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ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of financial condition as of December 31, 2020 and 2019 and results of operations for each of the years in the two-year period ended December 31, 2020 should be read in conjunction with our consolidated financial statements and related notes thereto, included in Part II ITEM 8 of this report. Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances. All share and per share data have been adjusted to reflect the stock split effective November 27, 2018.

Forward-Looking Statements

The disclosures set forth in this item are qualified by important factors detailed in Part I captioned Forward-Looking Statements and ITEM 1A captioned Risk Factors of this report and other cautionary statements set forth elsewhere in the report.

Critical Accounting Policies and Estimates

The SEC requires us to disclose "critical accounting policies" defined as those that are both most important to the presentation of our financial condition and results of operations and require management's most difficult, subjective, or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and imprecise. We consider accounting estimates to be critical to our financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain, (ii) management could have applied different assumptions during the reported period, and (iii) changes in the accounting estimate are reasonably likely to occur in the future and could have a material impact on our financial statements.

Management has determined the following accounting policies to be critical:

Allowance for Credit Losses on Loans and Unfunded Commitments - For information regarding critical estimates related to our allowance methodology, the provision for credit losses, and risks to asset quality and lending activity, including the transition from the incurred loss method to the current expected credit loss ("CECL") method under ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) and related amendments, which we adopted as of December 31, 2020, see ITEM 1A - Risk Factors, the Allowance for Credit Losses section in ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations, Note 1 - Summary of Significant Accounting Policies, and Note 3 - Loans and Allowance for Credit Losses in ITEM 8 - Financial Statements and Supplementary Data of this Form 10‐K.

Allowance for Credit Losses on Investment Securities - For information regarding our investment securities and risks associated with identifying impairment and estimating the allowance for credit losses under the new CECL method, see ITEM 1A - Risk Factors, Note 1 - Summary of Significant Accounting Policies, and Note 2 - Investment Securities in ITEM 8 - Financial Statements and Supplementary Data of this Form 10‐K.

Accounting for Income Taxes - For information on our tax assets and liabilities, and related provision for income taxes, see Note 1 - Summary of Significant Accounting Policies and Note 11 - Income Taxes in ITEM 8 - Financial Statements and Supplementary Data of this Form 10-K.

Fair Value Measurements - For information on our use of fair value measurements and our related valuation methodologies, see Note 1 - Summary of Significant Accounting Policies and Note 9 - Fair Value of Assets and Liabilities in ITEM 8 - Financial Statements and Supplementary Data of this Form 10-K.

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Executive Summary

Annual earnings were $30.2 million in 2020 compared to $34.2 million in 2019. Diluted earnings were $2.22 per share in 2020, compared to $2.48 per share in 2019.

The following are highlights of operating and financial performance for the year ended December 31, 2020:

•The Bank achieved total loan growth of $245.3 million, or 13% in 2020, to $2.089 billion at December 31, 2020, from $1.843 billion at December 31, 2019. SBA PPP loans outstanding at December 31, 2020 were $291.6 million.

•Credit quality remains strong with non-accrual loans representing 0.44% of the Bank's loan portfolio as of December 31, 2020. The adoption of CECL in the fourth quarter of 2020 resulted in an increase to the allowance for credit losses on loans of $748 thousand and a $1.1 million increase to the allowance for unfunded loan commitments. See Note 1, Summary of Significant Accounting Policies, for additional information.

•Deposits grew $167.8 million, or 7%, to $2.504 billion at December 31, 2020, compared to $2.336 billion at December 31, 2019. Non-interest bearing deposits grew by $225.8 million in 2020, or 20%, and made up 54% of total deposits at year-end. Cost of deposits remained low at 0.11% in 2020, compared to 0.20% in 2019.

•Net interest income totaled $96.7 million and $95.7 million in 2020 and 2019, respectively. The $1.0 million increase in 2020 was primarily due to SBA PPP loans and lower rates on interest-bearing deposits, largely offset by lower yields on earning-assets. The tax-equivalent net interest margin decreased to 3.55% in 2020, compared to 3.98% in 2019. The 43 basis point decrease was primarily due to lower yields across interest-earning asset categories, partially offset by lower rates on interest-bearing deposits.

•The efficiency ratio was 57.06% in 2020, up from 55.33% in 2019. Contributing to this increase was the decrease in net interest margin, higher provision for credit losses on unfunded loan commitments, and lower income from service charges on deposit accounts and ATM fees in 2020.

•For the year ended December 31, 2020, return on assets and return on equity were 1.04% and 8.60%, respectively, compared to 1.34% and 10.49% in the prior year.

•All capital ratios exceeded regulatory requirements. The total risk-based capital ratio for Bancorp was 16.0% at December 31, 2020 up from 15.1% at December 31, 2019. Tangible common equity to tangible assets was 11.3% at both December 31, 2020 and December 31, 2019 (See footnote 8, ITEM 6, Selected Financial Data, for the definition of this non-GAAP financial measure). The total risk-based capital ratio for the Bank was 15.8% at December 31, 2020 and 14.6% at December 31, 2019.

•The Board of Directors declared a cash dividend of $0.23 per share on January 22, 2021. This was the 63rd consecutive quarterly dividend paid by Bank of Marin Bancorp. The cash dividend was paid on February 12, 2021 to shareholders of record at the close of business on February 5, 2021.

•Our strong capital and liquidity position afforded us the opportunity to eliminate a high cost funding source. On March 15, 2021 we redeemed the $2.8 million subordinated debenture, which carried a rate of 5.68% in 2020. The redemption consisted of $4.1 million principal balance, quarterly interest due, and $1.3 million in accelerated accretion of purchase discount. The contractual interest rate on the subordinated debenture was 3-month LIBOR plus 1.40%, or 1.62% as of December 31, 2020.

COVID-19 Pandemic-Related Response Update - We have remained open and responded to customer needs throughout 2020. We more than doubled our charitable contributions to non-profit organizations in our community to over $1.0 million in 2020. In March 2020, we began waiving all ATM and overdraft fees and cancelling early withdrawal penalties for time certificate of deposits when allowed by law. We accommodated loan payment relief requests for borrowers with financial hardships and lowered interest rate floors on commercial Prime Rate loans. Under the provisions of the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") of 2020, Bank of Marin originated over 1,800 PPP loans to small businesses, reaching nearly 28,000 employees in our markets. In 2021, we are once again diligently working with our customers to accommodate requests for round two of PPP

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loans under the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act ("Economic Aid Act"), which became law in December of 2020.

Paycheck Protection Program - While the PPP affords us an opportunity to assist our customers and community and requires a large of amount of human resources, the PPP loans do not pose a significant amount of risk of loss to the Bank as they are 100% guaranteed by the SBA. As of December 31, 2020, there were 1,777 PPP loans outstanding totaling $291.6 million, net of $5.4 million in unearned fees. During the fourth quarter Bank of Marin opened a secure PPP loan forgiveness application portal and gave all PPP borrowers access to apply. As of December 31, 2020 we received SBA loan forgiveness payments totaling $10.9 million for 35 loans that were forgiven. Of the total PPP loans remaining, 74% (1,309 loans) totaling $58.7 million are less than or equal to $150 thousand and have access to streamlined forgiveness processing. On January 19, 2021, the Bank launched the application process and began accepting loan requests for the second round of PPP, as revised by the Economic Aid Act. As of March 11, 2021, we have received 974 loan applications totaling $131.6 million.

Payment Relief - During 2020, in accordance with section 4013 of the CARES Act, subsequently amended by the Economic Aid Act, we elected to apply the temporary accounting relief provisions for loan modifications that met certain criteria, which would otherwise be designated as TDRs under existing GAAP. Of the 269 loans totaling $402.9 million granted payment relief since the onset of the pandemic, 222 loans or $324.2 million have resumed normal payments and 18 loans or $7.7 million paid off. As of December 31, 2020, 21 borrowing relationships with 29 loans totaling $71.0 million had requested additional payment relief. We know each of these clients very well and monitor their loans closely, and anticipate that the vast majority will work through current adverse conditions and resume making full payments. The following table summarizes these loans by industry or collateral type.

Payment Relief by Type

Non-CRE Related 121 N/A

Residential Real Estate 1,130 60 %

Looking forward into the new year, with a low cost and stable deposit base, opportunities for loan growth, and our unwavering commitment to relationship banking, we believe we are well-positioned to navigate the remaining stages of the pandemic and build new capabilities. We have ample liquidity and capital to support organic growth and acquisitions in coming years. Acquisitions remain a component of our strategic plan and we will continue to evaluate merger and acquisition opportunities that fit with our culture and add value for our shareholders. Our disciplined credit culture and relationship-focused banking continue to be critical components of our success.

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RESULTS OF OPERATIONS

Net Interest Income

Net interest income is the interest earned on loans, investment securities and other interest-earning assets minus the interest expense incurred on deposits and other interest-bearing liabilities. Net interest income is affected by changes in general market interest rates and by changes in the amounts and composition of interest-earning assets and interest-bearing liabilities. Interest rate changes can create fluctuations in net interest income and/or margin due to an imbalance in the timing of repricing or maturity of assets or liabilities. We manage interest rate risk exposure with the goal of minimizing the effect of interest rate volatility on net interest income.

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.

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 the years indicated.

Table 1 Average Statements of Condition and Analysis of Net Interest Income

Year ended Year ended Year ended

Interest Interest Interest

Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/

Assets

Liabilities and Stockholders' Equity

Tax-equivalent net interest rate spread 3.41 % 3.74 % 3.72 %

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Table 2Analysis of Changes in 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.

Savings accounts 5 (7) — (2) (3) 1 — (2)

2020 Compared to 2019

Net interest income totaled $96.7 million and $95.7 million in 2020 and 2019, respectively. The $1.0 million increase in 2020 was primarily due to SBA PPP loans and lower rates on interest-bearing deposits, largely offset by lower yields on earning-assets, except for investment securities where we collected prepayment penalties on called securities in 2020. Notable balance increases occurred in interest-earning deposits with other banks, commercial real estate loans and deposits. The tax-equivalent net interest margin decreased 43 basis points to 3.55% in 2020, from 3.98% in 2019 for the reasons already mentioned and as shown in the above table. Additionally, the SBA PPP loans lowered the 2020 net interest margin by 6 basis points.

On March 15, 2021, we redeemed the $2.8 million subordinated debenture. The redemption consisted of $4.1 million principal balance, quarterly interest due, and $1.3 million in accelerated accretion of purchase discount. The contractual interest rate on the subordinated debenture was 3-month LIBOR plus 1.40%, or 1.62% as of December 31, 2020.

2019 Compared to 2018

Net interest income totaled $95.7 million and $91.5 million in 2019 and 2018, respectively. The increase of $4.2 million in 2019 was primarily due to higher average loan balances and assets yields across all categories and the early redemption of a high-rate subordinated debenture in the fourth quarter of 2018. Positive variances were partially offset by higher balances and rates on money market accounts. The tax-equivalent net interest margin increased eight basis points to 3.98% in 2019 compared to 3.90% in 2018 for the same reasons.

Market Interest Rates

Market interest rates are, in part, based on the target federal funds interest rate (the interest rate banks charge each other for short-term borrowings) implemented by the Federal Reserve Open Market Committee ("FOMC").

In response to the evolving risks to economic activity posed by the COVID-19 pandemic, the FOMC made two emergency cuts totaling 150 basis points to the federal funds rate in March 2020. The federal funds target rate range resided between 0.0% to 0.25% for the majority of 2020, putting downward pressure on our asset yields and net interest margin. In each of its July, September and October 2019 meetings, the FOMC lowered the federal

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funds target rate by 0.25% to a range of 1.50% to 1.75% at the end of 2019. During 2018, the FOMC made four 25-basis-point increases to a range of 2.25% to 2.50% as of December 2018.

A low interest rate environment will continue to put downward pressure on asset yields and net interest margin to be fully seen in future periods. See ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk for further information.

