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,
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.
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.
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
| | |
BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CONDITION |
December 31, 2021 and 2020 |
| | | | | | | | |
(in thousands, except share data) | 2021 | 2020 |
Assets | | |
Cash, cash equivalents and restricted cash | $ | 347,641 | | $ | 200,320 | |
| | |
| | |
Investment securities: | | |
Held-to-maturity, at amortized cost (net of zero allowance for credit losses at December 31, 2021 and 2020 1) | 342,222 | | 109,036 | |
Available-for-sale, at fair value (net of zero allowance for credit losses at December 31, 2021 and 20201) | 1,167,568 | | 392,351 | |
Total investment securities | 1,509,790 | | 501,387 | |
Loans, at amortized cost | 2,255,645 | | 2,088,556 | |
Allowance for credit losses on loans 1 | (23,023) | | (22,874) | |
Loans, net of allowance for credit losses on loans | 2,232,622 | | 2,065,682 | |
Goodwill | 72,754 | | 30,140 | |
Bank-owned life insurance | 61,473 | | 43,552 | |
Operating lease right-of-use assets | 23,604 | | 25,612 | |
Bank premises and equipment, net | 7,558 | | 4,919 | |
Core deposit intangible | 6,605 | | 3,831 | |
Other real estate owned | 800 | | — | |
Interest receivable and other assets | 51,362 | | 36,483 | |
Total assets | $ | 4,314,209 | | $ | 2,911,926 | |
Liabilities and Stockholders' Equity | | |
Liabilities | | |
Deposits: | | |
Non-interest bearing | $ | 1,910,240 | | $ | 1,354,650 | |
Interest bearing: | | |
Transaction accounts | 290,813 | | 183,552 | |
Savings accounts | 340,959 | | 201,507 | |
Money market accounts | 1,116,303 | | 667,107 | |
Time accounts | 150,235 | | 97,433 | |
Total deposits | 3,808,550 | | 2,504,249 | |
Borrowings and other obligations | 419 | | 58 | |
Subordinated debenture | — | | 2,777 | |
Operating lease liabilities | 25,429 | | 27,062 | |
Interest payable and other liabilities | 29,443 | | 19,527 | |
Total liabilities | 3,863,841 | | 2,553,673 | |
Stockholders' Equity | | |
Preferred stock, no par value, Authorized - 5,000,000 shares, none issued | — | | — | |
Common stock, no par value, Authorized - 30,000,000 shares; Issued and outstanding - 15,929,243 and 13,500,453 at December 31, 2021 and 2020, respectively | 212,524 | | 125,905 | |
Retained earnings | 239,868 | | 219,747 | |
Accumulated other comprehensive (loss) income, net of taxes | (2,024) | | 12,601 | |
Total stockholders' equity | 450,368 | | 358,253 | |
Total liabilities and stockholders' equity | $ | 4,314,209 | | $ | 2,911,926 | |
1 Refer to Note 1, Summary of Accounting Policies, for information on the adoption of ASU 2016-13 in 2020.
The accompanying notes are an integral part of these consolidated financial statements.
