ITEM 1A. RISK FACTORS
We assume and manage a certain degree of risk in order to conduct our business. The material risks and uncertainties that management believes may affect our business are listed below and in ITEM 7A, Quantitative and Qualitative Disclosure about Market Risk. The list is not exhaustive; additional risks and uncertainties that management is not aware of, or focused on, or currently deems immaterial may also impair business operations. If any of the following risks, or risks that have not been identified, actually occur, our financial condition, results of operations, and stock trading price could be materially and adversely affected. We manage these risks by promoting sound corporate governance practices, which include but are not limited to, establishing policies and internal controls, and implementing internal review processes. Before making an investment decision, investors should carefully consider the risks, together with all of the other information included or incorporated by reference in this Annual Report on Form 10-K and our other filings with the SEC. This report is qualified in its entirety by these risk factors.
Strategic, Financial, and Reputational Risks
Our Business, Results of Operations, and Financial Condition Have Been Adversely Affected by the Ongoing COVID-19 Pandemic
The COVID-19 pandemic has caused significant economic and business disruptions. The extent to which the pandemic impacts our business, results of operations and financial condition depends on future developments, which are uncertain and are difficult to predict and measure, including, but not limited to, the duration and spread of new variants, actions to contain the virus including the timely deployment of effective vaccination and other government-initiated actions or mandates, and how quickly and to what extent normal economic and operating conditions resume, particularly in California. As a result, we are subject to the following risks, which could have a material effect on our business, financial condition, results of operations, capital position and liquidity:
•The COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains, created significant volatility and disrupted financial markets and equity market valuations. These factors could lead to increases in loan delinquencies, problem assets and foreclosures, and closures of businesses, which may increase loan losses.
•Commercial real estate ("CRE") loan demand and credit risk could be adversely affected longer-term by the pandemic due to structural changes relating to remote work trends, continued migration of the workforce outside of metropolitan areas, and business closures. These trends could increase vacancy rates and reduce commercial real estate values.
•Demand for our products and services, including deposits, may decline making it increasingly difficult to grow assets and income.
•The low interest rate environment in 2020 and 2021 has resulted in decreases in yields on our interest-earning assets that exceed the decline in our cost of interest-bearing liabilities and has compressed our net interest margin.
•Our business operations may be disrupted if significant portions of our workforce are unable to work effectively because of illness, quarantines, government actions, and other restrictions in connection with the pandemic.
•Our borrowers' payment performance may be worse than anticipated, as pandemic-related payment deferrals expire. While approximately 94% of our payment relief loans have resumed normal payments, we have no assurance that these borrowers will not require additional payment relief in the future due to the continued impact of the pandemic.
12
Growth Strategy or Potential Mergers and Acquisitions May Produce Unfavorable Outcomes
We seek to expand our franchise safely and consistently. A successful growth strategy requires us to manage multiple aspects of the business simultaneously, such as following adequate loan underwriting standards, balancing loan and deposit growth without compressing our net interest margin, managing interest rate risk, maintaining sufficient capital, and recruiting, training and retaining qualified professionals. Our strategic plan also includes merger and acquisition opportunities, such as the 2021 merger with American River Bankshares, that either enhance our market presence or have potential for improved profitability through financial management, economies of scale or expanded services. We may incur significant acquisition related expenses either during the due diligence phase of acquisition targets or during integration of the acquirees. These expenses have and may continue to negatively impact our earnings prior to realizing the benefits of acquisitions. We may also be exposed to difficulties in combining the operations of acquired institutions into our own operations, which may prevent us from achieving the expected benefits from our acquisition activities. Our earnings, financial condition and prospects after the merger may affect our stock price and will depend in part on our ability to integrate the operations and management of the acquired institution while continuing to implement other aspects of our business plan. Inherent uncertainties exist in integrating the operations of an acquired institution and there is no assurance that we will be able to do so successfully. Among the issues that we could face are:
•unexpected problems with operations, personnel, technology or credit;
•loss of customers and employees of the acquiree;
•difficulty in working with the acquiree's employees and customers;
•the assimilation and integration of the acquiree's operations, culture and personnel;
•instituting and maintaining uniform standards, controls, procedures and policies; and
•litigation risk or obligations not discovered during due diligence.
Undiscovered factors as a result of an acquisition could bring liabilities against us, our management and the management of the institutions we acquire. These factors could contribute to our not achieving the expected benefits from our acquisitions within desired time frames, if at all. Further, although we generally anticipate cost savings from acquisitions, we may not be able to fully realize those savings. Any cost savings may be offset by losses in revenues or other charges to earnings.
Competition with Other Financial Institutions to Attract and Retain Banking Customers
We are facing significant competition for customers from other banks and financial institutions located in the markets that we serve. We compete with commercial banks, savings institutions, credit unions, non-bank financial services companies, including financial technology firms, and other financial institutions operating within or near our service areas. Some of our non-bank competitors and peer-to-peer lenders may not be subject to the same extensive regulations as we are, giving them greater flexibility in competing for business. We anticipate intense competition will continue for the coming year due to the consolidation of many financial institutions and more changes in legislation, regulation and technology. National and regional banks much larger than our size have entered our market through acquisitions and they may be able to benefit from economies of scale through their wider branch networks, more prominent national advertising campaigns, lower cost of borrowing, capital market access and sophisticated technology infrastructures. Further, intense competition for creditworthy borrowers could lead to pressure for loan rate concessions and affect our ability to generate profitable loans.
Going forward, we may see continued competition in the industry as competitors seek to expand market share in our core markets. Further, our customers may withdraw deposits to pursue alternative investment opportunities in the equity market. Technology and other changes have made it more convenient for bank customers to transfer funds into alternative investments or other deposit platforms such as online virtual banks and non-bank service providers. Efforts and initiatives we may undertake to retain and increase deposits, including deposit pricing, can increase our costs. Based on our current strong liquidity position, our adjustment to deposit pricing has lagged the market in a rising interest rate environment. If our customers move money into higher yielding deposits or alternative investments, we may lose a relatively inexpensive source of funds, thus increasing our funding costs through more expensive wholesale funding sources, such as federal funds or FHLB borrowings.
13
We May Not Be Able to Attract and Retain Key Employees
Our success depends in large part on our ability to attract qualified personnel and to retain key employees, as well as the prompt replacement of retiring executives. The loss of key personnel and/or our inability to secure qualified candidates to replace retiring executives could have an unfavorable effect on our business due to the required skills and knowledge of our market and years of industry experience.
Bancorp Relies on Dividends from the Bank to Pay Cash Dividends to its Shareholders as Well as to Meet Other Financial Obligations
Bancorp is a separate legal entity from its subsidiary, the Bank. Bancorp receives substantially all of its cash stream from the Bank in the form of dividends, which is Bancorp's principal source of funds to pay cash dividends to Bancorp's common shareholders, repurchase shares, and cover operational expenses of the holding company. Various federal and state laws and regulations limit the amount of dividends that the Bank may pay to Bancorp. In the event that the Bank is unable to pay dividends to Bancorp, Bancorp may not be able to pay dividends to its shareholders. As a result, it could have an adverse effect on Bancorp's stock price and investment value.
Federal law would prohibit capital distributions from the Bank, with limited exceptions, if the Bank were categorized as "undercapitalized" under applicable Federal Reserve or FDIC regulations. In addition, as a California bank, Bank of Marin is subject to state law restrictions on the payment of dividends. For further information on the distribution limit from the Bank to Bancorp, see the section captioned “Bank Regulation” in ITEM 1 above and “Dividends” in Note 8 to the Consolidated Financial Statements in ITEM 8 of this report.
The Value of Goodwill and Other Intangible Assets May Decline in the Future
As of December 31, 2021, we had goodwill totaling $72.8 million and a core deposit intangible asset totaling $6.6 million from business acquisitions. A significant decline in expected future cash flows, a significant adverse change in the business climate, or a significant and sustained decline in the price of our common stock could necessitate taking charges in the future related to the impairment of goodwill or other intangible assets. If we were to conclude that a future write-down of goodwill or other intangible assets is necessary, we would record the appropriate charge, which could have a material adverse effect on our business, financial condition and results of operations.
We May Take Tax Filing Positions or Follow Tax Strategies That May Be Subject to Challenge
We provide for current and deferred tax provision in our consolidated financial statements based on our results of operations, business activities and business combinations, legal structure and federal and state legislation and regulations. We may take filing positions or follow tax strategies that are subject to interpretation of tax statutes. Our net income may be reduced if a federal, state or local authority were to assess charges for taxes that have not been provided for in our consolidated financial statements. Taxing authorities could change applicable tax laws and interpretations, challenge filing positions or assess new taxes and interest charges. If taxing authorities take any of these actions, our business, results of operations or financial condition could be significantly affected.
Credit Risks
We are Subject to Significant Credit Risk and Loan Losses May Exceed Our Allowance for Credit Losses in the Future
The operation of our business requires us to manage credit risk. As a lender, we are exposed to the risk that our borrowers will be unable to repay their loans according to their terms, and that the collateral securing repayment of their loans, if any, may not be sufficient to ensure repayment. In addition, there are risks inherent in making any loan, including risks with respect to the period of time over which the loan may be repaid, risks relating to proper loan underwriting, risks resulting from changes in economic and industry conditions and risks inherent in dealing with individual borrowers. In order to successfully manage credit risk, we must, among other things, maintain disciplined and prudent underwriting standards and ensure that our bankers follow those standards. The weakening of these standards for any reason, such as an attempt to attract higher yielding loans, a lack of discipline or diligence by our employees in underwriting and monitoring loans, the inability of our employees to adequately adapt policies and procedures to changes in economic or any other conditions affecting borrowers and the quality of our
14
loan portfolio, may result in loan defaults, foreclosures and additional charge-offs and may necessitate that we significantly increase our allowance for credit losses on loans, each of which could adversely affect our net income. As a result, any inability to successfully manage credit risk could have a material adverse effect on our business, financial condition or results of operations.
