Bank of Marin Bancorp(BMRC) - 2021 Q2 - Quarterly Report

PART I FINANCIAL INFORMATION This section presents the company's unaudited consolidated financial statements and management's discussion and analysis of financial condition and results of operations ITEM 1. Financial Statements This section presents the unaudited consolidated financial statements of Bank of Marin Bancorp, including the statements of condition, comprehensive income, changes in stockholders' equity, and cash flows, along with detailed notes explaining the basis of presentation, accounting standards, fair value measurements, investment securities, loans, credit loss allowances, borrowings, stockholders' equity, commitments, contingencies, derivative instruments, and the merger agreement Consolidated Statements of Condition The Consolidated Statements of Condition provide a snapshot of the company's financial position at June 30, 2021, compared to December 31, 2020, showing increases in total assets, cash, and investment securities, alongside growth in deposits and a decrease in loans Consolidated Statements of Condition (in thousands) | Metric | June 30, 2021 (in thousands) | December 31, 2020 (in thousands) | | :-------------------------- | :--------------------------- | :------------------------------- | | Total Assets | $3,073,818 | $2,911,926 | | Cash, cash equivalents | $257,543 | $200,320 | | Total Investment Securities | $687,001 | $501,387 | | Loans, net | $1,983,667 | $2,065,682 | | Total Deposits | $2,683,575 | $2,504,249 | | Total Liabilities | $2,725,169 | $2,553,673 | | Total Stockholders' Equity | $348,649 | $358,253 | Consolidated Statements of Comprehensive Income The Consolidated Statements of Comprehensive Income show a significant increase in net income for both the three and six months ended June 30, 2021, compared to the prior year, driven by a reversal of credit loss provisions and stable net interest income, despite a decrease in total comprehensive income for the six-month period due to changes in unrealized gains on available-for-sale securities Consolidated Statements of Comprehensive Income (in thousands) | Metric | Three months ended June 30, 2021 (in thousands) | Three months ended June 30, 2020 (in thousands) | Six months ended June 30, 2021 (in thousands) | Six months ended June 30, 2020 (in thousands) | | :-------------------------------------- | :---------------------------------------------- | :---------------------------------------------- | :-------------------------------------------- | :-------------------------------------------- | | Net Interest Income | $24,534 | $24,375 | $46,565 | $48,494 | | (Reversal of) Provision for Credit Losses | $(920) | $2,000 | $(3,849) | $4,200 | | Total Non-interest Income | $2,022 | $1,813 | $3,848 | $4,933 | | Total Non-interest Expense | $15,556 | $13,881 | $30,968 | $29,248 | | Net Income | $9,285 | $7,406 | $18,232 | $14,634 | | Basic EPS | $0.71 | $0.55 | $1.38 | $1.08 | | Diluted EPS | $0.71 | $0.55 | $1.37 | $1.07 | | Total Comprehensive Income | $11,357 | $8,472 | $14,009 | $22,125 | Consolidated Statements of Changes in Stockholders' Equity The Consolidated Statements of Changes in Stockholders' Equity reflect a decrease in total stockholders' equity from December 31, 2020, to June 30, 2021, primarily due to stock repurchases and a negative change in accumulated other comprehensive income, despite positive net income and stock-based compensation Consolidated Statements of Changes in Stockholders' Equity (in thousands) | Metric | June 30, 2021 (in thousands) | December 31, 2020 (in thousands) | | :-------------------------------------- | :--------------------------- | :------------------------------- | | Common Stock | $108,430 | $125,905 | | Retained Earnings | $231,841 | $219,747 | | Accumulated Other Comprehensive Income | $8,378 | $12,601 | | Total Stockholders' Equity | $348,649 | $358,253 | - Stock repurchases, net of commissions, amounted to $(10.8) million for the three months ended June 30, 2021, and $(19.3) million for the six months ended June 30, 2021[14][16] - Cash dividends paid on common stock were $(3.0) million ($0.23 per share) for the three months ended June 30, 2021, and $(6.1) million ($0.46 per share) for the six months ended June 30, 2021[14][16] Consolidated Statements of Cash Flows The Consolidated Statements of Cash Flows indicate a net increase in cash, cash equivalents, and restricted cash of $57.2 million for the six months ended June 30, 2021, primarily driven by financing activities (net increase in deposits) and operating activities, partially offset by significant cash used in investing activities, mainly for purchasing investment securities Cash Flow Activity (Six months ended, in thousands) | Cash Flow Activity (Six months ended) | June 30, 2021 (in thousands) | June 30, 2020 (in thousands) | | :------------------------------------ | :--------------------------- | :--------------------------- | | Net cash provided by operating activities | $19,769 | $29,628 | | Net cash used in investing activities | $(112,165) | $(250,278) | | Net cash provided by financing activities | $149,619 | $434,961 | | Net increase in cash, cash equivalents and restricted cash | $57,223 | $214,311 | | Cash, cash equivalents and restricted cash at end of period | $257,543 | $397,699 | - Significant investing activities included purchases of held-to-maturity securities ($74.5 million) and available-for-sale securities ($170.2 million) in the first six months of 2021[20] - Financing activities were boosted by a net increase in deposits of $179.3 million for the six months ended June 30, 2021[20] Notes to Consolidated Financial Statements This section provides detailed disclosures and explanations for the consolidated financial statements, covering the basis of presentation, recently adopted accounting standards, fair value measurements, investment securities, loans and credit loss allowances, borrowings, stockholders' equity, commitments, contingencies, derivative instruments, and the pending merger agreement Note 1: Basis of Presentation The consolidated financial statements include Bank of Marin Bancorp and its wholly-owned subsidiary, Bank of Marin, prepared in accordance with SEC rules and GAAP. The NorCal Community Bancorp Trust II is not consolidated, with its subordinated debenture shown as a liability. EPS calculations are detailed, distinguishing between basic and diluted shares - The consolidated financial statements include Bank of Marin Bancorp and its wholly-owned bank subsidiary, Bank of Marin[22] - The NorCal Community Bancorp Trust II is not consolidated; its subordinated debenture is shown as a liability[24] EPS Metric (Six months ended) | EPS Metric (Six months ended) | June 30, 2021 | June 30, 2020 | | :---------------------------- | :------------ | :------------ | | Weighted average basic shares | 13,227 | 13,519 | | Weighted average diluted shares | 13,316 | 13,621 | | Basic EPS | $1.38 | $1.08 | | Diluted EPS | $1.37 | $1.07 | Note 2: Recently Adopted and Issued Accounting Standards The company adopted several ASUs in 2021, including those simplifying income tax accounting, clarifying equity method interactions, and codification improvements for receivables, none of which had a material impact. ASUs related to Reference Rate Reform (LIBOR) are not yet adopted, with ongoing assessment of their applicability - Adopted ASU No. 2019-12 (Income Taxes), ASU No. 2020-01 (Investments - Equity Securities), and ASU No. 2020-08 (Receivables—Nonrefundable Fees and Other Costs) on January 1, 2021, with no material impact on financial condition or results of operations[28][29][30] - Has not yet elected to apply amendments from ASU No. 2020-04 and ASU No. 2021-01 (Reference Rate Reform) but continues to monitor guidance and assess applicability[31][32] Note 3: Fair Value of Assets and Liabilities The company categorizes fair value measurements into a three-level hierarchy. Available-for-sale securities and derivative financial liabilities are measured at fair value on a recurring basis, primarily using Level 2 inputs. Loans and time deposits are recorded at amortized cost but their fair values are estimated for disclosure purposes, with loans largely falling into Level 3 due to unobservable inputs - Assets and liabilities measured at fair value are grouped into Level 1 (quoted prices in active markets), Level 2 (observable inputs), and Level 3 (unobservable inputs)[36][37][38] Financial Instrument Fair Value Hierarchy (in thousands) | Financial Instrument (in thousands) | June 30, 2021 Carrying Value | June 30, 2021 Fair Value Hierarchy | | :---------------------------------- | :----------------------------- | :--------------------------------- | | Securities available-for-sale | $517,963 | Level 2 | | Derivative financial liabilities | $1,363 | Level 2 | | Loans, net | $2,002,767 | Level 3 | | Time deposits | $95,350 | Level 2 | - Fair value of loans is based on exit price techniques from an independent third-party, using proprietary valuation models and methodology, and may not reflect actual or prospective market valuations[47] Note 4: Investment Securities The investment securities portfolio, comprising held-to-maturity and available-for-sale securities, increased significantly. The portfolio includes obligations of state and political subdivisions, U.S. federal government agencies, and GSEs. No allowance for credit losses was recorded for these securities due to strong credit quality and government guarantees. The company also holds non-marketable FHLB capital stock and Visa Inc. Class B common stock Investment Securities (in thousands) | Security Type (in thousands) | June 30, 2021 Amortized Cost | June 30, 2021 Fair Value | December 