Provision for Credit Losses on Loans

Management assesses the adequacy of the allowance for credit losses on loans quarterly based on several factors including growth of the loan portfolio, past events, current conditions, and reasonable and supportable forecasts to estimate expected losses over the contractual terms of our loans. The allowance for credit losses is increased by provisions charged to expense and loss recoveries and decreased by loans charged off. For additional information about the allowance for credit losses and transition from the incurred loss method to the CECL method in 2020, see Notes 1 and 3 to the Consolidated Financial Statements in ITEM 8 of this report.

We recorded a $4.6 million provision for credit losses in 2020, compared to a $900 thousand provision in 2019 and no provision for credit losses in 2018. The provision for credit losses in 2020 was largely due to the impact of the COVID-19 pandemic and its effect on the local and regional economies and economic outlook. In addition, under the CECL method, we increased our allowance for credit losses by approximately $925 thousand for previously acquired loans (i.e., non-purchased credit deteriorated or "non-PCD" loans); whereas, under previous GAAP (incurred loss method) we did not record an allowance on our unimpaired previously acquired non-PCD loans. Our allowance model is particularly sensitive to current and forecasted California unemployment rates, which increased from 3.7% at December 31, 2019 to 8.8% at December 31, 2020. The pandemic also negatively affected the financial condition of many of our borrowers, which was partially alleviated by our payment relief program under the CARES Act and the SBA PPP. Additionally, with the adoption of ASC 326 in 2020, our provision for credit losses may become more volatile in the future due to changes in macroeconomic conditions and forecasts, CECL model assumptions, and loan composition, which affect the allowance for credit losses balance. The provision for credit losses in 2019 was consistent with loan growth. The lack of a provision for credit losses in 2018 was primarily due to a $15.3 million decrease in classified loans, resulting from two borrowing relationships whose risk grades were upgraded from substandard to special mention in the second quarter of 2018.

Non-interest Income

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

Table 3 Components of Non-Interest Income

2020 Compared to 2019

Non interest income totaled $8.6 million and $9.1 million in 2020 and 2019, respectively. The $534 thousand decline was primarily due to $551 thousand lower service charges on deposit accounts and ATM fees, as these fees were waived during the pandemic, lower income from bank-owned life insurance ("BOLI") policies due to a $562 thousand benefit collected on BOLI policies in the third quarter of 2019 (partially offset by $283 thousand underwriting expenses for two new BOLI policies in the first quarter of 2019), $182 thousand lower fee income from

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one-way deposit sales to third-party deposit networks and $145 thousand lower dividends on FHLB stock, partially offset by $860 thousand net gains on the sale of investment securities.

2019 Compared to 2018

Non-interest income totaled $9.1 million and $10.1 million in 2019 and 2018, respectively. The decrease compared to the prior year primarily related to a $956 thousand pre-tax gain on the sale of 6,500 shares of Visa Inc. Class B restricted common stock, a $180 thousand Federal Home Loan Bank special dividend, and higher fee income from one-way deposit sales to third-party networks in 2018. The decrease in non-interest income was partially offset by a $562 thousand gain from the settlement of death benefits on bank-owned life insurance in 2019, net of underwriting costs associated with two new bank-owned life insurance policies.

Non-interest Expense

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

Table 4 Components of Non-Interest Expense

Other non-interest expense:

2020 Compared to 2019

Non-interest expense increased $2.1 million to $60.0 million in 2020 from $58.0 million in 2019. The largest increases came from the provision for unfunded loan commitments, occupancy expenses (primarily due to lease renewals for our existing headquarters offices and new lease for a loan production office in San Mateo, common area maintenance and janitorial expenses), and charitable contributions due to our outreach to nonprofit organizations in our community during the pandemic. The decrease in data processing costs was due to our digital platform conversion in 2019. While salaries and related benefits were relatively unchanged year-over-year, annual merit and related increases were mostly offset by $915 thousand in SBA PPP-related deferred loan origination costs.

The increase in the provision for credit losses on unfunded loan commitments was mainly attributed to a $75.3 million increase in unfunded loan commitments, an increase in expected loss rates due to the COVID-19 pandemic, and changes in certain allowance model assumptions in the transition from the incurred loss method to the CECL method in 2020(refer to Note 1, Summary of Significant Accounting Policies, for additional information).

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2019 Compared to 2018

In 2019, non-interest expense decreased by $296 thousand to $58.0 million. The decrease was primarily due to $1.0 million in consulting expenses related to core processing contract negotiations in 2018, lower data processing expenses in 2019 as a result of the renegotiation of the Bank's core systems contract, and lower Federal Deposit Insurance Corporation ("FDIC") deposit insurance expenses due to the FDIC Deposit Insurance Fund reserve exceeding its billing threshold in 2019. The decreases in non-interest expense were partially offset by $918 thousand higher salaries and related benefits as a result of annual merit increases, three additional full-time equivalent employees (on average), and personnel severance, as well as higher recruiting fees recorded in other expenses.

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 totaled $10.3 million at an effective tax rate of 25.5% in 2020, compared to $11.7 million at an effective tax rate of 25.4% in 2019 and $10.8 million at an effective tax rate of 24.9% in 2018. The decrease in the provision in 2020 compared to 2019 reflected lower pre-tax income and higher tax-exempt interest income on municipal securities. The slight increase in the effective tax rate in 2020 as compared to 2019 was due to a favorable deferred tax liability true-up recognized in 2019 and a lower tax benefit from BOLI income in 2020. The increase in the effective tax rate in 2019 compared to 2018 was due to a higher level of tax benefits in 2018 from the exercise of non-qualified stock options and disqualifying dispositions of incentive stock options by former employees of Bank of Napa post-acquisition.

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 December 31, 2020 and 2019, neither the Bank nor Bancorp had accruals for interest or penalties related to unrecognized tax benefits.

FINANCIAL CONDITION

Our assets increased $204.6 million from December 31, 2019 to December 31, 2020, mainly due to loan growth of $245.3 million, primarily driven by PPP loan originations, which were offset by a $68.3 million decrease in investment security balances.

Investment Securities

We maintain an investment securities portfolio to provide liquidity and to generate earnings on funds that have not been loaned to customers. Management determines the maturities and types of securities to be purchased based on liquidity and interest rate risk position, and the desire to attain a reasonable investment yield balanced with risk exposure. Table 5 shows the composition of the debt securities portfolio by expected maturity at December 31, 2020 and 2019. Expected maturities differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties. We estimate and update expected maturity dates regularly based on current and historical prepayment speeds. The weighted average life of the investment portfolio at December 31, 2020 and 2019 was approximately five and six years, respectively.

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Table 5 Investment Securities

December 31, 2020 Within 1 Year 1-5 Years 5-10 Years After 10 Years Total

Held-to-maturity:

Available-for-sale:

December 31, 2019 Within 1 Year 1-5 Years 5-10 Years After 10 Years Total

Held-to-maturity:

Available-for-sale:

1 Book value reflects cost, adjusted for accumulated amortization and accretion.

2 Weighted average calculation is based on amortized cost of securities.

3 Yields on tax-exempt municipal bonds are presented on a taxable equivalent basis, using federal tax rate of 21%.

The amortized cost of our investment securities portfolio decreased $79.3 million or 14% during 2020. We purchased $97.5 million in securities in 2020 designated as available-for-sale to provide flexibility for liquidity and interest rate risk management. These purchases were offset by $143.1 million of paydowns, calls and maturities, and $32.8 million of sales during 2020.

During 2020, we purchased $57.6 million in obligations of state and political subdivisions, $31.0 million in collateralized mortgage obligations ("CMOs") and $9.0 million in debentures of government sponsored agencies. We consider agency debentures and CMOs issued by U.S. government sponsored entities to have low credit risk as they carry the credit support of the U.S. federal government. The debentures, CMOs and MBS issued by U.S. government sponsored agencies, state and municipal securities, and SBA-backed securities made up 70.1%, 22.1% and 7.8% of the portfolio at December 31, 2020, compared to 79.6%, 12.4% and 7.8%, respectively at December 31, 2019. See the discussion in the section captioned “Securities May Lose Value due to Credit Quality of the Issuers” in ITEM 1A Risk Factors above.

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At December 31, 2020, distribution of our investment in obligations of state and political subdivisions was as follows:

Within California:

Outside California:

The portion of the portfolio outside the state of California is distributed among 10 states. The largest concentrations outside California are in Texas (55.3%), Washington (9.3%), and Maryland (6.4%). During March 2020, we strategically increased our credit exposure to obligations issued by high credit quality 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 $6.0 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 believe the healthy level of reserves and excess guarantee capacity at the PSF sufficiently mitigates any potential credit issues posed by the issuers' exposure to the oil and gas industry, as well as the negative effects of the recent winter storms in Texas. In addition, 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 local taxpayers and employers, income indices and home values

•For revenue bonds, the source and strength of revenue for municipal authorities including obligors' financial condition and reserve levels, annual debt service and debt coverage ratio, and credit enhancement (such as insurer’s strength)

•Credit ratings by major credit rating agencies

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Loans

Table 6 Loans Outstanding by Class at December 31

Real estate

Loans increased $245.3 million in 2020, or 13%, to $2.089 billion at December 31, 2020, from $1.843 billion at December 31, 2019. SBA PPP loans outstanding at December 31, 2020 totaled $291.6 million and were included in commercial and industrial loans. For the year ended December 31, 2020, new non-PPP-related loan originations were $165.5 million, compared to $259.6 million in 2019. The decrease in non-PPP loan originations was largely due a decrease in conventional loan demand as a result of the pandemic and shelter-at-home orders. New loan originations were more than offset by payoffs of $180.1 million and reduction in line usage. Loan payoffs were concentrated in consumer and retail loans (mostly tenant in common and HELOC) and commercial loans on which underlying assets were sold, loans refinanced with other banks, or loans that were paid off with cash. Payoffs as a percentage of beginning of the year loan balances were 9.8%, 8.3% and 9.4% in 2020, 2019 and 2018, respectively. Approximately 77% and 88%, of total loans were secured by real estate at December 31, 2020 and 2019, respectively. The decrease in the percentage in 2020 was due to PPP loans, which are not secured by real estate. For additional information on loan concentration risk, see ITEM 1A, Risk Factors.

The following table summarizes our commercial real estate loan portfolio by the county in which the property was located as of December 31, 2020 and 2019.

Table 7 Commercial Real Estate Loans Outstanding by County

(dollars in thousands; unaudited) December 31, 2020 December 31, 2019

Commercial real estate loans increased $11.0 million in 2020, compared to a $68.5 million increase in 2019. Of the commercial real estate loans at December 31, 2020, 76% were investor-owned and 24% were owner-occupied. Almost the entire commercial real estate loan portfolio is comprised of term loans for which the primary source of repayment is either the cash flow from the leasing activities of the real estate collateral or the operating cash flow of the owner occupant.

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We occasionally provide interest-only term loans to borrowers who exhibit strong financial capacity and/or for commercial real estate loans during the occupancy stabilization period. After the initial interest-only payment period, these loans will normally require principal and interest payments. In addition, we may make interest-only concessions in a modified troubled debt restructuring ("TDR"). At December 31, 2020 and 2019, approximately 3.4% and 3.7%, respectively, of our commercial real estate loans contained an interest-only feature as part of the loan terms. All of these loans were current with their payments as of December 31, 2020. Except for two TDR loans to one borrowing relationship totaling $7.1 million as of December 31, 2020, all were considered to have low credit risk (graded "Pass").

The following table shows an analysis of construction loans by type and county as of December 31, 2020 and 2019.

Table 8 Construction Loans Outstanding by Type and County

(dollars in thousands; unaudited) December 31, 2020 December 31, 2019

(dollars in thousands; unaudited) December 31, 2020 December 31, 2019

County Amount Percent of Construction Loans Amount Percent of Construction Loans

Construction loans increased by $12.0 million in 2020, compared to a $15.3 million decrease in 2019. The increase in 2020 primarily resulted from additional borrowings under existing construction loans as well as advances on six new construction loans to well-known, experienced builders. The increase was partially offset by the successful completion of projects, one of which converted to a permanent commercial real estate loan. The decrease in 2019 was primarily due to a $14.8 million loan that converted to a commercial real estate loan and one payoff from a completed apartment building construction project.