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BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME |
Years ended December 31, 2021, 2020 and 2019 |
| | | | | | | | | | | |
(in thousands, except per share amounts) | 2021 | 2020 | 2019 |
Interest income | | | |
Interest and fees on loans | $ | 91,612 | | $ | 84,674 | | $ | 84,331 | |
Interest on investment securities | 16,342 | | 14,503 | | 14,785 | |
Interest on federal funds sold and due from banks | 399 | | 461 | | 1,321 | |
Total interest income | 108,353 | | 99,638 | | 100,437 | |
Interest expense | | | |
Interest on interest-bearing transaction accounts | 172 | | 186 | | 347 | |
Interest on savings accounts | 94 | | 68 | | 70 | |
Interest on money market accounts | 1,520 | | 2,009 | | 3,439 | |
Interest on time accounts | 246 | | 554 | | 595 | |
Interest on borrowings and other obligations | 9 | | 4 | | 77 | |
Interest on subordinated debentures | 1,361 | | 158 | | 229 | |
Total interest expense | 3,402 | | 2,979 | | 4,757 | |
Net interest income | 104,951 | | 96,659 | | 95,680 | |
(Reversal of) provision for credit losses on loans | (1,449) | | 4,594 | | 900 | |
(Reversal of) provision for credit losses on unfunded loan commitments | (992) | | 1,570 | | 129 | |
Net interest income after (reversal of) provision for credit losses and unfunded loan commitments | 107,392 | | 90,495 | | 94,651 | |
Non-interest income | | | |
Wealth Management and Trust Services | 2,222 | | 1,851 | | 1,907 | |
Earnings from bank-owned life insurance, net | 2,194 | | 973 | | 1,196 | |
Debit card interchange fees, net | 1,812 | | 1,438 | | 1,586 | |
Service charges on deposit accounts | 1,593 | | 1,314 | | 1,865 | |
Dividends on FHLB stock | 760 | | 654 | | 799 | |
Merchant interchange fees, net | 422 | | 239 | | 331 | |
(Losses) gains on investment securities, net | (16) | | 915 | | 55 | |
Other income | 1,145 | | 1,166 | | 1,345 | |
Total non-interest income | 10,132 | | 8,550 | | 9,084 | |
Non-interest expense | | | |
Salaries and employee benefits | 41,939 | | 34,393 | | 34,253 | |
Occupancy and equipment | 7,302 | | 6,943 | | 6,143 | |
Data processing | 5,139 | | 3,184 | | 3,717 | |
Professional services | 4,974 | | 2,181 | | 2,132 | |
Depreciation and amortization | 1,740 | | 2,149 | | 2,228 | |
Information technology | 1,550 | | 1,050 | | 1,065 | |
Amortization of core deposit intangible | 1,135 | | 853 | | 887 | |
Directors' expense | 957 | | 713 | | 735 | |
Federal Deposit Insurance Corporation insurance | 889 | | 474 | | 361 | |
Charitable contributions | 587 | | 1,034 | | 508 | |
Other expense | 6,426 | | 5,484 | | 5,812 | |
Total non-interest expense | 72,638 | | 58,458 | | 57,841 | |
Income before provision for income taxes | 44,886 | | 40,587 | | 45,894 | |
Provision for income taxes | 11,658 | | 10,345 | | 11,653 | |
Net income | $ | 33,228 | | $ | 30,242 | | $ | 34,241 | |
Net income per common share: | | | |
Basic | $ | 2.32 | | $ | 2.24 | | $ | 2.51 | |
Diluted | $ | 2.30 | | $ | 2.22 | | $ | 2.48 | |
Weighted average common shares: | | | |
Basic | 14,340 | | 13,525 | | 13,620 | |
Diluted | 14,422 | | 13,617 | | 13,794 | |
Comprehensive income: | | | |
Net income | $ | 33,228 | | $ | 30,242 | | $ | 34,241 | |
Other comprehensive (loss) income: | | | |
Change in net unrealized gains or losses on available-for-sale securities | (21,281) | | 11,891 | | 11,839 | |
Reclassification adjustment for losses (gains) on available-for-sale securities in net income | 16 | | (915) | | (55) | |
| | | |
Amortization of net unrealized losses on securities transferred from available-for-sale to held-to-maturity | 493 | | 524 | | 445 | |
Other comprehensive (loss) income, before tax | (20,772) | | 11,500 | | 12,229 | |
Deferred tax (benefit) expense | (6,147) | | 3,402 | | 3,624 | |
Other comprehensive (loss) income, net of tax | (14,625) | | 8,098 | | 8,605 | |
Comprehensive income | $ | 18,603 | | $ | 38,340 | | $ | 42,846 | |
The accompanying notes are an integral part of these consolidated financial statements.