We maintain allowances for credit losses on loans and unfunded loan commitments that represent management's best estimate of expected credit losses over the contractual lives of our loans under the current expected credit loss method. The level of the allowance reflects management's continuous evaluation of specific credit risks, loan loss experience, current loan portfolio quality and present and forecasted economic, political and regulatory conditions. The determination of the appropriate level of the allowances inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and trends and future economic forecasts, all of which may undergo material changes. Inaccurate assumptions in appraisals or an inappropriate choice of the valuation techniques may lead to an inadequate level of specific reserve or charge-offs.
The Small to Medium-sized Businesses that we Lend to may have Fewer Resources to Weather Adverse Economic and Other Developments, which may Impair a Borrower's Ability to Repay a Loan
We focus our business development and marketing strategy primarily on small to medium-sized businesses. Small to medium-sized businesses frequently have smaller market shares than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience substantial volatility in operating results, any of which may impair a borrower's ability to repay a loan. In addition, the success of a small and medium-sized business often depends on the management talents and efforts of one or two people or a small group of people, and the death, disability or resignation of one or more of these people could adversely affect the business and its ability to repay its loan. If general economic conditions negatively affect the California markets in which we operate and small to medium-sized businesses are adversely affected or our borrowers are otherwise affected by adverse business developments, our business, financial condition and results of operations may be negatively affected.
Negative Conditions Affecting Real Estate May Harm Our Business and Our Commercial Real Estate Concentration May Heighten Such Risk
Concentration of our lending activities in the California real estate sector could negatively affect our results of operations if adverse changes in our lending area occur. We do not offer traditional first mortgages, nor have sub-prime or Alt-A residential loans or significant amounts of securities backed by such loans in the portfolios. As of December 31, 2021, approximately 86% of our loans were secured by real estate, with CRE comprising 75% and residential real estate the remaining 25%. Real estate valuations are influenced by demand, and demand is driven by economic factors such as employment rates and interest rates.
Loans secured by CRE include those secured by office buildings, owner-user office/warehouses, mixed-use commercial and retail properties. There can be no assurance that properties securing our loans will generate sufficient cash flows to allow borrowers to make full and timely loan payments to us. During the COVID-19 pandemic, many small businesses closed and may not reopen. Some pandemic-driven activity, such as shifts from in-person to online shopping and from office-based to remote work, may prove to be permanent. These shifts could impact the demand for CRE and also put persistent downward pressure on CRE valuations.
Rising CRE lending concentrations may expose institutions to unanticipated earnings and capital volatility in the event of adverse changes in the CRE market. Concentration risk exists when financial institutions deploy too many assets to any one industry or segment. Concentration stemming from commercial real estate is one area of regulatory concern. The CRE Concentration Guidance provides supervisory criteria, including the following numerical indicators, to assist bank examiners in identifying banks with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny: (i) commercial real estate loans exceeding 300% of capital and increasing 50% or more in the preceding three years; or (ii) construction and land development loans exceeding 100% of capital. The CRE Concentration Guidance does not limit banks’ levels of commercial real estate lending activities, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. As of December 31, 2021 and 2020, using regulatory definitions in the CRE Concentration Guidance, our CRE loans represented 332% and 314%, respectively, of our total risk-based capital. We are actively working to manage our CRE concentration and we have discussed the CRE Concentration Guidance with the regulatory agencies and believe that our
15
underwriting policies, management information systems, independent credit administration process, and monitoring of real estate loan concentrations are currently sufficient to address the CRE Concentration Guidance.
Accounting Estimates and Risk Management Processes Rely on Analytical and Forecasting Models
The processes we use to estimate expected credit losses on loans and investment securities, and to measure the fair value of financial instruments, as well as the processes used to estimate the effects of changing interest rates and other market measures on our financial condition and results of operations, depends upon the use of analytical and forecasting models. These models reflect assumptions that may not be accurate, particularly in times of market volatility or other unforeseen circumstances. Even if these assumptions are adequate, the models may prove to be inadequate or inaccurate because of other flaws in their design or their implementation. If the models we use for interest rate risk and asset-liability management are inadequate, we may incur increased or unexpected losses upon changes in market interest rates or other market factors. If the models we use for determining our expected credit losses on loans and investment securities are inadequate, the allowance for credit losses may not be sufficient to support future charge-offs. If the models we use to measure the fair value of financial instruments are inadequate, the fair value of such financial instruments may fluctuate unexpectedly or may not accurately reflect what we could realize upon sale or settlement of such financial instruments. Any such failure in our analytical or forecasting models could have a material adverse effect on our business, financial condition and results of operations.
Investment Securities May Lose Value due to Credit Quality of the Issuers
We invest in significant portions of debt securities issued by government-sponsored enterprises ("GSE"), such as Federal Home Loan Bank ("FHLB"), Federal National Mortgage Association (“FNMA”), and Federal Home Loan Mortgage Corporation ("FHLMC"). We also hold mortgage-backed securities (“MBS”) issued by FNMA and FHLMC, both of which have been under U.S. government conservatorship since 2008. While we consider FNMA and FHLMC securities to have low credit risk as they carry the explicit backing of the U.S. government due to the conservatorship, they are not direct obligations of the U.S. government. The fair value of our securities issued or guaranteed by these two GSE entities may be negatively impacted if the U.S. government ceases to provide support to the conservatorship or phases out its current practice of purchasing treasury and agency mortgage-backed securities. GSE debt is sponsored but not guaranteed by the federal government and carries implicit backing, whereas government agencies such as Government National Mortgage Association ("GNMA") are divisions of the government whose securities are backed by the full faith and credit of the U.S. government.
Although Congress has taken steps to improve regulation and consumer protection related to the housing finance system (e.g., Dodd-Frank Act), FNMA and FHLMC have entered their 14th year of U.S. government conservatorship via the Federal Housing Finance Agency (the "FHFA"). While proposals to end the conservatorship have considered solutions such as an initial public offering, at the date of this report, its future and ultimate impact on the financial markets and our investments in GSEs are uncertain.
While we generally seek to minimize our exposure by strategically diversifying our credit exposure to obligations of issuers in various geographic locations throughout California and the U.S., investing in investment grade securities and actively monitoring the credit worthiness of the issuers and/or credit guarantee providers, there is no guarantee that the issuers will remain financially sound or continue their payments on these debentures.
Market, Interest Rate, and Liquidity Risks
Earnings are Significantly Influenced by General Business and Economic Conditions
Our success depends, to a certain extent, on local, national and global economic and political conditions. Unlike larger national or other regional banks that are more geographically diversified, we provide banking and financial services to customers primarily in Northern California with particular focus on the local markets in the San Francisco Bay and Greater Sacramento regions. The local economic conditions in these areas have a significant impact on the demand for our products and services as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposits as our primary funding source. Economic pressure on consumers and uncertainty regarding the economy and local business climate may result in changes in consumer and business spending, borrowing and saving habits, which may affect the demand for loans and other products
16
and services we offer. Further, loan defaults that adversely affect our earnings correlate highly with deteriorating economic conditions (such as the California unemployment rate and California gross domestic product), which impact our borrowers' creditworthiness. In addition, health epidemics or pandemics (or expectations about them) such as the novel coronavirus (aka "COVID-19"), international trade disputes, inflation risks, oil price volatility, the level of U.S. debt and global economic conditions could destabilize financial markets in which we operate. Lastly, actions of the Federal Open Market Committee ("FOMC") of the Federal Reserve could cause financial market volatility, which will affect the pricing of our loan and deposit products.
Interest Rate Risk is Inherent in Our Business
Our earnings are largely dependent upon our net interest income, which is the difference between interest income earned on interest-earning assets, such as loans and securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are sensitive to many factors outside of our control, including general economic conditions and the policies of various governmental and regulatory agencies and, in particular, the FOMC, which regulates the supply of money and credit in the United States. Changes in monetary policy, including changes in interest rates, can influence not only the interest we receive on loans and securities and interest we pay on deposits and borrowings, but can also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, and (iii) the duration of our securities and loan portfolios. Our portfolio of loans and securities will generally decline in value if market interest rates increase, and increase in value if market interest rates decline. In addition, our loans and callable mortgage-backed securities are also subject to prepayment risk when interest rates fall, and the borrowers' credit risk may increase in rising rate or recessionary environments. Factors such as inflation, productivity, oil prices, unemployment rates, and global demand play a role in the FOMC's consideration of future rate adjustments. In March 2020, in response to the evolving risks to economic activity posed by the COVID-19 pandemic, the FOMC made two emergency cuts to the federal funds rate totaling 150 basis points to a current target range of 0.0% to 0.25%. This has put downward pressure on our asset yields and net interest margin. Our net interest income is vulnerable to low interest rates and will benefit if prevailing market rates increase. See the Net Interest Income section of Management's Discussion and Analysis of Financial Condition and Results of Operations in ITEM 7 and Quantitative and Qualitative Disclosures about Market Risk in ITEM 7A of this report for further discussion related to management of interest rate risk.