The following table presents the maturity distribution of our commercial and construction loans as of December 31, 2020 based on their contractual maturity dates and does not include scheduled payments or potential prepayments.

Table 9A Commercial and Industrial and Construction Loan Maturity Distribution

Due within Due after 1 but Due after

(in thousands; unaudited) 1 year within 5 years 5 years Total

1 Commercial and industrial due after 1 but within 5 years includes SBA PPP loans totaling $291.6 million, the majority of which are expected to be forgiven by the SBA in 2021.

2 Construction loans that mature after 5 years are structured to convert to permanent financing after the initial construction period.

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The following table shows the mix of variable-rate loans to fixed-rate loans for commercial and construction loans. The large majority of the variable-rate loans are tied to independent indices (such as the Prime Rate or a Treasury Constant Maturity Rate). Most loans with original terms of more than five years have provisions for the fixed rates to reset, or convert to variable rates, after three, five or seven years. These loans are included in variable-rate balances below.

Table 9B Commercial and industrial and Construction Loan Interest Rate Sensitivity

(in thousands; unaudited) Fixed Variable Total

1 Commercial and industrial includes SBA PPP 1% fixed rate loans totaling $291.6 million, the majority of which are expected to be forgiven by the SBA in 2021.

Allowance for Credit Losses on Loans

As of December 31, 2020, we calculated the allowance for credit losses using the current expected loss methodology, or CECL, which required us to estimate credit losses over the expected life of a loan and consider future changes in macroeconomic conditions. All specifically identifiable and quantifiable losses are charged off against the allowance. The ultimate adequacy of the allowance is dependent upon a variety of factors beyond our control, including the real estate market, changes in interest rates and economic and political environments. Based on the current conditions of the loan portfolio and reasonable and supportable forecasts, management believes that the $22.9 million allowance for credit losses at December 31, 2020 is adequate to absorb expected credit losses in our loan portfolio, but provides no assurance that adverse changes in economic conditions or other circumstances over the remaining terms of our loans will not result in increased losses in the portfolio. For information on our allowance for credit losses methodology and adoption of FASB ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, effective December 31, 2020, refer to Notes 1 and 3 to the Consolidated Financial Statements in ITEM 8 of this report.

The allowance for credit losses to loans was 1.10% at December 31, 2020 and 0.90% at both December 31, 2019 and 2018. The allowance for credit losses to loans, excluding SBA PPP loans and previously acquired loans was 1.27%, 0.96% and 0.98% at year-end 2020, 2019, and 2018, respectively (for a discussion of this non-GAAP financial measure, refer to ITEM 6, Selected Financial Data of this report). As stated in the Provision for Credit Losses section above, the increase in allowance for credit losses in 2020 was almost entirely due to the impact of the COVID-19 pandemic and its effect on the local and regional economies and economic outlook coupled with the transition to the CECL method. Due to the high credit quality of our loan portfolio, net charge-offs have been minimal for the past several years. Net charge-offs totaled $1 thousand in 2020 and $44 thousand in 2019, compared to net recoveries of $54 thousand in 2018.

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Table 10 shows the allocation of the allowance by loan class as well as the percentage of total loans in each of the same loan classes.

Table 10 Allocation of Allowance for Credit Losses

Real estate:

Table 11 shows the activity in the allowance for credit losses for each of the five years presented below.

Table 11 Allowance for Credit Losses Rollforward

Impact of CECL adoption 1,604 — — — —

Loans charged-off:

Real estate:

Commercial real estate, owner-occupied — — — — (20)

Installment and other consumer (1) (3) (2) (4) (5)

Loans recovered:

Real estate:

Commercial, investor-owned — 12 — — 2,156

Construction 3 — — — —

Home equity — — — — 3

Installment and other consumer — — 42 7 27

Net (charge-offs) recoveries to average loans NM NM NM (0.01) % 0.16 %

NM - Not meaningful.

Net charge-offs and recoveries for the years ended December 31, 2020, 2019 and 2018 were considered insignificant. Charge-offs in 2017 primarily included a $283 thousand unsecured commercial loan. Recoveries in 2016 primarily resulted from the resolution and pay-off of a commercial real estate credit.

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Table 12 shows non-performing assets and loans modified in a troubled debt restructuring ("TDR") for each of the years in the five-year period ended December 31, 2020.

Table 12 Non-Performing and Underperforming Assets and Troubled Debt Restructurings

Non-accrual loans:

Commercial and industrial $ — $ — $ 319 $ — $ —

Real estate:

Commercial, owner-occupied 7,147 — — — —

Commercial, investor-owned 1,610 — — — —

Installment and other consumer 17 58 65 — 54

Other real estate owned1 — — — — 408

Accruing TDR loans:2

Real estate:

Criticized and classified loans:

2 Excludes TDR loans on non-accrual status that are included above.

Non-Accrual and TDR

Non-accrual loans increased $9.0 million in 2020, primarily due to the placement of two existing well-secured owner-occupied commercial real estate TDR loans, secured by one property, totaling $7.1 million on non-accrual, as well as two well-secured investor-owned commercial loans totaling $1.6 million that were placed on non-accrual in 2020. In addition, we designated five loans totaling $2.1 million as TDRs during 2020, resulting in an overall increase of $2.8 million in total non-accrual and accruing TDR loans from 2019 to 2020. These increases were partially offset by approximately $1.0 million in paydowns and payoffs of non-accrual and TDR loans. The decrease in total non-accrual and accruing TDR loans from 2018 to 2019 primarily related to payoffs (including a $2.7 million TDR land development loan) and paydowns, partially offset by advances on existing impaired loans and the addition of one non-accrual home equity loan. The decrease in total non-accrual and accruing TDR loans from 2017 to 2018 primarily related to payoffs, paydowns, and two loans that were removed from TDR status.

Total accruing TDR loans were $5.1 million and $11.3 million as of December 31, 2020 and 2019, respectively. The $6.2 million decrease from 2019 to 2020 primarily related to the two existing well-secured commercial real estate TDR loans totaling $7.1 million that were transferred to non-accrual status coupled with payoffs and paydowns, partially offset by the $2.1 million in new TDR loans mentioned above. The decreases from 2018 to 2019 and from 2017 to 2018 primarily related to the same reasons mentioned in the preceding paragraph.

For information regarding temporary relief from TDR accounting afforded by the CARES Act, refer to the Executive Summary section above and Note 3 to the Consolidated Financial Statements in ITEM 8, under “Troubled Debt Restructuring."

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Criticized and Classified Loans

Loans designated special mention increased by $13.5 million in 2020, driven by loan downgrades totaling $31.0 million. Of these downgrades, approximately $24.5 million were loans to borrowers that were impacted by the pandemic, all of which were well-secured by commercial real estate. These additions to special mention were mostly offset by $15.8 million in upgrades to pass risk ratings, paydowns and payoffs, and $2.2 million in loans downgraded from special mention to substandard in 2020. Loans designated special mention increased by $56.1 million during 2019 due primarily to new commercial loan originations to three borrowing relationships totaling $17.7 million that were experiencing temporary financial conditions that warranted the initial designation, and downgrades of existing commercial real estate loans to two borrowing relationships totaling $26.7 million. Loans designated as special mention exhibit potential weakness that deserve close attention.

Loans classified substandard increased by $15.9 million in 2020, primarily due to downgrades totaling $18.5 million. Of these loans, $13.4 million were to borrowers that requested payment relief due to the pandemic, all of which were well-secured by commercial real estate. These downgrades to substandard were partially offset by approximately $2.8 million in payoffs and risk rating upgrades. Loans classified substandard decreased by $2.7 million during 2019 primarily due to the payoff of a land development loan.

Refer to Note 3 to the Consolidated Financial Statements in ITEM 8 of this report for an allocation of criticized and classified loans by loan class.

Other Assets

BOLI totaled $43.6 million at December 31, 2020, compared to $41.6 million at December 31, 2019, and is recorded in other assets. The increase of $1.9 million was due to the purchase of $943 thousand in new policies and a $973 thousand increase in the cash surrender value from net investment earnings.

Other assets also included net deferred tax assets of $6.9 million and $8.2 million at December 31, 2020 and 2019, respectively. Deferred tax assets consist primarily of tax benefits expected to be realized in future periods related to temporary differences such as the allowances for credit losses and unfunded loan commitments, net operating loss carryforwards, and deferred compensation and salary continuation plans. The $1.2 million decrease in net deferred tax assets in 2020 was primarily due to an increase in deferred tax liabilities related to unrealized gains on available-for-sale investment securities, partially offset by an increase in deferred tax assets related to the change in allowance for credit losses on loans and unfunded loan commitments. Management believes deferred tax assets will be realizable due to our consistent record of earnings and the expectation that earnings will continue at a level adequate to realize such benefits. Therefore, no valuation allowance was established as of December 31, 2020 or 2019. For additional information, refer to Note 11 to the Consolidated Financial Statements in ITEM 8 of this report.

In addition, we held $11.9 million and $11.7 million of FHLB stock recorded at cost in other assets at December 31, 2020 and 2019, respectively. The increase in 2020 resulted from the purchase of $176 thousand in FHLB stock. The FHLB paid $654 thousand, $799 thousand and $959 thousand in cash dividends in 2020, 2019 and 2018, respectively. FHLB dividends in 2018 included a special dividend of $180 thousand. For additional information, refer to Note 2 to the Consolidated Financial Statements in ITEM 8 of this report.

Deposits

Deposits grew by $167.8 million, to $2.504 billion at December 31, 2020, compared to $2.337 billion at December 31, 2019. Non-interest bearing deposits grew by $225.8 million in 2020 and made up 54% of total deposits at year end. See ITEM 1A, Risk Factors, for a discussion of potential risks associated with concentrations and volatility due to activity of our large deposit customers and impact of the PPP.

Table 13 Distribution of Average Deposits

Table 13 shows the relative composition of our average deposits for 2020 and 2019. For average rates paid on deposits, refer to Table 1 in ITEM 7- Management's Discussion and Analysis of Financial Condition and Results of Operations.

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Years ended December 31,

(dollars in thousands; unaudited) Amount Percent Amount Percent

Time deposits, including CDARS:

1 Money market balances include Insured Cash Sweep® ("ICS") in both 2020 and 2019. Demand Deposit Marketplace SM ("DDM") and ICS balances are discussed in Note 6 to the Consolidated Financial Statements in ITEM 8 of this report.

Table 14 Maturities of Time Deposits of $100,000 or More

Table 14 below shows the maturity groupings for time deposits of $100,000 or more at December 31, 2020 and 2019.

December 31,

Over six months through twelve months 21,006 17,033

Borrowings

As of December 31, 2020 and 2019, respectively, our available borrowing capacity included $642.5 million and $648.0 million in secured lines of credit with FHLB and $78.7 million and $80.3 million with the Federal Reserve Bank of San Francisco (“FRBSF”). We also had $135.0 million and $92.0 million in unsecured lines with correspondent banks to cover any short or long-term borrowing needs at December 31, 2020 and 2019, respectively. There were no FHLB overnight borrowings at December 31, 2020 and 2019. The FRBSF and correspondent bank lines were not utilized at December 31, 2020 or 2019.

As part of a bank acquisition in 2013, we assumed two subordinated debentures due to the NorCal Community Bancorp Trusts I and II at fair values totaling $5.0 million at the acquisition date and contractual balances totaling $8.2 million. On October 7, 2018, Bancorp redeemed in full the subordinated debenture due to NorCal Community Bancorp Trust I. The remaining subordinated debenture due to Trust II had been accreted up to $2.8 million and $2.7 million as of December 31, 2020 and 2019, respectively. On March 15, 2021, we redeemed the $2.8 million subordinated debenture due to Trust II, which carried an average interest rate of 5.68% in 2020.