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BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY |
Years ended December 31, 2021, 2020 and 2019 |
| | | | | | | | | | | | | | | | | |
(in thousands, except share data) | Common Stock | Retained Earnings | Accumulated Other Comprehensive Income (Loss), Net of Taxes | Total |
Shares | Amount |
Balance at December 31, 2018 | 13,844,353 | | $ | 140,565 | | $ | 179,944 | | $ | (4,102) | | $ | 316,407 | |
Net income | — | | — | | 34,241 | | — | | 34,241 | |
Other comprehensive income | — | | — | | — | | 8,605 | | 8,605 | |
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings | 45,553 | | 669 | | — | | — | | 669 | |
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 surrendered for tax withholdings upon vesting | (5,240) | | (220) | | — | | — | | (220) | |
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 | |
Stock repurchased, net of commissions | (356,000) | | (15,022) | | — | | — | | (15,022) | |
Balance at December 31, 2019 | 13,577,008 | | $ | 129,058 | | $ | 203,227 | | $ | 4,503 | | $ | 336,788 | |
Net income | — | | — | | 30,242 | | — | | 30,242 | |
Other comprehensive income | — | | — | | — | | 8,098 | | 8,098 | |
Cumulative effect of change in accounting principal ASU 2016-131 | — | | — | | (1,216) | | — | | (1,216) | |
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings | 65,407 | | 1,304 | | — | | — | | 1,304 | |
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 surrendered for tax withholdings upon vesting | (2,200) | | (73) | | — | | — | | (73) | |
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 repurchased, net of commissions | (203,709) | | (7,208) | | — | | — | | (7,208) | |
Balance at December 31, 2020 | 13,500,453 | | $ | 125,905 | | $ | 219,747 | | $ | 12,601 | | $ | 358,253 | |
Net income | — | | — | | 33,228 | | — | | 33,228 | |
Other comprehensive loss | — | | — | | — | | (14,625) | | (14,625) | |
| | | | | |
Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings | 36,338 | | 463 | | — | | — | | 463 | |
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 surrendered for tax withholdings upon vesting | (4,211) | | (166) | | — | | — | | (166) | |
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 | |
Stock issued to American River Bankshares shareholders | 3,441,235 | | 124,401 | | | | 124,401 | |
Stock repurchased, net of commissions | (1,117,666) | | (40,722) | | — | | — | | (40,722) | |
Balance at December 31, 2021 | 15,929,243 | | $ | 212,524 | | $ | 239,868 | | $ | (2,024) | | $ | 450,368 | |
1 Refer to Note 1, Summary of Accounting Policies, for information on the adoption of ASU 2016-13 in 2020.
The accompanying notes are an integral part of these consolidated financial statements.
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BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CASH FLOWS |
Years ended December 31, 2021, 2020 and 2019 |
| | | | | | | | | | | |
(in thousands) | 2021 | 2020 | 2019 |
Cash Flows from Operating Activities: | | | |
Net income | $ | 33,228 | | $ | 30,242 | | $ | 34,241 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | |
(Reversal of) provision for credit losses on loans | (1,449) | | 4,594 | | 900 | |
(Reversal of) provision for credit losses on unfunded loan commitments | (992) | | 1,570 | | 129 | |
| | | |
Noncash contribution expense to employee stock ownership plan | 1,330 | | 1,289 | | 1,245 | |
Noncash director compensation expense | 347 | | 301 | | 301 | |
Stock-based compensation expense | 972 | | 1,203 | | 1,512 | |
| | | |
Amortization of core deposit intangible | 1,135 | | 853 | | 887 | |
Amortization of investment security premiums, net of accretion of discounts | 5,799 | | 1,354 | | 1,633 | |
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) | |
| | | |
Depreciation and amortization | 1,740 | | 2,149 | | 2,228 | |
| | | |
| | | |
| | | |
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 | |
Total adjustments | 12,025 | | 10,603 | | 6,692 | |
Net cash provided by operating activities | 45,253 | | 40,845 | | 40,933 | |
Cash Flows from Investing Activities: | | | |
| | | |
Purchase of held-to-maturity securities | (305,329) | | — | | (3,549) | |
Purchase of available-for-sale securities | (620,236) | | (97,544) | | (110,934) | |
| | | |
Proceeds from sale of available-for-sale securities | 6,632 | | 33,756 | | 66,081 | |
| | | |
Proceeds from paydowns/maturities of held-to-maturity securities | 71,682 | | 28,144 | | 23,005 | |
Proceeds from paydowns/maturities of available-for-sale securities | 110,059 | | 114,991 | | 86,044 | |
| | | |
Loan principal collected, net of originations | 256,856 | | (249,337) | | (77,827) | |