A Lack of Liquidity could Adversely Affect our Operations and Jeopardize our Business, Financial Condition and Results of Operations
Liquidity is essential to our business. We rely on our ability to generate deposits and effectively manage the repayment and maturity schedules of our loans and investment securities, respectively, to ensure that we have adequate liquidity to fund our operations. An inability to raise funds through deposits, borrowings, securities sales, Federal Home Loan Bank advances, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our most important source of funding consists of deposits. Deposit balances can decrease when customers perceive alternative investments provide a better risk/return trade-off. If customers move money out of bank deposits and into other investments, then we would lose a relatively low-cost source of funds, increasing our funding costs and reducing our net interest income and net income.
Other primary sources of funds consist of cash flows from operations, investment maturities and sales, loan repayments, and proceeds from the issuance and sale of any equity and debt securities to investors. Additional liquidity is provided by the ability to borrow from the Federal Reserve Bank of San Francisco and the Federal Home Loan Bank and our ability to raise brokered deposits. We also may borrow funds from third-party lenders, such as other financial institutions. Our access to funding sources in amounts adequate to finance or capitalize our activities, or on terms that are acceptable to us, could be impaired by factors that affect us directly or the bank or non-bank financial services industries or the economy in general, such as disruptions in the financial markets or negative views and expectations about the prospects for the bank or non-bank financial services industries.
Based on experience, we believe that our deposit accounts are relatively stable sources of funds. If we increase interest rates paid to retain deposits, our earnings may be adversely affected, which could have an adverse effect on our business, financial condition and results of operations.
Any decline in available funding could adversely affect our ability to originate loans, invest in securities, meet our expenses, and pay dividends to our shareholders or fulfill obligations such as repaying our borrowings or meeting
17
deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, financial condition and results of operations.
Activities of Our Large Borrowers and Depositors May Cause Unexpected Volatilities in Our Loan and Deposit Balances, as well as Net Interest Margin
Loans originated at higher interest rates may be paid off and replaced by new loans with lower interest rates, causing downward pressure on our net interest margin. In addition, our top ten depositor relationships accounted for approximately 11% and 10% of our total deposit balances at December 31, 2021 and 2020, respectively. Since the start of the pandemic in 2020, the banking industry in general has experienced abundant liquidity driven by pandemic-related government programs such as PPP and consumer stimulus checks as well as elevated savings by depositors. This trend may reverse as the economy recovers. In addition, the business models and cash cycles of some of our large commercial depositors may also cause short-term volatility in their deposit balances held with us. As our customers' businesses grow, the dollar value of their daily activities may also grow leading to larger fluctuations in daily balances. Any long-term decline in deposit funding would adversely affect our liquidity. For additional information on our management of deposit volatility, refer to the Liquidity section of ITEM 7, Management's Discussion and Analysis, of this report.
Unexpected Early Termination of Interest Rate Swap Agreements May Affect Earnings
We have entered into interest-rate swap agreements, primarily as an asset/liability risk management tool, in order to mitigate the interest rate risk that causes fluctuations in the fair value of specified long-term fixed-rate loans or firm commitments to originate long-term fixed rate loans. In the event of default by the borrowers on our hedged loans, we may have to terminate these designated interest-rate swap agreements early, resulting in market value losses that could negatively affect our earnings.
The Trading Volume of Bancorp's Common Stock May Be Less than That of Other, Larger Financial Services Companies
Our common stock is listed on the Nasdaq Capital Market exchange. Our trading volume is less than that of nationwide or larger regional financial institutions. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence of willing buyers and sellers of common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the low trading volume of our common stock, significant trades of our stock in a given time, or the expectations of these trades, could cause volatility in the stock price.
We are Subject to Uncertainty from the Transition of London Interbank Offered Rate ('LIBOR") as a Reference Rate
LIBOR has been one of the most widely used global interest rate benchmark deeply embedded in global financial products. The long-term viability of LIBOR has been undermined due to cases of rate manipulation, low volumes for underlying interbank transactions and the reluctance of panel banks to submit quotes used to calculate LIBOR. As a result, the Financial Conduct Authority of the United Kingdom (the “FCA”) announced that the most commonly used U.S. dollar ("USD") LIBOR rates will either cease to be published or no longer be deemed representative after June 30, 2023. 1-week and 2-month USD LIBOR ceased to be published as of December 31, 2021. The Alternative Reference Rates Committee (“ARRC”), a steering committee comprised of U.S. financial market participants selected by the Federal Reserve Bank of New York, published recommended fall-back language for LIBOR-linked financial instruments and recommended alternatives for certain LIBOR rates (e.g., Secured Overnight Financing Rate (“SOFR”), a broad measure of the cost of overnight borrowings collateralized by Treasury securities, for USD LIBOR). The federal banking agencies have issued guidance requesting banking organizations cease using LIBOR as a reference rate in new contracts by December 31, 2021.
As of December 31, 2021, we had twenty-five investment securities with book values totaling $43.2 million, seven loans totaling $11.5 million, and four interest rate swap contracts with notional values of $13.0 million indexed to LIBOR. Almost all of our LIBOR-indexed investment securities were issued by GSEs who are members of ARRC and have transition strategies and timelines for their legacy LIBOR-indexed investment products, including fall-back rates tied to 30-day average SOFR or Term SOFR. We discontinued originating LIBOR-based loans effective
18
December 31, 2021. Loans currently indexed to LIBOR either have contractual fall-back rates or will be negotiated using replacement indices such as SOFR or Bloomberg Short-Term Bank Yield Index ("BSBY"), a benchmark developed by Bloomberg Professional Services. In addition, our interest rate swap agreements can either be subject to the fall-back index rate stipulated by the ISDA protocol or modified to other reference rates such as Prime or SOFR as mutually agreed by us and our counterparty.
While management has identified financial instruments indexed to LIBOR and evaluated contracts and index alternatives, we cannot predict any favorable or unfavorable effects the chosen alternative index may have on financial instruments that are currently indexed to LIBOR after its termination date.
Operational Risks
Risks Associated with Cybersecurity Could Negatively Affect Our Earnings and Reputation
Our business requires the secure management of sensitive client and bank information. We work diligently to implement security measures that intend to make our communications and information systems safe to conduct business. Cyber threats such as social engineering, ransomware, and phishing emails are more prevalent now than ever before. These incidents include intentional and unintentional events that may present threats designed to disrupt operations, corrupt data, release sensitive information or cause denial-of-service attacks. A cybersecurity breach of systems operated by the Bank, merchants, vendors, customers, or externally publicized breaches of other financial institutions may significantly harm our reputation, result in a loss of customer business, subject us to regulatory scrutiny, or expose us to civil litigation and financial liability. While we have systems and procedures designed to prevent security breaches, we cannot be certain that advances in criminal capabilities, physical system or network break-ins or inappropriate access will not compromise or breach the technology protecting our networks or proprietary client information. If a material security breach were to occur, the Bank has policies and procedures in place to ensure timely disclosure.
The Financial Services Industry is Undergoing Rapid Technological Changes and, As a Result, We Have a Continuing Need to Stay Current with Those Changes to Compete Effectively and Increase Our Efficiencies. We May Not Have the Resources to Implement New Technology to Stay Current with These Changes
The financial services industry is undergoing technological changes with frequent introductions of new technology-driven products and services. In addition to providing better client service, the effective use of technology increases efficiency and reduces operational costs. Our future success will depend in part upon our ability to use technology to provide products and services that will satisfy client demands securely and cost-effectively. In connection with implementing new technology enhancements and/or products, we may experience operational challenges (e.g. human error, system error, incompatibility) which could result in us not fully realizing the anticipated benefits from such new technology or require us to incur significant costs to remedy any such challenges in a timely manner.
Severe Weather, Natural Disasters or Other Climate Change Related Matters Could Significantly Affect Our Business
Our primary market is located in both earthquake and wildfire-prone zones in Northern California, which is also subject to other weather or disasters, such as severe rainstorms, drought or flood. These events have interrupted our business operations unexpectedly (e.g., PG&E power shutoff's in the North Bay and Sacramento Region) at times. Climate-related physical changes and hazards could also pose credit risks for us. For example, our borrowers may have collateral properties or operations located in areas at risk of wildfires, or coastal areas at risk to rising sea levels and erosion, or subject to the risk of drought in California. The properties pledged as collateral on our loan portfolio could also be damaged by tsunamis, landslides, floods, earthquakes or wildfires and thereby the recoverability of loans could be impaired. A number of factors can affect credit losses, including the extent of damage to the collateral, the extent of damage not covered by insurance, the extent to which unemployment and other economic conditions caused by the natural disaster adversely affect the ability of borrowers to repay their loans, and the cost of collection and foreclosure to us. Additionally, there could be increased insurance premiums and deductibles, or a decrease in the availability of coverage, due to severe weather-related losses. The ultimate outcome on our business of a natural disaster, whether or not caused by climate change, is difficult to predict.
19
We Rely on Third-Party Vendors for Important Aspects of Our Operation
We depend on the accuracy and completeness of information and systems provided by certain key vendors, including but not limited to data processing, payroll processing, technology support, investment safekeeping and accounting. For example, we outsource core processing to Fidelity Information Services ("FIS") and wire processing to Finastra, which are leading financial services solution providers that allow us access to competitive technology offerings without having to invest in their development. Our ability to operate, as well as our financial condition and results of operations, could be negatively affected in the event of an interruption of an information system, an undetected error, a cyber-breach, or in the event of a natural disaster whereby certain vendors are unable to maintain business continuity.