For additional information, see Note 7, Borrowings and Other Obligations, in ITEM 8 of this report.

Deferred Compensation Obligations

We maintain a non-qualified, unfunded deferred compensation plan for certain key management personnel. Under this plan, participating employees may defer compensation, which will entitle them to receive certain payments for up to fifteen years commencing upon retirement, death, disability or termination of employment. The participating employee may elect to receive payments over periods not to exceed fifteen years. At December 31, 2020 and 2019, our aggregate payment obligations under this plan totaled $4.7 million and $4.4 million, respectively.

Our Salary Continuation Plan ("Plan") provides a percentage of salary continuation benefits to a select group of executive management upon retirement at age sixty-five and reduced benefits upon early retirement. At December 31, 2020 and 2019, our liability under the Plan was $3.2 million and $3.0 million, respectively, and is

41

recorded in interest payable and other liabilities in the Consolidated Statements of Condition. The Plan is unfunded and non-qualified for tax purposes and for purposes of Title I of the Employee Retirement Income Security Act of 1974.

For additional information, see Note 10 to the Consolidated Financial Statements in ITEM 8 of this report.

Table 15 Off-Balance Sheet Arrangements, Commitments and Contractual Obligations

We make commitments to extend credit in the normal course of business to meet the financing needs of our customers. For additional information, see Note 16 to the Consolidated Financial Statements in ITEM 8 of this report.

Payments due by period

(in thousands; unaudited) <1 year 1-3 years 4-5 years >5 years Total

1 Represents future benefit payments under executive salary continuation agreements for retired Bank of Marin employees and for agreements assumed in a bank acquisition whereby participants receive payments upon reaching retirement age. Amounts exclude future benefit payment obligations totaling $3.6 million under Bank of Marin executive salary continuation agreements whereby participants will begin receiving payments upon reaching retirement age and fulfilling their service requirements. Salary continuation obligations are based on retirement date assumptions and may be adjusted upon actual retirement. For additional information, see Note 10 to the Consolidated Financial Statements in ITEM 8 of this report.

The contractual amount of unfunded loan commitments not reflected on the consolidated statements of condition was $604.4 million and $529.1 million at December 31, 2020 and 2019, respectively.

As permitted or required under California law and to the maximum extent allowable under that law, we have certain obligations to indemnify our current and former officers and directors for certain events or occurrences while the officer or director is, or was serving, at our request in such capacity. These indemnification obligations are valid as long as the director or officer acted in good faith and in a manner the person reasonably believed to be in, or not opposed to, our best interests, and with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful. The maximum potential amount of future payments we could be required to make under these indemnification obligations is unlimited; however, we have a director and officer insurance policy that mitigates our exposure and enables us to recover a portion of any future amounts paid. As we believe the possibility of potential claims to be remote and any amounts under the indemnifications would be covered by the insurance policy, we have not recorded an indemnification obligation.

Capital Adequacy

As discussed in Note 15 to the Consolidated Financial Statements in ITEM 8 of this report, the Bank's capital ratios were above regulatory guidelines to be considered "well capitalized" and Bancorp's ratios exceeded the required minimum ratios for capital adequacy purposes. For further discussion of bank capital requirements refer to the SUPERVISION AND REGULATION section in ITEM 1 of this report.

The Bank's total risk-based capital ratio increased from 14.6% at December 31, 2019 to 15.8% at December 31, 2020, primarily due to the Bank's $31.3 million net income in 2020, partially offset by $16.2 million in dividends paid to Bancorp to cover share repurchases, quarterly common stock dividends, and operating costs. Bancorp's total risk-based capital ratio was 15.1% at December 31, 2019 and 16.0% at December 31, 2020. Bancorp's 2020 Tier 1 capital included a subordinated debenture due to NorCal Community Bancorp Trust II, which was recorded only at the parent company level and accounted for approximately 18 basis points of the total risk-based capital ratio as of December 31, 2020. This subordinated debenture was early redeemed on March 15, 2021.

Bancorp's share repurchase program and activity are discussed in detail in ITEM 5 and in Note 8 to the Consolidated Financial Statements in ITEM 8 of this report. We expect to maintain strong capital levels and do not

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expect that we will be required to raise additional capital in 2021. Our anticipated sources of capital in 2021 include future earnings and shares issued under the stock-based compensation program.

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 7 to the Consolidated Financial Statement in ITEM 8 of this report. Our Asset Liability Management Committee ("ALCO"), which is comprised of independent Bank directors and the Bank's 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, as discussed in Note 6 to the consolidated financial statements in ITEM 8 of this report.

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 component of our daily liquidity position is customer deposits. The attraction and retention of new deposits depends upon the variety and effectiveness of our customer account products, service and convenience, rates paid to customers, and our financial strength. The cash cycles and unique business activities of some of our large commercial depositors may cause short-term fluctuations in their deposit balances held with us. In 2020 the banking industry experienced abundant liquidity driven by pandemic-related government programs such as PPP and stimulus checks as well as an elevated savings rate system-wide.

Our cash and cash equivalents increased $16.9 million from December 31, 2019. Significant sources of liquidity during 2020 included $176.9 million in paydowns, maturities and sales of investment securities, an increase in deposits of $167.8 million, and $40.8 million in net cash provided by operating activities (including $10.7 million in processing fees received from the SBA for the origination of PPP loans).

Significant uses of liquidity during 2020 were $249.3 million in loan originations and advances, net of principal collected, $97.5 million in investment securities purchased, $12.5 million in cash dividends paid on common stock to our shareholders, and $6.9 million in common stock repurchases. Refer to the Consolidated Statement of Cash Flows in this Form 10-K for additional information on our sources and uses of liquidity. Management anticipates that our current strong liquidity position and core deposit base are adequate to fund our operations.

Undrawn credit commitments, as discussed in Note 16 to the Consolidated Financial Statements in ITEM 8 of this report, totaled $604.4 million at December 31, 2020. We expect to fund these commitments to the extent utilized primarily through the repayment of existing loans, deposit growth and liquid assets. Over the next twelve months, $71.9 million of time deposits will mature. We expect to replace these funds with new deposits. Our emphasis on local deposits, combined with our liquid investment portfolio, provides a very stable 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 $5.3 million of cash at December 31, 2020. In January 2021, Bancorp obtained a dividend distribution from the Bank totaling $30.0 million, which is deemed sufficient to cover Bancorp's operational needs, share repurchases, repayment of a subordinated debenture and cash dividends to shareholders through the end of 2021. Management anticipates that there will be sufficient earnings at the Bank to provide dividends to Bancorp to meet its funding requirements for the foreseeable future.

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Quarterly Financial Data

Table 16 Summary of Quarterly Financial Data

Net interest income after provision for

Net income per common share:

Refer to the Executive Summary section above for a discussion of items that affected the financial results for the quarter ended December 31, 2020.

ITEM 7A. Quantitative and Qualitative Disclosures about MarketRisk

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. Refer to Note 14 to the Consolidated Financial Statements in ITEM 8 of this report.

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 December 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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Table 16 Effect of Interest Rate Change on Net Interest Income (NII)

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.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm

To the Shareholders and the Board of Directors of

Bank of Marin Bancorp

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated statements of condition of Bank of Marin Bancorp and subsidiary (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2020 and 2019, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.

Change in Accounting Principle

As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for credit losses effective December 31, 2020, due to the adoption of Accounting Standards Codification Topic 326: Financial Instruments – Credit Losses (“Topic 326”). The Company adopted the new credit loss standard using the modified retrospective approach such that prior period amounts are not adjusted and continue to be reported in accordance with previously applicable generally accepted accounting principles. The adoption of the new credit loss standard and it subsequent application is also communicated as a critical audit matter below.

Basis for Opinions

The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

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Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Allowance for Credit Losses - Loans

As discussed in Notes 1 and 3 to the consolidated financial statements, the allowance for credit losses on loans at December 31, 2020, was $22.9 million on a total loan portfolio of $2.1 billion. The Company adopted the current expected credit losses standard, and all related amendments as of December 31, 2020, and has an established process to determine the appropriateness of the allowance for credit losses on loans receivable. The allowance for credit losses provides an estimate of lifetime expected losses in the loan portfolio. The measurement of expected credit losses is based on relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the financial assets.

We identified the allowance for credit losses on loans as a critical audit matter. The principal considerations for our determination of allowance for credit losses on loans as a critical audit matter are subjectivity of the estimation and application of forecasted economic conditions, probabilities of default, loss given default, prepayments and curtailments over the contractual terms of the loan, and qualitative internal and external risk factors used in the calculation of the allowance for credit losses. The economic forecast component of the allowance for credit losses on loans is used to compare the conditions that existed during the historical period to current conditions and future expectations. The probabilities of default and loss given default are used to establish estimated losses at the loan portfolio segment level. Prepayments and curtailments over the contractual terms of the loans are used to estimate future cash flows. The qualitative internal and external risk factors are used to adjust for differences in segment-specific risk characteristics or to reflect the extent to which expected current conditions and reasonable and supportable forecasts of economic conditions differ from conditions that existed during the historical period included in the probability of default and loss given default development. Auditing management’s judgements regarding forecasted economic conditions, probabilities of default, loss given default, prepayments and curtailments over the contractual terms of the loan, and qualitative internal and external risk factors applied to the allowance for credit losses involved a high degree of subjectivity.

The primary procedures we performed to address this critical audit matter included:

a.Test the design, implementation, and operating effectiveness of controls related to management’s calculation of the allowance for credit losses on loans, including controls over the forecasted economic conditions used, probabilities of default, loss given default, prepayments and curtailments, and qualitative internal and external risk factors used.

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b.Obtaining management’s analysis and supporting documentation related to the forecasted economic conditions, and testing whether the forecasts used in the calculation of the allowance for credit losses on loans are reasonable and supportable based on the analysis provided by management.

c.Obtaining management’s analysis and supporting documentation related to the probabilities of default, and loss given default, and testing whether factors used in the calculation of the allowance for credit losses on loans are reasonable and supportable based on the analysis provided by management.

d.Obtaining management’s analysis and supporting documentation related to prepayments and curtailments, and testing whether factors used in the calculation of the allowance for credit losses on loans are reasonable and supportable based on the analysis provided by management.

e.Obtaining management’s analysis and supporting documentation related to the qualitative factors, and testing whether the environmental and qualitative factors used in the calculation of the allowance for credit losses on loans are supported by the analysis provided by management.

f.Testing the appropriateness of the methodology and assumptions used in the calculation of the allowance for credit losses on loans, as well as testing completeness and accuracy of the data used in the calculation, application of the forecasted economic conditions, probabilities of default, loss given default, prepayments and curtailments over the contractual terms of the loan, and factors determined by management and used in the calculation, and verifying calculations in the allowance for credit losses on loans.

Los Angeles, California

March 15, 2021

We have served as the Company’s auditor since 2004.

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March 15, 2021

Management's Report on Internal Control over Financial Reporting

Management of Bank of Marin Bancorp and subsidiary, (the "Company") is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed 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 ("GAAP"). The Company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company's assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are being made only in accordance with authorizations of management and board of directors; and (3) provide reasonable assurance regarding prevention, or timely detection and correction of unauthorized acquisition, use, or disposition of the Company's assets that could have a material effect on the financial statements.

Management conducted an assessment of the effectiveness of internal control over financial reporting as of December 31, 2020, utilizing the framework established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has concluded that the Company maintained effective internal control over financial reporting as of December 31, 2020.

The Company's independent registered public accounting firm, Moss Adams LLP, has issued an attestation report on our internal control over financial reporting, which appears on the previous page.

