of Class A common stock, effectively reducing the aggregate value of the Class B common stock held by Visa's member banks like us.

In 2012, Visa had reached a $4.0 billion interchange multidistrict litigation class settlement agreement with plaintiffs representing a class of U.S. retailers. On September 17, 2018, Visa signed an amended settlement agreement with
Page-25

the putative class action plaintiffs of the U.S. interchange multidistrict litigation that superseded the 2012 settlement agreement. Visa's share of the settlement amount under the amended class settlement agreement increased to $4.1 billion. On September 27, 2019, Visa deposited an additional $300 million into the litigation escrow account. Certain merchants chose to opt out of the class settlement agreement and on December 13, 2019, the court entered the final judgment order approving the amended settlement agreement. On December 27, 2019, Visa received a takedown payment of approximately $467 million, which was deposited into the litigation escrow account with a corresponding increase in accrued litigation to address opt-out claims. The escrow balance of $1.1 billion as of June 30, 2020 (most recent information available), combined with funds previously deposited with the court, are expected to cover the settlement payment obligations.

The outcome of the Covered Litigation affects the conversion rate of Visa Class B common stock held by us to Visa Class A common stock, as discussed above and in Note 4, Investment Securities. The final conversion rate might change depending on the final settlement payments, and the full effect on member banks is still uncertain. Litigation is ongoing and until the court approval process is complete, there is no assurance that Visa will resolve the claims as contemplated by the amended class settlement agreement, and additional lawsuits may arise from individual merchants who opted out of the class settlement. However, until the escrow account is fully depleted and the conversion rate of Class B to Class A common stock is reduced to zero, no future cash settlement payments are required by the member banks, such as us, on the Covered Litigation. Therefore, we are not required to record any contingent liabilities for the indemnification related to the Covered Litigation, as we consider the probability of losses to be remote.

Note 7:  Stockholders' Equity
 
Dividends and Stock Split

On October 18, 2019,23, 2020, Bancorp declared a $0.21$0.23 per share cash dividend, payable on November 8, 201913, 2020 to shareholders of record at the close of business on November 1, 2019. All share and per share data have been adjusted to reflect the 2-for-one stock split effective November 27, 2018.6, 2020.



Share-Based Payments
 
The fair value of stock options as of the grant date is recorded as stock-based compensation expense in the consolidated statements of comprehensive income over the requisite service period, which is generally the vesting period, with a corresponding increase in common stock. Stock-based compensation also includes compensation expense related to the issuance of restricted stock awards. The grant-date fair value of the restricted stock awards, which equals the intrinsic value,grant date price, is recorded as compensation expense over the requisite service period with a corresponding increase in common stock as the shares vest. Beginning in 2018, stock option and restricted stock awards issued include a retirement eligibility clause whereby the requisite service period is satisfied at the retirement eligibility date. For those awards, we accelerate the recording of stock-based compensation expense when the award holder is eligible to retire. However, retirement eligibility does not affect the vesting of restricted stock or the exercisability of the stock options, which are based on the scheduled vesting period.

Performance-based stock awards (restricted stock) are issued to a selected group of employees. Stock award vesting is contingent upon the achievement of pre-established long-term performance goals set by the Compensation Committee of the Board of Directors. Performance is measured over a three-yearthree-year period and cliff vested. These performance-based stock awards were granted at a maximum opportunity level, and based on the achievement of the pre-established goals, the actual payouts can range from 0% to 200% of the target award. For performance-based stock awards, an estimate is made of the number of shares expected to vest based on the probability that the performance criteria will be achieved to determine the amount of compensation expense to be recognized. The estimate is re-evaluated quarterly and total compensation expense is adjusted for any change in the current period.

We record excess tax benefits (deficiencies) resulting from the exercise of non-qualified stock options, the disqualifying disposition of incentive stock options and vesting of restricted stock awards as income tax benefits (expense) in the consolidated statements of comprehensive income with a corresponding decrease (increase) to current taxes payable.
 
The holders of unvested restricted stock awards are entitled to dividends on the same per-share ratio as holders of common stock. Tax benefits for dividends paid on unvested restricted stock awards are recorded as tax benefits in
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the consolidated statements of comprehensive income with a corresponding decrease to current taxes payable. Dividends on forfeited awards are included in stock-based compensation expense.

Stock options and restricted stock may be net settled in a cashless exercise by a reduction in the number of shares otherwise deliverable upon exercise or vesting in satisfaction of the exercise payment and/or applicable tax withholding requirements. During the nine months ended September 30, 2020, we withheld 9,214 shares totaling $369 thousand at a weighted-average price of $40.01 for cashless exercises. During the nine months ended September 30, 2019, we withheld 7,795 shares totaling $326 thousand at a weighted-average price of $41.84 for cashless exercises. During the nine months ended September 30, 2018, we withheld 41,962 shares totaling $1.5 million at a weighted-average price of $35.68 for cashless exercises. Shares withheld under net settlement arrangements are available for future grants.

Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income

We adopted ASU No. 2018-02,
Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, in the first quarter of 2018 and reclassified $638 thousand from AOCI to retained earnings. This amount represented the stranded income tax effects related to the unrealized loss on available-for-sale securities in AOCI on the date of the enactment of the Tax Cuts and Jobs Act of 2017.

Share Repurchase Program

On April 23, 2018, Bancorp announced that its Board of Directors approved a Share Repurchase Program under which Bancorp may repurchase up to $25.0 million of its outstanding common stock through May 1, 2019. Bancorp's Board of Directors subsequently extended the Share Repurchase Program through February 28, 2020. On January 24, 2020, Bancorp Board of Directors approved a new Share Repurchase Program under which Bancorp may repurchase up to $25.0 million of its outstanding common stock through February 28, 2022. The new share repurchase program which began on March 1, 2020 was suspended by the Board of Directors on March 20, 2020 in response to the COVID-19 pandemic. The program was reactivated by the Board of Directors on October 23, 2020.

Under the Share Repurchase Program, Bancorp may purchase shares of its common stock through various means such as open market transactions, including block purchases, and privately negotiated transactions. The number of shares repurchased and the timing, manner, price and amount of any repurchases will be determined at Bancorp's discretion. Factors include, but are not limited to, stock price, trading volume and general market conditions, along with Bancorp’s general business conditions. The program may be suspended or discontinued at any time and does not obligate Bancorp to acquire any specific number of shares of its common stock.



As part of the Share Repurchase Program, Bancorp entered into a trading plan adopted in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The 10b5-1 trading plan permits common stock to be repurchased at times that might otherwise be prohibited under insider trading laws or self-imposed trading restrictions. The 10b5-1 trading plan is administered by an independent broker and is subject to price, market volume and timing restrictions.

During the nine months ended September 30, 2019,2020, Bancorp repurchased 313,65192,664 shares totaling $13.2$3.2 million for a cumulative 484,868619,881 shares totaling $20.2$25.2 million repurchased from May 1, 2018 through September 30, 2019.2020. Due to the suspension of the program in March 2020, there were 0 shares repurchased during the second or third quarters of 2020.


Note 8:  Commitments and Contingencies
Financial Instruments with Off-Balance Sheet Risk
We make commitments to extend credit in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because various commitments will expire without being fully drawn, the total commitment amount does not necessarily represent future cash requirements.
Our credit loss exposure is equal to the contractual amount of the commitment in the event of nonperformance by the borrower. We use the same credit underwriting criteria for all credit exposure. The amount of collateral obtained, if deemed necessary by us, is based on Management's credit evaluation of the borrower. Collateral types pledged may include accounts receivable, inventory, other personal property and real property.
The contractual amount of undrawn loan commitments and standby letters of credit not reflected in the consolidated statements of condition are as follows:
(in thousands)September 30, 2019
December 31, 2018
Commercial lines of credit$239,465
$238,361
Revolving home equity lines190,230
189,971
Undisbursed construction loans40,101
46,229
Personal and other lines of credit9,888
14,109
Standby letters of credit2,014
2,636
   Total commitments and standby letters of credit$481,698
$491,306


We record an allowance for losses on these off-balance sheet commitments based on an estimate of probabilities of the utilization of these commitments according to our historical experience on different types of commitments and expected loss. The allowance for losses on off-balance sheet commitments totaled $1.1 million and $958 thousand as of September 30, 2019 and December 31, 2018, respectively, which is recorded in interest payable and other liabilities in the consolidated statements of condition.

Leases
We lease premises under long-term non-cancelable operating leases with remaining terms of 1 year to 13 years, most of which include escalation clauses and one or more options to extend the lease term, and some of which contain lease termination clauses. Lease terms may include certain renewal options that were considered reasonably certain to be exercised.

We lease certain equipment under finance leases with initial terms of 3 years to 5 years. The equipment finance leases do not contain renewal options, bargain purchase options or residual value guarantees.

The following table shows the balances of operating and finance lease right-of-use assets and lease liabilities as of September 30, 2019.


(in thousands)September 30, 2019
Operating leases: 
Operating lease right-of-use assets$11,934
Operating lease liabilities$13,665
Finance leases: 
Finance lease right-of-use assets$379
Accumulated amortization(127)
Finance lease right-of-use assets, net1
$252
Finance lease liabilities2
$255
1 Included in premises and equipment in the consolidated statements of condition.
2 Included in borrowings and other obligations in the consolidated statements of condition.


The following table shows supplemental disclosures of noncash investing and financing activities for the period presented. There were no lease-related noncash investing and financing activities for the nine months ended September 30, 2018.
 Nine months ended
(in thousands)September 30, 2019
Right-of-use assets obtained in exchange for operating lease liabilities$1,661
Right-of-use assets obtained in exchange for finance lease liabilities$31
Reclassification of deferred rent and unamortized lease incentives from other liabilities to operating lease right-of-use assets upon adoption of ASC 842$1,967

The following table shows components of operating and finance lease cost.
 Three months endedNine months ended
(in thousands)September 30, 2019September 30, 2019
Operating lease cost1
$1,051
$3,123
   
Finance lease cost:  
Amortization of right-of-use assets2
$43
$128
Interest on finance lease liabilities3
2
7
Total finance lease cost$45
$135
Total lease cost$1,096
$3,258
1 Included in occupancy and equipment expense in the consolidated statements of comprehensive income.
 
2 Included in depreciation and amortization in the consolidated statements of comprehensive income.
 
3 Included in interest on borrowings and other obligations in the consolidated statements of comprehensive income.
 


Operating lease rent expense totaled $1.1 million and $3.5 million, respectively, for the three and nine months ended September 30, 2018.

The following table shows the future minimum lease payments, weighted average remaining lease terms, and weighted average discount rates under operating and finance lease arrangements as of September 30, 2019. The discount rates used to calculate the present value of lease liabilities were based on the collateralized FHLB borrowing rates that were commensurate with lease terms and minimum payments on the later of the date we adopted the new lease accounting standards or lease commencement date.


(in thousands)September 30, 2019
YearOperating Leases
 Finance Leases
2019$1,139
 $45
20204,469
 170
20212,806
 36
20221,952
 8
20231,464
 1
Thereafter2,884
 —
Total minimum lease payments14,714
 260
Amounts representing interest (present value discount)(1,049) (5)
Present value of net minimum lease payments (lease liability)$13,665
 $255
    
Weighted average remaining term (in years)5.0
 1.6
Weighted average discount rate2.78% 2.87%


Litigation Matters

Bancorp may be party to legal actions that arise from time to time in the normal course of business. Bancorp's Management is not aware of any pending legal proceedings to which either it or the Bank may be a party or has recently been a party that will have a material adverse effect on the financial condition or results of operations of Bancorp or the Bank.

The Bank is responsible for a proportionate share of certain litigation indemnifications provided to Visa U.S.A. ("Visa") by its member banks in connection with Visa's lawsuits related to anti-trust charges and interchange fees ("Covered Litigation"). Our proportionate share of the litigation indemnification liability does not change or transfer upon the sale of our Class B Visa shares to member banks. Visa established an escrow account to pay for settlements or judgments in the Covered Litigation. Under the terms of the U.S. retrospective responsibility plan, when Visa funds the litigation escrow account, it triggers a conversion rate reduction of the Class B common stock to shares of Class A common stock, effectively reducing the aggregate value of the Class B common stock held by Visa's member banks like us.

In 2012, Visa had reached a $4.0 billion interchange multidistrict litigation class settlement agreement with plaintiffs representing a class of U.S. retailers. On September 17, 2018, Visa signed an amended settlement agreement with the putative class action plaintiffs of the U.S. interchange multidistrict litigation that superseded the 2012 settlement agreement. Visa's share of the settlement amount under the amended class settlement agreement increased to $4.1 billion. On January 24, 2019, the district court granted preliminary approval of the amended class settlement agreement, which was moved for final approval on June 7, 2019. Certain merchants chose to opt out of the class settlement agreement and a final settlement approval hearing is scheduled for November 7, 2019. On September 27, 2019, Visa deposited an additional $300 million into the litigation escrow account. The escrow balance combined with funds previously deposited with the court, are expected to cover the settlement payment obligations.