Regulatory and Compliance Risks
Banks and Bank Holding Companies are Subject to Extensive Government Regulation and Supervision
Bancorp and the Bank are subject to extensive federal and state governmental supervision, regulation and control. Holding company regulations affect the range of activities in which Bancorp is engaged. Banking regulations affect the Bank's lending practices, capital structure, investment practices, dividend policy, and compliance costs among other things. Compliance risk is the current and prospective risk to earnings or capital arising from violations of, or non-conformance with, laws, rules, regulations, prescribed practices, internal policies and procedures, or ethical standards set forth by regulators. Compliance risk also arises in situations where the laws or rules governing certain bank products or activities of our clients may be ambiguous or untested. This risk exposes Bancorp and the Bank to potential fines, civil money penalties, payment of damages and the voiding of contracts. Compliance risk can lead to diminished reputation, reduced franchise value, limited business opportunities, reduced expansion potential and an inability to enforce contracts. The Bank manages these risks through its extensive compliance plan, policies and procedures. For further information on supervision and regulation, see the section captioned “SUPERVISION AND REGULATION” in ITEM 1 of this report.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None
ITEM 2. PROPERTIES
We lease our corporate headquarters building in Novato, California, which houses loan production, operations, Wealth Management & Trust and administration. We lease branch and office facilities within our primary market areas in the cities of Corte Madera, San Rafael, Novato, Sausalito, Mill Valley, Tiburon, Greenbrae, Petaluma, Santa Rosa, Healdsburg, Sonoma, Napa, San Francisco, Alameda, Oakland, Walnut Creek, San Mateo, Gold River, Jackson, Pioneer, Roseville, and Sacramento. For additional information on properties, Refer to Note 4, Bank Premises and Equipment, and Note 12, Commitment and Contingencies, in ITEM 8 of this report.
ITEM 3. LEGAL PROCEEDINGS
For information on litigation matters, see Note 12, Commitment and Contingencies, in ITEM 8 of this report.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
20
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information and Holders
Bancorp's common stock trades on the Nasdaq Capital Market under the symbol BMRC. At February 28, 2022, 15,939,659 shares of Bancorp's common stock, no par value, were outstanding and held by approximately 2,900 holders of record and beneficial owners.
Five-Year Stock Price Performance Graph
The following graph, compiled by S&P Global Market Intelligence of New York, New York, shows a comparison of cumulative total shareholder return on our common stock during the five fiscal years ended December 31, 2021 compared to the Russell 2000 Stock index and the S&P Regional Banks Select Industry Index. The comparison assumes the investment of $100 in our common stock on December 31, 2016 and the reinvestment of all dividends. The graph represents past performance and does not indicate future performance. In addition, total return performance results vary depending on the length of the performance period.
Source: S&P Global Market Intelligence
1 The index comprises stocks in the S&P Total Market Index that are classified in the Global Industry Classification Standard regional banks sub-industry.
21
Shareholder Rights Agreement
On July 6, 2017, Bancorp executed a shareholder rights agreement (“Rights Agreement”), which is designed to discourage takeovers that involve abusive tactics or do not provide fair value to shareholders. For further information, see Note 8 to the Consolidated Financial Statements, under the heading “Preferred Stock and Shareholder Rights Plan” in ITEM 8 of this report.
Securities Authorized for Issuance under Equity Compensation Plans
The following table summarizes information as of December 31, 2021, with respect to equity compensation plans.
1 Represents shares of common stock issuable upon exercise of outstanding options under the Bank of Marin Bancorp 2017 Equity Plan and 2007 Equity Plan.
2 Represents remaining shares of common stock available for future grants under the 2017 Equity Plan and the 2020 Director Stock Plan, excluding 315,744 shares to be issued upon exercise of outstanding options and 377,475 shares available to be issued under the Employee Stock Purchase Plan.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
On April 23, 2018, Bancorp announced that its Board of Directors approved a Share Repurchase Program under which Bancorp may repurchase up to $25.0 million of its outstanding common stock through May 1, 2019. Bancorp's Board of Directors subsequently extended the Share Repurchase Program through February 28, 2020. A new Share Repurchase Program was approved by the Board of Directors on January 24, 2020, which began on March 1, 2020 and allowed Bancorp to repurchase up to $25.0 million of its outstanding common stock and ended May 2021. On July 16, 2021, Bancorp Board of Directors approved a share repurchase program under which Bancorp could repurchase up to $25.0 million of its outstanding common stock through July 31, 2023. On October 22, 2021, Bancorp's Board of Directors approved an amendment to the current share repurchase program, which increased the total authorization from $25.0 million to $57.0 million and left the expiration date unchanged.
Shares repurchased pursuant to our common stock share repurchase programs during 2021, 2020 and 2019, were as follows.
The following table reflects purchases under the Share Repurchase Program for the months presented in 2021.
Period
22
ITEM 6. [RESERVED]
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of financial condition as of December 31, 2021 and 2020 and results of operations for each of the years in the three-year period ended December 31, 2021 should be read in conjunction with our consolidated financial statements and related notes thereto, included in Part II ITEM 8 of this report.
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 Estimates
Critical accounting estimates are those estimates made in accordance with generally accepted accounting principles that involve a significant level of estimation and uncertainty and have had or are reasonably likely to have a material impact on our financial condition and results of operations. We consider accounting estimates to be critical to our financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain, (ii) management could have applied different assumptions during the reported period, and (iii) changes in the accounting estimate are reasonably likely to occur in the future and could have a material impact on our financial statements. Management has determined the following accounting estimates and related policies to be critical:
Allowance for Credit Losses on Loans and Unfunded Commitments
The allowance for credit losses on loans 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. The allowance for losses on unfunded loan commitments is based on estimates of probability that these commitments will be drawn upon according to historical utilization experience, expected loss severity and loss rates as determined for pooled funded loans. The allowance for credit losses on unfunded commitments is a liability account included in interest payable and other liabilities. Management estimates these allowances quarterly using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Credit loss experience among the Bank and peer groups provides the basis for the estimation of expected credit losses.
The allowance for credit losses ("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 generally correspond to federal regulatory reporting codes. In addition, 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.
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.
Our allowance model is particularly sensitive to forecasted and seasonally-adjusted actual California unemployment rates, which decreased to 6.5% at December 31, 2021 from 9.3% at December 31, 2020. The ACL model incorporates a one-year forecast. For periods beyond the forecast horizon the economic factors revert to historical averages on a straight-line basis over a one-year period. We performed a sensitivity analysis as of December 31, 2021 and determined that a 1% change (e.g., 5.5% to 6.5%) in the forecasted quarterly unemployment rates over the next four quarters resulted in an 8% change to our allowance for credit losses on loans. This impact does not consider other assumption changes to either the quantitative factors, such as probability of default, loss given
23
default, loan mix or cash flows, prepayment/curtailment rates, and individually analyzed loans, or qualitative factors as discussed in Note 1 - Summary of Significant Accounting Policies. Additionally, because current economic conditions and forecasts can change, as future events are inherently difficult to predict, the estimated credit losses on loans and unfunded commitments could change significantly.
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. For information regarding critical estimates related to our allowance for credit losses methodology, the provision for credit losses, and risks to asset quality and lending activity, 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,
Income Taxes
We are subject to the income tax laws of the U.S., its states, and the municipalities in which we operate. These tax laws are complex and subject to different interpretations by us and the government taxing authorities. We review our provision for income tax expense monthly and calculate the carrying value of deferred tax assets and liabilities quarterly. In establishing a provision for income tax expense, we make judgments and interpretations about the application of these inherently complex tax laws. In addition, our estimates include making judgements about when future items will affect taxable income. Although management believes that the judgments and estimates used are reasonable, actual results could differ and we may be exposed to losses or gains that could be material. For further 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
We use fair value measurements to record certain financial instruments and to determine fair value disclosures. Available-for-sale securities and interest rate swap agreements are financial instruments recorded at fair value on a recurring basis. Additionally, we record at fair value other financial assets on a nonrecurring basis such as collateral dependent loans and other real estate owned. These nonrecurring fair value adjustments typically involve write-downs of, or specific reserves against, individual assets. We group our assets and liabilities that are measured at fair value into three levels within the fair value hierarchy, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used in the measurement are observable or unobservable. Observable inputs reflect market-driven or market-based information obtained from independent sources, while unobservable inputs reflect our estimates about market data. The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market data. For financial instruments that trade actively and have quoted market prices or observable market data, there is minimal subjectivity involved in measuring fair value. When observable market prices and data are not fully available, management judgment is necessary to estimate fair value. In addition, changes in the market conditions may reduce the availability of quoted prices or observable data. Therefore, when market data is not available, we use valuation techniques that require more management judgment to estimate the appropriate fair value measurement. Fair value is discussed further in 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.
Business Combinations
Business combinations are accounted for using the acquisition method of accounting where the assets and liabilities of the acquired entities have been recorded at their estimated fair values at the date of acquisition. Goodwill represents the excess of the purchase price over the fair value of net assets acquired. The purchase price allocation process requires significant judgment in the estimation of the fair values of the assets acquired and the liabilities assumed. Management may obtain third-party valuations such as appraisals or discounted cash flow analyses, or we may derive fair values internally using techniques as discussed in Fair Value Measurements above. Management assesses qualifications of third-party valuation specialists, reviews assumptions applied and takes responsibility for the results of fair value estimates. Merger-related expenses include costs directly related to
24
merger activity such as legal and professional fees, system consolidation and conversion costs, and compensation costs associated with employee severance and retention incentives. We account for merger-related costs as expenses in the periods in which the costs are incurred and the services received. Accounting policies and estimates are discussed further in Note 1 - Summary of Significant Accounting Policies and Note 18 - Merger in ITEM 8 - Financial Statements and Supplementary Data of this Form 10-K.