31, 2020 Amortized Cost | December 31, 2020 Fair Value | | :--------------------------- | :--------------------------- | :----------------------- | :------------------------------- | :--------------------------- | | Total Held-to-maturity | $169,038 | $174,138 | $109,036 | $115,185 | | Total Available-for-sale | $504,934 | $517,963 | $373,038 | $392,351 | - No allowance for credit losses has been recorded for held-to-maturity or available-for-sale securities, as management expects to receive all contractual principal and interest, and does not intend to sell securities with unrealized losses before recovery of amortized cost[54][56][65] - The company held $11.9 million of FHLB stock and 10,439 shares of Visa Inc. Class B common stock (carrying value of zero) as of June 30, 2021[66][67] Note 5: Loans and Allowance for Credit Losses on Loans The loan portfolio decreased slightly, primarily due to PPP loan forgiveness. The company adopted the CECL standard, resulting in a reversal of credit loss provisions. Credit quality indicators remain strong, with a low percentage of non-accrual loans. Troubled Debt Restructurings (TDRs) are managed, and the company applied temporary accounting relief for certain loan modifications under the CARES Act Loan Category (in thousands) | Loan Category (in thousands) | June 30, 2021 | December 31, 2020 | | :--------------------------- | :------------ | :---------------- | | Commercial and industrial | $423,646 | $498,408 | | Commercial owner-occupied | $296,407 | $304,963 | | Commercial investor-owned | $967,335 | $961,208 | | Construction | $80,841 | $73,046 | | Home equity | $92,510 | $104,813 | | Other residential | $120,903 | $123,395 | | Installment and other consumer | $21,125 | $22,723 | | Total loans, at amortized cost | $2,002,767 | $2,088,556 | | Allowance for credit losses | $(19,100) | $(22,874) | - PPP loans outstanding totaled $248.3 million (net of $6.5 million in unrecognized fees and costs) as of June 30, 2021, with the vast majority expected to be fully forgiven by the SBA[76] Credit Quality Indicator (in thousands) | Credit Quality Indicator (in thousands) | June 30, 2021 | December 31, 2020 | | :-------------------------------------- | :------------ | :---------------- | | Total past due loans | $1,366 | $2,705 | | Non-accrual loans | $9,190 | $9,233 | | Recorded Investment in TDRs | $10,719 | $12,506 | - The allowance for credit losses on loans decreased by $3.8 million for the six months ended June 30, 2021, reflecting a reversal of provision under the CECL standard[104] Note 6: Borrowings and Other Obligations The company maintains various lines of credit with correspondent banks, FHLB, and FRBSF, with no outstanding overnight borrowings at June 30, 2021. The subordinated debenture was fully redeemed on March 15, 2021, and finance lease liabilities increased - Unsecured lines of credit for overnight borrowings totaled $115.0 million at June 30, 2021, with no outstanding borrowings[109] - FHLB lines of credit totaled $629.9 million and FRBSF lines of credit totaled $77.6 million at June 30, 2021, with no outstanding borrowings[110][111] - The $2.8 million subordinated debenture was fully redeemed on March 15, 2021, leading to accelerated accretion of the remaining purchase discount[112] - Finance lease liabilities increased to $438 thousand at June 30, 2021, from $58 thousand at December 31, 2020[113] Note 7: Stockholders' Equity Bancorp declared a $0.24 per share cash dividend. The company accounts for share-based payments, including stock options and restricted stock awards, as compensation expense. A new share repurchase program of up to $25.0 million was approved on July 16, 2021, following the completion of the previous program in May 2021 - A cash dividend of $0.24 per share was declared on July 16, 2021, payable on August 6, 2021[114] - Stock-based compensation expense is recorded for stock options and restricted stock awards, with performance-based awards vesting contingent on long-term goals[115][116] - A new share repurchase program of up to $25.0 million was approved on July 16, 2021, effective through July 31, 2023. The previous $25.0 million program was completed in May 2021, with 521,948 shares repurchased for $19.3 million during the first six months of 2021[121][124] Note 8: Commitments and Contingencies The company has off-balance sheet risks from commitments to extend credit and standby letters of credit, with an allowance for credit losses on unfunded commitments. Lease liabilities for operating and finance leases are detailed. Litigation matters, particularly related to Visa's Covered Litigation, are considered remote for contingent liabilities Commitment Type (in thousands) | Commitment Type (in thousands) | June 30, 2021 | December 31, 2020 | | :----------------------------- | :------------ | :---------------- | | Commercial