/s/ Russell A. Colombo

Russell A. Colombo, President and Chief Executive Officer

/s/ Tani Girton

Tani Girton, EVP and Chief Financial Officer

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BANK OF MARIN BANCORPCONSOLIDATED STATEMENTS OF CONDITION

(in thousands, except share data) 2020 2019

Assets

Cash, cash equivalents and restricted cash $ 200,320 $ 183,388

Investment securities:

Bank premises and equipment, net 4,919 6,070

Liabilities and Stockholders' Equity

Liabilities

Deposits

Interest bearing

Borrowings and other obligations 58 212

Interest payable and other liabilities 19,527 18,468

Stockholders' Equity

Preferred stock, no par value, Authorized - 5,000,000 shares, none issued — —

Accumulated other comprehensive income, net of taxes 12,601 4,503

1 Refer to Note 1, Summary of Accounting Policies, for information on the adoption of ASU 2016-13 in 2020.

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

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BANK OF MARIN BANCORPCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Interest income

Interest on federal funds sold and due from banks 461 1,321 1,461

Interest expense

Interest on interest-bearing transaction accounts 186 347 226

Interest on savings accounts 68 70 72

Interest on borrowings and other obligations 4 77 2

Provision for credit losses on loans 4,594 900 —

Non-interest income

Earnings on bank-owned life Insurance, net 973 1,196 913

Gains on investment securities, net 915 55 876

Non-interest expense

Provision for credit losses on unfunded loan commitments 1,570 129 —

Amortization of core deposit intangible 853 887 921

Federal Deposit Insurance Corporation insurance 474 361 756

Net income per common share:1

Weighted average common shares:1

Comprehensive income:

Other comprehensive income (loss):

Other comprehensive income (loss), net of tax 8,098 8,605 (978)

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

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

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BANK OF MARIN BANCORPCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

Shares1 Amount

Other comprehensive loss — — — (978) (978)

Reclassification of stranded tax effects in AOCI — — 638 (638)

Stock issued under employee stock purchase plan 1,036 39 — — 39

Stock issued under employee stock ownership plan 29,600 1,173 — — 1,173

Restricted stock granted 37,040 — — — —

Restricted stock forfeited / cancelled (12,056) — — — —

Stock-based compensation - stock options — 651 — — 651

Stock-based compensation - restricted stock — 1,013 — — 1,013

Cash dividends paid on common stock ($0.64 per share) 1 — — (8,860) — (8,860)

Stock purchased by directors under director stock plan 998 37 — — 37

Stock issued in payment of director fees 5,470 204 — — 204

Other comprehensive income — — — 8,605 8,605

Stock issued under employee stock purchase plan 1,355 54 — — 54

Stock issued under employee stock ownership plan 30,075 1,245 — — 1,245

Restricted stock granted 29,110 — — — —

Restricted stock forfeited / cancelled (18,333) — — — —

Stock-based compensation - stock options — 495 — — 495

Stock-based compensation - restricted stock — 1,017 — — 1,017

Cash dividends paid on common stock ($0.80 per share) — — (10,958) — (10,958)

Stock purchased by directors under director stock plan 591 24 — — 24

Stock issued in payment of director fees 5,544 231 — — 231

Other comprehensive income — — — 8,098 8,098

Stock issued under employee stock purchase plan 2,392 72 — — 72

Stock issued under employee stock ownership plan 39,900 1,289 — — 1,289

Restricted stock granted 29,100 — — — —

Restricted stock forfeited / cancelled (14,314) — — — —

Stock-based compensation - stock options — 319 — — 319

Stock-based compensation - restricted stock — 884 — — 884

Cash dividends paid on common stock ($0.92 per share) — — (12,506) — (12,506)

Stock purchased by directors under director stock plan 1,146 43 — — 43

Stock issued in payment of director fees 5,723 217 — — 217

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

2Refer to Note 1, Summary of Accounting Policies, for information on the adoption of ASU 2016-13 in 2020.

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

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BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CASH FLOWS

Cash Flows from Operating Activities:

Provision for credit losses 4,594 900 —

Provision for credit losses on unfunded loan commitments 1,570 129 —

Noncash contribution expense to employee stock ownership plan 1,289 1,245 1,173

Noncash director compensation expense 301 301 227

Amortization of core deposit intangible 853 887 921

Accretion of discount on acquired loans (165) (353) (807)

Accretion of discount on subordinated debentures 69 68 1,025

Net change in deferred loan origination costs/fees 5,040 (348) 183

Gain on sale of investment securities (915) (55) (876)

Earnings on bank-owned life insurance policies (973) (1,196) (913)

Net changes in:

Interest receivable and other assets (5,135) (329) 1,148

Interest payable and other liabilities (631) 70 902

Cash Flows from Investing Activities:

Purchase of held-to-maturity securities — (3,549) (1,988)

Proceeds from sale of Visa Inc. Class B restricted common stock — — 956

Purchase of bank-owned life insurance policies (941) (2,997) —

Cash receipts from bank-owned life insurance policies — 1,533 —

Purchase of premises and equipment (981) (542) (907)

Purchase of Federal Home Loan Bank stock (176) (616) —

Cash paid for low income housing tax credit investment (1,355) (952) (418)

Cash Flows from Financing Activities:

Proceeds from stock options exercised 1,304 669 537

Payment of tax withholdings for vesting of restricted stock (73) (220) (45)

Federal Home Loan Bank (repayment) borrowings — (7,000) 7,000

Repayment of subordinated debenture including execution costs — — (4,137)

Repayment of finance lease obligations (172) (168) —

Supplemental disclosure of cash flow information:

Supplemental disclosure of noncash investing and financing activities:

Stock issued to employee stock ownership plan $ 1,289 $ 1,245 $ 1,173

Repurchase of stock not yet settled $ 413 $ 103 $ 143

Stock issued in payment of director fees $ 217 $ 231 $ 204

Subscription in low income housing tax credit investment $ — $ — $ 3,000

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NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS

Note 1: Summary of Significant Accounting Policies

Nature of Operations - Bank of Marin Bancorp ("Bancorp"), headquartered in Novato, California, conducts business primarily through its wholly-owned subsidiary, Bank of Marin (the "Bank"), a California state-chartered commercial bank that provides a wide range of financial services to customers who are predominantly professionals, small and middle-market businesses, and individuals who work and/or reside in Marin, Sonoma, Napa, San Francisco, Alameda, Contra Costa and San Mateo counties. Besides its headquarters located in Novato, CA, the Bank operates ten branches in Marin County, two in Napa County, one in San Francisco, five in Sonoma County, three in Alameda County, and one loan production office in both Contra Costa County and San Mateo County.

Basis of Presentation - The consolidated financial statements include the accounts of Bancorp and the Bank. References to “we,” “our,” “us” mean Bancorp and the Bank that are consolidated for financial reporting purposes. Our accounting and reporting policies conform to U.S. generally accepted accounting principles ("GAAP"), general practice, and regulatory guidance within the banking industry. A summary of our significant policies follows. All material intercompany transactions have been eliminated. We evaluated subsequent events through the date of filing with the Securities and Exchange Commission (“SEC”) and determined that, other than the early redemption of the subordinated debenture mentioned below, there were no subsequent events that require additional recognition or disclosure.

The NorCal Community Bancorp Trusts I and II, respectively (the "Trusts"), were formed for the sole purpose of issuing trust preferred securities. Bancorp is not considered the primary beneficiary of the Trusts (variable interest entities), therefore the Trusts are not consolidated in our consolidated financial statements. Bancorp's investments in these Trusts are accounted for under the equity method and included in interest receivable and other assets and the subordinated debenture and related accrued interest payable are recorded as liabilities in our consolidated statements of condition. Refer to Note 7, Borrowings and Other Obligations, for detail on the early redemption on October 7, 2018 of the subordinated debenture due to Trust I and early redemption on March 15, 2021 of the subordinated debenture due to Trust II.

Accounting Changes and Reclassifications - Certain items in prior financial statements have been reclassified to conform to the current presentation.In addition, on December 31, 2020, we adopted Accounting Standards Update (“ASU”) 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and all applicable amendments as subsequently updated for certain clarifications, targeted relief and codification improvements. Accounting Standards Codification (“ASC”) Topic 326 (“ASC 326”) replaced the incurred loss method for measuring credit losses with a current expected credit loss ("CECL") method for financial assets recorded at amortized cost (i.e., loans originated by us and held-to-maturity investment securities). The previous incurred loss method included a general allowance on loans for known and inherent losses within the portfolio, which reflected adjusted historical loss rates and a specific allowance component for impaired loans. The CECL method requires the measurement of all expected credit losses for financial assets measured at amortized cost and certain off-balance-sheet credit exposures to consider credit losses expected to be incurred over the life of the financial asset based on past events, current conditions, and reasonable and supportable forecasts. ASC 326 also requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards. In addition, ASC 326 includes certain changes to the accounting for available-for-sale investment securities including the requirement to recognize an allowance when management intends to sell or believes that it is more likely than not they will be required to sell the security before recovery of its amortized cost.

ASC 326 was effective January 1, 2020. However, in accordance with the accounting relief provisions of the Coronavirus Aid, Relief and Economic Security ("CARES") Act passed in March 2020, we postponed the adoption of the CECL standard to the earlier of the end of the national emergency or December 31, 2020. Therefore, we adopted this standard using the modified retrospective method for all financial assets measured at amortized cost, and off-balance-sheet credit exposures, effective October 1, 2020 (the beginning of the first reporting period in which the standard was effective due to the postponement of CECL) through a cumulative adjustment to retained earnings. Results for reporting periods beginning after September 30, 2020 will be presented under the new standard while prior period amounts continue to be reported in accordance with previously applicable GAAP. Upon

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adoption, we recorded a cumulative adjustment to retained earnings, net of taxes, based on economic forecasts and other assumptions as of December 31, 2019. That adjustment resulted in an increase to our allowance for credit losses of $1.6 million and an increase to the allowance for unfunded loan commitments of $122 thousand. In addition, we recognized the remaining difference between the allowance for credit losses calculated under the CECL model as of December 31, 2020 and the allowance for credit losses calculated under the incurred loss model as of September 30, 2020 as a reversal of the provision for credit losses and a provision for credit losses on unfunded loan commitments, as showed in the tables below.

The following tables show the impact to our financial statement line items due to adoption of ASC 326 as of and during the quarter ended December 31, 2020.

Impact to allowance for credit losses on loans:

Allowance for credit losses on loans $ 748

Retained earnings (cumulative transition adjustment) $ (1,604) $ 474 $ (1,130)

Impact to allowance for credit losses on unfunded loan commitments:

Allowance for credit losses on unfunded commitments $ 1,082

Retained earnings (cumulative transition adjustment) $ (122) $ 36 $ (86)

The following table shows the impact on the allowance for credit losses due to the transition from the incurred loss method to the CECL method by loan class.

Allowance for credits losses on loans:

Real estate:

Installment and other consumer loans 406 (125) 281

Allowance for credit losses on unfunded commitments $ 1,697 $ 122 $ 1,819

The Bank did not record an allowance for credit losses on available-for-sale or held-to-maturity investment securities upon the adoption of CECL as the investment portfolio consisted primarily of debt securities explicitly or implicitly backed by the U.S. government and high credit quality obligations of state and political subdivisions. Refer to Note 2, Investment Securities, for more information.

Use of Estimates -The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant accounting estimates reflected in the consolidated financial statements include the allowance for credit losses, income taxes, and fair value measurements (including fair values of acquired assets and assumed liabilities at acquisition dates) as discussed in the Notes herein.

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Cash, Cash Equivalents and Restricted Cash - include cash, due from banks, federal funds sold and other short-term investments with maturities of less than three months at the time of purchase. Restricted cash includes reserve requirements held with the Federal Reserve Bank of San Francisco.

Investment Securities - are classified as "held-to-maturity," "trading securities" or "available-for-sale." Investments classified as held-to-maturity are those that we have the ability and intent to hold until maturity and are reported at cost, adjusted for the amortization or accretion of premiums or discounts. Investments held for resale in anticipation of short-term market movements are classified as trading securities and are reported at fair value, with unrealized gains and losses included in earnings. Investments that are neither held-to-maturity nor trading are classified as available-for-sale and are reported at fair value. Unrealized gains and losses for available-for-sale securities, net of related taxes, are reported as a separate component of comprehensive income and included in stockholders' equity until realized. For discussion of our methodology in determining fair value, see Note 9, Fair Value of Assets and Liabilities.

