Quarterly Report (10-q)

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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 March 31, 2020

☐ 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)



California				20-8859754
(State or other jurisdiction of incorporation or organization)				(IRS Employer Identification No.)
504 Redwood Blvd.	Suite 100	Novato	CA	94947
(Address of principal executive office)				(Zip Code)

Registrant’s telephone number, including area code: (415) 763-4520

Not Applicable

(Former name, former address and formal fiscal year, if changed since last report)



Securities registered pursuant to 12(b) of the Act:
Title of each class	Trading symbol	Name of each exchange on which registered
Common stock, no par value and attached Share Purchase Rights	BMRC	The 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 every Interactive Data File required to be submitted 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 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 whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No ☒

As of April 30, 2020, there were 13,570,788 shares of common stock outstanding.

TABLE OF CONTENTS




PART I	FINANCIAL INFORMATION	Page-3

ITEM 1.	Financial Statements	Page-3

	Consolidated Statements of Condition	Page-3
	Consolidated Statements of Comprehensive Income	Page-4
	Consolidated Statements of Changes in Stockholders' Equity	Page-5
	Consolidated Statements of Cash Flows	Page-6
	Notes to Consolidated Financial Statements	Page-7

ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	Page-27

ITEM 3.	Quantitative and Qualitative Disclosure about Market Risk	Page-38

ITEM 4.	Controls and Procedures	Page-39

PART II	OTHER INFORMATION	Page-40

ITEM 1.	Legal Proceedings	Page-40

ITEM 1A.	Risk Factors	Page-40

ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	Page-41

ITEM 3.	Defaults Upon Senior Securities	Page-41

ITEM 4.	Mine Safety Disclosures	Page-41

ITEM 5.	Other Information	Page-41

ITEM 6.	Exhibits	Page-42

SIGNATURES

Page-2

PART I FINANCIAL INFORMATION

ITEM 1. Financial Statements

BANK OF MARIN BANCORP

CONSOLIDATED STATEMENTS OF CONDITION

March 31, 2020 and December 31, 2019



(in thousands, except share data; unaudited)	March 31, 2020		December 31, 2019
Assets
Cash, cash equivalents and restricted cash	$	156,274	$	183,388
Investment securities
Held-to-maturity, at amortized cost	131,140		137,413
Available-for-sale, at fair value	448,868		432,260
Total investment securities	580,008		569,673
Loans, net of allowance for loan losses of $18,884 and $16,677 at March 31, 2020 and December 31, 2019, respectively	1,824,976		1,826,609
Bank premises and equipment, net	5,708		6,070
Goodwill	30,140		30,140
Core deposit intangible	4,471		4,684
Operating lease right-of-use assets	22,225		11,002
Interest receivable and other assets	73,936		75,714
Total assets	$	2,697,738	$	2,707,280

Liabilities and Stockholders' Equity
Liabilities
Deposits
Non-interest bearing	$	1,130,460	$	1,128,823
Interest bearing
Transaction accounts	137,802		142,329
Savings accounts	167,210		162,817
Money market accounts	776,271		804,710
Time accounts	95,367		97,810
Total deposits	2,307,110		2,336,489
Borrowings and other obligations	185		212
Subordinated debenture	2,725		2,708
Operating lease liabilities	23,726		12,615
Interest payable and other liabilities	18,052		18,468
Total liabilities	2,351,798		2,370,492

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 - 13,565,969 and 13,577,008 at March 31, 2020 and December 31, 2019, respectively	127,684		129,058
Retained earnings	207,328		203,227
Accumulated other comprehensive income, net of taxes	10,928		4,503
Total stockholders' equity	345,940		336,788
Total liabilities and stockholders' equity	$	2,697,738	$	2,707,280

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

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BANK OF MARIN BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME



	Three months ended
(in thousands, except per share amounts; unaudited)	March 31, 2020			March 31, 2019
Interest income
Interest and fees on loans	$	20,887		$	20,695
Interest on investment securities	4,165			4,097
Interest on federal funds sold and due from banks	332			139
Total interest income	25,384			24,931
Interest expense
Interest on interest-bearing transaction accounts	66			77
Interest on savings accounts	16			18
Interest on money market accounts	971			764
Interest on time accounts	161			119
Interest on borrowings and other obligations	2			47
Interest on subordinated debentures	49			60
Total interest expense	1,265			1,085
Net interest income	24,119			23,846
Provision for loan losses	2,200			—
Net interest income after provision for loan losses	21,919			23,846
Non-interest income
Service charges on deposit accounts	451			479
Wealth Management and Trust Services	504			438
Debit card interchange fees, net	360			380
Merchant interchange fees, net	73			87
Earnings on (cost of) bank-owned life insurance	275			(60		)
Dividends on Federal Home Loan Bank stock	208			196
Gains (losses) on sale of investment securities, net	800			(6		)
Other income	449			257
Total non-interest income	3,120			1,771
Non-interest expense
Salaries and related benefits	9,477			9,146
Occupancy and equipment	1,663			1,531
Depreciation and amortization	526			556
Federal Deposit Insurance Corporation insurance	2			179
Data processing	786			1,015
Professional services	544			586
Directors' expense	174			179
Information technology	250			259
Amortization of core deposit intangible	213			222
Provision for losses on off-balance sheet commitments	102			129
Other expense	1,732			1,726
Total non-interest expense	15,469			15,528
Income before provision for income taxes	9,570			10,089
Provision for income taxes	2,342			2,610
Net income	$	7,228		$	7,479
Net income per common share:
Basic	$	0.53		$	0.54
Diluted	$	0.53		$	0.54
Weighted average shares:
Basic	13,525			13,737
Diluted	13,656			13,924
Comprehensive income:
Net income	$	7,228		$	7,479
Other comprehensive income
Change in net unrealized gains or losses on available-for-sale securities included in net income	9,812			3,939
Reclassification adjustment for (gains) losses on available-for-sale securities in net income	(800		)	6
Amortization of net unrealized losses on securities transferred from available-for-sale to held-to-maturity	110			101
Subtotal	9,122			4,046
Deferred tax expense	2,697			1,198
Other comprehensive income, net of tax	6,425			2,848
Comprehensive income	$	13,653		$	10,327

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

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BANK OF MARIN BANCORP

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

For the three months ended March 31, 2020 and 2019



(in thousands, except share data; unaudited)	Common Stock					Retained Earnings			Accumulated Other Comprehensive Income (Loss), Net of Taxes			Total
	Shares		Amount
	Three months ended March 31, 2020
Balance at January 1, 2020	13,577,008		$	129,058		$	203,227		$	4,503		$	336,788
Net income	—		—			7,228			—			7,228
Other comprehensive income	—		—			—			6,425			6,425
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings	49,055		824			—			—			824
Stock issued under employee stock purchase plan	547		16			—			—			16
Stock issued under employee stock ownership plan	7,900		324			—			—			324
Restricted stock granted	29,100		—			—			—			—
Restricted stock surrendered for tax withholdings upon vesting	(2,200	)	(73		)	—			—			(73		)
Restricted stock forfeited / cancelled	(5,787	)	—			—			—			—
Stock-based compensation - stock options	—		169			—			—			169
Stock-based compensation - restricted stock	—		461			—			—			461
Cash dividends paid on common stock ($0.23 per share)	—		—			(3,127		)	—			(3,127		)
Stock purchased by directors under director stock plan	400		18			—			—			18
Stock issued in payment of director fees	2,610		117			—			—			117
Stock repurchased, net of commissions	(92,664	)	(3,230		)	—			—			(3,230		)
Balance at March 31, 2020	13,565,969		$	127,684		$	207,328		$	10,928		$	345,940
	Three months ended March 31, 2019
Balance at January 1, 2019	13,844,353		$	140,565		$	179,944		$	(4,102	)	$	316,407
Net income	—		—			7,479			—			7,479
Other comprehensive income	—		—			—			2,848			2,848
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings	28,142		259			—			—			259
Stock issued under employee stock purchase plan	377		15			—			—			15
Stock issued under employee stock ownership plan	8,000		313			—			—			313
Restricted stock granted	29,110		—			—			—			—
Restricted stock surrendered for tax withholdings upon vesting	(4,820	)	(202		)	—			—			(202		)
Restricted stock forfeited / cancelled	(7,393	)	—			—			—			—
Stock-based compensation - stock options	—		284			—			—			284
Stock-based compensation - restricted stock	—		569			—			—			569
Cash dividends paid on common stock ($0.19 per share)	—		—			(2,630		)	—			(2,630		)
Stock purchased by directors under director stock plan	199		8			—			—			8
Stock issued in payment of director fees	2,744		114			—			—			114
Stock repurchased, net of commissions	(113,904	)	(4,800		)	—			—			(4,800		)
Balance at March 31, 2019	13,786,808		$	137,125		$	184,793		$	(1,254	)	$	320,664

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 three months ended March 31, 2020 and 2019