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) | |
Net cash used in investing activities | (340,666) | | (173,443) | | (20,754) | |
Cash Flows from Financing Activities: | | | |
Net increase in deposits | 514,279 | | 167,760 | | 161,649 | |
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) | |
Cash dividends paid on common stock | (13,107) | | (12,506) | | (10,958) | |
Stock repurchased, net of commissions | (40,762) | | (6,898) | | (15,062) | |
Proceeds from stock issued under employee and director stock purchase plans | 124 | | 115 | | 78 | |
Net cash provided by financing activities | 442,734 | | 149,530 | | 128,988 | |
Net increase in cash, cash equivalents and restricted cash | 147,321 | | 16,932 | | 149,167 | |
Cash, cash equivalents and restricted cash at beginning of period | 200,320 | | 183,388 | | 34,221 | |
Cash, cash equivalents and restricted cash at end of period | $ | 347,641 | | $ | 200,320 | | $ | 183,388 | |
Supplemental disclosure of cash flow information: | | | |
Cash paid in interest | $ | 2,105 | | $ | 2,948 | | $ | 4,659 | |
Cash paid in income taxes | $ | 12,350 | | $ | 13,065 | | $ | 12,738 | |
Supplemental disclosure of noncash investing and financing activities: | | | |
Change in net unrealized gain or loss on available-for-sale securities | $ | (21,281) | | $ | 11,891 | | $ | 11,839 | |
Stock issued to employee stock ownership plan | $ | 1,330 | | $ | 1,289 | | $ | 1,245 | |
| | | |
Cumulative effect of change in accounting principle ASU 2016-13 | $ | — | | $ | (1,216) | | $ | — | |
Amortization of net unrealized loss on available-for-sale securities transferred to held-to-maturity | $ | 493 | | $ | 524 | | $ | 445 | |
Repurchase of stock not yet settled | $ | 373 | | $ | 413 | | $ | 103 | |
Stock issued in payment of director fees | $ | 217 | | $ | 217 | | $ | 231 | |
| | | |
| | | |
| | | |
Acquisition: Fair value of assets acquired, excluding cash and cash equivalents | $ | 757,844 | | $ | — | | $ | — | |
Fair value of liabilities assumed | $ | 816,558 | | $ | — | | $ | — | |
Restricted cash 1 | $ | 4,395 | | $ | 2,700 | | $ | 6,516 | |
| | | |
1Restricted cash includes reserve requirements held with the Federal Reserve Bank of San Francisco and other cash pledged. In response to the COVID-19 pandemic, the Federal Reserve reduced the reserve requirement ratios to zero percent effective March 26, 2020. The accompanying notes are an integral part of these consolidated financial statements. |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Summary of Significant Accounting Policies
Nature of Operations - Bank of Marin Bancorp ("Bancorp"), headquartered in Novato, California, conducts business primarily through its wholly-owned subsidiary, Bank of Marin (the "Bank"), a California state-chartered commercial bank that provides a wide range of financial services through 31 retail branches and 8 commercial banking offices across 10 counties, including Alameda, Amador, Contra Costa, Marin, Napa, Placer, Sacramento, San Francisco, San Mateo and Sonoma. Our customer base is made up of business, not-for-profit and personal banking relationships from the communities within our Northern California footprint.
Basis of Presentation - The consolidated financial statements include the accounts of Bancorp, a bank holding company, and its wholly-owned bank subsidiary, Bank of Marin, a California state-chartered commercial bank. Effective 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, followed thereafter at 12:05 AM on August 7, 2021, by the merger of American River Bank ("ARB") with and into Bank of Marin, with Bank of Marin (the "Bank") surviving, (collectively the "Merger"). The Merger was accounted for under ASC 805, Business Combinations. See Note 18, Merger, for further detail. References to “we,” “our,” “us” mean Bancorp and the Bank that are consolidated for financial reporting purposes. Our accounting and reporting policies conform to U.S. generally accepted accounting principles ("GAAP"), general practice, and regulatory guidance within the banking industry. A summary of our significant policies follows. All material intercompany transactions have been eliminated. We monitor financial performance and evaluate the revenue streams of the various products, services, locations, and operations on a company-wide basis. Accordingly, all of the community banking and wealth management and trust services are considered by management to be aggregated into one reportable operating segment, community banking. We evaluated subsequent events through the date of filing with the Securities and Exchange Commission (“SEC”) and determined that there were no subsequent events that require additional recognition or disclosure.