Purchase premiums and discounts on investment securities are amortized or accreted over the life of the related security as an adjustment to yield using the effective interest method. For certain callable debt securities purchased at a premium, we amortize the premium to the earliest call date.

Dividend and interest income are recognized when earned. Realized gains and losses on the sale of securities are included in non-interest income. The specific identification method is used to calculate realized gains and losses on sales of securities.

Securities transferred from the available-for-sale category to the held-to-maturity category are recorded at fair value at the date of transfer. Unrealized holding gains or losses on the dates of the transfer of securities from available-for-sale to held-to-maturity are included in the balance of accumulated other comprehensive income (loss), net of tax, in the consolidated balance sheets. These unrealized holding gains or losses on the dates of transfer are amortized over the remaining life of the securities as yield adjustments in a manner consistent with the amortization or accretion of the original purchase premium or discount on the associated security.

Allowance for Credit Losses on Investment Securities - The allowance for credit losses on held-to-maturity securities is a contra-asset valuation account determined in accordance with ASC 326, which is deducted from the securities' amortized cost basis at the balance sheet date as a result of management's assessment of the net amount expected to be collected. The allowance is measured on a pooled basis for securities with similar risk characteristics using historical credit loss information, adjusted for current conditions and reasonable and supportable forecasts. Securities that are determined to be uncollectible are written off against the allowance.

For available-for-sale securities in an unrealized loss position ("impaired security"), we assess whether 1) we intend to sell the security, or, 2) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. Under either of these conditions, the security's amortized cost is written down to fair value through a charge to previously recognized allowances or earnings, as applicable. For impaired securities that do not meet these conditions, we assess whether the decline in fair value was due to credit loss or other factors. This assessment considers, among other things: 1) the extent to which the fair value is less than amortized cost, 2) the financial condition and near-term prospects of the issuer, 3) any changes to the rating of the security by a rating agency, and 4) our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss component. Any impairment due to non-credit-related factors that has not been recorded through an allowance for credit losses is recognized in other comprehensive income. The discount rate used in determining the present value of the expected cash flows is based on the effective interest rate implicit in the security at the date of purchase.

Accrued interest receivable is excluded from the amortized costs and fair values of both held-to-maturity and available-for-sale securities and included in interest receivable and other assets on the consolidated statements of condition. Investment securities are placed on non-accrual status when principal or interest is contractually past due more than ninety days, or management does not expect full payment of principal and interest. We do not record an allowance for credit losses for accrued interest on investment securities, as the amounts are written-off

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when the investment is placed on non-accrual status. There were no non-accrual investment securities in any of the years presented in the consolidated financial statements.

Originated Loans - are reported at amortized cost, which is the principal amount outstanding net of deferred fees (costs), purchase premiums (discounts) and net charge-offs (recoveries). Amortized cost excludes accrued interest, which is reflected in interest receivable and other assets in the consolidated statements of condition. We do not measure an allowance for credit losses on accrued interest receivable balances because these balances are written off in a timely manner as a reduction to interest income when loans are placed on non-accrual status as discussed below. Interest income is accrued daily using the simple interest method. Fees collected upon loan origination and certain direct costs of originating loans are deferred and recognized over the contractual lives of the related loans as yield adjustments using the interest method or straightline method, as applicable. Upon prepayment or other disposition of the underlying loans before their contractual maturities, any associated unearned fees or unamortized costs are recognized.

Acquired Loans - ASC 326 modified 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 reported as a provision for credit losses. Subsequent changes in the allowance for credit losses on PCD assets are recognized through the provision for credit losses.

Past-Due and Non-Accrual Loan Policy - A loan is considered past due when a payment has not been received by the contractual due date. Loans are placed on non-accrual status when management believes that there is substantial doubt as to the collection of principal or interest, generally when they become contractually past due by 90 days or more with respect to principal or interest, except for loans that are well-secured and in the process of collection. When loans are placed on non-accrual status, any accrued but uncollected interest is reversed from current-period interest income and the amortization of deferred loan origination fees and costs is suspended. Interest payments received on nonaccrual loans are either applied against principal or reported as interest income, according to management’s judgment as to the ultimate collectability of principal. We may return non-accrual loans to accrual status when one of the following occurs:

•The borrower has resumed paying the full amount of the principal and interest and we are satisfied with the borrower's financial position. In order to meet this test, we must have received repayment of all past due principal and interest, unless the amounts contractually due are reasonably assured of repayment within a reasonable period of time, and there has been a sustained period of repayment performance (generally, six consecutive monthly payments), according to the original contractual terms or modified terms for loans whose contractual terms have been restructured in a manner which grants a concession to a borrower experiencing financial difficulties (“troubled debt restructuring”).

•The loan has become well secured and is in the process of collection.

Loan Charge-Off Policy - For all loan types excluding overdraft accounts, we generally make a charge-off determination at or before 90 days past due. A collateral-dependent loan is partially charged down to the fair value of collateral securing it if: (1) it is deemed uncollectable, or (2) it has been classified as a loss by either our internal loan review process or external examiners. A non-collateral-dependent loan is partially charged down to its net realizable value under the same circumstances. Overdraft accounts are generally charged off when they exceed 60 days past due.

Troubled Debt Restructured Loans - 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 may 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 six months, and obtains reasonable assurance of repayment and performance. Additionally, 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;

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•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.

Section 4013 of the CARES Act, subsequently amended by section 541 of the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act of 2020 ("Economic Aid Act"), provided optional, temporary relief from evaluating loans that may have been considered TDRs under GAAP. This relief applies to loan modifications executed between March 1, 2020 and the earlier of 60 days after the national emergency is terminated or January 1, 2022. The Bank elected to apply these temporary accounting provisions to payment relief loans beginning in March 2020. Accordingly, modifications that met certain criteria of the CARES Act were not categorized as troubled debt restructurings during 2020.

Collateral Dependent Loans - A loan is collateral dependent when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the sale or operation of the collateral. For collateral dependent loans, including those for which management determines foreclosure is probable, the allowance for credit losses is based on the fair value of the collateral, adjusted for estimated selling costs when repayment is expected from the sale of the collateral, less the loan's amortized cost. In determining the fair value, management considers such information as the appraised value of the collateral, observed and potential future changes in collateral value, and historical loss experience for loans that were secured by similar collateral. Generally, with problem credits that are collateral dependent, we obtain appraisals of the collateral at least annually. We may obtain appraisals more frequently if we believe the collateral value is subject to market volatility, if a specific event has affected the collateral, or if we believe foreclosure is imminent.

Allowance for Credit Losses on Loans ("ACL") - is a valuation account that is deducted from the amortized cost basis at the balance sheet date to present the net amount of loans expected to be collected. Amortized cost does not include accrued interest, which management elected to exclude from the estimate of expected credit losses (refer to the Past-Due and Non-Accrual Loan Policy section above). Management estimates the allowance quarterly using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Credit loss experience provides the basis for the estimation of expected credit losses.

The ACL model utilizes a discounted cash flow ("DCF") method to measure the expected credit losses on loans collectively evaluated that are sub-segmented by loan pools with similar credit risk characteristics, which are generally comprised of federal regulatory reporting codes (i.e., Call codes). Pooled segments include the following:

•Loans secured by real estate:

- 1-4 family residential construction loans

- Other construction loans and all land development and other land loans

- Secured by farmland (including residential and other improvements)

- Revolving, open-end loans secured by 1-4 family residential properties and extended under lines

of credit

- Closed-end loans secured by 1-4 family residential properties, secured by first liens

- Closed-end loans secured by 1-4 family residential properties, secured by junior liens

- Secured by multifamily (5 or more) residential properties

- Commercial real estate loans secured by owner-occupied non-farm nonresidential properties

- Commercial real estate loans secured by other non-farm nonresidential properties

•Loans to finance agricultural production and other loans to farmers

•Commercial and industrial loans

•Loans to individuals for household, family and other personal expenditures (i.e., consumer loans)

•Municipal entities

•Non-profit organizations

•Other loans (overdraft credit lines)

The DCF method incorporates assumptions for probability of default ("PD"), loss given default ("LGD"), and prepayments and curtailments over the contractual terms of the loans. Under the DCF method, the ACL reflects the difference between the amortized cost basis and the present value of the expected cash flows using the loan's effective rate. We elected to report the change in present values from one reporting period to the next due to the

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passage of time and changes in the estimate of future expected cash flows through the provision for credit losses, rather than though interest income.

In determining the PD for each pooled segment, the Bank utilized regression analyses to identify certain economic drivers that were considered highly correlated to historical Bank or peer loan default experience. As a result, management chose the California unemployment rate as the primary economic forecast driver for all segments, except for municipal loans. In addition, the annual percentage change in the California gross domestic product was used in the commercial and industrial loan segment and the annual percentage change in California retail sales was used in the owner-occupied and investor-owned commercial real estate segments. For municipal loans, the ACL model utilized a constant default rate obtained from a nationally recognized default rate study, which is updated annually. A third party provides LGD estimates for each segment based on a banking industry Frye-Jacobs Risk Index approach. The ACL model incorporates a one-year reasonable and supportable forecast of economic factors, updated quarterly, which is provided by a well-recognized economics advisory company. For periods beyond the forecast horizon the economic factors revert to historical averages on a straight-line basis over a one-year period.

Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments and curtailments, when appropriate. The pooled loans' contractual loan terms exclude extensions, renewals, and modifications unless one or more of the following applies: 1) management has a reasonable expectation at the reporting date that a troubled debt restructuring will be executed with an individual borrower, 2) the extension or renewal options are included in the original or modified contract, or 3) an existing troubled debt restructuring is within six months of maturity.

Loans that do not share the same risk characteristics as pooled loans are evaluated individually for credit loss and generally include all non-accrual loans, collateral dependent loans, and certain troubled debt restructured loans and loans graded substandard or worse as determined by management.

Management considers whether adjustments to the quantitative portion of the ACL are needed for differences in segment-specific risk characteristics or to reflect the extent to which it expects current conditions and reasonable and supportable forecasts of economic conditions to differ from the conditions that existed during the historical period included in the development of PD and LGD. Qualitative internal and external risk factors include, but are not limited to, the following:

•Changes in the nature and volume of the loan portfolio

•Changes in the volume and severity of past due loans, the volume of non-accruals loans, and the volume and severity of adversely classified or graded loans

•The existence and effect of individual loan and loan segment concentrations

•Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere

•Changes in the experience, ability, and depth of lending management and other relevant staff

•Changes in the quality of our systematic loan review processes

•Changes in economic and business conditions, and developments that affect the collectability of the portfolio

•Changes in the value of underlying collateral, where applicable

•The effect of other external factors such as legal and regulatory requirements on the level of estimated credit losses in the portfolio

•The effect of acquisitions of other loan portfolios on our infrastructure, including risk associated with entering new geographic areas as a result of such acquisitions

•The presence of specialized lending segments in the portfolio

While we believe we use the best information available to determine the allowance for credit losses, our results of operations could be significantly affected if circumstances differ substantially from the assumptions used in determining the allowance. Our ACL model is sensitive to changes in unemployment rate forecasts and certain other assumptions that could result in material fluctuations in the allowance for credit losses and adversely affect our financial condition and results of operations.

For further information regarding the allowance for loan losses, see Note 3, Loans and Allowance for Loan Losses.

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Allowance for Credit Losses on Unfunded Loan Commitments - We make commitments to extend credit to meet the financing needs of our customers in the form of loans or standby letters of credit. We are exposed to credit losses over a loan's contractual period in the event that a decline in credit quality of the borrower leads to nonperformance. We record an allowance for losses on unfunded loan commitments at the balance sheet date based on estimates of probability that these commitments will be drawn upon according to historical utilization experience of different types of commitments and expected loss severity and loss rates determined for pooled funded loans. The allowance for credit losses on unfunded commitments is a liability account included in interest payable and other liabilities on the consolidated statements of condition. Adjustments to the allowance for unfunded commitments are included in non-interest expense as a provision for (or reversal of) the allowance for unfunded commitments.