lines of credit | $282,611 | $287,533 | | Revolving home equity lines | $201,986 | $189,035 | | Undisbursed construction loans | $73,757 | $41,033 | | Standby letters of credit | $3,167 | $1,964 | | Total commitments | $571,706 | $529,132 | - An allowance for credit losses on unfunded loan commitments totaled $1.6 million at June 30, 2021, a reversal of $1.2 million for the six months ended June 30, 2021[128] Lease Type (in thousands) | Lease Type (in thousands) | June 30, 2021 | December 31, 2020 | | :------------------------ | :------------ | :---------------- | | Operating lease liabilities | $24,919 | $27,062 | | Finance lease liabilities | $438 | $58 | - The company considers the probability of losses from Visa's Covered Litigation to be remote and is not required to record contingent liabilities[141] Note 9: Derivative Financial Instruments and Hedging Activities The company uses interest rate swap agreements as fair value hedges to mitigate interest rate risk on long-term fixed-rate loans. As of June 30, 2021, there were four such agreements, with a total notional amount of $13.5 million and a fair value liability of $1.4 million - Interest rate swap agreements are used as fair value hedges to mitigate interest rate risk on long-term fixed-rate loans[142] Derivative Metric (in thousands) | Derivative Metric (in thousands) | June 30, 2021 | December 31, 2020 | | :------------------------------- | :------------ | :---------------- | | Interest rate contracts notional amount | $13,518 | $13,991 | | Interest rate contracts fair value (liability) | $1,363 | $1,912 | - Net losses on fair value hedging relationships recognized in interest income were $(0.2) million for the six months ended June 30, 2021, compared to $(0.1) million for the same period in 2020[147] Note 10: Merger Agreement Bancorp entered into a definitive agreement to acquire American River Bankshares (AMRB), expanding its presence in Northern California. The merger, valued at $134.5 million, is expected to close on August 6, 2021, and will result in Bank of Marin having approximately $4.0 billion in assets and 31 branches - Bancorp agreed to acquire American River Bankshares (AMRB) in a merger expected to close on August 6, 2021[148] - AMRB shareholders will receive 0.575 shares of Bancorp's common stock for each AMRB share, valuing the transaction at $134.5 million based on Bancorp's stock price on April 16, 2021[148] - Upon closing, Bank of Marin will have approximately $4.0 billion in assets and operate 31 branches across ten counties[157] ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's perspective on the company's financial performance and condition, including forward-looking statements, critical accounting policies, an executive summary of key financial highlights, and detailed analysis of results of operations and financial condition. It covers net interest income, credit loss provisions, non-interest income and expense, income taxes, and summaries of cash, investments, loans, liabilities, capital adequacy, and liquidity Forward-Looking Statements This section contains forward-looking statements regarding future operations, products, services, revenues, and earnings, based on management's current expectations. It highlights various factors that could cause actual results to differ materially, including economic conditions, interest rates, acquisitions, regulatory changes, and natural disasters - Forward-looking statements are based on management's current expectations and include descriptions of future operations, products, services, and forecasts of revenues and earnings[152] - Factors that could cause future results to vary materially include general economic conditions, changes in interest rates, deposit flows, real estate values, costs of acquisitions, competition, and regulatory changes[152] - Specific risks related to the AMRB acquisition include integration difficulties, lower-than-expected cost savings or revenues, and disruptions to customer and employee relationships[153] Critical Accounting Policies and Estimates The company's critical accounting policies, which involve significant management judgment and estimation, include Allowance for Credit Losses on Loans and Unfunded Commitments, Allowance for Credit Losses on Investments Securities, Accounting for Income Taxes, and Fair Value Measurements. No material changes to these policies occurred during the period - Critical accounting policies require management's most difficult, subjective, or complex judgments and include Allowance for Credit Losses on Loans and Unfunded Commitments, Allowance for Credit Losses on Investments Securities, Accounting for Income Taxes, and Fair Value Measurements[156] - There have been no material changes to the critical accounting policies during the period[156] Executive Summary The company reported increased net income and EPS