(in thousands; unaudited)	March 31, 2020			March 31, 2019
Cash Flows from Operating Activities:
Net income	$	7,228		$	7,479
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses	2,200			—
Provision for losses on off-balance sheet commitments	102			129
Noncash contribution expense to employee stock ownership plan	324			313
Noncash director compensation expense	75			75
Stock-based compensation expense	630			853
Amortization of core deposit intangible	213			222
Amortization of investment security (discounts) premiums, net	(93		)	485
Amortization of acquired loan premiums (discounts), net	11			(101		)
Accretion of discount on subordinated debenture	17			17
Net change in deferred loan origination costs/fees	(225		)	(49		)
(Gain) loss on sale of investment securities	(800		)	6
Depreciation and amortization	526			556
(Earnings on) cost of bank-owned life insurance policies	(275		)	60
Net change in operating assets and liabilities:
Interest receivable and other assets	293			1,641
Interest payable and other liabilities	(701		)	(1,157		)
Total adjustments	2,297			3,050
Net cash provided by operating activities	9,525			10,529
Cash Flows from Investing Activities:
Purchase of available-for-sale securities	(54,902		)	(11,282		)
Proceeds from sale of available-for-sale securities	27,442			4,229
Proceeds from paydowns/maturities of held-to-maturity securities	6,217			4,276
Proceeds from paydowns/maturities of available-for-sale securities	20,924			30,271
Loans originated and principal collected, net	1,117			(8,166		)
Purchase of bank-owned life insurance policies	(941		)	(1,892		)
Purchase of premises and equipment	(146		)	(67		)
Cash paid for low income housing tax credit investment	(1,251		)	(38		)
Net cash (used in) provided by investing activities	(1,540		)	17,331
Cash Flows from Financing Activities:
Net (decrease) increase in deposits	(29,379		)	3,789
Proceeds from stock options exercised	824			259
Payment of tax withholdings for stock options exercised and vesting of restricted stock	(73		)	(202		)
Proceeds from stock issued under employee and director stock purchase plans	34			23
Stock repurchased, net of commissions	(3,333		)	(4,640		)
Repayment of Federal Home Loan Bank borrowings	—			(7,000		)
Repayment of finance lease obligations	(45		)	(41		)
Cash dividends paid on common stock	(3,127		)	(2,630		)
Net cash used in financing activities	(35,099		)	(10,442		)
Net (decrease) increase in cash, cash equivalents and restricted cash	(27,114		)	17,418
Cash, cash equivalents and restricted cash at beginning of period	183,388			34,221
Cash, cash equivalents and restricted cash at end of period	$	156,274		$	51,639
Supplemental disclosure of cash flow information:
Cash paid in interest	$	1,260		$	1,066
Supplemental disclosure of noncash investing and financing activities:
Change in net unrealized gain or loss on available-for-sale securities	$	9,812		$	3,939
Amortization of net unrealized loss on available-for-sale securities transferred to held-to-maturity	$	110		$	101
Stock issued to employee stock ownership plan	$	324		$	313
Stock issued in payment of director fees	$	117		$	114
Repurchase of stock not yet settled	$	—		$	160
Restricted cash:
Federal Reserve Bank reserve requirements included in cash, cash equivalents and restricted cash¹	$	—		$	10,932

¹ 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 2019 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 Trust II (the "Trust") was formed for the sole purpose of issuing trust preferred securities. Bancorp is not considered the primary beneficiary of the Trust (a variable interest entity), therefore the Trust is not consolidated in our consolidated financial statements, but rather the subordinated debenture is shown as a liability on our consolidated statements of condition. Bancorp's investment in the securities of the Trust 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 additional information on the subordinated debenture due to NorCal Community Bancorp Trust 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 ended
(in thousands, except per share data)	March 31, 2020		March 31, 2019
Weighted average basic shares outstanding	13,525		13,737
Potentially dilutive common shares related to:
Stock options	106		155
Unvested restricted stock awards	25		32
Weighted average diluted shares outstanding	13,656		13,924
Net income	$	7,228	$	7,479
Basic EPS	$	0.53	$	0.54
Diluted EPS	$	0.53	$	0.54
Weighted average anti-dilutive shares not included in the calculation of diluted EPS	70		20

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Note 2: Recently Adopted and Issued Accounting Standards

Accounting Standards Adopted in 2020

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 unobservable inputs used to develop Level 3 fair value measurements. We adopted this ASU prospectively effective January 1, 2020. As the ASU’s requirements only relate to disclosures, the amendments did 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. We adopted this ASU prospectively on January 1, 2020, which did not impact our financial condition and results of operations.

Accounting Standards Not Yet Adopted

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 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 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 credit 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. However, in accordance with the accounting relief provisions of the Coronavirus Aid, Relief and Economic Security ("CARES") Act issued in March 2020, we postponed the adoption of the CECL standard. Implementation may be delayed until the end of the national emergency or December 31, 2020, whichever occurs first. Had we adopted the CECL standard as of January 1, 2020, the increase to our allowance for loan losses would have ranged from 5% to 15% of the amount recorded at December 31, 2019, which were based on economic forecasts at that time and did not include the subsequent COVID-19 pandemic related impact.

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 utilize a discounted cash flow approach that considers the probability of

Page-8

default and loss given default. Ongoing implementation activities include developing forecasts, running parallel calculations and evaluating results.

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. The provisions of this ASU under Topic 326 will be evaluated in conjunction with the adoption of ASU 2016-13, however, we do not expect it to have a material impact on our financial condition and 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 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

Page-9

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.

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.

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



(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
March 31, 2020
Securities available-for-sale:
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies	$	267,959	$	—	$	267,959	$	—	OCI
SBA-backed securities	33,923		—		33,923		—		OCI
Debentures of government sponsored agencies	42,609		—		42,609		—		OCI
Obligations of state and political subdivisions	103,376		—		103,376		—		OCI
Corporate bonds	1,001		—		1,001		—		OCI
Derivative financial liabilities (interest rate contracts)	2,618		—		2,618		—		NI
December 31, 2019
Securities available-for-sale:
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies	$	278,144	$	—	$	278,144	$	—	OCI
SBA-backed securities	36,286		—		36,286		—		OCI
Debentures of government sponsored agencies	49,046		—		49,046		—		OCI
Obligations of state and political subdivisions	67,282		—		67,282		—		OCI
Corporate bonds	1,502		—		1,502		—		OCI
Derivative financial liabilities (interest rate contracts)	1,178		—		1,178		—		NI

¹Other comprehensive income ("OCI") or net income ("NI").

Available-for-sale securities are recorded at fair value on a recurring basis. When available, quoted market prices (Level 1) are used to determine the fair value of available-for-sale securities. 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

Page-10

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 March 31, 2020 and December 31, 2019, there were no Level 1 or Level 3 securities.

Held-to-maturity securities may be written down to fair value as a result of other-than-temporary impairment, and we did not record any write-downs during the three months ended March 31, 2020 or March 31, 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 OIS curves as of the measurement date. When the value of any collateral placed with counterparties is less than the interest rate derivative liability, a credit valuation adjustment ("CVA") is applied to reflect the credit risk we pose to counterparties. We have used the spread between the Standard & Poor's BBB rated U.S. Bank Composite rate and 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 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 March 31, 2020 and December 31, 2019, we did not 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 March 31, 2020 and December 31, 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 held shares of Federal 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 March 31, 2020 or December 31, 2019. The values are discussed in Note 4, Investment Securities.



	March 31, 2020					December 31, 2019
(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	$	156,274	$	156,274	Level 1	$	183,388	$	183,388	Level 1
Investment securities held-to-maturity	131,140		137,501		Level 2	137,413		139,642		Level 2
Loans, net	1,824,976		1,816,190		Level 3	1,826,609		1,839,666		Level 3
Interest receivable	7,802		7,802		Level 2	7,732		7,732		Level 2
Financial liabilities (recorded at amortized cost)
Time deposits	95,367		95,731		Level 2	97,810		97,859		Level 2
Subordinated debenture	2,725		2,117		Level 3	2,708		3,182		Level 3
Interest payable	122		122		Level 2	134		134		Level 2

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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.

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 March 31, 2020 or December 31, 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 enterprises ("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") and collateralized mortgage obligations (“CMOs”) issued or guaranteed by the GSEs, as reflected in the following table:



	March 31, 2020									December 31, 2019
	Amortized		Fair		Gross Unrealized					Amortized		Fair		Gross Unrealized
(in thousands)	Cost		Value		Gains		(Losses)			Cost		Value		Gains		(Losses)
Held-to-maturity:
Securities of U.S. government-sponsored enterprises:
MBS pass-through securities issued by FHLMC and FNMA	$	77,682	$	81,590	$	3,908	$	—		$	80,451	$	81,325	$	1,018	$	(144	)
SBA-backed securities	7,031		7,434		403		—			7,999		8,264		265		—
CMOs issued by FNMA	9,586		10,088		502		—			10,210		10,492		282		—
CMOs issued by FHLMC	31,140		32,560		1,420		—			31,477		32,157		685		(5		)
CMOs issued by GNMA	3,768		3,828		60		—			3,763		3,816		53		—
Obligations of state and political subdivisions	1,933		2,001		68		—			3,513		3,588		75		—
Total held-to-maturity	131,140		137,501		6,361		—			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 FNMA	68,168		71,375		3,207		—			98,502		100,071		1,617		(48		)
SBA-backed securities	32,709		33,923		1,270		(56		)	35,674		36,286		688		(76		)
CMOs issued by FNMA	21,296		22,071		775		—			22,702		23,092		390		—
CMOs issued by FHLMC	154,735		163,290		8,573		(18		)	139,398		143,226		3,892		(64		)
CMOs issued by GNMA	10,759		11,223		464		—			11,719		11,755		42		(6		)
Debentures of government- sponsored agencies	41,845		42,609		764		—			48,389		49,046		727		(70		)
Obligations of state and political subdivisions	101,008		103,376		2,396		(28		)	66,042		67,282		1,386		(146		)
Corporate bonds	999		1,001		2		—			1,497		1,502		6		(1		)
Total available-for-sale	431,519		448,868		17,451		(102		)	423,923		432,260		8,748		(411		)
Total investment securities	$	562,659	$	586,369	$	23,812	$	(102	)	$	561,336	$	571,902	$	11,126	$	(560	)

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The amortized cost and fair value of investment debt securities by contractual maturity at March 31, 2020 and December 31, 2019 are shown below. Expected maturities may differ from contractual maturities if the issuers of the securities have the right to call or prepay obligations with or without call or prepayment penalties.