The outcome of the Covered Litigation affects the conversion rate of Visa Class B common stock held by us to Visa Class A common stock, as discussed above and in Note 4, Investment Securities. The final conversion rate might change depending on the final settlement payments, and the full effect on member banks is still uncertain. Litigation is ongoing and until the court approval process is complete, there is no assurance that Visa will resolve the claims as contemplated by the amended class settlement agreement, and additional lawsuits may arise from individual merchants who opted out of the class settlement. However, until the escrow account is fully depleted and the conversion rate of Class B to Class A common stock is reduced to zero, no future cash settlement payments are required by the member banks, such as us, on the Covered Litigation. Therefore, we are not required to record any contingent liabilities for the indemnification related to the Covered Litigation, as we consider the probability of losses to be remote.

Note 9: Derivative Financial Instruments and Hedging Activities

We entered into interest rate swap agreements, primarily as an interest rate riskasset/liability management strategy, in order to mitigate the changes in the fair value of specified long-term fixed-rate loans (or firm commitments to enter into long-term fixed-rate loans) caused by changes in interest rates. These hedges allow us to offer long-term fixed-rate loans to customers without assuming the interest rate risk of a long-term asset. Converting our fixed-rate interest payments


to floating-rate interest payments, generally benchmarked to the one-month U.S. dollar LIBOR index, protects us against changes in the fair value of our loans associated with fluctuating interest rates.

Our credit exposure, if any, on interest rate swap asset positions is limited to the fair value (net of any collateral pledged to us) and interest payments of all swaps by each counterparty. Conversely, when an interest rate swap is in a liability position exceeding a certain threshold, we may be required to post collateral to the counterparty in an amount determined by the agreements. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values.

As of September 30, 2019,2020, we had 5 interest rate swap agreements, which are scheduled to mature in June 2031, October 2031, July 2032, August 2037 and October 2037. All of our derivatives are accounted for as fair value hedges. The notional amounts of the interest rate contracts are equal to the notional amounts of the hedged loans. Our interest rate swap payments are settled monthly with counterparties. Accrued interest on the swaps
Page-27

totaled $4$13 thousand at September 30, 20192020 and $3$6 thousand at December 31, 2018.2019. Information on our interest rate swaps is shown in the derivative tables below:derivatives follows:
Asset Derivatives Liability DerivativesAsset DerivativesLiability Derivatives
(in thousands)September 30,
2019		December 31, 2018 September 30,
2019		December 31, 2018(in thousands)September 30,
2020		December 31, 2019September 30,
2020		December 31, 2019
Fair value hedges:   Fair value hedges:
Interest rate contracts notional amount$—
$8,895
 $17,199
$9,016
Interest rate contracts notional amount$0 $0 $16,218 $16,956 
Interest rate contracts fair value1
$—
$161
 $1,603
$375
Interest rate contracts fair value1
$0 $0 $2,529 $1,178 
1 See Note 3, Fair Value of Assets and Liabilities, for valuation methodology.

The following table presents the carrying amount and associated cumulative basis adjustment related to the application of fair value hedge accounting that is included in the carrying amount of hedged assets as of September 30, 20192020 and December 31, 2018:2019.
Carrying Amounts of Hedged AssetsCumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Loans
(in thousands)
September 30, 2020December 31, 2019September 30, 2020December 31, 2019
Loans$18,535 $17,900 $2,318 $944 
 Carrying Amounts of Hedged Assets Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Loans
(in thousands)

September 30, 2019December 31, 2018 September 30, 2019December 31, 2018
Loans$18,564
$17,917
 $1,365
$6


The following table presents the net gains (losses)losses recognized in interest income on loans on the consolidated statements of comprehensive income related to our derivatives designated as fair value hedges:hedges.
 Three months endedNine months ended
(in thousands)September 30, 2019September 30, 2018September 30, 2019September 30, 2018
Interest and fees on loans 1
$21,525
$20,284
$63,208
$58,795
(Decrease) increase in value of designated interest rate swaps due to LIBOR interest rate movements$(485)$222
$(1,389)$939
Payment on interest rate swaps(23)(32)(49)(127)
Increase (decrease) in value of hedged loans424
(231)1,359
(924)
Decrease in value of yield maintenance agreement(3)(4)(10)(11)
Net losses on fair value hedging relationships recognized in interest income$(87)$(45)$(89)$(123)

Three months endedNine months ended
(in thousands)September 30, 2020September 30, 2019September 30, 2020September 30, 2019
Interest and fees on loans 1
$21,776 $21,525 $63,880 $63,208 
Increase (decrease) in fair value of designated interest rate swaps due to LIBOR interest rate movements$152 $(485)$(1,351)$(1,389)
Payment on interest rate swaps(108)(23)(255)(49)
(Decrease) increase in value of hedged loans(155)424 1,374 1,359 
Decrease in value of yield maintenance agreement(3)(3)(9)(10)
Net losses on fair value hedging relationships recognized in interest income$(114)$(87)$(241)$(89)
1 Represents the income line item in the statement of comprehensive income in which the effects of fair value hedges are recorded.

Our derivative transactions with counterparties are under International Swaps and Derivative Association (“ISDA”) master agreements that include “right of set-off” provisions. “Right of set-off” provisions are legally enforceable rights to offset recognized amounts and there may be an intention to settle such amounts on a net basis. We do not offset such financial instruments for financial reporting purposes.



Information on financial instruments that are eligible for offset in the consolidated statements of condition follows:
Offsetting of Financial Assets and Derivative Assets
  Gross AmountsNet Amounts ofGross Amounts Not Offset in 
 Gross AmountsOffset in theAssets Presentedthe Statements of Condition 
 of RecognizedStatements ofin the StatementsFinancialCash Collateral 
(in thousands)
AssetsConditionof ConditionInstrumentsReceivedNet Amount
September 30, 2019      
Derivatives by Counterparty:      
Counterparty A$—
$—
$—
$—
$—
$—
Total$—
$—
$—
$—
$—
$—
December 31, 2018      
Derivatives by Counterparty:      
Counterparty A$161
$—
$161
$(161)$—
$—
Total$161
$—
$161
$(161)$—
$—

Offsetting of Financial Assets and Derivative Assets
Gross AmountsNet Amounts ofGross Amounts Not Offset in
Gross AmountsOffset in theAssets Presentedthe Statements of Condition
of RecognizedStatements ofin the StatementsFinancialCash Collateral
(in thousands)
AssetsConditionof ConditionInstrumentsReceivedNet Amount
September 30, 2020
Derivatives by Counterparty:
Counterparty A$0 $0 $0 $— $0 $0 
December 31, 2019
Derivatives by Counterparty:
Counterparty A$0 $0 $0 $0 $0 $0 
Offsetting of Financial Liabilities and Derivative Liabilities
  Gross AmountsNet Amounts ofGross Amounts Not Offset in 
 Gross AmountsOffset in theLiabilities Presentedthe Statements of Condition 
 of RecognizedStatements ofin the StatementsFinancialCash Collateral 
(in thousands)
Liabilities1
Condition
of Condition1
InstrumentsPledgedNet Amount
September 30, 2019      
Derivatives by Counterparty:      
Counterparty A$1,603
$—
$1,603
$—
$(1,603)$—
Total$1,603
$—
$1,603
$—
$(1,603)$—
December 31, 2018      
Derivatives by Counterparty:      
Counterparty A$375
$—
$375
$(161)$—
$214
Total$375
$—
$375
$(161)$—
$214
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Offsetting of Financial Liabilities and Derivative Liabilities
Gross AmountsNet Amounts ofGross Amounts Not Offset in
Gross AmountsOffset in theLiabilities Presentedthe Statements of Condition
of RecognizedStatements ofin the StatementsFinancialCash Collateral
(in thousands)
Liabilities1
Condition
of Condition1
InstrumentsPledgedNet Amount
September 30, 2020
Derivatives by Counterparty:
Counterparty A$2,529 $0 $2,529 $0 $(2,529)$0 
December 31, 2019
Derivatives by Counterparty:
Counterparty A$1,178 $0 $1,178 $0 $(1,178)$0 
1 Amounts exclude accrued interest totaling $4 thousand at September 30, 2019 and $3 thousand at December 31, 2018.on swaps.

For more information on how we account for our interest rate swaps, refer to Note 1 to the Consolidated Financial Statements included in our 20182019 Form 10-K filed with the SEC on March 14, 2019.13, 2020.
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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 consolidated financial statements in this Form 10-Q and with the audited consolidated financial statements and accompanying notes included in our 20182019 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 affect our earnings in future periods. A number of factors, many of which are beyond Management’s control, could cause future results to vary materially from current Management expectations. Such factors include, but are not limited to, natural disasters (such as wildfires and earthquakes), our borrowers’ actual payment performance as loan deferrals related to the COVID-19 pandemic expire, changes to statutes, regulations, or regulatory policies or practices as a result of, or in response to COVID-19, including the potential adverse impact of loan modifications and payment deferrals implemented consistent with recent regulatory guidance, general economic conditions, and the economic uncertainty in the United States


and abroad, including changes in interest rates, deposit flows, real estate values, and expected future cash flows on loans and securities; costs or effects of acquisitions; competition;acquisitions, competition, changes in accounting principles, policies or guidelines; changes inguidelines, legislation or regulation (including the Tax Cuts and& Jobs Act of 2017); natural disasters (such2017 and the Coronavirus Aid, Relief and Economic Security Act of 2020, as wildfires and earthquakes in our area); adverse weather conditions;amended), interruptions of utility service in our markets for sustained periods;periods, and other economic, competitive, governmental, regulatory and technological factors (including external fraud and cybersecurity threats) affecting ourBancorp's operations, pricing, products and services.

Important factors that could cause results or performance to materially differ from those expressed in our prior forward-looking statements are detailed in the Risk Factors section of this Form 10-Q and in Item 1A. Risk Factors section of our 20182019 Form 10-K as filed with the SEC, copies of which are available from us at no charge. These and other important factors are detailed in various securities law filings made periodically by Bancorp, copies of which are available from Bancorp without charge. Forward-looking statements speak only as of the date they are made. We do not undertakeBancorp undertakes no obligation to updaterelease publicly the result of any revisions to these forward-looking statements that may be made to reflect circumstancesevents or events that occurcircumstances after the date the forward-looking statements are madeof this Form 10-Q or to reflect the occurrence of unanticipated events.


Critical Accounting Policies and Estimates

Critical accounting policies are those that are both important to the portrayal of our financial condition and results of operations and require Management's most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and imprecise. There have been no material changes to our critical accounting policies, which include: Allowance for Loan Losses, Other-than-temporary Impairment of Investment Securities, Accounting for Income Taxes, and Fair Value Measurements. For a detailed discussion, refer to Note 1 to the Consolidated Financial Statements included in our 20182019 Form 10-K filed with the SEC on March 14, 201913, 2020 and Note 2, Recently Adopted and Issued Accounting Standards, to the Consolidated Financial Statements in this Form 10-Q. Under the accounting relief provisions of the Coronavirus Aid, Relief and Economic Security ("CARES") Act, which was signed into law on March 27, 2020, the Bank postponed the adoption of the current expected credit losses (“CECL”) accounting standard until the earlier of the end of the national emergency or December 31, 2020 to focus on customers' needs during the COVID-19

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pandemic. Additionally, the lack of clarity around the extent and duration of the COVID-19 pandemic hindered the development of reasonable and supportable economic forecasts early in the pandemic.

Executive Summary
 
Earnings inNet income for the third quarter of 20192020 totaled $9.4$7.5 million, compared to $8.7$9.4 million in the third quarter of 2018.2019. Diluted earnings per share were $0.69$0.55 in the third quarter of 2019,2020, compared to $0.62 (adjusted for stock split)$0.69 in the same quarter a year ago. Earnings for the first nine months of 20192020 totaled $25.2$22.1 million compared to $23.0$25.2 million in the same period last year. Diluted earnings per share were $1.82$1.62 and $1.64 (adjusted for stock-split)$1.82 in the first nine months of 2020 and 2019, and 2018, respectively.

Our net income for the first nine months of 2020 was $3.1 million lower than 2019, primarily due to the economic impact of the pandemic, resulting in a $5.1 million year-over-year increase in the provision for loan losses and an historic low interest rate environment. Our credit quality remained strong with non-accrual loans representing only 0.07% of total loans. We continue to focus on increasing efficiencies and controlling expenses to offset the impacts of net interest margin compression. Non-interest expenses remained relatively flat during 2020 resulting in an efficiency ratio of 56.21%.

The Bank has responded to the COVID-19 pandemic in a number of ways, including third quarter charitable contributions to non-profit organizations of $360 thousand to ensure equitable access to remote learning resources for underserved students in Marin, Napa and Sonoma counties and the City of Alameda. In addition, to assist our employees during the pandemic, we paid $1,200 to each employee totaling $360 thousand in the third quarter, with executive management directing their payments to non-profit organizations of their choice. Since the onset of the pandemic, Bank of Marin has made Small Business Administration ("SBA") Paycheck Protection Program ("PPP") loans to over 1,800 small businesses, reaching nearly 28,000 employees in our markets. We also accommodated loan payment relief requests for borrowers, lowered interest rate floors on commercial Prime Rate loans, waived ATM and overdraft fees, and cancelled early withdrawal penalties for certificates of deposit when allowed by law.