The NorCal Community Bancorp Trust II (the "Trust") was formed for the sole purpose of issuing trust preferred securities. Bancorp is not considered the primary beneficiary of the Trust (a variable interest entity), therefore the Trust is not consolidated in our consolidated financial statements, but rather the subordinated debenture is shown as a liability on our consolidated statements of condition. Bancorp's investment in the securities of the Trust is accounted for under the equity method and is included in interest receivable and other assets on the consolidated statements of condition. Refer to Note 7, Borrowings, for additional information on the subordinated debenture due to NorCal Community Bancorp Trust II and the early redemption that occurred on March 15, 2021.
Accounting Changes and Reclassifications - Certain items in prior financial statements have been reclassified to conform to the current presentation. In addition, on December 31, 2020, we adopted Accounting Standards Update (“ASU”) 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and all applicable amendments as subsequently updated for certain clarifications, targeted relief and codification improvements. Accounting Standards Codification (“ASC”) Topic 326 (“ASC 326”) replaced the incurred loss method for measuring credit losses with a current expected credit loss ("CECL") method for financial assets recorded at amortized cost (i.e., loans originated by us and held-to-maturity investment securities). The previous incurred loss method included a general allowance on loans for known and inherent losses within the portfolio, which reflected adjusted historical loss rates and a specific allowance component for impaired loans. The CECL method requires the measurement of all expected credit losses for financial assets measured at amortized cost and certain off-balance-sheet credit exposures to consider credit losses expected to be incurred over the life of the financial asset based on past events, current conditions, and reasonable and supportable forecasts. ASC 326 also requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards. In addition, ASC 326 includes certain changes to the accounting for available-for-sale investment securities including the requirement to recognize an allowance when management intends to sell or believes that it is more likely than not they will be required to sell the security before recovery of its amortized cost.
ASC 326 was effective January 1, 2020. However, in accordance with the accounting relief provisions of the Coronavirus Aid, Relief and Economic Security ("CARES") Act passed in March 2020, we postponed the adoption of the CECL standard to the earlier of the end of the national emergency or December 31, 2020. Therefore, we adopted this standard using the modified retrospective method for all financial assets measured at amortized cost, and off-balance-sheet credit exposures, effective October 1, 2020 (the beginning of the first reporting period in
which the standard was effective due to the postponement of CECL) through a cumulative adjustment to retained earnings. Results for reporting periods beginning after September 30, 2020 have been presented under the new standard while prior period amounts continue to be reported in accordance with previously applicable GAAP. Upon adoption, we recorded a cumulative adjustment to retained earnings, net of taxes, based on economic forecasts and other assumptions as of December 31, 2019. That adjustment resulted in an increase to our allowance for credit losses of $1.6 million and an increase to the allowance for unfunded loan commitments of $122 thousand. In addition, we recognized the remaining difference between the allowance for credit losses calculated under the CECL model as of December 31, 2020 and the allowance for credit losses calculated under the incurred loss model as of September 30, 2020 as a reversal of the provision for credit losses and a provision for credit losses on unfunded loan commitments, as showed in the tables below.
The following tables show the impact to our financial statement line items due to adoption of ASC 326 as of and during the quarter ended December 31, 2020.
| | | | | | | | | | | |
(in thousands) | Pre-Tax Increase (Decrease) Upon the Adoption of CECL | Deferred Tax Effect | After Tax Impact of Adoption of CECL |
Impact to allowance for credit losses on loans: | | | |
Allowance for credit losses on loans | $ | 748 | | | |
Retained earnings (cumulative transition adjustment) | $ | (1,604) | | $ | 474 | | $ | (1,130) | |
Net income (reversal of provision for credit losses on loans) | $ | 856 | | $ | (253) | | $ | 603 | |
Impact to allowance for credit losses on unfunded loan commitments: | | | |
Allowance for credit losses on unfunded commitments | $ | 1,082 | | | |
Retained earnings (cumulative transition adjustment) | $ | (122) | | $ | 36 | | $ | (86) | |
Net income (provision for credit losses on unfunded commitments) | $ | (960) | | $ | 284 | | $ | (676) | |
The following table shows the impact on the allowance for credit losses due to the transition from the incurred loss method to the CECL method by loan class.