	March 31, 2020								December 31, 2019
	Held-to-Maturity				Available-for-Sale				Held-to-Maturity				Available-for-Sale
(in thousands)	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
Within one year	$	1,342	$	1,388	$	16,847	$	16,935	$	1,807	$	1,811	$	6,699	$	6,706
After one but within five years	2,243		2,316		56,500		58,504		2,256		2,296		48,706		49,619
After five years through ten years	54,483		57,447		186,662		196,730		56,221		57,544		208,806		214,277
After ten years	73,072		76,350		171,510		176,699		77,129		77,991		159,712		161,658
Total	$	131,140	$	137,501	$	431,519	$	448,868	$	137,413	$	139,642	$	423,923	$	432,260

Sales of investment securities and gross gains and losses are shown in the following table:



	Three months ended
(in thousands)	March 31, 2020		March 31, 2019
Available-for-sale:
Sales proceeds	$	27,442	$	4,229
Gross realized gains	800		3
Gross realized losses	—		(9		)

Pledged investment securities are shown in the following table:



(in thousands)	March 31, 2020		December 31, 2019
Pledged to the State of California:
Secure public deposits in compliance with the Local Agency Security Program	$	121,330	$	126,598
Collateral for trust deposits	742		742
Total investment securities pledged to the State of California	122,072		127,340
Collateral for Wealth Management and Trust Services checking account	623		622
Total pledged investment securities	$	122,695	$	127,962

Other-Than-Temporarily Impaired ("OTTI") Debt Securities

There were 13 and 40 securities in unrealized loss positions at March 31, 2020 and December 31, 2019, respectively. Those securities are summarized and classified according to the duration of the loss period in the tables below:



March 31, 2020	< 12 continuous months					≥ 12 continuous months					Total securities in a loss position
(in thousands)	Fair value		Unrealized loss			Fair value		Unrealized loss			Fair value		Unrealized loss
Available-for-sale:
SBA-backed securities	$	—	$	—		$	2,209	$	(56	)	$	2,209	$	(56	)
CMOs issued by FHLMC	2,750		(17		)	1,600		(1		)	4,350		(18		)
Obligations of state and political subdivisions	11,439		(28		)	—		—			11,439		(28		)
Total available-for-sale	14,189		(45		)	3,809		(57		)	17,998		(102		)
Total temporarily impaired securities	$	14,189	$	(45	)	$	3,809	$	(57	)	$	17,998	$	(102	)

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December 31, 2019	< 12 continuous months					≥ 12 continuous months					Total securities in a loss position
(in thousands)	Fair value		Unrealized loss			Fair value		Unrealized loss			Fair value		Unrealized loss
Held-to-maturity:
MBS pass-through securities issued by FHLMC and FNMA	$	14,203	$	(60	)	$	6,073	$	(84	)	$	20,276	$	(144	)
CMOs issued by FHLMC	—		—			1,725		(5		)	1,725		(5		)
Total held-to-maturity	14,203		(60		)	7,798		(89		)	22,001		(149		)
Available-for-sale:
MBS pass-through securities issued by FHLMC and FNMA	4,367		(34		)	4,464		(14		)	8,831		(48		)
SBA-backed securities	9,227		(14		)	2,448		(62		)	11,675		(76		)
CMOs issued by FHLMC	14,918		(58		)	2,981		(6		)	17,899		(64		)
CMOs issued by GNMA	7,139		(6		)	—		—			7,139		(6		)
Debentures of government- sponsored agencies	25,228		(70		)	—		—			25,228		(70		)
Obligations of state and political subdivisions	20,579		(145		)	659		(1		)	21,238		(146		)
Corporate Bonds	500		(1		)	—		—			500		(1		)
Total available-for-sale	81,958		(328		)	10,552		(83		)	92,510		(411		)
Total temporarily impaired securities	$	96,161	$	(388	)	$	18,350	$	(172	)	$	114,511	$	(560	)

As of March 31, 2020, the investment portfolio included 7 investment securities that had been in a continuous loss position for twelve months or more and 6 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 obligations of state and political subdivisions and corporate bonds, were deemed credit worthy after our internal analyses of the issuers’ latest financial information, 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 was primarily driven by factors other than credit, such as changes in market interest rates and liquidity spreads subsequent to purchase. At March 31, 2020, Management determined that it did not intend to sell 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 March 31, 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 million of FHLB stock included in other assets on the consolidated statements of condition at both March 31, 2020 and December 31, 2019. 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 March 31, 2020 and December 31, 2019. On April 28, 2020, FHLB announced a cash dividend for the first quarter of 2020 at an annualized dividend rate of 5.00% to be distributed in mid-May 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 March 31, 2020 and December 31, 2019. These shares have a carrying value of zero 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

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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 March 31, 2020 and December 31, 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 $2.7 million and $3.2 million at March 31, 2020 and December 31, 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 $4.0 million and $4.1 million recorded in other assets as of March 31, 2020 and December 31, 2019, respectively. In the first three months of 2020, we recognized $169 thousand of low-income housing tax credits and other tax benefits, offset by $141 thousand of amortization expense of low-income housing tax credit investment, as a component of income tax expense. As of March 31, 2020, our unfunded commitments for these low-income housing tax credit funds totaled $924 thousand. We did not recognize any impairment losses on these low-income housing tax credit investments during the first three months of 2020 or 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 March 31, 2020 and December 31, 2019.



Loan Aging Analysis by Class
(in thousands)	Commercial and industrial		Commercial real estate, owner-occupied		Commercial real estate, investor-owned		Construction		Home equity		Other residential		Installment and other consumer		Total
March 31, 2020
30-59 days past due	$	129	$	—	$	1,406	$	—	$	97	$	453	$	61	$	2,146
60-89 days past due	—		—		—		—		488		—		—		488
90 days or more past due	—		—		—		—		98		—		—		98
Total past due	129		—		1,406		—		683		453		61		2,732
Current	264,276		306,371		929,073		63,425		116,285		135,476		26,222		1,841,128
Total loans ¹	$	264,405	$	306,371	$	930,479	$	63,425	$	116,968	$	135,929	$	26,283	$	1,843,860
Non-accrual loans ²	$	—	$	—	$	942	$	—	$	633	$	—	$	57	$	1,632
December 31, 2019
30-59 days past due	$	1	$	—	$	1,001	$	—	$	279	$	—	$	7	$	1,288
60-89 days past due	—		—		—		—		98		—		95		193
90 days or more past due	—		—		—		—		167		—		—		167
Total past due	1		—		1,001		—		544		—		102		1,648
Current	246,686		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	$	—	$	—	$	—	$	—	$	168	$	—	$	58	$	226

¹ Amounts include net deferred loan origination costs of $1.2 million and $983 thousand at March 31, 2020 and December 31, 2019, respectively. Amounts are also net of unaccreted purchase discounts on non-PCI loans of $991 thousand at March 31, 2020 and $983 thousand at December 31, 2019.

²There were no accruing loans past due more than ninety days at March 31, 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.

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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.

Construction loans are generally made to developers and builders to finance construction, renovation and occasionally land acquisitions in anticipation of near-term development. Construction loans include interest reserves that are used for the payment of interest during the development and marketing periods and 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,

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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. 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, at March 31, 2020 and December 31, 2019.



Credit Risk Profile by Internally Assigned Risk Grade
(in thousands)	Commercial and industrial		Commercial real estate, owner-occupied		Commercial real estate, investor-owned		Construction		Home equity		Other residential		Installment and other consumer		Total
March 31, 2020
Pass	$	228,088	$	262,309	$	924,924	$	63,425	$	115,318	$	135,929	$	26,135	$	1,756,128
Special Mention	36,092		34,681		4,057		—		846		—		—		75,676
Substandard	225		9,381		1,498		—		804		—		148		12,056
Total loans	$	264,405	$	306,371	$	930,479	$	63,425	$	116,968	$	135,929	$	26,283	$	1,843,860
December 31, 2019
Pass	$	209,213	$	264,766	$	945,757	$	61,095	$	114,935	$	136,657	$	27,538	$	1,759,961
Special Mention	37,065		35,016		560		—		750		—		—		73,391
Substandard	409		9,042		—		—		339		—		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. There were no loans removed from TDR designation during the three months ended March 31, 2020 and 2019.

In accordance with Section 4013 of the CARES Act, we elected to suspend the requirements under GAAP for loan modifications related to the COVID-19 pandemic that would otherwise be designated as TDRs or considered impaired for accounting purposes. The temporary suspension became effective March 1, 2020 and ends on either the earlier of 60 days after the national emergency is terminated or December 31, 2020 for loans that were less than 30 days delinquent as of December 31, 2019. The suspension is not applicable to any TDRs that are not related to the pandemic. As of April 30, 2020, we approved 253 loan modifications for principal and/or interest deferrals for up to 120 days on loan balances totaling $358 million that, pursuant to the CARES Act, we did not evaluate for TDR designation but may have otherwise been TDRs under GAAP.

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The following table summarizes the carrying amount of TDR loans by loan class as of March 31, 2020 and December 31, 2019.



(in thousands)
Recorded Investment in Troubled Debt Restructurings ¹	March 31, 2020		December 31, 2019
Commercial and industrial	$	975	$	1,223
Commercial real estate, owner-occupied	6,997		6,998
Commercial real estate, investor-owned	1,756		1,770
Home equity	251		251
Other residential	449		452
Installment and other consumer	731		639
Total	$	11,159	$	11,333

¹There were no acquired TDR loans as of March 31, 2020 or December 31, 2019. TDR loans on non-accrual status totaled $57 thousand and $58 thousand at March 31, 2020 and December 31, 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, if applicable.