The following are highlights of our operating and financial performance for the periods presented:
•Loans totaled $1,798.7$2,108.0 million at September 30, 2019,2020, compared to $1,763.9$1,843.3 million at December 31, 2018. New2019, an increase of $264.7 million, primarily due to SBA PPP loans, which totaled $301.7 million, or 14% of loan originations of $156.1 million inbalances at September 30, 2020. During the first nine months of 2019 was partially offset by payoffs of $107.8 million, and combined with changes in lines of credit utilization and amortization on existing loans, resulted in the net increase of $34.8 million. For the third quarter of 2019,2020, new non-PPP-related loan originations of $77.3$122.4 million compared withwere offset by $124.7 million in loan payoffs and a $24.5 million decrease in line utilization.
•Bank of Marin is awaiting further guidance from the SBA and the Department of Treasury regarding the PPP loan forgiveness process. We are prepared to open our secure portal for customers to submit forgiveness applications online in the fourth quarter of 2020. Of the total PPP loans, 48% (870 loans) totaling $18.4 million had principal balances of less than or equal to $50,000 as of September 30, 2020.
•While California’s wildfire season has once again been challenging for many communities in Northern California, fortunately, Bank of Marin and our clients have been minimally impacted. The fires had a negligible impact on our third quarter 2018 loan originations of $52.6 million. Loan payoffs of $38.5results.
•Since granting $388.5 million in payment relief for 264 loans at the third quarteronset of 2019, were lower than payoffsthe pandemic, 236 loans totaling $336.3 million have resumed or are scheduled to resume normal payments and eight loans totaling $5.0 million paid off. As of $52.0October 19, 2020, twenty loans totaling $47.2 million (balances as of September 30, 2020) had either requested additional payment relief or the samerelief period a year ago.had not expired. We know each of these clients very well and presently expect the majority will navigate through the pandemic and resume normal payments. The following table summarizes these loans by industry:
Strong credit
Page-31

Payment Relief by Type
IndustryOutstanding Loan Balance
(in thousands)		Weighted Average LTV
Education$17,48126%
Hospitality10,43149%
Retail Related CRE6,29548%
Health Clubs6,20160%
Office and Mixed Use5,37155%
Non-CRE Related1,459N/A
Payment Relief Totals$47,23842%

•Credit quality remains a cornerstone of the Bank's consistent performance. Non-accrual loans totaled $422 thousand,$1.4 million, or 0.02%0.07% of the loan portfoliototal loans at September 30, 2019,2020, compared to $697$226 thousand, or 0.04%0.01% at December 31, 2018. Classified loans totaled $9.9 million at September 30, 2019, compared to $12.6 million at December 31, 2018. Accruing loans past due 30 to 89 days totaled $574 thousand at September 30, 2019, compared to $1.1 million at December 31, 2018. A $400 thousand2019. Despite the low non-accrual totals, we considered the potential impact of the COVID-19 pandemic on the economy in general and recorded a provision for loan losses was recorded inof $5.45 million for the first nine months of 2019. There was no2020, compared to a $400 thousand provision for loanthe same period in 2019. Provision for losses recordedon off-balance sheet commitments for the first nine months of 2020 was $610 thousand compared to $129 thousand for the same period in 2018.2019. SBA PPP loans are fully guaranteed by the SBA and did not contribute to the provisions.
•Total deposits increased $49.7$232.8 million in the first nine months of 20192020 to $2,224.5$2,569.3 million at September 30, 2019. The increase was primarily due to normal cash fluctuations in some of our large business accounts. 2020.
•Non-interest bearing deposits increased $35.2 million from December 31, 2018 and represented 50%54% of total deposits atas of September 30, 2020, compared to 48% at December 31, 2019. The annualized cost of totalaverage deposits fordecreased 7 basis points to 0.13% during the first nine months of 2019 was 0.20%. Total deposits increased $122.5 million in the third quarter of 2019, compared to $75.1 million in the third quarter of 2018.2020.
All capital ratios were above regulatory requirements to be considered well-capitalized. The total risk-based capital ratio for Bancorp was 15.3% at September 30, 2019, compared to 14.9% at December 31, 2018.
•Return on assets was 1.49% for the quarter ended September 30, 2019, compared to 1.38% for the quarter ended September 30, 2018. Return on assets was 1.33%1.03% for the nine months ended September 30, 2019,2020, compared to 1.24%1.33% for the first nine months of 2019. Return on equity was 8.47% for the nine months ended September 30, 2018. Return on equity was 11.34% for the quarter ended September 30, 2019,2020, compared to 11.20% for the quarter ended September 30, 2018. Return on equity was 10.40% for the nine months ended September 30, 2019,2019.
•All capital ratios were above well capitalized regulatory requirements. The total risk-based capital ratio for the Bank was 15.5% at September 30, 2020, compared to 10.17%14.6% at December 31, 2019.
•On October 23, 2020, the Board of Directors approved the reactivation of the share repurchase program that was suspended on March 20, 2020 as part of the early pandemic response, of which $23.2 million remains available for the nine months ended September 30, 2018.future repurchases.
Earnings were positively impacted by a benefit collected on bank-owned-life insurance ("BOLI") policies and an adjustment to the income tax provision related to a deferred tax liability true-up. These items positively impacted diluted earnings per share by approximately $0.06 for the quarter and first nine months of 2019.
•The Board of Directors declared a cash dividend of $0.21$0.23 per share on October 18, 2019.23, 2020. This represents the 58th62nd consecutive quarterly dividend paid by Bank of Marin Bancorp, a 30% payout ratio and 2% dividend yield based on the September 30, 2019 share price.Bancorp. The dividend is payable on November 8, 2019,13, 2020, to shareholders of record at the close of business on November 1, 2019.6, 2020.

For the remainderBank of 2019 and looking forward into 2020, we believe thatMarin's strong balance sheet is built from our core values - relationship banking, disciplined fundamentals and commitment to the communities that we serve - will continue to driveserve. For the successremainder of the Bank.  By building strong relationships in vibrant markets,2020 and looking forward into 2021, we are able to grow our loan portfolio and deposit franchise organically. Disciplined fundamentals ensurebelieve that our credit quality remains high, our deposit base is reasonably priced, and our operations are highly efficient, all of which contribute to profitability.

Our strongrobust liquidity and capital support our organic growth as well as possible acquisitions. This givespositions, high credit quality loan portfolio, excellent credit metrics and low-cost deposit base should help us a great deal of flexibility as we seek opportunities that add value tonavigate the Bank.
pandemic and low interest rate environment.

Page-32

RESULTS OF OPERATIONS
 
Highlights of the financial results are presented in the following tables:
(dollars in thousands)September 30, 2020December 31, 2019
Selected financial condition data:
Total assets$2,975,225 $2,707,280 
Loans, net2,085,878 1,826,609 
Deposits2,569,289 2,336,489 
Borrowings and other obligations2,859 2,920 
Stockholders' equity357,570 336,788 
Asset quality ratios:
Allowance for loan losses to total loans1.05 %0.90 %
Allowance for loan losses to total loans, excluding non-PCI and SBA PPP loans 1
1.29 %0.96 %
Allowance for loan losses to non-accrual loans15.34x73.86x
Non-accrual loans to total loans0.07 %0.01 %
Capital ratios:
Equity to total assets ratio12.02 %12.44 %
Tangible common equity to tangible assets 2
11.00 %11.30 %
Total capital (to risk-weighted assets)16.05 %15.07 %
Tier 1 capital (to risk-weighted assets)14.92 %14.24 %
Tier 1 capital (to average assets)10.58 %11.66 %
Common equity Tier 1 capital (to risk weighted assets)14.79 %14.11 %
(dollars in thousands)September 30, 2019December 31, 2018
Selected financial condition data:  
Total assets$2,592,071
$2,520,892
Loans, net1,782,450
1,748,043
Deposits2,224,524
2,174,840
Borrowings and other obligations2,946
9,640
Stockholders' equity333,065
316,407
Asset quality ratios:  
Allowance for loan losses to total loans0.90%0.90%
Allowance for loan losses to non-accrual loans38.45x
22.71x
Non-accrual loans to total loans0.02%0.04%
Capital ratios:  
Equity to total assets ratio12.85%12.55%
Tangible common equity to tangible assets 1
11.70%11.30%
Total capital (to risk-weighted assets)15.31%14.93%
Tier 1 capital (to risk-weighted assets)14.46%14.10%
Tier 1 capital (to average assets)11.92%11.54%
Common equity Tier 1 capital (to risk weighted assets)14.33%13.98%

Three months ended Nine months endedThree months endedNine months ended
(dollars in thousands, except per share data)September 30, 2019September 30, 2018 September 30, 2019September 30, 2018(dollars in thousands, except per share data)September 30, 2020September 30, 2019September 30, 2020September 30, 2019
Selected operating data:   Selected operating data:
Net interest income$24,151
$23,539
 $71,786
$68,272
Net interest income$24,566 $24,151 $73,060 $71,786 
Provision for loan lossesProvision for loan losses1,250 400 5,450 400 
Non-interest income2,721
2,236
 6,766
6,716
Non-interest income1,790 2,721 6,723 6,766 
Non-interest expense14,200
13,971
 44,644
44,561
Non-interest expense15,238 14,200 44,848 44,644 
Net income9,448
8,680
 25,162
22,960
Net income7,491 9,448 22,125 25,162 
Net income per common share: 4
   
Net income per common share:Net income per common share:
Basic$0.70
$0.63
 $1.84
$1.66
Basic$0.55 $0.70 $1.64 $1.84 
Diluted$0.69
$0.62
 $1.82
$1.64
Diluted$0.55 $0.69 $1.62 $1.82 
Performance and other financial ratios:   Performance and other financial ratios:
Return on average assets1.49%1.38% 1.33%1.24%Return on average assets0.98 %1.49 %1.03 %1.33 %
Return on average equity11.34%11.20% 10.40%10.17%Return on average equity8.37 %11.34 %8.47 %10.40 %
Tax-equivalent net interest margin 2
4.04%3.97% 4.03%3.91%
Tax-equivalent net interest margin 3
Tax-equivalent net interest margin 3
3.44 %4.04 %3.61 %4.03 %
Cost of depositsCost of deposits0.09 %0.21 %0.13 %0.20 %
Efficiency ratio52.84%54.20% 56.83%59.42%Efficiency ratio57.82 %52.84 %56.21 %56.83 %
Cash dividend payout ratio on common stock 3
30.00%25.60% 32.07%27.79%
Cash dividend payout ratio on common stock 4
Cash dividend payout ratio on common stock 4
41.82 %30.00 %28.05 %32.07 %
1 The allowance for loan losses to total loans, excluding non-impaired non-PCI and guaranteed SBA PPP loans, is considered a meaningful non-GAAP financial measure, as it represents only those loans that were considered in the calculation of the allowance for loan losses. Non-PCI loans that were not impaired at September 30, 2020 and December 31, 2019 totaled $90.4 million and $106.8 million, respectively. SBA PPP loans totaled $301.7 million at September 30, 2020. There were no SBA PPP loans as of December 31, 2019.
2 Tangible common equity to tangible assets is considered to be a meaningful non-GAAP financial measure of capital adequacy and is useful for investors to assess Bancorp's ability to absorb potential losses. Tangible common equity of $298$323 million and $281$302 million at September 30, 20192020 and December 31, 2018,2019, respectively, includes common stock, retained earnings and unrealized gains (losses) on available-for sale securities, net of tax, less goodwill and intangible assets. Tangible assets exclude goodwill and intangible assets of $35.0$34.2 million and $35.7$34.8 million at September 30, 20192020 and December 31, 2018,2019, respectively.
23 Tax-equivalent net interest margin is computed by dividing taxable equivalent net interest income, which is adjusted for taxable equivalent income on tax-exempt loans and securities based on Federal statutory rate of 21 percent, by total average interest-earning assets.
34 Calculated as dividends on common shares divided by basic net income per common share.
4 Share and per share data have been adjusted to reflect the two-for-one stock split effective November 27, 2018.