Transfers of Financial Assets - We have entered into certain loan participation agreements with other organizations. We account for these transfers of financial assets as sales when control over the transferred financial assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets and liabilities have been isolated from us, (2) the transferee has the right to pledge or exchange the assets (or beneficial interests) it received, free of conditions that constrain it from taking advantage of that right, beyond a trivial benefit and (3) we do not maintain effective control over the transferred financial assets or third-party beneficial interests related to those transferred assets. No gain or loss has been recognized by us on the sale of these participation interests in 2020, 2019 and 2018.

Premises and Equipment - Premises and equipment consist of leasehold improvements, furniture, fixtures, software and equipment and are stated at cost, less accumulated depreciation and amortization, which are calculated on a straight-line basis. Furniture and fixtures are depreciated over eight years and equipment is generally depreciated over three to twenty years. Leasehold improvements are amortized over the lesser of their estimated useful lives or the terms of the leases. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation or amortization are removed from the accounts and any resulting gain or loss is recognized in income for the period. The cost of maintenance and repairs is charged to expense as incurred.

Leases - We account for leases in accordance with ASC 842, Leases. As a result of the adoption of ASU 2016-02 on January 1, 2019, we recorded operating and finance lease right-of-use assets totaling $13.4 million, net of deferred rent and unrecognized lease incentives, operating and finance lease liabilities totaling $15.4 million, and no cumulative-effect adjustments to retained earnings. Under the standard's transition guidance, we elected the package of practical expedients, which allowed us to carry forward existing lease classifications under ASC 840, Leases (previous GAAP), and did not require us to reassess initial direct costs for any existing leases. We elected the hindsight practical expedient when determining the lease term (i.e., considering whether we are reasonably certain to exercise options to extend or terminate the lease). In addition, we made accounting policy elections not to separate non-lease components from lease components and to exclude short-term leases (i.e., lease term of 12 months or less at the commencement date) from right-of-use assets and lease liabilities for all lease classifications.

We lease certain premises under long-term non-cancelable operating leases, most of which include escalation clauses and one or more options to extend the lease term, and some of which contain lease termination clauses. Only those renewal and termination options that management determines are reasonably certain of exercising are included in the calculation of the lease liability. In addition, we lease certain equipment under finance leases. The equipment finance lease terms do not contain renewal options, bargain purchase options or residual value guarantees. We did not have any significant short-term leases during the reported periods.

Lease right-of-use assets represent the right to use the underlying asset while lease liabilities represent the present value of future lease obligations. When calculating the lease liability, because most lease contracts do not contain an implicit interest rate, we discount lease payments over a lease's expected term based on the collateralized Federal Home Loan Bank borrowing rate that was commensurate with lease terms and minimum payments at the lease commencement date. Right-of-use assets for operating leases are amortized over the lease term by amounts that represent the difference between periodic straight-line lease expense and periodic interest accretion on the related liability to make lease payments, whereas finance leases are amortized on a straight-line basis over the term of the lease. Expense recognition for operating leases is recorded on a straight-line basis while expense recognition for finance leases represents the sum of periodic amortization of the associated right-of-use asset and the interest accretion on the lease liability. Refer to Note 12, Commitments and Contingencies, for further information.

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Business Combinations - Business combinations are accounted for under the acquisition method of accounting in accordance with ASC 805, Business Combinations. A business is defined as a set of activities and assets that is both self-sustaining and managed to provide a return to investors and generally has three elements: inputs, processes and outputs. Under the acquisition method, the acquiring entity in a business combination recognizes the acquired assets and assumed liabilities at their estimated fair values as of the date of acquisition. Any excess of the purchase price over the fair value of net assets and other identifiable intangible assets acquired is recorded as goodwill. To the extent the fair value of net assets acquired, including other identifiable assets, exceed the purchase price, a bargain purchase gain is recognized. Assets acquired and liabilities assumed from a business combination are recognized at fair value, if the fair value can be determined during the measurement period. Results of operations of an acquired business are included in the consolidated statements of operations from the date of acquisition. Business acquisition-related costs, including conversion and restructuring charges, are expensed as incurred. If substantially all of an acquisition is made up of one asset or several similar assets, or without a substantive process that together contributes to the ability to create outputs, the acquisition is accounted for as an asset acquisition and acquisition costs will be capitalized as part of the assets acquired, rather than expensed in a business combinations.

Goodwill and Other Intangible Assets - Goodwill is determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill that arises from a business combination is periodically evaluated for impairment at the reporting unit level, at least annually. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Core deposit intangible ("CDI") represents the estimated future benefit of deposits related to an acquisition and is booked separately from the related deposits and evaluated periodically for impairment. The CDI asset is amortized on an accelerated method over its estimated useful life of ten years.At December 31, 2020, the future estimated amortization expense for the CDI arising from our past acquisitions is as follows:

We make a qualitative assessment of whether it is more likely than not that the fair value of a reporting unit where goodwill is assigned is less than its carrying amount. If we conclude that it is more likely than not that the fair value is more than its carrying amount, no impairment is recorded. Goodwill is tested for impairment on an interim basis if circumstances change or an event occurs between annual tests that would more likely than not reduce the fair value of the reporting unit below its carrying amount. The qualitative assessment includes adverse events or circumstances identified that could negatively affect the reporting units’ fair value as well as positive and mitigating events. Such indicators may include, among others, significant changes in legal factors or in the general business climate, significant changes in our stock price and market capitalization, unanticipated competition, and an action or assessment by a regulator. If the fair value of a reporting unit is less than its carrying amount, an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value is recognized. The loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.

Bank Owned Life Insurance ("BOLI") - The Bank owns life insurance policies on certain key current and former officers. BOLI is recorded in interest receivable and other assets on the consolidated statements of condition at the amount that can be realized under the insurance contract at period-end, which is the cash surrender value adjusted for other charges or amounts due that are probable at settlement.

Federal Home Loan Bank of San Francisco ("FHLB") Stock - The Bank is a member of the FHLB. Members are required to own a certain amount of stock based on the level of borrowings and other factors. As of December 31, 2020 and 2019 our investment in FHLB stock was carried 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. We periodically evaluate FHLB stock for impairment based on ultimate recovery of par value. FHLB stock is included as part of interest receivable and other assets on the consolidated statements of condition. Both cash and stock dividends are reported as non-interest income.

Investments in Low Income Housing Tax Credit Funds - We have invested in limited partnerships that were formed to develop and operate affordable housing projects for low or moderate-income tenants throughout

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California. Our ownership percentage in each limited partnership ranges from 1.0% to 3.5%. We account for the investments in qualified affordable housing tax credit funds using the proportional amortization method, where the initial cost of the investment is amortized in proportion to the tax credits and other tax benefits received. Low income housing tax credits and other tax benefits received, net of the amortization of the investment is recognized as part of income tax benefit. Each of the partnerships must meet the regulatory minimum requirements for affordable housing for a minimum 15-year compliance period to fully utilize the tax credits. If the partnerships cease to qualify during the compliance period, the credit may be denied for any period in which the project is not in compliance and a portion of the credit previously taken is subject to recapture with interest. We record an impairment charge if the value of the future tax credits and other tax benefits is less than the carrying value of the investments.

Employee Stock Ownership Plan (“ESOP”) - We recognize compensation cost for ESOP contributions when funds become committed for the purchase of Bancorp's common shares into the ESOP in the year in which the employees render service entitling them to the contribution. If we contribute stock, the compensation cost is the fair value of the shares when they are committed to be released (i.e., when the number of shares becomes known and formally approved). In 2020, 2019 and 2018, the Bank only made stock contributions to the ESOP.

Income Taxes - Income taxes reported in the consolidated financial statements are computed based on an asset and liability approach. We recognize the amount of taxes payable or refundable for the current year and we record deferred tax assets and liabilities for future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases using enacted tax rates in effect for the year in which the temporary differences are expected to reverse. We record net deferred tax assets to the extent it is more likely than not that they will be realized. In evaluating our ability to recover the deferred tax assets and the need to establish a valuation allowance against the deferred tax assets, management considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies. In projecting future taxable income, management develops assumptions including the amount of future state and federal pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates being used to manage the underlying business. Bancorp files consolidated federal and combined state income tax returns.

We recognize the financial statement effect of a tax position when it is more likely than not, based on the technical merits and all available evidence, that the position will be sustained upon examination, including the resolution through protests, appeals or litigation processes. For tax positions that meet the more likely than not threshold, we measure and record the largest amount of tax benefit that is greater than fifty percent likely of being realized upon ultimate settlement with the taxing authority. The remainder of the benefits associated with tax positions taken is recorded as unrecognized tax benefits, along with any related interest and penalties. Interest and penalties related to unrecognized tax benefits are recorded in tax expense.

In deciding whether or not our tax positions taken meet the more likely than not recognition threshold, we must make judgments and interpretations about the application of inherently complex state and federal tax laws. To the extent tax authorities disagree with tax positions taken by us, our effective tax rates could be materially affected in the period of settlement with the taxing authorities. Revision of our estimate of accrued income taxes also may result from our own income tax planning, which may affect effective tax rates and results of operations for any reporting period.

We present an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss ("NOL") carryforward, or similar tax loss or tax credit carryforward, rather than as a liability, when (1) the uncertain tax position would reduce the NOL or other carryforward under the tax law of the applicable jurisdiction and (2) we intend to and are able to use the deferred tax asset for that purpose. Otherwise, the unrecognized tax benefit is presented as a liability instead of being netted with deferred tax assets.

Earnings per share (“EPS”)- are based upon the weighted average number of common shares outstanding during each year. 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 EPS are calculated by dividing net income by the weighted average number of common

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shares outstanding during each annual 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 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.

Potentially dilutive common shares related to:

Unvested restricted stock awards 23 26 29

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

Share-Based Compensation - All share-based payments, including stock options and restricted stock, are recognized as stock-based compensation expense in the consolidated statements of comprehensive income based on the grant-date fair value of the award with a corresponding increase in common stock. The grant-date fair value of the award is amortized on a straight-line basis over the requisite service period, which is generally the vesting period. The stock-based compensation expense excludes stock grants to directors as compensation for their services, which are recognized as director expenses separately based on the grant-date value of the stock. We account for forfeitures as they occur. See Note 8, Stockholders' Equity and Stock Option Plans, for further discussion.

We determine the fair value of stock options at the grant date using a Black-Scholes pricing model that takes into account the stock price at the grant date, exercise price, expected life of the option, volatility of the underlying stock, expected dividend yield and risk-free interest rate over the expected life of the option. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. Expected volatility is based on the historical volatility of the common stock over the most recent period that is generally commensurate with the expected life of the options. The Black-Scholes option valuation model requires the input of highly subjective assumptions, including the expected life of the stock-based award and stock price volatility. The assumptions used represent management's best estimates based on historical information, but these estimates involve inherent uncertainties and the application of management's judgment. As a result, if other assumptions had been used, the recorded stock-based compensation expense could have been materially different from that recorded in the consolidated financial statements. The fair value of restricted stock is based on the stock price on the grant date.

We record excess tax benefits resulting from the exercise of non-qualified stock options, the disqualifying disposition of incentive stock options and vesting of restricted stock awards as tax benefits in the consolidated statements of comprehensive income with a corresponding decrease to current taxes payable. In addition, we reflect excess tax benefits as an operating activity in the consolidated statements of cash flows.

Cash paid for tax withholdings when shares are surrendered in a cashless stock option exchange is classified as a financing activity in the consolidated statements of cash flows.