(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 March 31, 2020:
Commercial and industrial	1	$	170	$	162	$	144
Installment and other consumer	2	$	103	$	103	$	103
	3	$	273	$	265	$	247
TDRs during the three months ended March 31, 2019:
None	—	$	—	$	—	$	—

The loans modified in 2020 reflected debt consolidation, interest rate concessions, and/or other loan term and payment modifications. During the three months ended March 31, 2020 and 2019, there were no 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.

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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 loans.



(in thousands)	Commercial and industrial		Commercial real estate, owner-occupied		Commercial real estate, investor-owned		Construction		Home equity		Other residential		Installment and other consumer		Total
March 31, 2020
Recorded investment in impaired loans:
With no specific allowance recorded	$	830	$	—	$	942	$	—	$	633	$	449	$	95	$	2,949
With a specific allowance recorded	145		6,997		1,756		—		251		—		636		9,785
Total recorded investment in impaired loans	$	975	$	6,997	$	2,698	$	—	$	884	$	449	$	731	$	12,734
Unpaid principal balance of impaired loans	$	968	$	6,993	$	2,693	$	—	$	902	$	448	$	729	$	12,733
Specific allowance	9		277		37		—		4		—		119		446
Average recorded investment in impaired loans during the quarter ended March 31, 2020	1,099		6,997		2,234		—		651		451		685		12,117
Interest income recognized on impaired loans during the quarter ended March 31, 2020¹	14		66		19		—		4		5		7		115
Average recorded investment in impaired loans during the quarter ended March 31, 2019	1,666		6,997		1,816		2,690		580		461		680		14,890
Interest income recognized on impaired loans during the quarter ended March 31, 2019¹	22		66		20		42		4		5		6		165

¹No interest income was recognized on a cash basis during the three months ended March 31, 2020 and 2019.



(in thousands)	Commercial and industrial		Commercial real estate, owner-occupied		Commercial real estate, investor-owned		Construction		Home equity		Other residential		Installment and other consumer		Total
December 31, 2019
Recorded investment in impaired loans:
With no specific allowance recorded	$	349	$	—	$	—	$	—	$	167	$	452	$	98	$	1,066
With a specific allowance recorded	874		6,998		1,770		—		251		—		541		10,434
Total recorded investment in impaired loans	$	1,223	$	6,998	$	1,770	$	—	$	418	$	452	$	639	$	11,500
Unpaid principal balance of impaired loans	$	1,209	$	6,992	$	1,764	$	—	$	417	$	451	$	638	$	11,471
Specific allowance	$	103	$	195	$	41	$	—	$	5	$	—	$	53	$	397

Management monitors delinquent loans continuously and identifies problem loans (loans on non-accrual status and loans modified in a TDR) to evaluate individually for 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 no charged-off amounts on impaired loans at March 31, 2020 or December 31, 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 March 31, 2020 and December 31, 2019, unused commitments to extend credit on impaired loans, including performing loans to borrowers whose terms have been modified in TDRs, totaled $600 thousand and $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 industrial			Commercial real estate, owner-occupied			Commercial real estate, investor-owned			Construction			Home equity			Other residential			Installment and other consumer			Unallocated			Total
Three months ended March 31, 2020
Beginning balance	$	2,334		$	2,462		$	8,483		$	638		$	850		$	973		$	284		$	653		$	16,677
Provision (reversal)	446			335			742			86			132			125			79			255			2,200
Charge-offs	—			—			—			—			—			—			—			—			—
Recoveries	4			—			—			3			—			—			—			—			7
Ending balance	$	2,784		$	2,797		$	9,225		$	727		$	982		$	1,098		$	363		$	908		$	18,884
Three months ended March 31, 2019
Beginning balance	$	2,436		$	2,407		$	7,703		$	756		$	915		$	800		$	310		$	494		$	15,821
Provision (reversal)	180			(49		)	63			(52		)	8			—			30			(180		)	—
Charge-offs	(9		)	—			—			—			—			—			—			—			(9		)
Recoveries	5			—		—			—			—			—			—			—			5
Ending balance	$	2,612		$	2,358		$	7,766		$	704		$	923		$	800		$	340		$	314		$	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-owned			Construction			Home equity			Other residential			Installment and other consumer			Unallocated		Total
March 31, 2020
Ending ALLL related to loans collectively evaluated for impairment	$	2,775		$	2,520		$	9,188		$	727		$	978		$	1,098		$	244		$	908	$	18,438
Ending ALLL related to loans individually evaluated for impairment	9			277			37			—			4			—			119			—		446
Ending balance	$	2,784		$	2,797		$	9,225		$	727		$	982		$	1,098		$	363		$	908	$	18,884
Recorded Investment:
Collectively evaluated for impairment	$	263,430		$	299,374		$	927,781		$	63,425		$	116,084		$	135,480		$	25,552		$	—	$	1,831,126
Individually evaluated for impairment	975			6,997			2,698			—			884			449			731			—		12,734
Total	$	264,405		$	306,371		$	930,479		$	63,425		$	116,968		$	135,929		$	26,283		$	—	$	1,843,860
Ratio of allowance for loan losses to total loans	1.05		%	0.91		%	0.99		%	1.15		%	0.84		%	0.81		%	1.38		%	NM		1.02		%
Allowance for loan losses to non-accrual loans	NM			NM			979		%	NM			155		%	NM			637		%	NM		1,157		%

NM - Not Meaningful



Allowance for Loan Losses and Recorded Investment in Loans
(dollars in thousands)	Commercial and industrial			Commercial real estate, owner-occupied			Commercial real estate, investor-owned			Construction			Home equity			Other residential			Installment and other consumer			Unallocated		Total
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 impairment	103			195			41			—			5			—			53			—		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		$	—	$	1,831,786
Individually evaluated for impairment	1,223			6,998			1,770			—			418			452			639			—		11,500
Total	$	246,687		$	308,824		$	946,317		$	61,095		$	116,024		$	136,657		$	27,682		$	—	$	1,843,286
Ratio of allowance for loan losses to total loans	0.95		%	0.80		%	0.90		%	1.04		%	0.73		%	0.71		%	1.03		%	NM		0.90		%
Allowance for loan losses to non-accrual loans	NM			NM			NM			NM			506		%	NM			490		%	NM		7,379		%

NM - Not Meaningful

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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 $1,168.8 million and $1,133.4 million at March 31, 2020 and December 31, 2019, respectively. In addition, we pledge eligible TIC loans, which totaled $116.9 million and $115.7 million at March 31, 2020 and December 31, 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 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 $8.1 million at March 31, 2020 and $8.3 million at December 31, 2019. In addition, undisbursed commitments to related parties totaled $8.9 million at March 31, 2020 and $9.2 million at December 31, 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 million at March 31, 2020 and December 31, 2019. In general, interest rates on these lines approximate the federal funds target rate. We had no overnight borrowings under these credit facilities at March 31, 2020 or December 31, 2019.

Federal Home Loan Bank Borrowings – As of March 31, 2020 and December 31, 2019, the Bank had lines of credit with the FHLB totaling $676.8 million and $648.0 million, respectively, based on eligible collateral of certain loans. There were no FHLB overnight borrowings at March 31, 2020 or December 31, 2019.

Federal Reserve Line of Credit – The Bank has a line of credit with the FRBSF secured by certain residential loans. At March 31, 2020 and December 31, 2019, the Bank had borrowing capacity under this line totaling $79.3 million and $80.3 million, respectively, and had no outstanding borrowings with the FRBSF.

Subordinated Debenture – As part of an acquisition in 2013, Bancorp assumed a subordinated debenture due to NorCal Community Bancorp Trust 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. The subordinated debenture was recorded at fair 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 debenture. Accretion on the subordinated debenture totaled $17 thousand for the three months ended March 31, 2020 and 2019. Bancorp has the option to defer payment of the interest on the subordinated debenture 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, which have identical maturity, repricing and payment terms as the subordinated debenture. 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 2.14% as of March 31, 2020) is redeemable in whole or in part on any interest payment date.

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

Note 7: Stockholders' Equity

Dividends

On April 17, 2020, Bancorp declared a $0.23 per share cash dividend, payable on May 8, 2020 to shareholders of record at the close of business on May 1, 2020.

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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 grant date price, is recorded as compensation expense over the requisite service period with a corresponding increase in common stock as the shares vest. Beginning in 2018, stock option and restricted stock awards issued include a retirement eligibility clause whereby the requisite service period is satisfied at the retirement eligibility date. For those awards, we accelerate the recording of stock-based compensation when the award holder is eligible to retire. However, retirement eligibility does not affect the vesting of restricted stock or the exercisability of the stock options, which are based on the scheduled vesting period.

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

We record excess tax benefits (deficiencies) resulting from the exercise of non-qualified stock options, the disqualifying disposition of incentive stock options and vesting of restricted stock awards as income tax benefits (expense) in the consolidated statements of comprehensive income with a corresponding decrease (increase) to current taxes payable.

The holders of unvested restricted stock awards are entitled to dividends on the same per-share ratio as holders of common stock. Tax benefits for dividends paid on unvested restricted stock awards are recorded as tax benefits in the consolidated statements of comprehensive income with a corresponding decrease to current taxes payable. Dividends on forfeited awards are included in stock-based compensation expense.

Stock options and restricted stock may be net settled in a cashless exercise by a reduction in the number of shares otherwise deliverable upon exercise or vesting in satisfaction of the exercise payment and/or applicable tax withholding requirements. During the three months ended March 31, 2020, we withheld 8,409 shares totaling $346 thousand at a weighted-average price of $41.17 for cashless exercises. During the three months ended March 31, 2019, we withheld 6,398 shares totaling $267 thousand at a weighted-average price of $41.78 for cashless exercises. Shares withheld under net settlement arrangements are available for future grants.

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 began on March 1, 2020 and was suspended indefinitely by the Board of Directors on March 20, 2020 to focus our resources on responding to customer needs during the COVID-19 pandemic.

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.