25
RESULTS OF OPERATIONS
Financial Highlights
The following are highlights of our financial condition and results of operations. The data was derived from the audited consolidated financial statements of Bank of Marin Bancorp.
At December 31,
(dollars in thousands, except per share data) 2021 2020
Selected financial condition data:
Borrowings and other obligations $ 419 $ 58
Subordinated debenture $ — $ 2,777
Asset quality ratios:
Allowance for credit losses to total loans 1.02 % 1.10 %
Allowance for credit losses to non-accrual loans 3 2.75x 2.48x
Non-accrual loans to total loans 3 0.37 % 0.44 %
Capital ratios:
Tangible common equity to tangible assets 4 8.76 % 11.27 %
Total capital (to risk-weighted assets) 14.58 % 16.03 %
Tier 1 capital (to risk-weighted assets) 13.70 % 14.82 %
Tier 1 capital (to average assets) 8.85 % 10.80 %
Common equity Tier 1 capital (to risk-weighted assets) 13.70 % 14.69 %
Other data:
Number of branches 31 22
Full time equivalent employees 328 289
For the Years Ended December 31,
Selected operating data:
Net income per common share:
Performance and other financial ratios:
Tax-equivalent net interest margin 6 3.17 % 3.55 % 3.98 %
Cash dividend payout ratio on common stock 7 40.52 % 41.07 % 31.87 %
Cash dividends per common share $ 0.94 $ 0.92 $ 0.80
26
Executive Summary
Annual earnings were $33.2 million in 2021 compared to $30.2 million in 2020. Diluted earnings were $2.30 per share in 2021, compared to $2.22 per share in 2020.
The following are highlights of operating and financial performance for the year ended December 31, 2021:
•Merger-related one-time and conversion costs reduced net income by $4.9 million, net of taxes, or 34 cents per share for the year ended December 31, 2021. Return on average assets ("ROA") and return on average equity ("ROE") were also significantly impacted by provisions for credit losses on acquired loans and shares issued in conjunction with the merger. As shown in the reconciliation of GAAP to non-GAAP financial measures on page 28, year-to-date ROA of 0.94% and ROE 8.43% would have been 1.08% and 9.67%, respectively, compared to 1.04% and 8.60% in the prior year.
•Loans increased $167.1 million in 2021, or 8%, to $2.256 billion at December 31, 2021, from $2.089 billion at December 31, 2020. Year-over-year growth was largely attributable to $419.4 million in loans from the American River Bank ("ARB") acquisition on August 6, 2021. Non-PPP loan originations of $181.7 million for the year were concentrated in commercial and real estate loans and compared to $165.5 million in 2020. Payoffs included $218.1 million non-PPP loans compared to $169.2 million in 2020. In 2021, PPP loan originations were $136.2 million and PPP loans forgiven and paid off were $328.5 million.
•Credit quality remains strong with non-accrual loans representing 0.37% of the Bank's loan portfolio as of December 31, 2021, compare to 0.44% at December 31, 2020. During 2021, we reversed $1.4 million in credit losses on loans and $992 thousand in credit losses on unfunded commitments. These reversals compared to provisions for credit losses on loans of $4.6 million and provisions for credit losses on unfunded commitments of $1.6 million in the prior year. 2021 activity included the effects of the business combination with ARB, partially offset by ongoing improvements in the underlying economic forecasts. 2020 credit loss provisions included significant qualitative adjustments for uncertainties associated with the COVID-19 pandemic as well as the adoption of the current expected credit loss methodology.
•Deposits grew $1.304 billion, or 52%, to $3.809 billionat December 31, 2021, compared to $2.504 billion at December 31, 2020. Growth was comprised of $790.0 million related to the August 6, 2021 ARB acquisition, new accounts and growth in the existing customer base. Non-interest bearing deposits grew by $555.6 million, or 41%, in 2021 and made up 50% of total deposits at year end. Cost of deposits remained low at 0.07% for the full year of 2021, down from 0.11% in 2020. Additionally, as part of our liquidity management, the Bank maintained $173.1 million and $173.4 million in off-balance sheet deposits with deposit networks at December 31, 2021 and 2020, respectively.
•Net interest income totaled $105.0 million and $96.7 million in 2021 and 2020, respectively. The $8.3 million increase in 2021 was primarily due to higher average loan and investment securities balances and higher SBA PPP loan fee accretion income. These increases were partially offset by $1.3 million in accelerated discount accretion on the early redemption of a subordinated debenture in the first quarter of 2021, and lower yields on investment securities. The tax-equivalent net interest margin decreased by 38 basis points to 3.17% in 2021, compared to 3.55% in 2020 for the reasons already mentioned.
•The efficiency ratio was 63.12% in 2021, up from 55.56% in 2020. As shown in the reconciliation of GAAP to non-GAAP financial measures on page 28, the 2021 efficiency ratio excluding merger-related one-time and conversion costs would have been 57.51%.
•All capital ratios were above regulatory requirements for a well-capitalized institution. The total risk-based capital ratio for Bancorp was 14.6% at December 31, 2021 and 16.0% at December 31, 2020. Tangible common equity to tangible assets declined to 8.8% at December 31, 2021 from 11.3% at December 31, 2020 primarily due to share repurchases and growth in excess liquidity from an increase in legacy Bank of Marin deposits (refer to footnote 4 on page 26 for definition of this non-GAAP financial measure). The total risk-based capital ratio for the Bank was 14.4% at December 31, 2021 and 15.8% at December 31, 2020.
27
•The Board of Directors declared a cash dividend of $0.24 per share on January 21, 2022. This is the 67th consecutive quarterly dividend paid by Bank of Marin Bancorp. The cash dividend is payable on February 11, 2022 to shareholders of record at the close of business on February 4, 2022.
Statement Regarding Use of Non-GAAP Financial Measures
In this Form 10-K, Bancorp's financial results are presented in accordance with GAAP and refer to certain non-GAAP financial measures. Management believes that presentation of operating results using non-GAAP financial measures provides useful supplemental information to investors and facilitates the analysis of Bancorp's operating results and comparison of operating results across reporting periods. Management also uses non-GAAP financial measures to establish budgets and manage Bancorp's business. A reconciliation of the GAAP financial measures to comparable non-GAAP financial measures is presented below.
Reconciliation of GAAP and Non-GAAP Financial Measures
Year ended December 31,
Net income
Merger-related one-time and conversion costs:
Personnel and severance 3,005 — —
Professional services 1,976 — —
Data processing 1,127 — —
Total merger costs before tax benefits 6,458 — —
Income tax benefit of merger-related expenses (1,547) — —
Diluted earnings per share
Diluted earnings per share (GAAP) $ 2.30 $ 2.22 $ 2.48
Merger-related one-time and conversion costs, net of tax benefits 0.34 — —
Comparable diluted earnings per share (non-GAAP) $ 2.64 $ 2.22 $ 2.48
Return on average assets
Return on average assets (GAAP) 0.94 % 1.04 % 1.34 %
Comparable return on average assets (non-GAAP) 1.08 % 1.04 % 1.34 %
Return on average equity
Return on average equity (GAAP) 8.43 % 8.60 % 10.49 %
Comparable return on average equity (non-GAAP) 9.67 % 8.60 % 10.49 %
Efficiency ratio
Merger-related expenses (6,458) — —
Comparable efficiency ratio (non-GAAP) 57.51 % 55.56 % 55.21 %
28
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 optimizing 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.
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 3.04 % 3.41 % 3.74 %
29
Analysis 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.
2021 Compared to 2020
Net interest income totaled $105.0 million and $96.7 million in 2021 and 2020, respectively. The $8.3 million increase in 2021 was primarily due to higher average loan and investment securities balances and higher SBA PPP loan income. These increases were partially offset by $1.3 million in accelerated discount accretion on the early redemption of a subordinated debenture in the first quarter of 2021, and lower yields on investment securities.
We recognized $8.3 million in SBA PPP fees, net of cost in 2021, compared to $3.8 million in 2020. As of December 31, 2021, $2.5 million SBA PPP fees, net of deferred costs remained outstanding and will be recognized into income in future periods.
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 subordinated debenture carried an average interest rate of 5.68% in 2020.
The tax-equivalent net interest margin decreased 38 basis points to 3.17% in 2021, from 3.55% in 2020 for the reasons already mentioned and as shown in the above table. The SBA PPP loans improved the 2021 net interest margin by 10 basis points, and the early redemption of the subordinated debenture reduced it by 4 basis points.
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.
30
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% in 2021 and 2020, putting downward pressure on our asset yields and net interest margin. In its January 26, 2022 meeting the FOMC kept the federal funds target rate range between 0.0% to 0.25%, but signaled that it will raise interest rates in 2022 to combat inflation. Our net interest margin should benefit from a rising interest rate environment. See ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk for further information.