Page-33

Net Interest Income
 
Net interest income is the difference between the interest earned on loans, investments and other interest-earning assets and 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 table also presents net interest income, net interest margin and net interest rate spread for each period reported.
Three months endedThree months ended
September 30, 2020September 30, 2019
InterestInterest
AverageIncome/Yield/AverageIncome/Yield/
(dollars in thousands)BalanceExpenseRateBalanceExpenseRate
Assets
Interest-earning deposits with banks 1
$184,883 $50 0.11 %$77,467 $425 2.15 %
Investment securities 2, 3
527,077 3,481 2.64 %506,023 3,443 2.72 %
Loans 1, 3, 4
2,117,679 21,957 4.06 %1,780,325 21,719 4.77 %
   Total interest-earning assets 1
2,829,639 25,488 3.52 %2,363,815 25,587 4.24 %
Cash and non-interest-bearing due from banks55,353 38,434 
Bank premises and equipment, net5,412 6,713 
Interest receivable and other assets, net138,938 114,537 
Total assets$3,029,342 $2,523,499 
Liabilities and Stockholders' Equity
Interest-bearing transaction accounts$153,089 $41 0.11 %$137,861 $101 0.29 %
Savings accounts191,915 17 0.04 %170,166 17 0.04 %
Money market accounts802,585 377 0.19 %661,131 855 0.51 %
Time accounts including CDARS97,465 133 0.54 %101,404 147 0.57 %
Borrowings and other obligations 1
113 — 2.51 %599 4 2.69 %
Subordinated debenture 1
2,751 35 4.97 %

2,682 57 8.27 %
   Total interest-bearing liabilities1,247,918 603 0.19 %1,073,843 1,181 0.44 %
Demand accounts1,380,708 1,088,903 
Interest payable and other liabilities44,486 30,268 
Stockholders' equity356,230 330,485 
Total liabilities & stockholders' equity$3,029,342 $2,523,499 
Tax-equivalent net interest income/margin 1
$24,885 3.44 %$24,406 4.04 %
Reported net interest income/margin 1
$24,566 3.40 %$24,151 4.00 %
Tax-equivalent net interest rate spread3.33 %3.80 %
Page-34

Nine months endedNine months ended


Three months ended
Three months endedSeptember 30, 2020September 30, 2019


September 30, 2019
September 30, 2018InterestInterest



Interest


Interest
AverageIncome/Yield/AverageIncome/Yield/

AverageIncome/Yield/
AverageIncome/Yield/
(dollars in thousands)BalanceExpenseRate
BalanceExpenseRate
(in thousands; unaudited)(in thousands; unaudited)BalanceExpenseRateBalanceExpenseRate
AssetsAssets




Assets
Interest-bearing due from banks 1
$77,467
$425
2.15%
$79,674
$400
1.96%
Interest-earning deposits with banks 1
$152,587 $421 0.36 %$43,896 $754 2.27 %
Investment securities 2, 3
506,023
3,443
2.72%
558,741
3,624
2.59%
Investment securities 2, 3
544,754 11,632 2.85 %564,050 11,477 2.71 %
Loans 1, 3, 4
1,780,325
21,719
4.77%
1,715,295
20,504
4.68%
Loans 1, 3, 4
1,998,456 64,423 4.24 %1,765,260 63,786 4.76 %
   Total interest-earning assets 1
2,363,815
25,587
4.24%
2,353,710
24,528
4.08%
   Total interest-earning assets 1
2,695,797 76,476 3.73 %2,373,206 76,017 4.22 %
Cash and non-interest-bearing due from banks38,434



41,316


Cash and non-interest-bearing due from banks44,665 34,634 
Bank premises and equipment, net6,713



7,866


Bank premises and equipment, net5,631 7,108 
Interest receivable and other assets, net114,537



86,039


Interest receivable and other assets, net130,525 108,806 
Total assetsTotal assets$2,523,499



$2,488,931


Total assets$2,876,618 $2,523,754 
Liabilities and Stockholders' EquityLiabilities and Stockholders' Equity




Liabilities and Stockholders' Equity
Interest-bearing transaction accounts$137,861
$101
0.29%
$134,293
$58
0.17%Interest-bearing transaction accounts$144,784 $146 0.13 %$130,109 $269 0.28 %
Savings accounts170,166
17
0.04%
179,429
18
0.04%Savings accounts179,288 50 0.04 %174,837 52 0.04 %
Money market accounts661,131
855
0.51%
609,821
337
0.22%Money market accounts786,012 1,731 0.29 %665,167 2,406 0.48 %
Time accounts including CDARS101,404
147
0.57%
132,588
130
0.39%Time accounts including CDARS96,237 436 0.61 %109,978 441 0.54 %
Borrowings and other obligations 1
599
4
2.69% 112
1
2.06%
Borrowings and other obligations 1
208 3 2.14 %3,848 75 2.57 %
Subordinated debentures 1
2,682
57
8.27%
5,815
125
8.43%
Subordinated debenture 1
2,733 124 5.96 %2,664 175 8.66 %
   Total interest-bearing liabilities1,073,843
1,181
0.44%
1,062,058
669
0.25%   Total interest-bearing liabilities1,209,262 2,490 0.27 %1,086,603 3,418 0.42 %
Demand accounts1,088,903



1,101,288


Demand accounts1,278,265 1,083,260 
Interest payable and other liabilities30,268



18,022


Interest payable and other liabilities40,279 30,344 
Stockholders' equity330,485



307,563


Stockholders' equity348,812 323,547 
Total liabilities & stockholders' equityTotal liabilities & stockholders' equity$2,523,499



$2,488,931


Total liabilities & stockholders' equity$2,876,618 $2,523,754 
Tax-equivalent net interest income/margin 1
Tax-equivalent net interest income/margin 1

$24,406
4.04%

$23,859
3.97%
Tax-equivalent net interest income/margin 1
$73,986 3.61 %$72,599 4.03 %
Reported net interest income/margin 1
Reported net interest income/margin 1

$24,151
4.00%

$23,539
3.91%
Reported net interest income/margin 1
$73,060 3.56 %$71,786 3.99 %
Tax-equivalent net interest rate spreadTax-equivalent net interest rate spread
3.80%

3.83%Tax-equivalent net interest rate spread3.45 %3.80 %
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.
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.
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%.
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%.
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.
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.


  Nine months ended Nine months ended
  September 30, 2019 September 30, 2018
   Interest   Interest 
  AverageIncome/Yield/ AverageIncome/Yield/
(in thousands; unaudited)BalanceExpenseRate BalanceExpenseRate
Assets       
 
Interest-bearing due from banks 1
$43,896
$754
2.27% $82,304
$1,088
1.74%
 
Investment securities 2, 3
564,050
11,477
2.71% 555,414
10,512
2.52%
 
Loans 1, 3, 4
1,765,260
63,786
4.76% 1,697,093
59,475
4.62%
 
   Total interest-earning assets 1
2,373,206
76,017
4.22% 2,334,811
71,075
4.01%
 Cash and non-interest-bearing due from banks34,634
   42,488
  
 Bank premises and equipment, net7,108
   8,188
  
 Interest receivable and other assets, net108,806
   87,403
  
Total assets$2,523,754
   $2,472,890
  
Liabilities and Stockholders' Equity       
 Interest-bearing transaction accounts$130,109
$269
0.28% $148,141
$158
0.14%
 Savings accounts174,837
52
0.04% 179,543
54
0.04%
 Money market accounts665,167
2,406
0.48% 601,896
789
0.18%
 Time accounts including CDARS109,978
441
0.54% 142,563
426
0.40%
 
Borrowings and other obligations 1
3,848
75
2.57% 115
2
1.92%
 
Subordinated debentures 1
2,664
175
8.66% 5,785
362
8.25%
    Total interest-bearing liabilities1,086,603
3,418
0.42% 1,078,043
1,791
0.22%
 Demand accounts1,083,260
   1,074,778
  
 Interest payable and other liabilities30,344
   18,127
  
 Stockholders' equity323,547
   301,942
  
Total liabilities & stockholders' equity$2,523,754
   $2,472,890
  
Tax-equivalent net interest income/margin 1
 $72,599
4.03%  $69,284
3.91%
Reported net interest income/margin 1
 $71,786
3.99%  $68,272
3.86%
Tax-equivalent net interest rate spread  3.80%   3.79%
         
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%.
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.



Analysis of Changes in Tax-Equivalent Net Interest Income

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 years 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.balances, including one more day in the nine months ended September 30, 2020.
Page-35

 Three Months Ended September 30, 2019 Compared to Three Months Ended September 30, 2018Nine Months Ended September 30, 2019 Compared to Nine Months Ended September 30, 2018
(in thousands)Volume
Yield/Rate
Mix
Total
Volume
Yield/Rate
Mix
Total
Interest-bearing due from banks$(11)$37
$(1)$25
$(508)$326
$(152)$(334)
Investment securities 1
(342)177
(16)(181)163
789
13
965
Loans 1
777
422
16
1,215
2,389
1,849
73
4,311
Total interest-earning assets424
636
(1)1,059
2,044
2,964
(66)4,942
Interest-bearing transaction accounts2
41
—
43
(19)148
(18)111
Savings accounts(1)1
(1)(1)(1)—
(1)(2)
Money market accounts28
452
38
518
83
1,388
146
1,617
Time accounts, including CDARS(30)62
(15)17
(97)146
(34)15
Borrowings and other obligations3
—
—
3
54
1
18
73
Subordinated debentures(67)(2)1
(68)(195)18
(10)(187)
Total interest-bearing liabilities(65)554
23
512
(175)1,701
101
1,627
Changes in tax-equivalent net interest income$489
$82
$(24)$547
$2,219
$1,263
$(167)$3,315
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%.

Three Months Ended September 30, 2020 Compared to Three Months Ended September 30, 2019Nine Months Ended September 30, 2020 Compared to Nine Months Ended
September 30, 2019
(in thousands)VolumeYield/RateMixTotalVolumeYield/RateMixTotal
Interest-earning deposits with banks$589 $(404)$(560)$(375)$1,867 $(633)$(1,567)$(333)
Investment securities 1
143 (101)(4)38 (393)567 (19)155 
Loans 1
4,116 (3,260)(618)238 8,426 (7,088)(701)637 
Total interest-earning assets4,848 (3,765)(1,182)(99)9,900 (7,154)(2,287)459 
Interest-bearing transaction accounts11 (64)(7)(60)30 (138)(15)(123)
Savings accounts1 (1)— — 1 (3)— (2)
Money market accounts183 (544)(117)(478)437 (946)(166)(675)
Time accounts, including CDARS(6)(8)— (14)(55)56 (6)(5)
Borrowings and other obligations(3)(6)5 (4)(71)(13)12 (72)
Subordinated debenture1 (23)— (22)5 (55)(1)(51)
Total interest-bearing liabilities187 (646)(119)(578)347 (1,099)(176)(928)
Changes in tax-equivalent net interest income$4,661 $(3,119)$(1,063)$479 $9,553 $(6,055)$(2,111)$1,387 
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%.
Third Quarter of 20192020 Compared to Third Quarter of 20182019

Net interest income totaled $24.2$24.6 million in the third quarter of 2019,2020, compared to $23.5$24.2 million in the same quarter a year ago. The $612$415 thousand increase from the comparative quarter a year ago was reflective ofprimarily attributed to $2.4 million from SBA PPP loans, higher averagenon-PPP loan balances higher yields across earning asset categories, and a land development loanlower interest recovery,expense on deposits. These positive variances were partially offset by higherthe impact of lower interest rates on deposits.non-PPP loans, cash and investments.


The reportedtax-equivalent net interest margin was 4.00%3.44% in the third quarter of 20192020 compared to 3.91%4.04% in the same quarter of the previous year.  The 9 basis points increase compareddecrease in tax-equivalent net interest margin was attributable to both the lower interest rate environment and SBA PPP loans. SBA PPP loans lowered the third quarter 2020 net interest margin by 4 basis points.

In October 2020, due to the continued delay in the PPP forgiveness process, the Bank extended the payment deferral period from six to sixteen months for PPP loans that originated prior to June 5, 2020 in accordance with the PPP Flexibility Act. The extension of 2018 wasthe first payment due date decreased the effective rate used to accrete net loan origination fees and costs, which will affect the timing of when the accretion of PPP net loan origination fees will be recognized. We estimate this change will decrease fourth quarter 2020 net interest income by approximately $850 thousand. The decrease may be partially or fully offset by the accelerated fee accretion related to higher yields, loan growth,loans that are forgiven and paid off during the land development loan interest recovery (6 basis points), partially offset by an increase in rates on deposit accounts.fourth quarter, which cannot be estimated at this time.


First Nine Months of 20192020 Compared to First Nine Months of 20182019

Net interest income totaled $71.8$73.1 million in the first nine months of 2019,ended September, 30 2020, compared to $68.3$71.8 million in the same period a year ago. The $3.5$1.3 million increase was primarily relatesdue to SBA PPP loan income, higher averagecommercial loan balances, and higher yields across earning asset categories,on investments and lower rates on deposits partially offset by higher rateslower yields on deposits.loans.

The reportedtax-equivalent net interest margin was 3.99%3.61% in the first nine months of 2019,ended September 30, 2020, compared to 3.86%4.03% in the same period a year ago.  The decrease in tax-equivalent net interest margin was attributable to both the lower interest rate environment and SBA PPP loans. SBA PPP loans lowered the 2020 net interest margin by 3 basis points. To offset the impacts of 2018.  The 13 basis points increase was relatedmargin compression, we continue to higher yields, higher loan balances,focus on increasing efficiencies and controlling expenses including evaluating the land development loan interest recovery (2 basis points), partially offset by an increase in rates on deposit accounts.cost of our facilities.