for Q2 and H1 2021, driven by SBA PPP fee recognition and credit loss provision reversals, partially offset by accelerated discount accretion from a debenture redemption. Loans decreased due to PPP forgiveness, while deposits grew. Capital ratios remained strong, and a new share repurchase program was approved. The pending AMRB acquisition is expected to be accretive and expand the bank's footprint - Net income for Q2 2021 was $9.3 million (Diluted EPS $0.71), up from $7.4 million (Diluted EPS $0.55) in Q2 2020. For H1 2021, net income was $18.2 million (Diluted EPS $1.37), up from $14.6 million (Diluted EPS $1.07) in H1 2020[158] - Earnings increases were driven by $2.6 million (Q2 2021) and $4.3 million (H1 2021) in SBA PPP fees and reversals of credit loss provisions ($0.9 million in Q2 2021, $3.8 million in H1 2021)[159] Executive Summary Metrics | Metric | June 30, 2021 | December 31, 2020 | | :-------------------------------------- | :------------ | :---------------- | | Total Loans | $2.003 billion| $2.089 billion |\n| Total Deposits | $2.684 billion| $2.504 billion |\n| Allowance for credit losses on loans to total loans | 0.95% | 1.10% |\n| Total risk-based capital ratio (Bancorp)| 15.5% | 16.0% |\n| Tangible common equity to tangible assets | 10.4% | 11.3% | - A new share repurchase program of up to $25.0 million was approved on July 16, 2021. A cash dividend of $0.24 per share was declared, a $0.01 increase from the prior quarter[162] RESULTS OF OPERATIONS This section provides a detailed analysis of the company's operating performance, including net interest income, provision for credit losses, non-interest income, non-interest expense, and provision for income taxes. It highlights the impact of PPP loans, interest rate environment, and acquisition-related expenses on profitability and efficiency Net Interest Income Net interest income slightly increased in Q2 2021 YoY due to PPP loans and lower interest-bearing liability rates, but decreased in H1 2021 YoY due to accelerated discount accretion and lower asset yields. The tax-equivalent net interest margin declined in both periods, primarily due to the low interest rate environment, though PPP loans provided some positive impact Net Interest Income and Margin | Metric | Three months ended June 30, 2021 (in thousands) | Three months ended June 30, 2020 (in thousands) | Six months ended June 30, 2021 (in thousands) | Six months ended June 30, 2020 (in thousands) | | :-------------------------------------- | :---------------------------------------------- | :---------------------------------------------- | :-------------------------------------------- | :-------------------------------------------- | | Net Interest Income | $24,534 | $24,375 | $46,565 | $48,494 | | Tax-equivalent net interest margin | 3.37% | 3.53% | 3.28% | 3.70% | | Cost of deposits | 0.07% | 0.09% | 0.07% | 0.15% | - The $0.2 million increase in Q2 2021 net interest income was primarily due to higher income from SBA PPP loans, higher average investment securities and commercial real estate loan balances, and lower rates on interest-bearing liabilities[179] - The decrease in H1 2021 net interest income was primarily attributed to $1.3 million in accelerated discount accretion from the early redemption of a subordinated debenture, lower yielding interest-earning assets, and lower average balances of commercial and consumer loans[181] - SBA PPP loans contributed 12 basis points to Q2 2021's net interest margin and 5 basis points to H1 2021's net interest margin[180][182] Provision for Credit Losses on Loans The company recorded reversals of provision for credit losses in 2021, primarily due to improved California unemployment rate forecasts and a decrease in non-PPP loan balances. Credit quality remained strong, with a decrease in special mention loans and a slight increase in classified assets Provision for Credit Losses on Loans (in thousands) | Metric | Three months ended June 30, 2021 (in thousands) | Three months ended June 30, 2020 (in thousands) | Six months ended June 30, 2021 (in thousands) | Six months ended June 30, 2020 (in thousands) | | :-------------------------------------- | :---------------------------------------------- | :---------------------------------------------- | :-------------------------------------------- | :-------------------------------------------- | | (Reversal of) provision for credit losses on loans | $(920) | $2,000 | $(3,849) | $4,200 | - Provision reversals in 2021 were due to improved forecasted California unemployment rates (decreased to 8.0% at June 30, 2021 from 9.1% at December 31, 2020) and a $42.5 million year-to-date decrease in non-PPP loan balances[188] - Special mention loans decreased by $37.9 million to $49.0 million at June 30, 2021, from $86.9 million at December 31, 2020. Classified assets increased by $5.0 million to $30.8 