Provision for Credit Losses on Loans
We recorded a $1.4 million reversal of the provision for credit losses on loans in 2021, compared to a $4.6 million provision for credit losses in 2020 and $900 thousand provision for credit losses in 2019. The net provision reversal in 2021 was primarily due to continued improvements in Moody's Analytics' Baseline Forecast of California unemployment rates and adjustments to qualitative risk factors due to a decline in the volume of loans downgraded to substandard classification, fewer delinquencies, and the elimination of an allowance related to a commercial real estate loan that had been individually analyzed for potential credit losses in the previous periods and paid off in 2021. These reversals were partially offset by an increase in the allowance for credit losses related to qualitative risk factor adjustments for recent changes in executive leadership and senior lending positions, and integration of ARB.
The provision for credit losses in 2020 calculated under the incurred loss method (prior to the adoption of the excepted credit loss method on December 31, 2020) was largely due to the uncertainty about the impact of the COVID-19 pandemic on the local and regional economies and our customers at that time. 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. The pandemic also negatively affected the financial condition of many of our borrowers, which was partially alleviated by our payment relief program under the 2020 CARES Act and the SBA PPP. The provision for credit losses in 2019 accounted for under the incurred loss methodology was consistent with loan growth.
For additional information about the allowance for credit losses and transition from the incurred loss method to the CECL method in 2020, see the Critical Accounting Estimates section above and Notes 1 and 3 to the Consolidated Financial Statements in ITEM 8 of this report.
Non-interest Income
The table below details the components of non-interest income.
31
2021 Compared to 2020
Non-interest income totaled $10.1 million and $8.6 million in 2021 and 2020, respectively. The $1.5 million increase was primarily due to the collection of $1.1 million in benefits on bank-owned life insurance policies and an increase in service charges and interchange fees related to the expanded deposit base. In March 2020, we implemented temporary waivers for all ATM fees, overdraft fees and early withdrawal penalties for time deposits to help ease the financial burden customers began experiencing due to the pandemic. We reinstituted the fees in May 2021. Additionally, Wealth Management and Trust income increased due to the addition of new accounts and favorable market performance in 2021. Increases were partially offset by the $931 thousand reduction in gains on sales of investment securities.
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 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.
Non-interest Expense
The table below details the components of non-interest expense.
Other non-interest expense:
2021 Compared to 2020
Non-interest expense increased $14.1 million to $72.6 million in 2021 from $58.5 million in 2020. The largest increase of $6.5 million came from acquisition related one-time and conversion costs. In addition to $3.0 million in one-time merger cost, salaries and related benefits rose another $4.5 million due to increased numbers of employees, regularly scheduled annual merit and related increases, and lower deferred loan origination costs. Professional services included $817 thousand more in consulting expenses for PPP loan forgiveness application processing, investment advisory services, and legal costs. Data processing increased by an additional $828 thousand primarily due to increases core processing and mobile banking systems charges, and other categories increased due to the larger size of the bank. FDIC insurance increased by $415 thousand due to an increase in our deposit base. Charitable contributions decreased due to supplemental contributions in 2020 related to the pandemic.
32
2020 Compared to 2019
In 2020, non-interest expense increased by $617 thousand to $58.5 million from $57.8 million. The largest increases came from the 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.
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 $11.7 million at an effective tax rate of 26.0% in 2021, compared to $10.3 million at an effective tax rate of 25.5% in 2020 and $11.7 million at an effective tax rate of 25.4% in 2019. The increase in the provision in 2021 compared to 2020 reflected higher pre-tax income. The 50 basis point increase in the effective tax rate in 2021 as compared to 2020 was primarily due to non-deductible merger expenses and executive compensation, partially offset by higher BOLI income and tax exempt loan and investment securities interest income. The slight increase in the effective tax rate in 2020 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.
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, 2021 and 2020, neither the Bank nor Bancorp had accruals for interest or penalties related to unrecognized tax benefits.
FINANCIAL CONDITION
Our assets increased $1.4 billion from December 31, 2020 to December 31, 2021. Increases reflected both the acquisition of ARB and organic growth.
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. The table below shows the composition of the debt securities portfolio by expected maturity at December 31, 2021 and 2020. 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, 2021 and 2020 was approximately six and five years, respectively.
33
December 31, 2021 Within 1 Year 1-5 Years 5-10 Years After 10 Years Total
Held-to-maturity:
Available-for-sale:
December 31, 2020 Within 1 Year 1-5 Years 5-10 Years After 10 Years Total
Held-to-maturity:
34
December 31, 2020 Within 1 Year 1-5 Years 5-10 Years After 10 Years Total
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 increased $1.03 billion or 214% during 2021. We purchased $620.2 million in securities in 2021 designated as available-for-sale to provide flexibility for liquidity and interest rate risk management. We also purchased $305.3 million in securities in 2021 designated as held-to-maturity. These purchases were offset by $181.7 million of paydowns, calls and maturities, and $6.6 million of sales during 2021. We also acquired $297.8 million in securities from ARB. The weighted average yield on the purchases of securities was 1.68% for the 2021 year and 1.60% for the fourth quarter of 2021.
During 2021, we purchased $287.6 million in agency mortgage-backed securities ("MBSs"), $271.7 million in debentures of government sponsored agencies, $268.6 million in agency collateralized mortgage obligations ("CMOs"), $60.7 million in obligations of state and political subdivisions and $37.0 million in corporate bonds. 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, SBA-backed securities and U.S. Treasury securities made up 85.6% of the portfolio at December 31, 2021, compared to 77.9% at December 31, 2020. See the discussion in the section captioned “Securities May Lose Value due to Credit Quality of the Issuers” in ITEM 1A Risk Factors above.
At December 31, 2021, 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 thirteen states. Of the total investment in obligations of state and political subdivisions, the largest concentrations outside California are in
35
Texas (38.4%), Washington (16.4%), and Wisconsin (6.7%). Our investment in obligations issued by municipal issuers in Texas are either guaranteed by the AAA-rated Texas Permanent School Fund ("PSF") or backed by revenue sources from essential services (such as utilities and transportation). 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 the PSF.
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
Loans
Loans Outstanding by Class at December 31
Real estate
Allowance for credit losses on loans (23,023) (22,874)
Total loans, net of allowance for credit losses $ 2,232,622 $ 2,065,682
Loans increased $167.1 million in 2021, or 8%, to $2.256 billion at December 31, 2021, from $2.089 billion at December 31, 2020. Year-over-year growth was largely attributable to $419.4 million in loans from the ARB acquisition on August 6, 2021. Non-PPP loan originations of $181.7 million for the year were concentrated in commercial and real estate loans and compared to $165.5 million in 2020. 2021 payoffs included $218.1 million non-PPP loans, compared to $169.2 million in 2020. In 2021, PPP loan originations were $136.2 million and PPP loans forgiven and paid off were $328.5 million.
Non-PPP payoffs as a percentage of beginning of the year loan balances were 10.4% in 2021 and 9.2% in 2020. Approximately 86% and 77%, of total loans were secured by real estate at December 31, 2021 and 2020, respectively. The increase in the percentage secured by real estate from 2020 to 2021 was primarily due to a $180.4 million reduction in unsecured loans guaranteed by the SBA under the PPP, which are included in commercial and industrial loans. For additional information on loan concentration risk, see ITEM 1A, Risk Factors.
The following table summarizes our commercial real estate loan concentrations by the county in which the property was located as of December 31, 2021 and 2020.
36
Commercial Real Estate Loans Outstanding by County
(dollars in thousands; unaudited) December 31, 2021 December 31, 2020
Commercial real estate loans increased $315.2 million in 2021, compared to a $68.5 million increase in 2020. The increase was primarily due to the ARB acquisition and expanded footprint in Northern California. Of the commercial real estate loans at December 31, 2021, 75% were investor-owned and 25% 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.
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, 2021 and 2020, approximately 5.0% and 3.4%, 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, 2021. Except for three substandard classified loans to two borrowing relationships totaling $24.7 million (or 1.6%) as of December 31, 2021, 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, 2021 and 2020.
Construction Loans Outstanding by Type and County
(dollars in thousands; unaudited) December 31, 2021 December 31, 2020
37
(dollars in thousands; unaudited) December 31, 2021 December 31, 2020
County Amount Percent of Construction Loans Amount Percent of Construction Loans
Construction loans increased by $46.8 million in 2021, compared to an increase of $12.0 million in 2020. The increase in 2021 was primarily due to $48.8 million advanced on existing construction loans, $13.2 million in loans assumed in the ARB acquisition and $7.2 million in new financing. These increases were partially offset by $19.5 million in payoffs and $2.9 million in conversions to commercial real estate financing. 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 following table presents the amortized costs and maturity distribution of our loans by class as of December 31, 2021 based on their contractual maturity dates. Maturities do not include scheduled payments or potential prepayments.
Loan Maturity Distribution
(in thousands; unaudited)
Real estate
1 Commercial and industrial due after 1 but within 5 years includes SBA PPP loans totaling $111.2 million (net of $2.5 million in unrecognized fees and costs), the majority of which are expected to be forgiven by the SBA in 2022.
2 Construction loans that mature after 5 years are structured to convert to permanent financing after the initial construction period.
The following table shows the mix of variable-rate loans to fixed-rate loans due after one year by class as of December 31 2021. 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.
38
Loan Interest Rate Sensitivity - Due After One Year
(in thousands; unaudited) Fixed Variable Total
Real estate —
1 Commercial and industrial includes SBA PPP 1% fixed rate loans totaling $111.2 million (net of $2.5 million in unrecognized fees and costs), the majority of which are expected to be forgiven by the SBA in 2022.