Market Interest Rates

Market interest rates are, in part, influencedIn response to the evolving risks to economic activity posed by the target federal funds interest rate (the interest rate banks charge each other for short-term borrowings) set byCOVID-19 pandemic, the Federal Reserve Open Market Committee ("FOMC"). During 2018, the FOMC made four 25-basis-point increasestwo emergency cuts totaling 150 basis points to a range of 2.25% to 2.50% as of December 2018, where it remained during the first half of 2019. In each of its July, September and October 2019 meetings, the FOMC lowered the federal funds rate by 0.25%in March 2020. This will continue to a range of 1.50% to 1.75% as of October 31, 2019. Because the Bank isput downward pressure on our asset sensitive, falling


interest rates could put pressure onyields and net interest margin. See ITEM 3. Quantitative and Qualitative Disclosure about Market Risk for further information.
Page-36


Provision for Loan Losses
 
Management assesses the adequacy of the allowance for loan losses quarterly based on several factors including growth of the loan portfolio, analysis of probable losses in the portfolio, historical loss experience and the current economic climate.climate, including the economic uncertainties of the COVID-19 pandemic. While loss recoveries and provisions for loan losses charged to expense increase the allowance, actual losses on loans reduce the allowance.
Impaired loan balancesloans totaled $12.4$13.8 million at September 30, 20192020 and $15.0$11.5 million at December 31, 2018,2019, with specific valuation allowances of $389$1,106 thousand and $778$397 thousand forat the same respective dates. Loans graded special mention totaled $54.0$87.7 million at September 30, 20192020 and $17.3$73.4 million at December 31, 2018. Contributing to the change in2019. While special mention during 2019graded loans are not considered adversely classified, the $14.4 million increase was largely due to a small number of commercial real estate borrowers who, after further analysis, were four newgranted additional payment relief beyond the initial relief period and a few commercial real estate loans that warrantedwere considered temporarily affected by the designation due to unique circumstances. Thesepandemic. All of these loans are either well-secured or have strong sponsorshiplow loan-to-value ratios and are not indicativewill be monitored at least quarterly as part of deterioratingthe Bank's credit quality in the loan portfolio.management process. Classified assets (loans with substandard or doubtful risk grades) decreasedtotaled $11.0 million at September 30, 2020, compared to $9.9 million at September 30, 2019, from $12.6 million at December 31, 2018. The $2.7 million decrease was primarily due to a substantial pay down on a substandard classified land development loan in the second quarter, which was upgraded to a pass risk rating due to the borrower’s improved financial condition and low loan-to-value ratio.2019. There were no loans with doubtful risk grades at September 30, 20192020 or December 31, 2018.

2019.
A $400 thousand
In accordance with the accounting relief provisions of the CARES Act, the Bank has postponed the adoption of the CECL accounting standard to focus on our customers' needs during the COVID-19 pandemic and due to the lack of clarity around the extent and duration of the COVID-19 pandemic, which hindered development of reasonable and supportable forecasts in the early days of the pandemic. Under the existing incurred loss model we adjusted certain qualitative factors, primarily to account for the significant increase in the unemployment rate and recorded a $5.45 million loan loss provision for loan losses was recorded in the quarter ended September 30, 2019, which was consistent with loan growth. There was no provision for loan losses recorded in the three and nine months ended September 30, 2018. Net recoveries2020, compared to $400 thousand for the same period in the third quarter of 2019 totaled $6prior year. Net charge-offs were $14 thousand for the nine months ended September 30, 2020, compared to net recoveries of $4$19 thousand same period in the same quarter a year ago. Net recoveries totaled $19 thousand in the first nine months of 2019, compared to net recoveries of $50 thousand in the same period a year ago.prior year.

The ratio of allowance for loan loss reserveslosses to total loans, including acquired loans and SBA-guaranteed PPP loans, was 0.90%1.05% at September 30, 20192020, compared to 0.90% at December 31, 2019. Excluding guaranteed SBA PPP loans and non-PCI acquired loans, the ratio of the allowance for loan losses to total loans would have been 1.29% and 0.96% at September 30, 2020 and December 31, 2018.2019, respectively (Refer to footnote 1 on page 33 for a definition and reconciliation of this non-GAAP financial measure). Non-accrual loans totaled $422 thousand,$1.4 million, or 0.02%0.07% of total loans at September 30, 2019,2020, compared to $697$226 thousand, or 0.04%,0.01% of total loans at December 31, 2018.2019. The $1.4 million increase in non-accrual loans was primarily attributable to one loan secured by a triplex property with a low loan-to-value ratio as well as one home equity loan.

For more information, refer to Note 5 to the Consolidated Financial Statements in this Form 10-Q.


Non-interest Income
 
The following table detailstables detail the components of non-interest income.
 Three months endedAmountPercent
(dollars in thousands)September 30, 2020September 30, 2019Increase (Decrease)Increase (Decrease)
Service charges on deposit accounts$284 $439 $(155)(35.3)%
Wealth Management and Trust Services450 495 (45)(9.1)%
Debit card interchange fees, net383 406 (23)(5.7)%
Merchant interchange fees, net63 79 (16)(20.3)%
Earnings on bank-owned life insurance232 795 (563)(70.8)%
Dividends on FHLB stock149 202 (53)(26.2)%
Gains on sale of investment securities, net— — — N/A
Other income229 305 (76)(24.9)%
Total non-interest income$1,790 $2,721 $(931)(34.2)%
Page-37

 Three months ended Amount Percent
(dollars in thousands)September 30, 2019September 30, 2018 Increase (Decrease) Increase (Decrease)
Service charges on deposit accounts$439
$475
 $(36) (7.6)%
Wealth Management and Trust Services495
490
 5
 1.0 %
Debit card interchange fees, net406
402
 4
 1.0 %
Merchant interchange fees, net79
99
 (20) (20.2)%
Earnings on bank-owned life insurance, net795
227
 568
 250.2 %
Dividends on FHLB stock202
194
 8
 4.1 %
(Losses) on investment securities, net—
(90) 90
 (100.0)%
Other income305
439
 (134) (30.5)%
Total non-interest income$2,721
$2,236
 $485
 21.7 %
 Nine months ended Amount Percent
(dollars in thousands)September 30, 2019September 30, 2018 Increase (Decrease) Increase (Decrease)
Service charges on deposit accounts$1,403
1,407
 $(4) (0.3)%
Wealth Management and Trust Services1,406
1,493
 (87) (5.8)%
Debit card interchange fees, net1,200
1,158
 42
 3.6 %
Merchant interchange fees, net253
297
 (44) (14.8)%
Earnings on bank-owned life insurance, net970
685
 285
 41.6 %
Dividends on FHLB stock591
582
 9
 1.5 %
Gains (losses) on investment securities, net55
(79) 134
 NM
Other income888
1,173
 (285) (24.3)%
Total non-interest income$6,766
$6,716
 $50
 0.7 %
NM- Not Meaningful      

 Nine months endedAmountPercent
(dollars in thousands)September 30, 2020September 30, 2019Increase (Decrease)Increase (Decrease)
Service charges on deposit accounts$1,028 $1,403 $(375)(26.7)%
Wealth Management and Trust Services1,375 1,406 (31)(2.2)%
Debit card interchange fees, net1,051 1,200 (149)(12.4)%
Merchant interchange fees, net183 253 (70)(27.7)%
Earnings on bank-owned life insurance, net741 970 (229)(23.6)%
Dividends on FHLB stock503 591 (88)(14.9)%
Gains on sale of investment securities, net915 55 860 1,563.6 %
Other income927 888 39 4.4 %
Total non-interest income$6,723 $6,766 $(43)(0.6)%

Third Quarter of 20192020 Compared to Third Quarter of 2019
2018

Non-interest income increaseddecreased by $485$931 thousand in the third quarter of 20192020 to $2.7$1.8 million, compared to $2.2$2.7 million in the same quarter a year ago. The increase in earnings on BOLIdecrease was primarily attributeddue to a $562 thousand benefit collected on BOLI policies. The decreasepolicies in other income was primarily due tothe third quarter of 2019. Additionally fewer ATM fees and service charges on deposit accounts, lower dividends on FHLB stock, and lower fee income from one-way deposit sales to third-party deposit networks. Additionally, there was a net loss on investments securitiesnetworks in the samethird quarter a year ago dueof 2020 all contributed to the sale of municipal securities.decrease.


First Nine Months of 20192020 Compared to First Nine Months of 20182019

Non-interest income increaseddecreased by $50$43 thousand in the first nine months of 20192020 to $6.7 million, compared to $6.8 million in the same period a year ago. The small decline was driven by decreases across most non-interest income categories, partially offset by higher gains on sales of investment securities in the first nine months of 2020.

Non-interest Expense
The following tables detail the components of non-interest expense.
 Three months endedAmountPercent
(dollars in thousands)September 30, 2020September 30, 2019Increase (Decrease)Increase (Decrease)
Salaries and related benefits$8,638 $8,412 $226 2.7 %
Occupancy and equipment1,776 1,507 269 17.9 %
Depreciation and amortization539 573 (34)(5.9)%
Federal Deposit Insurance Corporation insurance181 1 180 18,000.0 %
Data processing822 923 (101)(10.9)%
Professional services655 580 75 12.9 %
Directors' expense184 189 (5)(2.6)%
Information technology256 279 (23)(8.2)%
Amortization of core deposit intangible213 222 (9)(4.1)%
Provision for losses on off-balance sheet commitments248 — 248 100.0 %
Charitable contributions481 111 370 333.3 %
Other non-interest expense
Advertising163 183 (20)(10.9)%
Other expense1,082 1,220 (138)(11.3)%
Total other non-interest expense1,245 1,403 (158)(11.3)%
Total non-interest expense$15,238 $14,200 $1,038 7.3 %
Page-38

Nine months endedAmountPercent
(dollars in thousands)September 30, 2020September 30, 2019Increase (Decrease)Increase (Decrease)
Salaries and related benefits$25,979 $26,426 $(447)(1.7)%
Occupancy and equipment5,100 4,616 484 10.5 %
Depreciation and amortization1,591 1,701 (110)(6.5)%
Federal Deposit Insurance Corporation insurance299 354 (55)(15.5)%
Data processing2,437 2,942 (505)(17.2)%
Professional services1,749 1,701 48 2.8 %
Directors' expense533 555 (22)(4.0)%
Information technology758 822 (64)(7.8)%
Amortization of core deposit intangible639 665 (26)(3.9)%
Provision for losses on off-balance sheet commitments610 129 481 372.9 %
Charitable contributions921 377 544 144.3 %
Other non-interest expense 
Advertising572588(16)(2.7)%
Other expense3,660 3,768 (108)(2.9)%
Total other non-interest expense4,232 4,356 (124)(2.8)%
Total non-interest expense$44,848 $44,644 $204 0.5 %

Third Quarter of 2020 Compared to Third Quarter of 2019

Non-interest expense increased by $1.0 million to $15.2 million, compared to $6.7$14.2 million in the same period a year ago. The increase in earnings on bank-owned life insurance was primarily due to the benefit mentioned above (partially offset by $283 thousand non-refundable underwriting costs associated with two new bank-owned life insurance policies purchased in the first quarter of 2019). The sale of securities resulted in a net gain in the first nine months of 2019, contrary to the net loss experienced in the same period a year ago. The decrease in other income was primarily due to the decrease in deposit network income discussed above. The decrease in wealth management and trust services income was primarily attributed to the exit of a high-risk, high balance trust client and multiple large estate asset distributions in mid-2018, and the loss of a large agency client in June of 2019 due to death. These losses were partially offset by new clients in late 2018 and early 2019.



Non-interest Expense
The following table details the components of non-interest expense.
 Three months ended Amount Percent
(dollars in thousands)September 30, 2019 September 30, 2018 Increase (Decrease) Increase (Decrease)
Salaries and related benefits$8,412
 $8,069
 $343
 4.3 %
Occupancy and equipment1,507
 1,444
 63
 4.4 %
Depreciation and amortization573
 532
 41
 7.7 %
Federal Deposit Insurance Corporation insurance1
 186
 (185) (99.5)%
Data processing923
 950
 (27) (2.8)%
Professional services580
 727
 (147) (20.2)%
Directors' expense189
 173
 16
 9.2 %
Information technology279
 262
 17
 6.5 %
Core deposit intangible amortization222
 230
 (8) (3.5)%
Other non-interest expense    

  
Advertising183
 118
 65
 55.1 %
Other expense1,331
 1,280
 51
 4.0 %
Total other non-interest expense1,514
 1,398
 116
 8.3 %
Total non-interest expense$14,200
 $13,971
 $229
 1.6 %
        
 Nine months ended Amount Percent
(dollars in thousands)September 30, 2019 September 30, 2018 Increase (Decrease) Increase (Decrease)
Salaries and related benefits$26,426
 $25,402
 $1,024
 4.0 %
Occupancy and equipment4,616
 4,462
 154
 3.5 %
Depreciation and amortization1,701
 1,625
 76
 4.7 %
Federal Deposit Insurance Corporation insurance354
 568
 (214) (37.7)%
Data processing2,942
 3,354
 (412) (12.3)%
Professional services1,701
 2,836
 (1,135) (40.0)%
Directors' expense555
 530
 25
 4.7 %
Information technology822
 795
 27
 3.4 %
Core deposit intangible amortization665
 691
 (26) (3.8)%
Provision for losses on off-balance sheet commitments129
 —
 129
 100.0 %
Other non-interest expense  
    
Advertising588
 426
 162
 38.0 %
Other expense4,145
 3,872
 273
 7.1 %
Total other non-interest expense4,733
 4,298
 435
 10.1 %
Total non-interest expense$44,644
 $44,561
 $83
 0.2 %
        

Third Quarter of 2019 Compared to Third Quarter of 2018

Non-interest expense increased by $229 thousand to $14.2 million in the third quarter of 2019, compared to $14.0 million the same quarter a year ago. The increase was primarily due to $343$370 thousand more in salaries and related benefits duecharitable contributions to six additional full-time equivalent ("FTE") staff and annual merit increases, partially offset by a reversal of Federal Deposit Insurance Corporation ("FDIC") deposit insurance expense when notified that the June 30, 2019 FDIC Deposit Insurance Fund reserve exceeded its billing threshold. Additionally, there were fewer fees associated with professional services in the third quarter of 2019 (primarily due to core processing system contract negotiation costs in 2018).