| | | | | | | | | | | |
(in thousands) | Pre-Adoption Balance at September 30, 2020 | Cumulative Transition Adjustment 1 | Post Adoption Adjusted Balance at October 1, 2020 |
Allowance for credits losses on loans: | | | |
Commercial and industrial | $ | 2,525 | | $ | (278) | | $ | 2,247 | |
Real estate: | | | |
Commercial owner-occupied | 3,135 | | 138 | | 3,273 | |
Commercial investor-owned | 11,624 | | 1,755 | | 13,379 | |
Construction | 860 | | 201 | | 1,061 | |
Home equity | 1,038 | | (361) | | 677 | |
Other residential | 1,260 | | (212) | | 1,048 | |
Installment and other consumer loans | 406 | | (125) | | 281 | |
Unallocated | 1,265 | | 486 | | 1,751 | |
Total | $ | 22,113 | | $ | 1,604 | | $ | 23,717 | |
| | | |
Allowance for credit losses on unfunded commitments | $ | 1,697 | | $ | 122 | | $ | 1,819 | |
1 The cumulative transition adjustment resulted from applying the CECL method, which was based on economic forecasts and other assumptions as of December 31, 2019. Refer to Note 3, Loans and Allowance for Credit Losses, for more information. |
The Bank did not record an allowance for credit losses on available-for-sale or held-to-maturity investment securities upon the adoption of CECL as the investment portfolio consisted primarily of debt securities backed by the U.S. government and high credit quality obligations of state and political subdivisions. Refer to Note 2, Investment Securities, for more information.
In the second quarter of 2021, we reclassified the provision for credit losses on unfunded commitments from non-interest expense to a separate line item under the provision for credit losses on loans in the consolidated statements of comprehensive income.
Use of Estimates - The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant accounting estimates reflected in the consolidated financial statements include the allowance for credit losses, income taxes, and fair value measurements (including fair values of acquired assets and assumed liabilities at acquisition dates) as discussed in the Notes herein.
Cash, Cash Equivalents and Restricted Cash - include cash, due from banks, federal funds sold and other short-term investments with maturities of less than three months at the time of purchase. Restricted cash includes balances not immediately available for business operations such as Federal Reserve Bank of San Francisco reserve requirements and cash pledged for interest rate swap contracts and local agency deposits.
Investment Securities - are classified as "held-to-maturity," "trading securities" or "available-for-sale." Investments classified as held-to-maturity are those that we have the ability and intent to hold until maturity and are reported at cost, adjusted for the amortization or accretion of premiums or discounts. Investments held for resale in anticipation of short-term market movements are classified as trading securities and are reported at fair value, with unrealized gains and losses included in earnings. Investments that are neither held-to-maturity nor trading are classified as available-for-sale and are reported at fair value. Unrealized gains and losses for available-for-sale securities, net of related taxes, are reported as a separate component of comprehensive income and included in stockholders' equity until realized. For discussion of our methodology in determining fair value, see Note 9, Fair Value of Assets and Liabilities.
Purchase premiums and discounts on investment securities are amortized or accreted over the life of the related security as an adjustment to yield using the effective interest method. For certain callable debt securities purchased at a premium, we amortize the premium to the earliest call date.
Dividend and interest income are recognized when earned. Realized gains and losses on the sale of securities are included in non-interest income. The specific identification method is used to calculate realized gains and losses on sales of securities.
Securities transferred from the available-for-sale category to the held-to-maturity category are recorded at fair value at the date of transfer. Unrealized holding gains or losses on the dates of the transfer of securities from available-for-sale to held-to-maturity are included in the balance of accumulated other comprehensive income (loss), net of tax, in the consolidated balance sheets. These unrealized holding gains or losses on the dates of transfer are amortized over the remaining life of the securities as yield adjustments in a manner consistent with the amortization or accretion of the original purchase premium or discount on the associated security.
Allowance for Credit Losses on Investment Securities - The allowance for credit losses on held-to-maturity securities is a contra-asset valuation account determined in accordance with ASC 326, which is deducted from the securities' amortized cost basis at the balance sheet date as a result of management's assessment of the net amount expected to be collected. The allowance is measured on a pooled basis for securities with similar risk characteristics using historical credit loss information, adjusted for current conditions and reasonable and supportable forecasts. Securities that are determined to be uncollectible are written off against the allowance.