Allowance for Credit Losses on Loans
As of December 31, 2021, 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 depends on 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 $23.0 million allowance for credit losses at December 31, 2021 was 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 1.02% at December 31, 2021 and 1.10% at December 31, 2020. The allowance for credit losses to loans, excluding SBA PPP loans and previously acquired loans was 1.07 and 1.27% at year-end 2021 and 2020, respectively (for a discussion of this non-GAAP financial measure, refer to ITEM 7, Reconciliation of GAAP and Non-GAAP Financial Measures section of this report).
The $149 thousand increase in the allowance for credit losses on loans in 2021 was largely due to loans acquired from ARB, partially offset by improvements in economic factors that drive the quantitative portion of the allowance. The $6.2 million increase in the 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. For further information, refer to the Provision for Credit Losses section above, and Notes 1 and 3 to the Consolidated Financial Statements in ITEM 8 of this report.
Due to the high credit quality of our loan portfolio, net charge-offs have been minimal for the past several years. Net recoveries totaled $93 thousand in 2021, compared to net charge-offs of $1 thousand in 2020 and $44 thousand in 2019.
The following table shows the allocation of the allowance by loan class as well as the percentage of total loans in each of the same loan classes.
39
Allocation of Allowance for Credit Losses
Real estate:
Unallocated allowance 2,286 N/A 1,300 N/A
Total allowance for credit losses $ 23,023 $ 22,874
The table below shows the activity in the allowance for credit losses for each of the five years presented below.
Allowance for Credit Losses Rollforward
Impact of CECL adoption — 1,604 —
Provision for (reversal of) credit losses (1,449) 4,594 900
Initial allowance for PCD loans 1,505
Loans charged-off:
Commercial and industrial — (30) (75)
Installment and other consumer (5) (1) (3)
Total loans charged-off (5) (31) (78)
Loans recovered:
Commercial and industrial 14 27 22
Real estate:
Commercial, investor-owned — — 12
Construction 34 3 —
Home equity 50 — —
Net loans (charged-off) recovered 93 (1) (44)
Net recoveries (charge-offs) to average loans NM NM NM
NM - Not meaningful.
Net charge-offs and recoveries for the years ended December 31, 2021, 2020 and 2019 were considered insignificant.
The following 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, 2021.
40
Non-Performing and Loans and Troubled Debt Restructurings
(dollars in thousands; unaudited) 2021 2020
Non-accrual loans:
Real estate:
Commercial, investor-owned 694 1,610
Installment and other consumer — 17
Accruing TDR loans:1
Commercial and industrial $ 1,183 $ 1,021
Real estate:
Commercial, investor-owned 179 3,305
Installment and other consumer 607 735
Total non-accrual and accruing TDR loans $ 10,475 $ 14,304
Criticized and classified loans:
Doubtful $ 114 $ —
Allowance for credit losses to non-accrual loans 2.75x 2.48x
Non-accrual loans to total loans 0.37 % 0.44 %
1 Excludes TDR loans on non-accrual status that are included above.
Non-Accrual and TDR
Non-accrual loans decreased by $857 thousand primarily due to $1.0 million in payoffs and paydowns, partially offset by a $114 thousand well-secured investor-owned commercial real estate loan assumed in the ARB acquisition and one $67 thousand home equity loan placed on non-accrual status in 2021.
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.
Total accruing TDR loans were $2.1 million and $5.1 million as of December 31, 2021 and 2020, respectively. The $3.0 million decrease in 2021 was primarily due to $4.0 million in paydowns and payoffs, partially offset by two loans totaling $1.0 million that were designated as TDRs during 2021. 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.
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."
Criticized and Classified Loans
Loans designated as special mention decreased by $13.6 million in 2021, primarily due to $18.9 million in paydowns and payoffs, $33.1 million in upgrades to a pass risk rating and two loans that were downgraded from special mention to substandard totaling $5.4 million. These decreases were partially offset by $17.2 million in loans that were downgraded from pass/watch, $13.5 million in loans assumed in the ARB acquisition, and $13.2 million in loans that were upgraded from substandard to special mention during 2021. Of the $17.2 million in downgrades, $13.2 million were well-secured by commercial real estate and the remaining $4.0 million in commercial loans had strong support. Loans designated special mention increased by $13.5 million in 2020, driven by loan downgrades
41
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 as special mention exhibit potential weakness that deserve close attention.
Loans classified substandard increased by $13.3 million in 2021, primarily due to downgrades totaling $25.4 million and $2.3 million in substandard loans assumed in the ARB acquisition. Of the downgraded loans, $24.2 million were secured by commercial real estate. The downgrades were partially offset by $13.2 million in upgrades to special mention and $4.2 million in paydowns and payoffs. 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 $61.5 million at December 31, 2021, compared to $43.6 million at December 31, 2020, and is recorded in other assets. The increase of $17.9 million was primarily due to the acquisition of $15.7 million in ARB policies and the purchase of $1.9 million in new policies.
Interest receivable and other assets totaled $51.4 million and $36.5 million at December 31, 2021 and 2020, respectively. The $14.9 million increase was primarily due to a $6.4 million increase in net deferred tax assets, a $4.9 million increase in FHLB stock and a $2.6 million increase in accrued interest on investment securities as discussed below.
Net deferred tax assets totaled $13.3 million and $6.9 million at December 31, 2021 and 2020, 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 $6.4 million increase in net deferred tax assets in 2021 was primarily due to a $4.5 million decrease in deferred tax liabilities related to changes in unrealized gains on available-for-sale investment securities, a $1.6 million increase in deferred tax assets related to the change in deferred compensation plan and salary continuation plan, a $781 thousand increase in deferred tax assets related to accrued but unpaid expenses and a $640 thousand increase in deferred tax assets related to fair value adjustments on acquired loans. These increases were partially offset by a $820 thousand increase in deferred tax liabilities related to the increase in core deposit intangibles. 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, 2021 or 2020. For additional information, refer to Note 11 to the Consolidated Financial Statements in ITEM 8 of this report.
We held $16.7 million and $11.9 million of FHLB stock recorded at cost in other assets at December 31, 2021 and 2020, respectively. The increase in 2021 resulted from the acquisition of $4.9 million of ARB's FHLB stock. The FHLB paid $760 thousand, $654 thousand and $799 thousand in cash dividends in 2021, 2020 and 2019, respectively. For additional information, refer to Note 2 to the Consolidated Financial Statements in ITEM 8 of this report.
Accrued interest on investment securities totaled $4.8 million and $2.2 million at December 31, 2021 and 2020, respectively. The increase was primarily due to purchases of $925.6 million in securities and acquisition of $297.8 million in securities from ARB.
Deposits
Deposits grew by $1.304 billion, to $3.809 billion at December 31, 2021, compared to $2.504 billion at December 31, 2020. Non-interest bearing deposits grew by $555.6 million in 2021 and made up 50% of total
42
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 SBA PPP loans. Our relationship banking model is the foundation for the strong deposit base and allows us to proactively and strategically address changes in the interest rate environment and technology adoption by our customers.
Distribution of Average Deposits
The table below shows the relative composition of our average deposits for 2021 and 2020. For average rates paid on deposits, refer to Average Statements of Condition and Analysis of Net Interest Income table in ITEM 7- Management's Discussion and Analysis of Financial Condition and Results of Operations.
As of December 31,
1 Money market balances include Insured Cash Sweep® ("ICS") in both 2021 and 2020. Demand Deposit Marketplace SM ("DDM") and ICS balances are discussed in Note 6 to the Consolidated Financial Statements in ITEM 8 of this report.
Total estimated uninsured deposits as of December 31, 2021 and December 31, 2020 were $1.830 billion and $1.116 billion, respectively.
Maturities of Uninsured Time Deposits
The following table shows time deposits by account that are in excess of $250,000 by time remaining to maturity at December 31, 2021.
(in thousands; unaudited) Total Uninsured Portion
Over three months through six months 5,155 1,405
Over six months through twelve months 10,991 5,491
Borrowings
As of December 31, 2021 and 2020, respectively, our available borrowing capacity included $820.5 million and $642.5 million in secured lines of credit with FHLB and $70.8 million and $78.7 million with the Federal Reserve Bank of San Francisco (“FRBSF”). We also had $150.0 million and $135.0 million in unsecured lines with correspondent banks to cover any short or long-term borrowing needs at December 31, 2021 and 2020, respectively. There were no FHLB overnight borrowings at December 31, 2021 or 2020. The FRBSF and correspondent bank lines were not utilized at December 31, 2021 or 2020.
As part of a bank acquisition in 2013, we assumed a subordinated debenture due to the NorCal Community Bancorp Trust II with a contractual balance of $4.1 million. On March 15, 2021, we redeemed the $2.8 million subordinated debenture (accreted value), 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
43
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. A similar Deferred Director Fee Plan entitles participating members of the Board of Directors to receive payments as elected by the participant upon separation from service, death, disability or termination of service. At December 31, 2021 and 2020, our aggregate payment obligations under both plans totaled $7.9 million and $4.7 million, respectively.
Our Salary Continuation Plan ("SERP") 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, 2021 and 2020, our liability under the SERP was $5.3 million and $3.2 million, respectively, and is 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.
Increases in obligations under both the deferred compensation plan and SERP in 2021 were due to the assumption of the liabilities from the ARB acquisition.
For additional information, see Note 10 to the Consolidated Financial Statements in ITEM 8 of this report.