million[189] - The ratio of allowance for credit losses on loans to total loans was 0.95% at June 30, 2021, down from 1.10% at December 31, 2020[190] Non-interest Income Non-interest income increased in Q2 2021 due to higher debit card interchange fees and wealth management income, but decreased in H1 2021 primarily due to the absence of investment security sales gains and lower service charges on deposit accounts, partly from temporary fee waivers Non-interest Income Component (in thousands) | Non-interest Income Component (in thousands) | Three months ended June 30, 2021 | Three months ended June 30, 2020 | Six months ended June 30, 2021 | Six months ended June 30, 2020 | | :------------------------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Wealth Management and Trust Services | $530 | $421 | $1,018 | $925 | | Debit card interchange fees | $419 | $308 | $785 | $668 | | Service charges on deposit accounts | $317 | $293 | $598 | $744 | | Gains on sale of investment securities, net | $0 | $115 | $0 | $915 | | Total non-interest income | $2,022 | $1,813 | $3,848 | $4,933 | - Q2 2021 non-interest income increased by $0.2 million, mainly from debit card interchange fees (up $0.1 million) and wealth management and trust services (up $0.1 million)[195] - H1 2021 non-interest income decreased by $1.1 million, primarily due to no gains on investment security sales (vs. $0.9 million in H1 2020) and lower service charges on deposit accounts (down $0.1 million)[196] Non-interest Expense Non-interest expense increased in both Q2 and H1 2021, driven by higher salaries and benefits (due to fewer deferred PPP loan origination costs), increased professional services (including ARB acquisition-related expenses), and higher FDIC insurance expenses due to the absence of assessment credits Non-interest Expense Component (in thousands) | Non-interest Expense Component (in thousands) | Three months ended June 30, 2021 | Three months ended June 30, 2020 | Six months ended June 30, 2021 | Six months ended June 30, 2020 | | :-------------------------------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Salaries and related benefits | $8,888 | $7,864 | $18,096 | $17,341 | | Professional services | $986 | $550 | $1,849 | $1,094 | | Charitable contributions | $462 | $273 | $493 | $440 | | Federal Deposit Insurance Corporation insurance | $182 | $116 | $361 | $118 | | Total non-interest expense | $15,556 | $13,881 | $30,968 | $29,248 | - Q2 2021 non-interest expense increased by $1.7 million, primarily due to $1.0 million higher salaries and benefits (fewer deferred PPP loan origination costs) and $0.4 million in ARB acquisition-related expenses[200] - H1 2021 non-interest expense increased by $1.7 million, with professional services up $0.8 million (pandemic delays and ARB acquisition) and FDIC insurance up $0.2 million (absence of assessment credits)[201][203] Provision for Income Taxes The provision for income taxes increased in both Q2 and H1 2021 due to higher pre-tax income. The effective tax rate slightly decreased in Q2 2021 due to a true-up of low-income tax credits Provision for Income Taxes (in thousands) | Metric (in thousands) | Three months ended June 30, 2021 | Three months ended June 30, 2020 | Six months ended June 30, 2021 | Six months ended June 30, 2020 | | :-------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Provision for income taxes | $3,247 | $2,641 | $6,264 | $4,983 | | Effective tax rate | 25.9% | 26.3% | 25.6% | 25.4% | - The increase in provision for income taxes reflected higher pre-tax income for both the second quarter and first half of 2021[206] - The 40 basis point decrease in the effective tax rate in Q2 2021 was primarily due to the true-up of low-income tax credits[206] FINANCIAL CONDITION SUMMARY This section summarizes the company's financial condition, highlighting an increase in total assets driven by investment securities purchases and deposit inflows. It details changes in cash, investment portfolio composition, loan balances (affected by PPP forgiveness), and liabilities. Capital adequacy remains strong, exceeding regulatory requirements, and liquidity is robust, supported by core deposits and available credit lines Cash, Cash Equivalents and Restricted Cash Total cash, cash equivalents, and restricted cash increased to $257.5 million at June 30, 2021, from $200.3 million at December 31, 2020, mainly due to SBA PPP loan forgiveness and increased deposits Cash, Cash Equivalents and Restricted Cash (in thousands) | Metric (in thousands) | June 30, 2021 | December 31, 2020 | | :-------------------- | :------------ | :---------------- | | Cash, cash equivalents and restricted cash | $257,543 | $200,320 | - The increase was mainly due to SBA PPP loan forgiveness and an increase in deposits[208] Investment Securities The investment securities portfolio grew by $185.6 