First Nine Months of 2019 Compared to First Nine Months of 2018



Non-interest expense increased by $83 thousand to $44.6 million in the first nine months of 2019, compared to $44.56 million in the same period a year ago. In the first nine months of 2019, we incurred $1.0 million more in salaries and related benefits due to four additional FTE staff, personnel severance, and annual merit increases. In contrast, $1.1 million more in core processing system contract negotiation costs and $954 thousand Bank of Napa acquisition related expenses were incurred in 2018. The alleviation of data processing costs (mostly attributed to Bank of Napa conversion fees in 2018) and FDIC insurance expense reversal mentioned above, are more than offset by a $129non-profit organizations, $248 thousand provision for losses on off-balance sheet commitments, and higher costssalaries and benefits driven by annual merit increases. Additionally, the third quarter of 2020 included higher FDIC insurance expense due to fewer FDIC assessment credits, and higher occupancy expense associated with the normal courserenewal of businessleases for our existing headquarters offices and a new lease for a loan production office in San Mateo.

First Nine Months of 2020 Compared to First Nine Months of 2019

Non-interest expense increased by $204 thousand to $44.8 million in the first nine months of 2019.2020, compared to $44.6 million in the same period a year ago. The increase was primarily due to $544 thousand higher charitable contributions to non-profit organizations, $484 thousand higher occupancy expense associated with new and renewed leases mentioned above, and $481 thousand higher provision for losses on off-balance sheet commitments. These increases were partially offset by decreases in salaries and related benefits primarily due to $915 thousand SBA PPP-related deferred loan origination costs and fewer data processing costs from our digital platform conversion.

Provision for Income Taxes

Income tax provisions reflect accruals for taxes at the applicable rates for federal income tax and California franchise tax based upon reported pre-tax income. Provisions also reflect permanent differences between income for tax and financial reporting purposes (such as earnings on tax exempt loans and municipal securities, BOLI, and low-income housing tax credits) as well as transactions with discrete tax effects (such ascredits, and stock-based compensation from the exercise of stock options, the disqualifying dispositions of incentive stock options and vesting of restricted stock awards).

The provision for income taxes for the third quarter of 20192020 totaled $2.8 million at an effective tax rate of 23.0%, compared to $3.1$2.4 million at an effective tax rate of 26.5%24.1%, compared to $2.8 million at an effective tax rate of 23.0% in the same quarter last year. The decrease in the provision reflected higher tax exempt BOLIa lower level of pre-tax income from death benefits (discussed in Non-Interest Income, above) and2020, partially offset by a $327 thousandfavorable deferred tax liability true-up adjustment recognized in the third quarter of 2019. The increase in the effective tax rate was primarily due to the true-up adjustment recognized in third quarter of 2019.

The provision for income taxes for the first nine months of 20192020 totaled $7.4 million at an effective tax rate of 25.0%, compared to $8.3 million at an effective tax rate of 24.9%, compared to $7.5 million at an effective tax rate of 24.5% for the first nine months of 2018.2019. The increasedecrease in the provision reflected the highera lower level of pre-tax income and lower tax-exempt interest income.higher tax exempt earnings on investment securities in 2020. The slight increase in the effective tax rate in the first nine months of 2019 compared to the first nine months of 2018 was primarily due to the 2019 favorable deferred tax liability true-up
Page-39

adjustment as described above and a lower tax benefit from BOLI income in 2020. These increases were substantially offset by a higher level of discrete tax benefits in 20182020 from the exercise of non-qualified stock options and vestingdisqualifying dispositions of restricted stock. These discrete tax benefits reduced the effective tax rate approximately 50 basis points in the first nine months of 2019 versus 150 basis points in the same period a year ago. Discrete tax benefits were higher in the first nine months of 2018 dueincentive stock options compared to higher nonqualified stock option exercise activity from former employees of Bank of Napa post-acquisition. The increase in the effective tax rate was partially offset by approximately 100 basis points due to the deferred tax liability true-up adjustment.2019.

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, 2019,2020, neither the Bank nor Bancorp had accruals for interest nor penalties related to unrecognized tax benefits.

FINANCIAL CONDITION SUMMARY

At September 30, 2019,2020, assets totaled $2,592.1$2,975.2 million, an increase of $71.2$267.9 million, from $2,707.3 million at December 31, 2018,2019, mainly reflectingdue to an increase in cash and loans related to our participation in the PPP in response to the COVID-19 pandemic as explained below, partially offset by a $38.9 million decrease in investment securities.
Cash, Cash Equivalents and Restricted Cash

Total cash, cash equivalents and restricted cash were $213.6 million at September 30, 2020, compared to $183.4 million at December 31, 2019. The $30.2 million increase was largely due to temporary increases in SBA PPP borrowers' deposit inflowsaccounts. Cash and cash flows fromequivalents as of September 30, 2020 do not include $146.6 million in temporary one-way sale transfers of deposits to third-party deposit networks as part of our securities portfolioliquidity management. Effective March 26, 2020, the Federal Reserve reduced the reserve requirement ratios to zero percent in response to the COVID-19 pandemic resulting in no restricted cash requirements as discussed below.of September 30, 2020. Restricted cash held at the Federal Reserve as of December 31, 2019 totaled $4.8 million.

Investment Securities

The investment securities portfolio totaled $500.9$530.8 million at September 30, 2019,2020, a decrease of $118.7$38.9 million from December 31, 2018.2019. The decrease reflects paydowns, calls paydowns,and maturities totaling $88.0 million and sales totaling $150.5$32.8 million during the first nine months of 2020, partially offset by purchases of $18.9$71.7 million in 2019high credit quality longer duration securities and increase in the fair value of available-for-sale securities in 2019. We2020. During the first and second quarters of 2020, respectively, we sold $66$26.6 million of short duration agency residential mortgage-backed securities subject to increasing prepayment speeds and $6.2 million of obligations of state and political subdivisions that were sensitive to the credit exposure posed by the COVID-19 pandemic. There were no security sales in lower yielding, shorter term securities in early 2019 to manage our interest rate spread and cash position.the third quarter.

The following table summarizes our investment in obligations of state and political subdivisions at September 30, 20192020 and December 31, 2018.2019.

September 30, 2020December 31, 2019
(dollars in thousands)Amortized CostFair Value% of Total State and Political SubdivisionsAmortized CostFair Value% of Total State and Political Subdivisions
Within California:
General obligation bonds$3,333 $3,570 3.6 %$4,597 $4,813 6.6 %
Revenue bonds2,569 2,675 2.8 2,928 2,977 4.2 
Tax allocation bonds3,343 3,416 3.7 3,376 3,456 4.9 
Total within California9,245 9,661 10.1 10,901 11,246 15.7 
Outside California:
General obligation bonds62,182 64,836 68.2 45,974 46,976 66.1 
Revenue bonds19,763 20,966 21.7 12,680 12,648 18.2 
Total outside California81,945 85,802 89.9 58,654 59,624 84.3 
Total obligations of state and political subdivisions$91,190 $95,463 100.0 %$69,555 $70,870 100.0 %

  September 30, 2019 December 31, 2018
(dollars in thousands)Amortized CostFair Value% of Total State and Political Subdivisions Amortized CostFair Value% of Total State and Political Subdivisions
Within California:       
 General obligation bonds$4,603
$4,828
8.2% $14,438
$14,418
16.0%
 Revenue bonds2,930
2,980
5.2
 7,109
7,108
7.9
 Tax allocation bonds3,886
3,978
6.9
 4,541
4,601
5.0
Total within California11,419
11,786
20.3
 26,088
26,127
28.9
Outside California:       
 General obligation bonds39,476
40,409
70.5
 56,186
55,199
62.3
 Revenue bonds5,140
5,172
9.2
 7,883
7,850
8.8
Total outside California44,616
45,581
79.7
 64,069
63,049
71.1
Total obligations of state and political subdivisions$56,035
$57,367
100.0% $90,157
$89,176
100.0%

The portion of the portfolio outside the state of California is distributed among twelveeleven states. Of the total investment in obligations of state and political subdivisions, the largest concentrations outside of California are in Texas (28.2%(47.6%), FloridaWashington (9.7%), and Washington (8.3%Maryland (7.5%). Revenue bonds, both within and outside California, primarily consist of bonds relatingDuring March 2020, we strategically increased our credit
Page-40

exposure to obligations issued by high credit quality municipal issuers in Texas that are either guaranteed by the AAA-rated Texas Permanent School Fund ("PSF") or backed by revenue sources from essential services (such as public improvements, transportationutilities and utilities) andtransportation). We have $6.0 million in obligations of Texas school district bonds.issuers having high concentrations in oil and gas industry taxpayers and all of them have credit guarantees from PSF. We have little or no exposure to municipal sectors such as higher education or health care that are most vulnerable to credit risks posed by the COVID-19 pandemic.

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

Loans

LoansDuring the first nine months of 2020, loans increased by $34.8$264.7 million and totaled $1,798.7$2,108.0 million at September 30, 2019.2020, primarily due to SBA PPP loans which totaled $308.2 million. We ended the origination of new PPP loans on June 30, 2020 to focus our efforts on helping our customers through the loan forgiveness process. New non-PPP related loan originations of $156.1 million in the first nine months of 2019 were distributed across Commercial Banking and Consumer Banking. Loan payoffs totaled $107.8$122.4 million in the first nine months. The largest portionmonths of payoffs2020. Payoffs totaled $124.7 million and line utilization decreased $24.5 million during the first nine months of 2020. While we have had success originating new loans this year, we have found that the pandemic has extended traditional timelines as loans move through the origination process. During these unprecedented times, we are focused on maintaining relationships with our customers and bringing in 2019 reflected the sale of assets underlying loansnew client relationships where prudent and the successful completion of construction projects.possible.

Liabilities

During the first nine months of 2019,2020, total liabilities increased by $54.5$247.2 million to $2,259.0$2,617.7 million. Deposits increased $49.7$232.8 million in the first nine months of 2019.2020, primarily driven by a combination of PPP loan proceeds and increased liquidity throughout the banking system as a result of depositors' higher level of savings during these uncertain economic times. Non-interest bearing deposits increased $35.2$254.9 million in the first nine months of 20192020 to $1,101.3$1,383.7 million, and represented 49.5%53.9% of total deposits at September 30, 2019,2020, compared to 49.0%48.3% at December 31, 2018. We repaid a $7.0 million overnight borrowing from FHLB at year end of 2018.2019. Liabilities as of September 30, 20192020 included operating lease liabilities totaling $13.7$27.5 million, that were recordedwhich increased $14.9 million in 2019 after the adoptionfirst nine months of 2020 due to the extension of lease terms for our existing headquarters office and seven retail branches and a new lease accounting standard, as discussed in Notes 2 and 8 to the consolidated financial statements.agreement for one of our retail branches.


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 to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet our anticipated future needs.  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 JuneSeptember 30, 2019.2020. There are no conditions or events since that
Page-41

notification that Management believes have changed the Bank’s categories and we expect the Bank to remain well capitalized for prompt corrective action purposes.

In July 2013, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency ("Agencies") finalized regulatory capital rules known as “Basel III.” Fully phased in on January 1, 2019, Basel III required the Bank to maintain (i) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 8.5%, and (ii) a minimum ratio of common equity Tier 1 capital to risk-weighted assets of at least 7.0%, both inclusive of a 2.50% “capital conservation buffer." The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and was phased in over a four-year period (increasing by 0.625% each subsequent January 1, until it reached 2.50% on January 1, 2019). In August 2018, the Board of Governors of the Federal Reserve System changed the definition of a "Small Bank Holding Company" by increasing the asset threshold from $1.0 billion to $3.0 billion. As a result, Bancorp is no longerwas not subject to separate minimum capital requirements.requirements as of September 30, 2020 and December 31, 2019. However, we disclosed comparative capital ratios for Bancorp, which would have exceeded well-capitalized levels had Bancorp been subject to the same minimum capital requirements.requirements in 2020 and 2019.