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 decreased from 15.8% at December 31, 2020 to 14.4% at December 31, 2021, primarily due to $64.0 million in dividends paid to Bancorp to cover share repurchases, quarterly common stock dividends, and operating costs, partially offset by the Bank's $37.4 million net income in 2021. Bancorp's total risk-based capital ratio was 16.0% at December 31, 2020 and 14.6% at December 31, 2021. 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 expect that we will be required to raise additional capital in 2022. Our anticipated sources of capital in 2022 include future earnings and shares issued under the stock-based compensation program.
Liquidity and Capital Resources
The goal of liquidity management is to provide adequate funds to meet loan demand and to fund operating activities and deposit withdrawals. We accomplish this goal by maintaining an appropriate level of liquid assets and formal lines of credit with the FHLB, FRBSF and correspondent banks that enable us to borrow funds as 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.
44
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. Since 2020 the banking industry has 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 $147.3 million from December 31, 2020. The most significant source of liquidity during 2021 was deposit growth of $514.3 million (exclusive of deposits added through the ARB acquisition). Proceeds from loans collected net of origination was $256.9 million, mainly due to SBA PPP loan forgiveness. Proceeds from principal paydowns, maturities and sales of investment securities totaled $188.4 million. In addition, $140.6 million of cash was acquired from ARB, and $45.3 million in net cash was provided by operating activities.
Significant uses of liquidity during 2021 were $925.6 million in investment securities purchased, $40.8 million in common stock repurchases, 13.9 million for a repayment of an FHLB loan acquired from ARB, $13.1 million in cash dividends paid on common stock to our shareholders, and $4.1 million in repayment of a subordinated debenture. 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 $634.2 million at December 31, 2021. 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, 109.8 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 stock repurchases, shareholder dividends and ordinary operating expenses. Bancorp held $6.6 million of cash at December 31, 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.
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 lending, investment, borrowing, and deposit gathering activities. The Bank manages interest rate sensitivity to maximize our net interest margin, earnings, and capital over a variety of interest rate scenarios. 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
45
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, 2021, 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.
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, otherwise known as the deposit beta. We applied an average deposit beta of 58% to rates paid on interest-bearing deposits in rising rate scenarios, reflected in the table above. However, our historical beta in the prior rising rate cycle was less than half of the modeled beta. 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.
46
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, 2021 and 2020, 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, 2021, 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, 2021, 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, 2021 and 2020, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, 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, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
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.
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,
47
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 Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were 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 matters below, providing a separate opinion on the critical audit matters or on the accounts or disclosures to which they relate.
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, 2021 was $23 million on a total loan portfolio of $2.2 billion. 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.Testing 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.
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.
48
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 internal and external risk factors, and testing whether the qualitative factors used in the calculation of the allowance for credit losses on loans are reasonable and supportable based on 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.
Merger of American River Bankshares – Valuation of Acquired Loans
As discussed in Notes 1 and 18 to the consolidated financial statements, on August 6, 2021 (the “merger date”), American River Bankshares (“AMRB”) merged with and into Bank of Marin Bancorp (“Bancorp”), with Bank of Marin Bancorp surviving. On August 7, 2021, American River Bank (“ARB”) merged with and into Bank of Marin, with Bank of Marin (the “Bank”) surviving, (collectively the “Merger”). Total merger consideration, including cash paid for outstanding options and cash paid in lieu of fractional shares was approximately $124.5 million. The merger was accounted for using the acquisition method of accounting in which assets, liabilities and consideration exchanged were recorded at their respective fair value at the merger date.
We identified the valuation of acquired loans as a critical audit matter. The principal considerations for our determination of valuation of acquired loans as a critical audit matter are the level of management judgement involved in evaluating management’s identification of loans with evidence of credit deterioration, the need for specialized skill in evaluating the reasonableness of unobservable inputs and assumptions used in management’s estimation of fair value of all acquired loans. Auditing management’s judgements regarding identification of loans with evidence of credit deterioration and evaluating unobservable inputs and assumptions used in the measurement of allowance for credit loss require a high degree of subjectivity.
The primary procedures we performed to address this critical audit matter included:
a.Testing the design, implementation, and operating effectiveness of internal controls related to the completeness and accuracy of acquired loan level data, management’s estimate of fair value of acquired loans, including the method and assumptions used to estimate fair value, internal controls over the measurement of merger date allowance for credit loss on purchase credit deteriorated loans.
b.Testing the completeness and accuracy of loans determined to have credit deterioration at merger date and evaluating the reasonableness of the criteria used by management in their identification of purchase credit deteriorated loans.
c.Testing the completeness and accuracy of acquired loan level data used in the fair value estimate calculation.
d.Utilizing an internal firm specialist to evaluate the reasonableness of significant assumptions and methods used by management, by preparing an independent fair value calculation, as well as an assessment of the overall reasonableness of the fair value estimates of all acquired loans.
e.Testing the appropriateness of the methodology and significant assumptions used in the calculation of allowance for credit losses on acquired loans identified as purchase credit deteriorated.
/s/ Moss Adams LLP
Sacramento, California
March 15, 2022
We have served as the Company’s auditor since 2004.
49
March 15, 2022
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, 2021, 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, 2021.
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/ Timothy D. Myers
Timothy D. Myers, President and Chief Executive Officer
/s/ Tani Girton
Tani Girton, EVP and Chief Financial Officer
50
BANK OF MARIN BANCORPCONSOLIDATED STATEMENTS OF CONDITION
(in thousands, except share data) 2021 2020
Assets
Cash, cash equivalents and restricted cash $ 347,641 $ 200,320
Investment securities:
Allowance for credit losses on loans 1 (23,023) (22,874)
Bank premises and equipment, net 7,558 4,919
Other real estate owned 800 —
Liabilities and Stockholders' Equity
Liabilities
Deposits:
Interest bearing:
Borrowings and other obligations 419 58
Subordinated debenture — 2,777
Interest payable and other liabilities 29,443 19,527
Stockholders' Equity
Preferred stock, no par value, Authorized - 5,000,000 shares, none issued — —
Accumulated other comprehensive (loss) income, net of taxes (2,024) 12,601
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.
51
BANK OF MARIN BANCORPCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Interest income
Interest on federal funds sold and due from banks 399 461 1,321
Interest expense
Interest on interest-bearing transaction accounts 172 186 347
Interest on savings accounts 94 68 70
Interest on borrowings and other obligations 9 4 77
(Reversal of) provision for credit losses on loans (1,449) 4,594 900
Non-interest income
Earnings from bank-owned life insurance, net 2,194 973 1,196
(Losses) gains on investment securities, net (16) 915 55
Non-interest expense
Amortization of core deposit intangible 1,135 853 887
Federal Deposit Insurance Corporation insurance 889 474 361
Net income per common share:
Weighted average common shares:
Comprehensive income:
Other comprehensive (loss) income:
Other comprehensive (loss) income, net of tax (14,625) 8,098 8,605
The accompanying notes are an integral part of these consolidated financial statements.
52
BANK OF MARIN BANCORPCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Shares Amount
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
Stock issued under employee stock purchase plan 2,648 90 — — 90
Stock issued under employee stock ownership plan 36,075 1,330 — — 1,330
Restricted stock granted 30,742 — — — —
Restricted stock forfeited / cancelled (3,848) — — — —
Stock-based compensation - stock options — 491 — — 491
Stock-based compensation - restricted stock — 481 — — 481
Cash dividends paid on common stock ($0.94 per share) — — (13,107) — (13,107)
Stock purchased by directors under director stock plan 1,034 34 — — 34
Stock issued in payment of director fees 6,443 217 — — 217
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.
53
BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows from Operating Activities:
(Reversal of) provision for credit losses on loans (1,449) 4,594 900
Noncash contribution expense to employee stock ownership plan 1,330 1,289 1,245
Noncash director compensation expense 347 301 301
Amortization of core deposit intangible 1,135 853 887
Accretion of discount on acquired loans (571) (165) (353)
Accretion of discount on subordinated debentures 1,347 69 68
Net change in deferred loan origination costs/fees (3,155) 5,040 (348)
Loss (gain) on sale of investment securities 16 (915) (55)
Earnings on bank-owned life insurance policies (2,194) (973) (1,196)
Net changes in:
Interest receivable and other assets 5,554 (5,135) (329)
Interest payable and other liabilities 2,146 (631) 70
Cash Flows from Investing Activities:
Purchase of held-to-maturity securities (305,329) — (3,549)
Proceeds from sale of available-for-sale securities 6,632 33,756 66,081
Purchase of bank-owned life insurance policies (1,943) (941) (2,997)
Cash receipts from bank-owned life insurance policies 2,478 — 1,533
Purchase of premises and equipment (1,044) (981) (542)
Cash and cash equivalents acquired from American River Bankshares 140,577 — —
Purchase of Federal Home Loan Bank stock — (176) (616)
Cash paid for low income housing tax credit investment (398) (1,355) (952)
Cash Flows from Financing Activities:
Proceeds from stock options exercised 463 1,304 669
Payment of tax withholdings for vesting of restricted stock (166) (73) (220)
Federal Home Loan Bank (repayment) borrowings (13,885) — (7,000)
Repayment of subordinated debenture including execution costs (4,126) — —
Repayment of finance lease obligations (86) (172) (168)
Supplemental disclosure of cash flow information:
Supplemental disclosure of noncash investing and financing activities:
Stock issued to employee stock ownership plan $ 1,330 $ 1,289 $ 1,245
Repurchase of stock not yet settled $ 373 $ 413 $ 103
Stock issued in payment of director fees $ 217 $ 217 $ 231