million to $687.0 million at June 30, 2021, primarily from $244.7 million in purchases to deploy excess cash. The fair value of available-for-sale securities decreased by $6.3 million due to higher interest rates Total Investment Securities (in thousands) | Metric (in thousands) | June 30, 2021 | December 31, 2020 | | :-------------------- | :------------ | :---------------- | | Total investment securities | $687,001 | $501,387 | - The increase was primarily due to $244.7 million in purchases to deploy excess cash into interest-earning assets[209] - The fair value of available-for-sale securities decreased $6.3 million due to the higher interest rate environment[209] - The largest concentrations of obligations of state and political subdivisions outside of California are in Texas (51.0%), Washington (16.0%), and Maryland (5.7%)[213] Loans Total loans decreased by $85.8 million to $2.003 billion at June 30, 2021, mainly due to a $43.3 million net decrease in PPP loans. New non-PPP loan originations of $69.1 million were offset by $95.4 million in payoffs and a $34.8 million decrease in line utilization Loans, at amortized cost (in thousands) | Metric (in thousands) | June 30, 2021 | December 31, 2020 | | :-------------------- | :------------ | :---------------- | | Loans, at amortized cost | $2,002,767 | $2,088,556 | - The decrease was primarily due to SBA PPP loans, which totaled $248.3 million at June 30, 2021, down from $291.6 million at December 31, 2020[215] - New non-PPP related loan originations totaled $69.1 million, but were offset by $95.4 million in payoffs and a $34.8 million decrease in line utilization[215] - As of July 31, 2021, 6 borrowing relationships with 9 loans totaling $43.4 million were still benefiting from payment relief[218] Liabilities Total liabilities increased by $171.5 million to $2.725 billion, driven by a $179.3 million increase in deposits. Non-interest bearing deposits grew by $105.4 million and represented 54.4% of total deposits. The cost of average deposits decreased to 0.07% in Q2 and H1 2021 Liabilities (in thousands) | Metric (in thousands) | June 30, 2021 | December 31, 2020 | | :-------------------- | :------------ | :---------------- | | Total liabilities | $2,725,169 | $2,553,673 | | Total deposits | $2,683,575 | $2,504,249 | | Non-interest bearing deposits | $1,460,076 | $1,354,650 | - Deposits increased $179.3 million, primarily from PPP loan proceeds and normal fluctuations in large commercial accounts[219] - Non-interest bearing deposits represented 54.4% of total deposits at June 30, 2021, up from 54.1% at December 31, 2020[219] - The cost of average deposits decreased by 2 basis points in Q2 2021 and 8 basis points in H1 2021 compared to the prior year periods, reaching 0.07%[219] Capital Adequacy Bancorp and the Bank maintained capital ratios above well-capitalized regulatory requirements. The redemption of the subordinated debenture in March 2021 reduced Bancorp's total risk-based capital ratio by approximately 18 basis points. Bancorp is not subject to separate minimum capital requirements as a Small Bank Holding Company - All capital ratios for both Bancorp and the Bank exceeded well-capitalized regulatory requirements at June 30, 2021[221] Capital Ratio (Bancorp) | Capital Ratio (Bancorp) | June 30, 2021 | December 31, 2020 | | :---------------------- | :------------ | :---------------- | | Total Capital | 15.53% | 16.03% | | Tier 1 Capital | 14.54% | 14.82% | | Common Equity Tier 1 | 14.54% | 14.69% | - The redemption of the subordinated debenture on March 15, 2021, reduced Bancorp's total risk-based capital ratio by approximately 18 basis points[223] - Bancorp is not subject to separate minimum capital requirements as a Small Bank Holding Company due to the increased asset threshold to $3.0 billion[222] Liquidity The company maintains a strong liquidity position through liquid assets, formal lines of credit, and a robust core deposit base. Key liquidity sources in 2021 included increased deposits and loan collections, while significant uses were investment securities purchases and stock repurchases. Management anticipates adequate liquidity to fund operations and commitments - Liquidity is managed by maintaining liquid assets and formal lines of credit with FHLB, FRBSF, and correspondent banks[226] - The most significant source of liquidity in 2021 was a $179.3 million increase in deposits, primarily from PPP borrower-related accounts[230] - Significant uses of liquidity included $244.7 million in investment securities purchased and $19.7 million in common stock repurchases[231] - Undrawn credit commitments totaled $571.7 million at June 30, 2021, expected to be funded through loan repayments, deposit growth, and liquid assets[232] ITEM 3. Quantitative and Qualitative Disclosure about Market Risk The company actively manages interest rate risk, a