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The 10b5-1 trading plan is administered by an independent broker and is subject to price, market volume and timing restrictions.

During the three months ended March 31, 2020, Bancorp repurchased 92,664 shares totaling $3.2 million for a cumulative 619,881 shares totaling $25.2 million repurchased from May 1, 2018 through March 31, 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)	March 31, 2020		December 31, 2019
Commercial lines of credit	$	259,151	$	287,533
Revolving home equity lines	185,715		189,035
Undisbursed construction loans	31,367		41,033
Personal and other lines of credit	10,730		9,567
Standby letters of credit	1,904		1,964
Total commitments and standby letters of credit	$	488,867	$	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 $1.2 million and $1.1 million as of March 31, 2020 and December 31, 2019, respectively, which is recorded in interest payable and other liabilities in the consolidated statements of condition.

Pursuant to the CARES Act, on April 6, 2020, we began accepting applications from eligible small businesses and non-profit organizations to participate in the Paycheck Protection Program (“PPP”) administered by the U.S. Small Business Administration (“SBA”). PPP loans have up to a two-year term and earn interest at 1%. In addition, the Bank receives a fee of 1%-5% from the SBA based on the loan amount, which is amortized into interest income over the life of the loan. These loans are fully guaranteed by the SBA and may be forgiven by the SBA if they meet certain requirements in accordance with the terms of the program. As of April 30, 2020, through two waves of SBA funding, we submitted and received approval for 1,452 applications for a total of $294 million. Most have been funded with the remainder to be funded in the next several days.

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.

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The following table shows the balances of operating and finance lease right-of-use assets and lease liabilities as of March 31, 2020.



(in thousands)	March 31, 2020			December 31, 2019
Operating leases:
Operating lease right-of-use assets	$	22,225		$	11,002
Operating lease liabilities	$	23,726		$	12,615
Finance leases:
Finance lease right-of-use assets	$	396		$	379
Accumulated amortization	(213		)	(170		)
Finance lease right-of-use assets, net¹	$	183		$	209
Finance lease liabilities²	$	185		$	212
¹Included in premises and equipment in the consolidated statements of condition.
²Included 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.



	Three months ended
(in thousands)	March 31, 2020		March 31, 2019
Right-of-use assets obtained in exchange for operating lease liabilities	$	12,178	$	266
Right-of-use assets obtained in exchange for finance lease liabilities	$	18	$	—
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 ended
(in thousands)	March 31, 2020		March 31, 2019
Operating lease cost	$	1,055	$	1,004
Variable lease cost	2		—
Total operating lease cost¹	1,057		1,004
Finance lease cost:
Amortization of right-of-use assets²	$	44	$	42
Interest on finance lease liabilities³	1		2
Total finance lease cost	$	45	$	44
Total lease cost	$	1,102	$	1,048
¹Included in occupancy and equipment expense in the consolidated statements of comprehensive income.
²Included in depreciation and amortization in the consolidated statements of comprehensive income.
³Included 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 March 31, 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.

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(in thousands)	March 31, 2020
Year	Operating Leases			Finance Leases
2020	$	3,360		$	129
2021	3,546			42
2022	3,172			13
2023	2,716			4
2024	2,075			—
Thereafter	11,133			—
Total minimum lease payments	26,002			188
Amounts representing interest (present value discount)	(2,276		)	(3		)
Present value of net minimum lease payments (lease liability)	$	23,726		$	185

Weighted average remaining term (in years)	8.7			1.4
Weighted average discount rate	2.19		%	2.69		%

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 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 $1.3 billion as of March 31, 2020, 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 asset/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

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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 March 31, 2020, we had five 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 totaled $11 thousand at March 31, 2020 and $6 thousand at December 31, 2019. Information on our derivatives follows:



	Asset Derivatives				Liability Derivatives
(in thousands)	March 31, 2020		December 31, 2019		March 31, 2020		December 31, 2019
Fair value hedges:
Interest rate contracts notional amount	$	—	$	—	$	16,711	$	16,956
Interest rate contracts fair value¹	$	—	$	—	$	2,618	$	1,178

¹See 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 March 31, 2020 and December 31, 2019.



	Carrying Amounts of Hedged Assets				Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Loans
(in thousands)	March 31, 2020		December 31, 2019		March 31, 2020		December 31, 2019
Loans	$	19,125	$	17,900	$	2,414	$	944

The following table presents the net gains (losses) recognized in interest income on loans on the consolidated statements of comprehensive income related to our derivatives designated as fair value hedges.



	Three months ended
(in thousands)	March 31, 2020			March 31, 2019
Interest and fees on loans ¹	$	20,887		$	20,695
Decrease in value of designated interest rate swaps due to LIBOR interest rate movements	$	(1,440	)	$	(357	)
Payment on interest rate swaps	(67		)	(12		)
Increase in value of hedged loans	1,470			362
Decrease in value of yield maintenance agreement	(3		)	(4		)
Net losses on fair value hedging relationships recognized in interest income	$	(40	)	$	(11	)

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.

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Information on financial instruments that are eligible for offset in the consolidated statements of condition follows:

Offsetting of Financial Assets and Derivative Assets

Gross Amounts

Net Amounts of

Gross Amounts Not Offset in

Gross Amounts

Offset in the

Assets Presented

the Statements of Condition

of Recognized

Statements of

in the Statements

Financial

Cash Collateral

(in thousands)

Assets

Condition

of Condition

Instruments

Received

Net Amount

March 31, 2020

Derivatives by Counterparty:

Counterparty A

—

Total

—

December 31, 2019

Derivatives by Counterparty:

Counterparty A

—

Total

—



Offsetting of Financial Liabilities and Derivative Liabilities
			Gross Amounts		Net Amounts of		Gross Amounts Not Offset in
	Gross Amounts		Offset in the		Liabilities Presented		the Statements of Condition
	of Recognized		Statements of		in the Statements		Financial		Cash Collateral
(in thousands)	Liabilities¹		Condition		of Condition¹		Instruments		Pledged			Net Amount
March 31, 2020
Derivatives by Counterparty:
Counterparty A	$	2,618	$	—	$	2,618	$	—	$	(2,260	)	$	358
Total	$	2,618	$	—	$	2,618	$	—	$	(2,260	)	$	358
December 31, 2019
Derivatives by Counterparty:
Counterparty A	$	1,178	$	—	$	1,178	$	—	$	(1,178	)	$	—
Total	$	1,178	$	—	$	1,178	$	—	$	(1,178	)	$	—

¹Amounts exclude accrued interest on swaps.

For more information on how we account for our interest rate swaps, refer to Note 1 to the Consolidated Financial Statements included in our 2019 Form 10-K filed with the SEC on March 13, 2020.

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 2019 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), pandemics such as

Page-27

COVID-19 and the economic impact caused by the disease and by government responses thereto, general economic conditions, economic uncertainty in the United States and abroad, changes in interest rates, deposit flows, real estate values, costs or effects of acquisitions, competition, changes in accounting principles, policies or guidelines, legislation or regulation (including the Tax Cuts & Jobs Act of 2017 and the Coronavirus Aid, Relief and Economic Security Act of 2020), interruptions of utility service in our markets for sustained periods, and other economic, competitive, governmental, regulatory and technological factors (including external fraud and cybersecurity threats) affecting Bancorp'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 2019 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. Bancorp undertakes no obligation to release publicly the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date of 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 2019 Form 10-K filed with the SEC on March 13, 2020 and Note 2, Recently Adopted and Issued Accounting Standards, to the Consolidated Financial Statements in this Form 10-Q. Note that in accordance with the accounting relief provisions of the Coronavirus Aid, Relief and Economic Security ("CARES") Act, the Bank postponed the adoption of the current expected credit losses (“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.

Executive Summary

Net income for the first quarter of 2020 totaled $7.2 million, compared to $7.5 million in the first quarter of 2019. Diluted earnings per share were $0.53 in the first quarter of 2020, compared to $0.54 in the same quarter a year ago. First quarter 2020 net income reflected a $2.2 million provision for loan losses related to the economic uncertainties of the COVID-19 pandemic as well as typical first quarter increases in non-interest expenses. The provision for loan losses negatively impacted diluted earnings per share by approximately $0.12. The decrease in earnings was partially offset by gains on investment securities sales and accelerated discount accretion from the early call on an investment security, which positively impacted diluted earnings per share by approximately $0.07.

Since March 2020, Bank of Marin has been actively engaged in responding to the COVID-19 pandemic. All branches remain open to serve our customers and local communities, with modified hours and strict social distancing protocols in place as well as a maximum of two customers allowed in a branch at one time. To protect the health of everyone, many employees are working remotely, travel restrictions are in effect, and cleaning protocols have been enhanced across all locations.

We announced in March 2020 the waiver of all ATM and overdraft fees, and the cancellation of early withdrawal penalties for time certificate of deposits when allowed by law. We are providing payment relief for up to 120 days to borrowers with hardship requests, have reduced interest rate floors on mostly commercial Prime Rate based loans and are participating in the Small Business Administration’s ("SBA's") Paycheck Protection Program ("PPP") under the CARES Act. In addition, we have suspended our share repurchase program. As these measures were taken late in the quarter, they did not significantly impact first quarter earnings. The full impact will be seen in future periods.

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The following are highlights of our operating and financial performance for the periods presented:


•	Loans totaled $1,843.9 million at March 31, 2020, compared to $1,843.3 million at December 31, 2019. New loan originations of $29.8 million and line utilization increases of $28.9 million were mostly offset by payoffs of $51.7 million, for an overall net increase of $574 thousand.

•

As of March 31, 2020 our loan portfolio exposure to industries most affected by the shelter-in-place order included 10.4% retail properties and businesses, 4.6% wine-related businesses and 2.7% hospitality. Transportation, dental, recreation and entertainment combined represented less than 1.5% of the total portfolio. Loans to these customers are generally secured by real estate with low loan-to-value ratios and strong guarantors.