The Bancorp’s and Bank’s capital adequacy ratios as of September 30, 20192020 and December 31, 20182019 are presented in the following tables. Bancorp's Tier 1 capital includes the subordinated debentures,debenture, which are not included at the Bank level.
Capital Ratios for Bancorp
(dollars in thousands)
Actual RatioAdequately Capitalized ThresholdRatio to be a Well Capitalized Bank Holding Company
September 30, 2020AmountRatioAmountRatioAmountRatio
Total Capital (to risk-weighted assets)$338,841 16.05 %≥ $221,701 ≥ 10.50 %≥ $211,144 ≥ 10.00 %
Tier 1 Capital (to risk-weighted assets)$315,031 14.92 %≥ $179,472 ≥   8.50 %≥ $168,915 ≥   8.00 %
Tier 1 Capital (to average assets)$315,031 10.58 %≥ $119,063 ≥   4.00 %≥ $148,829 ≥   5.00 %
Common Equity Tier 1 (to risk-weighted assets)$312,271 14.79 %≥ $147,801 ≥   7.00 %≥ $137,243 ≥   6.50 %
December 31, 2019   
Total Capital (to risk-weighted assets)$319,317 15.07 %≥ $222,430 ≥ 10.50 %≥ $211,838 ≥ 10.00 %
Tier 1 Capital (to risk-weighted assets)$301,553 14.24 %≥ $180,063 ≥   8.50 %≥ $169,471 ≥   8.00 %
Tier 1 Capital (to average assets)$301,553 11.66 %≥ $103,489 ≥   4.00 %≥ $129,361 ≥   5.00 %
Common Equity Tier 1 (to risk-weighted assets)$298,845 14.11 %≥ $148,287 ≥   7.00 %≥ $137,695 ≥   6.50 %
Capital Ratios for Bancorp
(dollars in thousands)
Actual Ratio
Adequately Capitalized Threshold1
Ratio to be a Well Capitalized Bank Holding Company
September 30, 2019Amount
Ratio
Amount
Ratio
Amount
Ratio
Capital Ratios for the Bank
(dollars in thousands)
Capital Ratios for the Bank
(dollars in thousands)
Actual RatioAdequately Capitalized ThresholdRatio to be Well Capitalized under Prompt Corrective Action Provisions
September 30, 2020September 30, 2020AmountRatioAmountRatioAmountRatio
Total Capital (to risk-weighted assets)$312,801
15.31%≥ $204,365
≥ 10.00%≥ $204,365
≥ 10.00%Total Capital (to risk-weighted assets)$326,658 15.47 %≥ $221,693 ≥ 10.50 %≥ $211,136 ≥ 10.00 %
Tier 1 Capital (to risk-weighted assets)$295,474
14.46%≥ $163,492
≥ 8.00%≥ $163,492
≥ 8.00%Tier 1 Capital (to risk-weighted assets)$302,848 14.34 %≥ $179,466 ≥   8.50 %≥ $168,909 ≥   8.00 %
Tier 1 Capital (to average assets)$295,474
11.92%≥ $123,958
≥ 5.00%≥ $123,958
≥ 5.00%Tier 1 Capital (to average assets)$302,848 10.17 %≥ $119,062 ≥   4.00 %≥ $148,827 ≥   5.00 %
Common Equity Tier 1 (to risk-weighted assets)$292,783
14.33%≥ $132,837
≥ 6.50%≥ $132,837
≥ 6.50%Common Equity Tier 1 (to risk-weighted assets)$302,848 14.34 %≥ $147,795 ≥   7.00 %≥ $137,239 ≥   6.50 %
December 31, 2018 
  
 
  
December 31, 2019December 31, 2019 
Total Capital (to risk-weighted assets)$305,224
14.93%≥ $201,943
≥ 9.875%≥ $204,499
≥ 10.00%Total Capital (to risk-weighted assets)$309,875 14.63 %≥ $222,437 ≥ 10.50 %≥ $211,844 ≥ 10.00 %
Tier 1 Capital (to risk-weighted assets)$288,445
14.10%≥ $161,043
≥ 7.875%≥ $163,599
≥ 8.00%Tier 1 Capital (to risk-weighted assets)$292,111 13.79 %≥ $180,068 ≥   8.50 %≥ $169,476 ≥   8.00 %
Tier 1 Capital (to average assets)$288,445
11.54%≥ $100,011
≥ 4.000%≥ $125,013
≥ 5.00%Tier 1 Capital (to average assets)$292,111 11.29 %≥ $103,488 ≥   4.00 %≥ $129,360 ≥   5.00 %
Common Equity Tier 1 (to risk-weighted assets)$285,805
13.98%≥ $130,368
≥ 6.375%≥ $132,925
≥ 6.50%Common Equity Tier 1 (to risk-weighted assets)$292,111 13.79 %≥ $148,291 ≥   7.00 %≥ $137,699 ≥   6.50 %
1 The adequately capitalized threshold includes the capital conservation buffer that was effective in 2018 and fully phased-in on January 1, 2019.


Capital Ratios for the Bank
(dollars in thousands)
Actual Ratio
Adequately Capitalized Threshold1
Ratio to be Well Capitalized under Prompt Corrective Action Provisions
September 30, 2019Amount
Ratio
Amount
Ratio
Amount
Ratio
Total Capital (to risk-weighted assets)$298,291
14.60%≥ $204,347
≥ 10.00%≥ $204,347
≥ 10.00%
Tier 1 Capital (to risk-weighted assets)$280,964
13.75%≥ $163,478
≥ 8.00%≥ $163,478
≥ 8.00%
Tier 1 Capital (to average assets)$280,964
11.33%≥ $123,945
≥ 5.00%≥ $123,945
≥ 5.00%
Common Equity Tier 1 (to risk-weighted assets)$280,964
13.75%≥ $132,826
≥ 6.50%≥ $132,826
≥ 6.50%
December 31, 2018 
 
 
 
 
 
Total Capital (to risk-weighted assets)$285,969
13.98%≥ $201,297
≥ 9.875%≥ $204,483
≥ 10.00%
Tier 1 Capital (to risk-weighted assets)$269,191
13.16%≥ $161,031
≥ 7.875%≥ $163,587
≥ 8.00%
Tier 1 Capital (to average assets)$269,191
10.77%≥ $99,994
≥ 4.000%≥ $124,992
≥ 5.00%
Common Equity Tier 1 (to risk-weighted assets)$269,191
13.16%≥ $130,358
≥ 6.375%≥ $132,914
≥ 6.50%
1 The adequately capitalized threshold includes the capital conservation buffer that was effective in 2018 and fully phased-in on January 1, 2019.

Liquidity

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 discussed in Note 6 to the Consolidated Financial Statements in ITEM 1 of this report. Our Asset Liability Management Committee ("ALCO"), which is comprised of independent Bank directors and the President and Chief Executive Officer, is responsible for approving and monitoring our liquidity targets and strategies. ALCO has adopted a contingency funding plan that provides 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.
 
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We obtain funds from the repayment and maturitycollection of loans,loan payments, deposit inflows, investment security maturities, paydowns and paydowns,sales, federal funds purchases, FHLB advances, other borrowings, and cash flow from operations.  Our primary uses of funds are the origination of loans, the purchase of investment securities, withdrawals of deposits, maturity of certificates of deposit, repayment of borrowings and dividends to common stockholders.
 
The most significant factor in our daily liquidity position has been the level of customer deposits. We attractThe attraction and retainretention of new deposits which depends upon the variety and effectiveness of our customer account products, service and convenience, and rates paid to customers, as well as our financial strength. The cash cyclesDeposit balances increased by $232.8 million in the first nine months of some2020 due to the increased level of our large commercial depositors (including local government agencies) may cause short-term fluctuationsliquidity in their deposit balances held with us.the financial markets. In addition, there has been an influx of deposits throughout the banking system as a result of depositors' higher level of savings during the uncertain economic times.

At September 30, 2019 our liquid assets, which includedSince March 2020, we have granted $388.5 in payment relief for 264 loans by allowing certain borrowers with hardship requests either full payment deferrals or interest-only payments. As of October 19, 2020, 236 loans totaling $336.3 million have resumed or are scheduled to resume normal payments and eight loans totaling $5.0 million have paid off. The Bank has substantial contingent and on-balance-sheet liquidity to support the loan payment relief programs, including unencumbered available-for-sale securities and cash, totaled $471.0 million, an increase of $37.8 million from December 31, 2018. Ourcash. At September 30, 2020, our cash and cash equivalents increased $148.3$30.2 million from December 31, 2018. Significant2019, primarily due to an increase in deposits of $232.8 million, as explained above. Other significant sources of liquidity during the first nine months of 20192020 included $150.5$121.7 million in paydowns, maturities and sales of investment securities an increase in deposits of $49.7 million, and $30.6$31.3 million net cash provided by operating activities. Significant usesactivities (including $10.7 million in processing fees received from the SBA for the origination of PPP loans as of September 30, 2020). Uses of liquidity during the first nine months of 20192020 included $32.9$269.4 million in loan originations, net of collections, $18.9principal collected, $71.7 million in investment securities purchased, $13.3 million in common stock repurchases, $7.0 million repayment of borrowing from FHLB, $8.1purchases, and $9.4 million in cash dividends paid on common stock to our shareholders, and $1.9 million in purchases of bank-owned life insurance policies.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 and core deposit base will provide adequate liquidity to fund our operations.

Undrawn credit commitments, as discussed in Note 8 to the Consolidated Financial Statements in this Form 10-Q, totaled $481.7$567.5 million at September 30, 2019.2020. These commitments, to the extent used, are expected to be funded primarily through the repayment of existing loans, deposit growth and liquid assets. Over the next twelve months, $62.9$70.7 million of time deposits will mature. We expect newIn addition, we waived the early withdrawal penalties for certificates of deposit when allowed by law in response to the pandemic, which might cause more depositors to withdraw time deposits to replace these funds.during the uncertain economic environment. Our emphasis on local deposits combined with our equity position providesis expected to provide a very stablestrong funding base.


 
Since 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 $14.3$12.2 million of cash at September 30, 2019.2020. The cash level at Bancorp is deemed sufficient to cover Bancorp's operational needs share repurchases, and cash dividends to shareholders through mid 2020.mid-2021. Management anticipates that the Bank will continue to have sufficient earnings to provide dividends to Bancorp to meet its funding requirements going forward.

ITEM 3.     Quantitative and Qualitative Disclosure about Market Risk

Market risk is defined as the risk of loss arising from an adverse change in the market value (or prices) of financial instruments. A significant form of market risk is interest rate risk, which is inherent in our investment, borrowing, lending and deposit gathering activities. The Bank manages interest rate sensitivity to minimize the exposure of our net interest margin, earnings, and capital to changes in interest rates. Interest rate changes can create fluctuations in the net interest margin due to an imbalance in the timing of repricing or maturity of assets or liabilities.

To mitigate interest rate risk, the structure of the Consolidated Statement of Conditionour assets and liabilities is managed with the objective of correlating the effects of interest rate changes on loans and investments with those of deposits and borrowings. The asset liability management policy sets limits on the acceptable amount of change to net interest income and economic value of equity in different interest rate environments.

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From time to time, we enter into interest rate swap contracts to mitigate the changes in the fair value of specified long-term fixed-rate loans and firm commitments to enter into long-term fixed-rate loans caused by changes in interest rates. See Note 9 to the Consolidated Financial Statements in this Form 10-Q.

ALCO and the Board of Directors review our exposure to interest rate risk at least quarterly. We use simulation models to measure interest rate risk and to evaluate strategies to improve profitability. A simplified static statement of condition is prepared on a quarterly basis as a starting point, using instrument level data of our actual loans, investments, borrowings and deposits as inputs. If potential changes to net equity value and net interest income resulting from hypothetical interest rate changes are not within the limits established by the Board of Directors, Management may adjust the asset and liability mix to bring the risk position within approved limits or take other actions. At September 30, 2019,2020, interest rate risk was within policy guidelines established by ALCO and the Board. One set of interest rates modeled and evaluated against flat interest rates is a series of immediate parallel shifts in the yield curve. These are provided in the following table as an example rather than an expectation of likely interest rate movements.
Immediate Changes in Interest Rates (in basis points)Estimated Change in Net Interest Income in Year 1, as percent of Net Interest IncomeEstimated Change in Net Interest Income in Year 2, as percent of Net Interest Income
up 400(3.4)%4.2 %
up 300(2.4)%3.4 %
up 200(1.7)%1.8 %
up 100(1.2)%(0.3)%
down 100(0.5)%(0.9)%
Immediate Changes in Interest Rates (in basis points)Estimated Change in Net Interest Income in Year 1, as percent of Net Interest Income
Estimated Change in Net Interest Income in Year 2, as percent of Net Interest Income
up 400(1.7)%8.7 %
up 300(1.0)%7.4 %
up 200(0.4)%5.9 %
up 100— %3.7 %
down 100(4.2)%(8.9)%
down 200(7.9)%(15.9)%

Interest rate sensitivity is a function of the repricing characteristics of our assets and liabilities. The Bank runs a combination of scenarios and sensitivities in its attempt to capture the range of interest rate risk including the simulations mentioned above. As with any simulation model or other method of measuring interest rate risk, limitations are inherent in the process and dependent on assumptions. For example, if we choose to pay interest on certain business deposits that are currently non-interest bearing, causing those deposits to become rate sensitive in the future, we would become less asset sensitive than the model currently indicates. Assets and liabilities may react differently to changes in market interest rates in terms of both timing and responsiveness to market rate movements. Important deposit modeling assumptions are the speed of deposit run-off and the amount by which interest-bearing deposit rates increase or decrease when market interest rates change. Further, the actual rates and timing of prepayments on loans and


investment securities could vary significantly from the assumptions applied in the various scenarios. Lastly, changes in U.S. Treasury rates accompanied by a change in the shape of the yield curve could produce different results from those presented in the table. Accordingly, the results presented should not be relied upon as indicative of actual results in the event of changing market interest rates.