significant form of market risk, to minimize its impact on net interest margin, earnings, and capital. It uses interest rate swap contracts as fair value hedges and employs simulation models to measure and evaluate risk exposure against Board-established limits. At June 30, 2021, interest rate risk was within policy guidelines - Interest rate risk is managed to minimize exposure to net interest margin, earnings, and capital, with the objective of correlating the effects of interest rate changes on assets and liabilities[234][235] - Interest rate swap contracts are used as fair value hedges to mitigate changes in the fair value of long-term fixed-rate loans caused by interest rate fluctuations[236] Estimated Change in Net Interest Income from Interest Rate Changes | Immediate Changes in Interest Rates (in basis points) | Estimated Change in Net Interest Income in Year 1, as percent of Net Interest Income | | :---------------------------------------------------- | :----------------------------------------------------------------------------------- | | up 400 | 9.1% | | up 300 | 6.9% | | up 200 | 4.6% | | up 100 | 2.2% | | down 100 | (1.9)% | - At June 30, 2021, interest rate risk was within policy guidelines established by ALCO and the Board[237] ITEM 4. Controls and Procedures Management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective as of June 30, 2021. There were no significant changes that materially affected internal control over financial reporting during the quarter - The Chief Executive Officer and Chief Financial Officer concluded that disclosure controls and procedures were effective as of June 30, 2021[240] - No significant changes materially affected internal control over financial reporting during the quarter ended June 30, 2021[241] PART II OTHER INFORMATION This section provides additional information including legal proceedings, risk factors, equity sales, defaults, mine safety, and exhibits ITEM 1. Legal Proceedings The company refers to previous disclosures regarding legal proceedings, indicating no material adverse effects on financial condition or results of operations from pending legal actions - Management is not aware of any pending legal proceedings that will have a material adverse effect on the financial condition or results of operations[137] ITEM 1A. Risk Factors There have been no material changes to the risk factors previously disclosed in the company's 2020 Form 10-K - No material changes from the risk factors previously disclosed in the 2020 Form 10-K[244] ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds There were no unregistered sales of equity securities during the period. The company completed its $25.0 million share repurchase program in May 2021, repurchasing 297,935 shares for $10.7 million in Q2 2021. A new $25.0 million share repurchase program was approved on July 16, 2021 - No unregistered sales of equity securities occurred during the reporting period[245] - The $25.0 million share repurchase program, approved on January 24, 2020, was completed in May 2021[246] Share Repurchase Program Activity | Period | Total Number of Shares Purchased | Average Price Paid per Share | | :--------------- | :------------------------------- | :--------------------------- | | April 1-30, 2021 | 130,680 | $36.63 | | May 1-31, 2021 | 167,255 | $35.58 | | June 1-30, 2021 | — | — | | Total | 297,935 | $36.04 | - A new share repurchase program of up to $25.0 million was approved on July 16, 2021, through July 31, 2023[247] ITEM 3. Defaults Upon Senior Securities There were no defaults upon senior securities during the period - No defaults upon senior securities[248] ITEM 4. Mine Safety Disclosures This item is not applicable to the company - Not applicable[248] ITEM 5. Other Information No other information is reported under this item - None[248] ITEM 6. Exhibits This section lists all exhibits filed as part of the report or incorporated by reference, including the merger agreement, articles of incorporation, bylaws, various stock plans, indemnification agreements, employment agreements, and certifications - Includes the Agreement to Merge and Plan of Reorganization, Articles of Incorporation, Bylaws, various stock plans (Employee Stock Ownership Plan, Employee Stock Purchase Plan, Equity Plan, Director Stock Plan), and employment agreements[251] - Certifications by the Principal Executive Officer and Principal Financial Officer (pursuant to Sarbanes-Oxley Act of 2002) are filed[251] SIGNATURES The report is duly signed on August 5, 2021, by Russell A. Colombo (Chief Executive Officer), Tani Girton (Executive Vice President & Chief Financial Officer), and David A. Merck (Vice President & Financial Reporting Manager) - The report was signed on August 5, 2021, by Russell A. Colombo (CEO), Tani Girton (EVP & CFO), and David A. Merck (VP & Financial Reporting Manager)[253]