•

To provide immediate relief to our clients experiencing hardship, as of April 30, 2020, we approved 253 loans for principal and/or interest deferrals for up to 120 days on loan balances totaling $358 million. In addition, 96% of the total requests were secured by real estate with loan-to-value ratios averaging less than 46%, and $141 million was linked to industries most impacted by the stay at home order.


•	As of April 30, 2020, through two waves of SBA funding, we submitted and received approval for 1,452 applications for a total of $294 million, which will help 25,412 employees of local businesses and nonprofit organizations.

•

Strong credit quality remains a cornerstone of the Bank's consistent performance. Non-accrual loans totaled $1.6 million, or 0.09% of the loan portfolio at March 31, 2020, compared to $226 thousand, or 0.01% at December 31, 2019. Classified loans totaled $12.1 million at March 31, 2020, compared to $9.9 million at December 31, 2019. Accruing loans past due 30 to 89 days totaled $1.3 million at March 31, 2020, compared to $1.5 million at December 31, 2019. A $2.2 million provision for loan losses and $102 thousand provision for losses on off-balance sheet commitments were recorded in the first quarter of 2020 based on information available as of March 31, 2020 to take into account the impact of the COVID-19 pandemic to the best of our ability. There was no provision for loan losses and a $129 thousand provision for losses on off-balance sheet commitments in the same period last year.

•

Total deposits increased $29.4 million in the first three months of 2020 to $2,307.1 million at March 31, 2020. The increase was primarily due to normal cash fluctuations in some of our large business accounts. Non-interest bearing deposits increased $1.6 million from December 31, 2019 and represented 49% of total deposits at March 31, 2020. The cost of average deposits was 0.21% in the first quarter of 2020, an increase of 3 basis points from the same quarter a year ago.


•	All capital ratios were above regulatory requirements to be considered well-capitalized. The total risk-based capital ratio for Bancorp was 15.3% at March 31, 2020, compared to 15.1% at December 31, 2019.


•	Return on assets was 1.09% for the quarter ended March 31, 2020, compared to 1.19% for the quarter ended March 31, 2019. Return on equity was 8.54% for the quarter ended March 31, 2020, compared to 9.54% for the quarter ended March 31, 2019.


•	Because of our continued profitability, the Board of Directors declared a cash dividend of $0.23 per share on April 17, 2020. This represents the 60th consecutive quarterly dividend paid by Bank of Marin Bancorp. The dividend is payable on May 8, 2020, to shareholders of record at the close of business on May 1, 2020.

Bank of Marin's strong balance sheet is built from our core values - relationship banking, disciplined fundamentals and commitment to the communities that we serve. For the remainder of 2020 and looking forward into 2021, we believe that our robust liquidity and capital positions, high credit quality loan portfolio, excellent credit metrics and low-cost deposit base will help us navigate the pandemic and low interest rate environment.

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RESULTS OF OPERATIONS

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



(dollars in thousands)	March 31, 2020			December 31, 2019
Selected financial condition data:
Total assets	$	2,697,738		$	2,707,280
Loans, net	1,824,976			1,826,609
Deposits	2,307,110			2,336,489
Borrowings and other obligations	2,910			2,920
Stockholders' equity	345,940			336,788
Asset quality ratios:
Allowance for loan losses to total loans	1.02		%	0.90		%
Allowance for loan losses to non-accrual loans	11.57x			73.86x
Non-accrual loans to total loans	0.09		%	0.01		%
Capital ratios:
Equity to total assets ratio	12.82		%	12.44		%
Tangible common equity to tangible assets ¹	11.69		%	11.30		%
Total capital (to risk-weighted assets)	15.29		%	15.07		%
Tier 1 capital (to risk-weighted assets)	14.35		%	14.24		%
Tier 1 capital (to average assets)	11.66		%	11.66		%
Common equity Tier 1 capital (to risk weighted assets)	14.22		%	14.11		%



	Three months ended
(dollars in thousands, except per share data)	March 31, 2020			March 31, 2019
Selected operating data:
Net interest income	$	24,119		$	23,846
Provision for loan losses	2,200			—
Non-interest income	3,120			1,771
Non-interest expense	15,469			15,528
Net income	7,228			7,479
Net income per common share:
Basic	$	0.53		$	0.54
Diluted	$	0.53		$	0.54
Performance and other financial ratios:
Return on average assets	1.09		%	1.19		%
Return on average equity	8.54		%	9.54		%
Tax-equivalent net interest margin ²	3.88		%	4.02		%
Cost of deposits	0.21		%	0.18		%
Efficiency ratio	56.79		%	60.62		%
Cash dividend payout ratio on common stock ³	43.40		%	35.19		%

¹Tangible 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 $311 million and $302 million at March 31, 2020 and December 31, 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 $34.6 million and $34.8 million at March 31, 2020 and December 31, 2019, respectively.

² 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.

³ Calculated as dividends on common shares divided by basic net income per common share.

Page-30

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 ended						Three months ended
		March 31, 2020						March 31, 2019
				Interest						Interest
		Average		Income/		Yield/		Average		Income/		Yield/
(dollars in thousands)		Balance		Expense		Rate		Balance		Expense		Rate
Assets
	Interest-bearing due from banks¹	$	99,362	$	332	1.32	%	$	22,690	$	139	2.45	%
	Investment securities^{2, 3}	556,897		4,266		3.06	%	619,562		4,191		2.71	%
	Loans ^{1, 3, 4}	1,833,180		21,066		4.55	%	1,756,316		20,887		4.76	%
	Total interest-earning assets¹	2,489,439		25,664		4.08	%	2,398,568		25,217		4.21	%
	Cash and non-interest-bearing due from banks	40,844						30,947
	Bank premises and equipment, net	5,939						7,512
	Interest receivable and other assets, net	118,909						104,685
Total assets		$	2,655,131					$	2,541,712
Liabilities and Stockholders' Equity
	Interest-bearing transaction accounts	$	138,395	$	66	0.19	%	$	127,733	$	77	0.24	%
	Savings accounts	163,439		16		0.04	%	180,355		18		0.04	%
	Money market accounts	760,616		971		0.51	%	673,137		764		0.46	%
	Time accounts including CDARS	96,157		161		0.67	%	113,389		119		0.43	%
	Borrowings and other obligations ¹	358		2		1.81	%	7,414		47		2.55	%
	Subordinated debenture ¹	2,715		49		7.19	%	2,647		60		9.05	%
	Total interest-bearing liabilities	1,161,680		1,265		0.44	%	1,104,675		1,085		0.40	%
	Demand accounts	1,119,975						1,086,947
	Interest payable and other liabilities	33,045						32,163
	Stockholders' equity	340,431						317,927
Total liabilities & stockholders' equity		$	2,655,131					$	2,541,712
Tax-equivalent net interest income/margin ¹				$	24,399	3.88	%			$	24,132	4.02	%
Reported net interest income/margin¹				$	24,119	3.83	%			$	23,846	3.98	%
Tax-equivalent net interest rate spread						3.64	%					3.81	%



¹Interest income/expense is divided by actual number of days in the period times 360 days to correspond to stated interest rate terms, where applicable.
²Yields 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.
³Yields and interest income on tax-exempt securities and loans are presented on a taxable-equivalent basis using the Federal statutory rate of 21%.
⁴Average 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.

Page-31

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, including one more day in first quarter of 2020.



	Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019
(in thousands)	Volume			Yield/Rate			Mix			Total
Interest-bearing due from banks	$	469		$	(64	)	$	(212	)	$	193
Investment securities ¹	(424		)	555			(56		)	75
Loans¹	914			(927		)	192			179
Total interest-earning assets	959			(436		)	(76		)	447
Interest-bearing transaction accounts	6			(16		)	(1		)	(11		)
Savings accounts	(2		)	—			—			(2		)
Money market accounts	99			85			23			207
Time accounts, including CDARS	(18		)	68			(8		)	42
Borrowings and other obligations	(45		)	(14		)	14			(45		)
Subordinated debenture	2			(13		)	—			(11		)
Total interest-bearing liabilities	42			110			28			180
Changes in tax-equivalent net interest income	$	917		$	(546	)	$	(104	)	$	267
¹ Yields and interest income on tax-exempt securities and loans are presented on a taxable-equivalent basis using the federal statutory rate of 21%.

First Quarter of 2020 Compared to First Quarter of 2019

Net interest income totaled $24.1 million in the first quarter of 2020, compared to $23.8 million in the same quarter a year ago. The $273 thousand increase was reflective of higher average loan balances, accelerated accretion on a called bond and one more day of interest, partially offset by lower yields on loans and higher deposit balances and rates.

The tax-equivalent net interest margin was 3.88% in the first quarter of 2020 compared to 4.02% in the same quarter of the previous year. The decrease from the first quarter of 2019 was primarily driven by lower interest rates impacting yields on loans and cash balances, higher cash balances and higher rates on certain deposit categories. Accelerated accretion on the called investment security contributed 7 basis points to the first quarter 2020 net interest margin.

Effective March 2020, we began providing payment relief for up to 120 days to borrowers with hardship requests and have reduced interest rate floors on mostly commercial Prime Rate based loans. We are anticipating an annual reduction of $750 thousand to $1.0 million in net interest income due to reduced interest rate floors.

Market Interest Rates

In response to the evolving risks to economic activity posed by the COVID-19 pandemic, the Federal Reserve Open Market Committee ("FOMC") made two emergency cuts totaling 150 basis points to the federal funds rate in March. This will put downward pressure on our asset yields and net interest margin with the full effect to be seen in future quarters. See ITEM 3. Quantitative and Qualitative Disclosure about Market Risk for further information.

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, 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.