ITEM 4.       Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures

Bank of Marin Bancorp and its subsidiary (the "Company") conducted an evaluation under the supervision and with the participation of our Management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934 (the “Act”)) as of the end of the period covered by this report. The term disclosure controls and procedures means controls and other procedures that are designed to ensure that information we are required to disclose in the reports that we file or submit under the Act (15 U.S.C. 78a et seq.) is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information we are required to disclose in the reports that we file or submit under the Act is accumulated and communicated to our Management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Changes in Internal Control over Financial Reporting
Page-44


While many employees have been working remotely due to the COVID-19 pandemic, we continually monitor our internal controls over financial reporting to minimize any related impact of the pandemic.

During the quarter ended September 30, 2019,2020, there were no significant changes that materially affected, or are reasonably likely to affect, our internal control over financial reporting. The term internal control over financial reporting, as defined by Rule 15d-15(f) of the Act, is a process designed by, or under the supervision of, the issuer's principal executive and principal financial officers, or persons performing similar functions, and effected by the issuer's board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.

PART II       OTHER INFORMATION
 
ITEM 1         Legal Proceedings

Refer to Note 12 to the Consolidated Financial Statements in Item 8 of our 20182019 Form 10-K and Note 8 to the Consolidated Financial Statements in this Form 10-Q.

ITEM 1A      Risk Factors
 
ThereThe following risk factors are in addition to the risks described in the Company’s Form 10-K under Item 1A, “Risk Factors” for its year ended December 31, 2019 and in its subsequent periodic reports filed with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. The effects of the events and circumstances described in the following risk factors may have heightened several of the risks contained in our Form 10-K.
Our Business, Results of Operations, and Financial Condition Have Been, and Will Likely Continue to be, Adversely Affected by the Ongoing COVID-19 Pandemic
On March 11, 2020, the World Health Organization declared COVID-19 a pandemic, which has spread globally including in the United States. On March 13, 2020, the President of the United States declared the COVID-19 pandemic a national emergency. The pandemic has caused significant economic disruption and many states and local governments have continued to order non-essential businesses to close or scale back services. The extent to which the pandemic impacts our business, results of operations and financial condition will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of the outbreak, its severity, actions to contain the virus including the timing and deployment of a successful vaccine, and how quickly and to what extent normal economic and operating conditions can resume, particularly in California. As a result, we are subject to the following risks, which could have a material effect on our business, financial condition, results of operations, capital position and liquidity:
•The COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains, created significant volatility and disruption in financial markets and equity market valuations, and increased unemployment levels. This may lead to an increase in loan delinquencies, problem assets and foreclosures, which may increase loan losses, particularly if businesses remain closed, the impact on the global economy worsens, or more customers draw on their lines of credit or seek additional loans to help finance their businesses. Additionally, the expiration of the payment relief provided under Section 4013 of the CARES Act may result in loan delinquencies and impairments that could increase the provision for loan losses.
•Collateral securing our loans may decline in value, which could increase credit losses in our loan portfolio and necessitate increases in the allowance for loan losses.
•The commercial real estate ("CRE") loan market and CRE loan demand could be adversely affected longer-term by the pandemic due to structural changes relating to remote work trends or migration outside of metropolitan areas. These trends could increase vacancy rates and reduce commercial real estate values. As of September 30, 2020, using regulatory definitions in the CRE Concentration Guidance, our concentration in investor-owned commercial real estate loans as a percentage of capital was 323%, compared to 330% at December 31, 2019.
•Demand for our products and services may decline, and deposit balances may decrease making it difficult to grow assets and income.
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•The decline in the target federal funds rate has decreased yields on our assets that exceed the decline in our cost of interest-bearing liabilities. A prolonged low interest rate environment could continue to compress our net interest margin.
•Net interest margin in future periods may be significantly impacted by the accretion of the remaining $6.5 million in net deferred PPP loan origination fees and costs, which is influenced by, among other things, the timing of SBA loan forgiveness.
•The future adoption of the CECL standard, which is highly dependent on unemployment rate forecasts over the life of our loans, could significantly increase the allowance for credit losses and decrease net income.
•The continued market turmoil could reduce our wealth management and trust services revenue.
•Our business operations may be disrupted if significant portions of our workforce are unable to work effectively because of illness, quarantines, government actions, and other restrictions in connection with the pandemic.
•Our borrowers' actual payment performance may be worse than anticipated as the payment deferrals related to the COVID-19 pandemic expire, and we may experience potential adverse impact from loan modifications and payment deferrals despite their implementation consistent with recent regulatory guidance. While over 90% of the payment relief loans have resumed or are scheduled to resume normal payments, we have no assurance that these borrowers will not require additional payment relief in the future due to the continued impact of the pandemic.
Recent government actions to provide substantial financial support to businesses (e.g., Paycheck Protection Program) could partially mitigate the financial impact to us and our borrowers. However, the success of these measures is unknown and they may not be sufficient to mitigate fully the negative impact of the ongoing pandemic. In addition, the stalled Congressional support for an additional relief package and results of the presidential election could exacerbate the negative effects of the pandemic, the impact of which cannot be quantified at this time.
Our Traditional Service Delivery Channels may be Impacted by the COVID-19 Pandemic
In light of the external COVID-19 threat, the Board of Directors and senior management are continuously monitoring the situation, providing frequent communications, and making adjustments and accommodations for both external clients and our employees. All branches remain open to serve our customers and local communities, with modified hours and strict social distancing protocols in place as well as limits on the number of customers allowed in a branch at one time. Our customers have been no materialencouraged to utilize alternative banking options including ATM, digital and telephone banking. Further, many employees are working remotely, and travel as well as face-to-face meeting restrictions are in effect. In addition, given the increasing risk of cybersecurity incidents during the pandemic, we have enhanced our cybersecurity protocols. If the pandemic worsens or lasts for an extended period of time, to protect the health of the Bank’s workforce and our customers, we may need to enact further precautionary measures to help minimize the risks to our employees and customers, thus potentially altering our service delivery channels and operations over a prolonged period. These changes from the risk factors previously disclosed into our 2018 Form 10-K. Refer to "Risk Factors" in Item 1Atraditional service delivery channels may negatively impact our customers' experience of banking with us, and therefore negatively impact our 2018 Form 10-K, pages 11 through 18.financial condition and results of operations.



ITEM 2       Unregistered Sales of Equity Securities and Use of Proceeds
 
On April 23, 2018, Bancorp announced that its Board of Directors approved a Share Repurchase Program under which Bancorp may repurchase up to $25.0 million of its outstanding common stock through May 1, 2019, which the2019. The Board subsequently extended tothe Share Repurchase Program, which expired on February 28, 2020, with cumulative purchases of 561,355 shares totaling $23.5 million. Approximately $1.5 million in authorized share repurchases expired unutilized.

On January 24, 2020, Bancorp Board of Directors approved a new Share Repurchase Program under which Bancorp may repurchase up to $25.0 million of its outstanding common stock through February 28, 2022. The new share repurchase program began in March 2020 and was suspended by the Board of Directors on March 20, 2020 as part of the early pandemic response. Prior to suspension, repurchases under this program were 58,526 shares totaling $1.8 million, with approximately $23.2 million available for future repurchases. In light of continued capital strength, on October 23, 2020, the Board of Directors reactivated this program.

There were 92,664 shares repurchased totaling $3.2 million in the first nine months of 2020, none of which took place in the third quarter of 2020. For additional information, refer to Note 7 to the Consolidated Financial Statements in this Form 10-Q.

During the three months ended September 30, 2019, Bancorp repurchased 65,127 shares at an average price of $41.79 per share for a total cost of $2.7 million. The following table reflects repurchases under the Share Repurchase Program for the periods presented.
Page-46

(in thousands, except per share data)Total Number of Shares Purchased
Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Programs
Approximate Dollar Value That May yet Be Purchased Under the Program
Period
July 1-31, 201919,070
$42.62
19,070
$6,730
August 1-31, 201926,019
41.21
26,019
5,657
September 1-30, 201920,038
41.76
20,038
4,819
Total65,127
$41.79
65,127


ITEM 3       Defaults upon Senior Securities
None.
 
ITEM 4      Mine Safety Disclosures
Not applicable.

ITEM 5      Other Information
None.
Page-47

ITEM 6       Exhibits

The following exhibits are filed as part of this report or hereby incorporated by references to filings previously made with the SEC.
 Incorporated by Reference 
Exhibit NumberExhibit DescriptionFormFile No.ExhibitFiling DateHerewith
3.0110-Q001-335723.01November 7, 2007 
3.0210-Q001-335723.02May 9, 2011
3.02a8-K001-335723.03July 6, 2015
4.018-A12B001-335724.1July 7, 2017
4.0210-K001-335724.02March 13, 2020
10.01S-8333-2182744.1May 26, 2017 
10.02S-8333-2212194.1October 30, 2017
10.03S-8333-2278404.1October 15, 2018 
10.04S-8333-2395554.1June 30, 2020 
10.0510-Q001-3357210.06November 7, 2007 
10.068-K001-3357210.1January 26, 2009 
10.078-K001-3357299.1October 21, 2010 
10.088-K001-3357210.1January 6, 2011 
10.098-K001-3357210.2November 4, 2014
10.108-K001-3357210.3November 4, 2014 
10.118-K001-3357210.1October 31, 2007 
10.12Filed to correct previously incorrect hyperlink
31.01    Filed
31.02    Filed
32.01    Filed
101.INSInline XBRL Instance DocumentFiled
101.SCHInline XBRL Taxonomy Extension Schema DocumentFiled
101.CALInline XBRL Taxonomy Extension Calculation Linkbase DocumentFiled
101.LABInline XBRL Taxonomy Extension Label Linkbase Document    Filed
101.PREInline XBRL Taxonomy Extension Presentation Linkbase DocumentFiled
101.DEFInline XBRL Taxonomy Extension Definition Linkbase DocumentFiled
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  Incorporated by Reference 
Exhibit NumberExhibit DescriptionFormFile No.ExhibitFiling DateHerewith
2.01
Agreement to Merger and Plan of Reorganization with Bank of Napa, dated July 31, 2017
8-K001-335722.1August 2, 2017 
3.01
Articles of Incorporation, as amended
10-Q001-335723.01November 7, 2007 
3.02
Bylaws
10-Q001-335723.02May 9, 2011 
3.02a
Bylaw Amendment
8-K001-335723.03July 6, 2015 
4.01
Rights Agreement, dated July 6, 2017
8-A12B001-335724.1July 7, 2017 
10.01
Employee Stock Ownership Plan
S-8333-2182744.1May 26, 2017 
10.02
2017 Employee Stock Purchase Plan
S-8333-2212194.1October 30, 2017 
10.03
2017 Equity Plan, as amended
S-8333-2278404.1October 15, 2018 
10.04
2010 Director Stock Plan
S-8333-1676394.1June 21, 2010 
10.05
Form of Indemnification Agreement for Directors and Executive Officers, dated August 9, 2007
10-Q001-3357210.06November 7, 2007 
10.06
Form of Employment Agreement, dated January 23, 2009
8-K001-3357210.1January 26, 2009 
10.07
2010 Annual Individual Incentive Compensation Plan
8-K001-3357299.1October 21, 2010 
10.08
Salary Continuation Agreement for executive officer Russell Colombo, Chief Executive Officer, dated January 1, 2011
8-K001-3357210.1January 6, 2011 
10.09
Salary Continuation Agreement for executive officer Peter Pelham, Director of Retail Banking, dated January 1, 2011
8-K001-3357210.4January 6, 2011 
10.10
Salary Continuation Agreement for executive officer Tani Girton, Chief Financial Officer, dated October 18, 2013
8-K001-3357210.2November 4, 2014 
10.11
Salary Continuation Agreement for executive officer Elizabeth Reizman, Chief Credit Officer, dated July 20, 2014
8-K001-3357210.3November 4, 2014 
10.12
Salary Continuation Agreement for executive officer Timothy Myers, Executive Vice President and Commercial Banking Manager, dated May 28, 2015
8-K001-3357210.4June 2, 2015 
10.13
2007 Form of Change in Control Agreement
8-K001-3357210.1October 31, 2007 
10.14
Waiver and Release Agreement by and between James Kimball and Bank of Marin, dated as of July 25, 2019.
8-K001-3357210.1July 26, 2019 
11.01
Earnings Per Share Computation - included in Note 1 to the Consolidated Financial Statements
    Filed
31.01
Certification of Principal Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
    Filed
31.02
Certification of Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
    Filed
32.01
Certification pursuant to 18 U.S.C. §1350 as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002
    Filed
101.INSInline XBRL Instance Document    Filed
101.SCHInline XBRL Taxonomy Extension Schema Document    Filed
101.CALInline XBRL Taxonomy Extension Calculation Linkbase Document    Filed
101.LABInline XBRL Taxonomy Extension Label Linkbase Document    Filed
101.PREInline XBRL Taxonomy Extension Presentation Linkbase Document    Filed
101.DEFInline XBRL Taxonomy Extension Definition Linkbase Document    Filed


SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Bank of Marin Bancorp
(registrant)
November 8, 20196, 2020/s/ Russell A. Colombo
DateRussell A. Colombo
President &
Chief Executive Officer
(Principal Executive Officer)
November 8, 20196, 2020/s/ Tani Girton
DateTani Girton
Executive Vice President &
Chief Financial Officer
(Principal Financial Officer)
November 8, 20196, 2020/s/ David A. Merck
DateDavid A. Merck
Vice President &
Financial Reporting Manager
(Principal Accounting Officer)


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