Derivative Financial Instruments and Hedging Activities - Fair Value Hedges - All of our interest rate swap contracts are designated and qualified as fair value hedges. The terms of our interest rate swap contracts are closely aligned to the terms of the designated fixed-rate loans. The hedging relationships are tested for

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effectiveness on a quarterly basis using a qualitative approach. The qualitative analysis includes verification that there are no changes to the derivative's or hedged item's key terms and conditions and no adverse developments regarding risk of counterparty default, and validation that we continue to have fair value hedge designation. The interest rate swaps are carried on the consolidated statements of condition at their fair value in other assets (when the fair value is positive) or in other liabilities (when the fair value is negative). The changes in the fair value of the interest rate swaps are recorded in interest income. The unrealized gains or losses due to changes in fair value of the hedged fixed-rate loans due to changes in benchmark interest rates are recorded as an adjustment to the hedged loans and offset in interest income. For derivative instruments executed with the same counterparty under a master netting arrangement, we do not offset fair value amounts of interest rate swaps in liability positions with the ones in asset positions.

From time to time, we make firm commitments to enter into long-term fixed-rate loans with borrowers backed by yield maintenance agreements and simultaneously enter into forward interest rate swap agreements with correspondent banks to mitigate the change in fair value of the yield maintenance agreement. Prior to loan funding, yield maintenance agreements with net settlement features that meet the definition of a derivative are considered as non-designated hedges and are carried on the consolidated statements of condition at their fair value in other assets (when the fair value is positive) or in other liabilities (when the fair value is negative). The offsetting changes in the fair value of the forward swap and the yield maintenance agreement are recorded in interest income. When the fixed-rate loans are originated, the forward swaps are designated to offset the change in fair value in the loans. Subsequent to the point of the swap designations, the fair value of the related yield maintenance agreements at the designation date that was recorded in other assets is amortized using the effective yield method over the life of the respective designated loans.

The net effect of the change in fair value of interest rate swaps, the amortization of the yield maintenance agreement and the change in the fair value of the hedged loans due to changes in benchmark interest rates result in an insignificant amount recognized in interest income. For further detail, see Note 14, Derivative Financial Instruments and Hedging Activities.

Revenue Recognition - We utilize the following five-step model for non-financial instrument related revenue that is in scope for ASC 606, Revenue from Contracts with Customers: 1) identify the contract, 2) identify the performance obligations in the contract, 3) determine the transaction price, 4) allocate the transaction price to the performance obligations in the contract, and, 5) recognize revenue when (or as) the entity satisfies the performance obligation. Our main revenue streams in scope for ASC 606 include:

•Wealth Management & Trust ("WM&T") fees - WM&T services include, but are not limited to: customized investment advisory and management; administrative services such as bill pay and tax reporting; trust administration, estate settlement, custody and fiduciary services. Performance obligations for investment advisory and management services are generally satisfied over time. Revenue is recognized monthly according to a tiered fee schedule based on the client's month-end market value of assets under our management. WM&T does not earn revenue based on performance or incentives. Costs associated with WM&T revenue-generating activities, such as payments to sub-advisors, are recorded separately as part of professional service expenses when incurred.

•Deposit account service charges - Service charges on deposit accounts consist of monthly maintenance fees, business account analysis fees, business online banking fees, check order charges, and other deposit account-related fees. Performance obligations for monthly maintenance fees and account analysis fees are satisfied, and the related revenue recognized, when we complete our performance obligation each month. Performance obligations related to transaction-based services (such as check orders) are satisfied, and the related revenue recognized, at a point in time typically when the transaction is completed, except for business accounts subject to analysis where the transaction-based fees are part of the monthly account analysis fees.

•Debit card interchange fees - We issue debit cards to our consumer and small business customers that allow them to purchase goods and services from merchants in person, online, or via mobile devices using funds held in their demand deposit accounts held with us. Debit cards issued to our customers are part of global electronic payment networks (such as Visa) who pass a portion of the merchant interchange fees to debit card-issuing member banks like us when our customers make purchases through their networks.

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Performance obligations for debit card services are satisfied and revenue is recognized daily as the payment networks process transactions. Because we act in an agent capacity, we recognize network costs on a net basis with interchange fees in non-interest income.

Advertising Costs - are expensed as incurred. For the years ended December 31, 2020, 2019, and 2018, advertising costs totaled $769 thousand, $775 thousand, and $666 thousand, respectively.

Comprehensive Income (Loss) - includes net income, changes in the unrealized gains or losses on available-for-sale investment securities, and amortization of net unrealized gains or losses on securities transferred from available-for-sale to held-to-maturity, net of related taxes, reported on the consolidated statements of comprehensive income and as components of stockholders' equity.

Fair Value Measurements - We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. We base our fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e., exit price notion) reflecting factors such as a liquidity premium. Securities available-for-sale and derivatives are recorded at fair value on a recurring basis. Our equity investments that do not have readily determinable fair values are recorded at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. FHLB stock and Visa Inc. Class B common stock are carried at cost as of December 31, 2020 and 2019, as there was no impairment or changes resulting from observable price changes in orderly transactions for an identical or similar investment of the same issuer. Additionally, from time to time, we may be required to record certain assets and liabilities at fair value on a non-recurring basis, such as purchased loans and acquired deposits recorded at acquisition date, certain impaired loans, other real estate owned and securities held-to-maturity that are other-than-temporarily impaired. These non-recurring fair value adjustments typically involve write-downs of individual assets due to application of lower-of-cost or market accounting.

When we develop our fair value measurement process, we maximize the use of observable inputs. Whenever there is no readily available market data, we use our best estimates and assumptions in determining fair value, but these estimates involve inherent uncertainties and the application of management's judgment. As a result, if other assumptions had been used, our recorded earnings or disclosures could have been materially different from those reflected in these consolidated financial statements.

Other Recently Adopted Accounting Standards

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (ASC 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 9, 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 (ASC 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.

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Accounting Standards Not Yet Effective

In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (ASC 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 ASC 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 (ASC Topic 321), Investments - Equity Method and Joint Ventures (ASC Topic 323), and Derivatives and Hedging (ASC Topic 815) - Clarifying the Interactions between ASC 321, ASC 323, and ASC 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 ASC 323,for the purposes of applying the measurement alternative in accordance with ASC 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 of accounting for, or recognizing the effects of reference rate reform. The amendments in this ASU provide optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The amendments in this ASU may be elected as of March 12, 2020 through December 31, 2022. An entity may choose to elect the amendments in this update at an interim period subsequent to March 12, 2020 with adoption methods varying based on transaction type. We have not elected to apply amendments at this time, however, will assess the applicability of this ASU to us as we continue to monitor guidance for reference rate reform from FASB and its impact on our financial condition and results of operations.

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

In January 2021, the FASB issued ASU No. 2021-01, Reference Rate Reform (Topic 848). The main amendments in this ASU are intended to clarify certain optional expedients and scope of derivative instruments. The amendments are elective and effective immediately upon issuance of this ASU. Amendments may be elected through December 31, 2022. We have not elected to apply amendments at this time, however, will assess the applicability of this ASU (and ASU 2020-04) to us as we continue to monitor guidance for reference rate reform from FASB and its impact on our financial condition and results of operations.

Note 2: Investment Securities

Our investment securities portfolio consists of obligations of state and political subdivisions, U.S. federal government agencies such as Government National Mortgage Association ("GNMA") and Small Business Administration ("SBA"), U.S. government-sponsored enterprises ("GSEs") such as Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC), Federal Farm Credit Banks Funding Corporation and FHLB. 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.

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A summary of the amortized cost, fair value and allowance for credit losses related to securities held-to-maturity as of December 31, 2020 and December 31, 2019 is presented below.

(in thousands) Gains (Losses)

Securities of U.S. government-sponsored enterprises:

Securities of U.S. government-sponsored enterprises:

Obligations of state and political subdivisions 3,513 — 3,513 75 — 3,588

Management measures expected credit losses on held-to-maturity securities on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. With regard to MBSs and CMOs issued or guaranteed by the GSEs, and SBA-backed securities, we expect to receive all the contractual principal and interest on these securities as such securities are backed by the full faith and credit of and/or guaranteed by the U.S. government. Accordingly, no allowance for credit losses has been recorded for these securities. With regard to securities issued by states and political subdivisions, management considers (i) issuer and/or guarantor credit ratings, (ii) historical probability of default and loss given default rates for given bond ratings and remaining maturity,(iii) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities, (iv) internal credit review of the financial information, and (v) whether or not such securities have credit enhancements such as guarantees, contain a defeasance clause, or are pre-refunded by the issuers. Based on the comprehensive analysis, no credit losses are expected.

The following table summarizes Moody's and/or Standard & Poor's bond ratings for our portfolio of held-to-maturity securities issued by states and political subdivisions as of December 31, 2020.

(in thousands) Obligations of state and political subdivisions

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A summary of the amortized cost, fair value and allowance for credit losses related to securities available-for-sale as of December 31, 2020 and December 31, 2019 is presented below.

(in thousands) Gains (Losses)

Securities of U.S. government-sponsored enterprises:

Securities of U.S. government-sponsored enterprises:

The amortized cost and fair value of investment debt securities by contractual maturity at December 31, 2020 and 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.

Held-to-Maturity Available-for-Sale Held-to-Maturity Available-for-Sale

As part of our ongoing review of our investment securities portfolio, we reassessed the classification of certain securities issued by government sponsored agencies. During 2018, we transferred $27.4 million, from available-for-sale to held-to-maturity at fair value. We intend and have the ability to hold these securities to maturity. The net unrealized pre-tax loss of $278 thousand, remained in accumulated other comprehensive income and is amortized over the remaining life of the securities along with amortization of any prior transfers. Amortization of the net unrealized pre-tax loss totaled $524 thousand, $445 thousand and $516 thousand in 2020, 2019 and 2018, respectively. There were no securities transferred from available-for-sale to held-to-maturity at fair value in 2020 or 2019.

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

Available-for-sale:

Gross realized losses $ (1) $ (159) $ (106)

Pledged investment securities are shown in the following table.

Pledged to the State of California:

Collateral for trust deposits 751 742

There were 10 and 40 securities in unrealized loss positions at December 31, 2020and 2019, respectively. Those securities are summarized and classified according to the duration of the loss period in the tables below.

Available-for-sale:

Debentures of government-sponsored agencies 3,943 (24) — — 3,943 (24)

Held-to-maturity:

Available-for-sale:

Debentures of government- sponsored agencies 25,228 (70) — — 25,228 (70)

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As of December 31, 2020, the investment portfolio included 5investment securities that had been in a continuous loss position for twelve months or more and 5 investment securities 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.

Our investment in obligations of state and political subdivisions bonds are deemed credit worthy after our comprehensive analysis of the issuers' latest financial information, credit ratings by major credit agencies, and/or credit enhancements.

At December 31, 2020, management determined that it did not intend to sell investment securities with unrealized losses, and it is not more than likely than not that we will have to sell any of the securities with unrealized losses before recovery of their amortized cost. Therefore, no allowance for credit losses has been recognized on available for sale securities in an unrealized loss position as management does not believe any of the securities are impaired due to reasons of credit quality at December 31, 2020.

Non-Marketable Securities

FHLB Capital Stock

As a member of the FHLB, we are required to maintain a minimum investment in FHLB capital stock determined by the Board of Directors of the FHLB. The minimum investment requirements can increase in the event we increase our total asset size or borrowings with the FHLB. Shares cannot be purchased or sold except between the FHLB and its members at the $100 per share par value. We held $11.9 million and $11.7 million of FHLB stock included in other assets on the consolidated statements of condition at December 31, 2020 and 2019, respectively. The carrying amounts of these investments are reasonable estimates of fair value because the securities are restricted to member banks and they do not have a readily determinable market value. Based on our analysis of FHLB’s financial condition and certain qualitative factors, we determined that the FHLB stock was not impaired at December 31, 2020 and 2019. On February 18, 2021, FHLB announced a cash dividend for the fourth quarter of 2020 at an annualized dividend rate of 5.00% to be distributed in mid-March 2021. Cash dividends paid on FHLB capital stock are recorded as non-interest income.

Visa Inc. Class B Common Stock