Page-32

Impaired loan balances totaled $12.7 million at March 31, 2020 and $11.5 million at December 31, 2019, with specific valuation allowances of $446 thousand and $397 thousand for the same respective dates. Loans graded special mention totaled $75.7 million at March 31, 2020 and $73.4 million at December 31, 2019. Classified assets (loans with substandard or doubtful risk grades) increased to $12.1 million at March 31, 2020, from $9.9 million at December 31, 2019. The $2.1 million increase was primarily due to the downgrade of one non-owner occupied commercial real estate loan and one loan secured by a triplex property (both with low loan-to-value ratios), and three home equity loans. There were no loans with doubtful risk grades at March 31, 2020 or December 31, 2019.

In accordance with the accounting relief provisions of the CARES Act, the Bank has postponed the adoption of the current expected credit losses (“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. Under the existing incurred loss model we adjusted certain qualitative factors, taking into account the economic uncertainty of the pandemic, and recorded a $2.2 million loan loss provision in the first quarter of 2020, compared to no provision for loan losses in the comparable quarter in 2019. Net recoveries in the first quarter of 2020 totaled $7 thousand, compared to charge offs of $4 thousand in the same quarter a year ago.

The ratio of loan loss reserves to total loans was 1.02% at March 31, 2020 and 0.90% at December 31, 2019. Non-accrual loans totaled $1.6 million, or 0.09% of total loans, at March 31, 2020, compared to $226 thousand, or 0.01%, at December 31, 2019.

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

Non-interest Income

The following table details the components of non-interest income.



	Three months ended					Amount			Percent
(dollars in thousands)	March 31, 2020		March 31, 2019			Increase (Decrease)			Increase (Decrease)
Service charges on deposit accounts	$	451	$	479		$	(28	)	(5.8	)%
Wealth Management and Trust Services	504		438			66			15.1	%
Debit card interchange fees, net	360		380			(20		)	(5.3	)%
Merchant interchange fees, net	73		87			(14		)	(16.1	)%
Earnings on (cost of) bank-owned life insurance	275		(60		)	335			(558.3	)%
Dividends on FHLB stock	208		196			12			6.1	%
Gains (losses) on sale of investment securities, net	800		(6		)	806			(13,433.3	)%
Other income	449		257			192			74.7	%
Total non-interest income	$	3,120	$	1,771		$	1,349		76.2	%

First Quarter of 2020 Compared to First Quarter of 2019

Non-interest income increased by $1.3 million in the first quarter of 2020 to $3.1 million, compared to $1.8 million in the same quarter a year ago. The increase was primarily due to $800 thousand in gains on the sale of short-duration agency residential mortgage-backed investment securities subject to increasing prepayment speeds. The increase in earnings from bank-owned life insurance ("BOLI") was related to $283 thousand in non-refundable costs for underwriting two BOLI policies purchased in the first quarter of 2019 and annual dividends we received from those two policies in the first quarter of 2020. The increase in wealth management and trust service income was largely due to final fees received from various trust administrations in the first quarter of 2020. The increase in other income was comprised of several small dollar items in the first quarter of 2020.

Effective March 2020, we began waiving ATM and overdraft fees and canceling early withdrawal penalties for time certificate of deposits when allowed by law. We expect these waivers to have a minimal effect on non-interest income.

Page-33

Non-interest Expense

The following table details the components of non-interest expense.



	Three months ended				Amount			Percent
(dollars in thousands)	March 31, 2020		March 31, 2019		Increase (Decrease)			Increase (Decrease)
Salaries and related benefits	$	9,477	$	9,146	$	331		3.6	%
Occupancy and equipment	1,663		1,531		132			8.6	%
Depreciation and amortization	526		556		(30		)	(5.4	)%
Federal Deposit Insurance Corporation insurance	2		179		(177		)	(98.9	)%
Data processing	786		1,015		(229		)	(22.6	)%
Professional services	544		586		(42		)	(7.2	)%
Directors' expense	174		179		(5		)	(2.8	)%
Information technology	250		259		(9		)	(3.5	)%
Amortization of core deposit intangible	213		222		(9		)	(4.1	)%
Provision for losses on off-balance sheet commitments	102		129		(27		)	(20.9	)%
Other non-interest expense
Advertising	251		211		40			19.0	%
Other expense	1,481		1,515		(34		)	(2.2	)%
Total other non-interest expense	1,732		1,726		6			0.3	%
Total non-interest expense	$	15,469	$	15,528	$	(59	)	(0.4	)%

First Quarter of 2020 Compared to First Quarter of 2019

Non-interest expense decreased by $59 thousand to $15.5 million, compared to the same period a year ago. The decrease was primarily due to costs associated with the conversion to a new digital banking platform in 2019 and the lack of Federal Deposit Insurance Corporation ("FDIC") deposit insurance expense in the first quarter of 2020 as the FDIC Deposit Insurance Fund reserve exceeded its billing threshold. Additionally, accelerated stock-based compensation expense for retirement eligible employees was lower in the first quarter of 2020, as compared to the same quarter in 2019. Decreases in non-interest expense were partially offset by higher salaries and benefits related to annual merit increases, one additional full-time equivalent staff and an increase in occupancy and equipment expense (primarily due to common area maintenance adjustments, lease term modifications for our existing headquarters office, and a new lease agreement for one of our retail branches).

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, low-income housing tax credits, and stock-based compensation from the exercise of stock options, disqualifying dispositions of incentive stock options and vesting of restricted stock awards).

The provision for income taxes for the first quarter of 2020 totaled $2.3 million at an effective tax rate of 24.5%, compared to $2.6 million at an effective tax rate of 25.9% in the same quarter last year. The decrease in the provision reflected the lower level of pre-tax income and higher tax exempt earnings on BOLI. The decrease in the effective tax rate reflected a higher level of discrete tax benefits in 2020 from the exercise of non-qualified stock options and disqualifying dispositions of incentive stock options compared to 2019, partially offset by a decrease in tax benefits associated with the vesting of restricted stock.

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 March 31, 2020, neither the Bank nor Bancorp had accruals for interest nor penalties related to unrecognized tax benefits.

Page-34

FINANCIAL CONDITION SUMMARY

At March 31, 2020, assets totaled $2,697.7 million, a decrease of $9.5 million, from December 31, 2019, mainly due to a decrease in cash primarily as a result of a $29.4 million decrease in total deposits, offset by a $10.3 million increase in investments primarily as a result of the increase in fair value in available-for-sale securities and $11.2 million increase in operating lease right-of-use assets, reflecting modified lease terms for our existing headquarters office and a new lease agreement for one of our retail branches.

Investment Securities

The investment securities portfolio totaled $580.0 million at March 31, 2020, an increase of $10.3 million from December 31, 2019. The increase reflects purchases of $54.9 million in 2020, a majority of which are high credit quality longer duration obligations of state and political subdivisions, and increase in the fair value of available-for-sale securities in 2020, partially offset by calls, paydowns, maturities and sales totaling $53.8 million. During the first quarter 2020, we sold $26.6 million short duration agency residential mortgage-backed securities subject to increasing prepayment speeds, which resulted in a gain of $800 thousand.

The following table summarizes our investment in obligations of state and political subdivisions at March 31, 2020 and December 31, 2019.



		March 31, 2020						December 31, 2019
(dollars in thousands)		Amortized Cost		Fair Value		% of Total State and Political Subdivisions		Amortized Cost		Fair Value		% of Total State and Political Subdivisions
Within California:
	General obligation bonds	$	4,591	$	4,814	4.4	%	$	4,597	$	4,813	6.6	%
	Revenue bonds	2,882		2,947		2.8		2,928		2,977		4.2
	Tax allocation bonds	3,365		3,450		3.3		3,376		3,456		4.9
Total within California		10,838		11,211		10.5		10,901		11,246		15.7
Outside California:
	General obligation bonds	61,640		63,103		59.9		45,974		46,976		66.1
	Revenue bonds	30,463		31,063		29.6		12,680		12,648		18.2
Total outside California		92,103		94,166		89.5		58,654		59,624		84.3
Total obligations of state and political subdivisions		$	102,941	$	105,377	100.0	%	$	69,555	$	70,870	100.0	%

The portion of the portfolio outside the state of California is distributed among fourteen states. Of the total investment in obligations of state and political subdivisions, the largest concentrations outside of California are in Texas (53.4%), Maryland (6.6%), and Florida (5.3%). During March 2020, we strategically increased our credit 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 utilities and transportation). We have $7.5 million in obligations of Texas school district 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

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Loans

Loans increased by $574 thousand and totaled $1,843.9 million at March 31, 2020. New loan originations totaled $29.8 million in the first three months of 2020. Loan payoffs totaled $51.7 million in the first three months and consisted largely of loans whereby underlying assets were sold, including construction loans, and planned payoffs expected to refinance elsewhere as part of risk concentration management. Commitment line utilization contributed to the overall increase in loans in the first quarter.

Liabilities

During the first three months of 2020, total liabilities decreased by $18.7 million to $2,351.8 million. Deposits decreased $29.4 million in the first three months of 2020, mainly due to the cash cycles of some of our large commercial depositors. Non-interest bearing deposits decreased $1.6 million in the first three months of 2020 to $1,130.5 million, and represented 49.0% of total deposits at March 31, 2020, compared to 48.3% at December 31, 2019. Liabilities as of March 31, 2020 included operating lease liabilities totaling $23.7 million, which increased $11.1 million in the first quarter of 2020 due to the extension of lease terms for our existing headquarters office and a new lease 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 March 31, 2020. There are no conditions or events since that notification that Management believes have changed the Bank’s categories and we expect the Bank to remain well capitalized for prompt corrective action purposes.

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 longer subject to separate minimum capital requirements. However, we disclose comparative capital ratios for Bancorp, which would have exceeded well-capitalized levels had Bancorp been subject to the same minimum capital requirements.

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The Bancorp’s and Bank’s capital adequacy ratios as of March 31, 2020 and December 31, 2019 are presented in the following tables. Bancorp's Tier 1 capital includes the subordinated debenture, which are not included at the Bank level.



Capital Ratios for Bancorp (dollars in thousands)	Actual Ratio				Adequately Capitalized Threshold¹				Ratio to be a Well Capitalized Bank Holding Company
March 31, 2020	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total Capital (to risk-weighted assets)	$	324,520	15.29	%	≥ $	222,784	≥ 10.50	%	≥ $	212,175	≥ 10.00	%
Tier 1 Capital (to risk-weighted assets)	$	304,448	14.35	%	≥ $	180,349	≥ 8.50	%	≥ $	169,740	≥ 8.00	%
Tier 1 Capital (to average assets)	$	304,448	11.66	%	≥ $	104,422	≥ 4.00	%	≥ $	130,528	≥ 5.00	%
Common Equity Tier 1 (to risk-weighted assets)	$	301,723	14.22	%	≥ $	148,523	≥ 7.00	%	≥ $	137,914	≥ 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	%

¹The 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
March 31, 2020	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total Capital (to risk-weighted assets)	$	305,573	14.40	%	≥ $	222,780	≥ 10.50	%	≥ $	212,172	≥ 10.00	%
Tier 1 Capital (to risk-weighted assets)	$	285,501	13.46	%	≥ $	180,346	≥ 8.50	%	≥ $	169,737	≥ 8.00	%
Tier 1 Capital (to average assets)	$	285,501	10.94	%	≥ $	104,421	≥ 4.00	%	≥ $	130,527	≥ 5.00	%
Common Equity Tier 1 (to risk-weighted assets)	$	285,501	13.46	%	≥ $	148,520	≥ 7.00	%	≥ $	137,912	≥ 6.50	%
December 31, 2019
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)	$	292,111	13.79	%	≥ $	180,068	≥ 8.50	%	≥ $	169,476	≥ 8.00	%
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)	$	292,111	13.79	%	≥ $	148,291	≥ 7.00	%	≥ $	137,699	≥ 6.50	%

¹The 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.

We obtain funds from the repayment and maturity of loans, deposit inflows, investment security maturities and paydowns, federal funds purchases, FHLB advances, other borrowings, and cash flow from operations. 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. The attraction and retention of new deposits 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 cycles of some of our large

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commercial depositors may cause short-term fluctuations in their deposit balances held with us. In addition, in March 2020, we began providing loan payment relief by allowing certain borrowers with hardship requests to defer payments for up to 120 days. We are also participating in the SBA's PPP as noted above in the Executive Summary section. The Bank has substantial contingent and on-balance-sheet liquidity to support these programs, including unencumbered available-for-sale securities and cash totaling $517.9 million at March 31, 2020.

Our cash and cash equivalents decreased $27.1 million from December 31, 2019, primarily due to a decrease in deposits of $29.4 million. Other significant uses of liquidity during the first three months of 2020 included $54.9 million in investment securities purchases, $3.3 million in common stock repurchases and $3.1 million in cash dividends paid on common stock to our shareholders. Significant sources of liquidity during the first three months of 2020 included $54.6 million in paydowns, maturities and sales of investment securities and $9.5 million net cash provided by operating activities. Refer to the Consolidated Statement of Cash Flows in this Form 10-Q for additional information on our sources and uses of liquidity. Management anticipates that our current strong liquidity position 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 $488.9 million at March 31, 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, $66.2 million of time deposits will mature. In addition, we waived the early withdrawal penalties for certificate of deposits as part of the CARES Act which may cause more depositors to withdraw time deposits during the uncertain economic environment. We expect new deposits, some from the PPP, to replace these funds. Our emphasis on local deposits combined with our equity position is expected to provide a strong 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 $18.9 million of cash at March 31, 2020. The cash level at Bancorp is deemed sufficient to cover Bancorp's operational needs and cash dividends to shareholders through 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 Condition 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.

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 March 31, 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.

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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	(5.0	)%	7.1	%
up 300	(3.6	)%	6.3	%
up 200	(2.2	)%	5.3	%
up 100	(1.0	)%	3.5	%
down 100	(4.5	)%	(9.5	)%

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

During the quarter ended March 31, 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.

Page-39

PART II OTHER INFORMATION

ITEM 1 Legal Proceedings

Refer to Note 12 to the Consolidated Financial Statements in Item 8 of our 2019 Form 10-K and Note 8 to the Consolidated Financial Statements in this Form 10-Q.

ITEM 1A Risk Factors

The 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 most states and local governments have ordered non-essential businesses to close and residents to shelter in place in their homes. 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, 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, lowered equity market valuations, created significant volatility and disruption in financial markets, 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.


•	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.


•	Demand for our products and services may decline, and deposit balances may decrease making it difficult to grow assets and income.


•	The decline in the target federal funds rate could decrease yields on our assets that exceed the decline in our cost of interest-bearing liabilities, which may reduce our net interest margin.


•	The 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.

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.

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 a maximum of two customers allowed in a branch at one time. Our customers have been encouraged 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, resurges 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

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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 to our traditional service delivery channels may negatively impact our customers' experience of banking with us, and therefore negatively impact our 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 the Board subsequently extended to 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 began in March 2020 and was suspended indefinitely by the Board of Directors on March 20, 2020 to focus our resources on responding to customer needs during the COVID-19 pandemic. For additional information, refer to Note 7 to the Consolidated Financial Statements in this Form 10-Q.

During the quarter, Bancorp repurchased 92,664 shares totaling $3.2 million. Bancorp's $25.0 million share repurchase program originally announced by the Board April 23, 2018 and subsequently extended to February 28, 2020 expired with cumulative purchases of 561,355 shares totaling $23.5 million. Bancorp repurchased 34,138 shares during the final two months of the program at an average price of $43.30 for a total cost of $1.5 million. Repurchases under the new program were 58,526 shares at an average price of $30.00 totaling $1.8 million. The program may be reinstated when the Board deems appropriate.

The following table reflects repurchases under the Share Repurchase Program for the periods presented.



(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	Total Number of Shares Purchased	Average Price Paid per Share
January 1-31, 2020	13,283	$	44.42	13,283	$	2,376
February 1-29, 2020	20,855	42.17		20,855	1,495
March 1-31, 2020	58,526	30.00		58,526	23,241
Total	92,664	38.86		92,664

ITEM 3 Defaults upon Senior Securities

None.

ITEM 4 Mine Safety Disclosures

Not applicable.

ITEM 5 Other Information

None.

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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 Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Herewith
3.01	Articles of Incorporation, as amended	10-Q	001-33572	3.01	November 7, 2007
3.02	Bylaws	10-Q	001-33572	3.02	May 9, 2011
3.02a	Bylaws Amendment	8-K	001-33572	3.03	July 6, 2015
4.01	Rights Agreement, dated July 6, 2017	8-A12B	001-33572	4.1	July 7, 2017
10.01	Employee Stock Ownership Plan	S-8	333-218274	4.1	May 26, 2017
10.02	2017 Employee Stock Purchase Plan	S-8	333-221219	4.1	October 30, 2017
10.03	2017 Equity Plan, as amended	S-8	333-227840	4.1	October 15, 2018
10.04	2010 Director Stock Plan	S-8	333-167639	4.1	June 21, 2010
10.05	Form of Indemnification Agreement for Directors and Executive Officers, dated August 9, 2007	10-Q	001-33572	10.06	November 7, 2007
10.06	Form of Employment Agreement, dated January 23, 2009	8-K	001-33572	10.1	January 26, 2009
10.07	2010 Annual Individual Incentive Compensation Plan	8-K	001-33572	99.1	October 21, 2010
10.08	Salary Continuation Agreement for executive officer Russell Colombo, Chief Executive Officer, dated January 1, 2011	8-K	001-33572	10.1	January 6, 2011
10.09	Salary Continuation Agreement for executive officer Peter Pelham, Director of Retail Banking, dated January 1, 2011	8-K	001-33572	10.4	January 6, 2011
10.10	Salary Continuation Agreement for executive officer Tani Girton, Chief Financial Officer, dated October 18, 2013	8-K	001-33572	10.2	November 4, 2014
10.11	Salary Continuation Agreement for executive officer Elizabeth Reizman, Chief Credit Officer, dated July 20, 2014	8-K	001-33572	10.3	November 4, 2014
10.12	Salary Continuation Agreement for executive officer Timothy Myers, Executive Vice President and Commercial Banking Manager, dated May 28, 2015	8-K	001-33572	10.4	June 2, 2015
10.13	2007 Form of Change in Control Agreement	8-K	001-33572	10.1	October 31, 2007
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.INS	Inline XBRL Instance Document					Filed
101.SCH	Inline XBRL Taxonomy Extension Schema Document					Filed
101.CAL	Inline XBRL Taxonomy Extension Calculation Linkbase Document					Filed
101.LAB	Inline XBRL Taxonomy Extension Label Linkbase Document					Filed
101.PRE	Inline XBRL Taxonomy Extension Presentation Linkbase Document					Filed
101.DEF	Inline XBRL Taxonomy Extension Definition Linkbase Document					Filed

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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)


	May 8, 2020		/s/ Russell A. Colombo
	Date		Russell A. Colombo
			President &
			Chief Executive Officer
			(Principal Executive Officer)


	May 8, 2020		/s/ Tani Girton
	Date		Tani Girton
			Executive Vice President &
			Chief Financial Officer
			(Principal Financial Officer)


	May 8, 2020		/s/ David A. Merck
	Date		David A. Merck
			Vice President &
			Financial Reporting Manager
			(Principal Accounting Officer)