For available-for-sale securities in an unrealized loss position ("impaired security"), we assess whether 1) we intend to sell the security, or, 2) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. Under either of these conditions, the security's amortized cost is written down to fair value through a charge to previously recognized allowances or earnings, as applicable. For impaired securities that do not meet these conditions, we assess whether the decline in fair value was due to credit loss or other factors. This assessment considers, among other things: 1) the extent to which the fair value is less than amortized cost, 2) the financial condition and near-term prospects of the issuer, 3) any changes to the rating of the security by a rating agency, and 4) our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss component. Any impairment due to non-credit-related factors that has not been recorded through an allowance for credit losses is recognized in other comprehensive income. The discount rate used in determining the present
value of the expected cash flows is based on the effective interest rate implicit in the security at the date of purchase.
Accrued interest receivable is excluded from the amortized costs and fair values of both held-to-maturity and available-for-sale securities and included in interest receivable and other assets on the consolidated statements of condition. Investment securities are placed on non-accrual status when principal or interest is contractually past due more than ninety days, or management does not expect full payment of principal and interest. We do not record an allowance for credit losses for accrued interest on investment securities, as the amounts are written-off when the investment is placed on non-accrual status. There were no non-accrual investment securities in any of the years presented in the consolidated financial statements.
Originated Loans - are reported at amortized cost, which is the principal amount outstanding net of deferred fees (costs), purchase premiums (discounts) and net charge-offs (recoveries). Amortized cost excludes accrued interest, which is reflected in interest receivable and other assets in the consolidated statements of condition. We do not measure an allowance for credit losses on accrued interest receivable balances because these balances are written off in a timely manner as a reduction to interest income when loans are placed on non-accrual status as discussed below. Interest income is accrued daily using the simple interest method. Fees collected upon loan origination and certain direct costs of originating loans are deferred and recognized over the contractual lives of the related loans as yield adjustments using the interest method or straight-line method, as applicable. Upon prepayment or other disposition of the underlying loans before their contractual maturities, any associated unearned fees or unamortized costs are recognized.
Acquired Loans - ASC 326 modified the accounting for purchased loans and requires that an allowance for credit losses be established at the date of acquisition. However, for purchased financial assets with a more-than-insignificant amount of credit deterioration since origination (“PCD assets”) that are measured at amortized cost, the initial allowance for credit losses is added to the purchase price rather than reported as a provision for credit losses. Subsequent changes in the allowance for credit losses on PCD assets are recognized through the provision for credit losses.
Past-Due and Non-Accrual Loan Policy - A loan is considered past due when a payment has not been received by the contractual due date. Loans are placed on non-accrual status when management believes that there is substantial doubt as to the collection of principal or interest, generally when they become contractually past due by 90 days or more with respect to principal or interest, except for loans that are well-secured and in the process of collection. When loans are placed on non-accrual status, any accrued but uncollected interest is reversed from current-period interest income and the amortization of deferred loan origination fees and costs is suspended. Interest payments received on nonaccrual loans are either applied against principal or reported as interest income, according to management’s judgment as to the ultimate collectability of principal. We may return non-accrual loans to accrual status when one of the following occurs:
•The borrower has resumed paying the full amount of the principal and interest and we are satisfied with the borrower's financial position. In order to meet this test, we must have received repayment of all past due principal and interest, unless the amounts contractually due are reasonably assured of repayment within a reasonable period of time, and there has been a sustained period of repayment performance (generally, six consecutive monthly payments), according to the original contractual terms or modified terms for loans whose contractual terms have been restructured in a manner which grants a concession to a borrower experiencing financial difficulties (“troubled debt restructuring”).
•The loan has become well secured and is in the process of collection.
Loan Charge-Off Policy - For all loan types excluding overdraft accounts, we generally make a charge-off determination at or before 90 days past due. A collateral-dependent loan is partially charged down to the fair value of collateral securing it if: (1) it is deemed uncollectable, or (2) it has been classified as a loss by either our internal loan review process or external examiners. A non-collateral-dependent loan is partially charged down to its net realizable value under the same circumstances. Overdraft accounts are generally charged off when they exceed 60 days past due.
Troubled Debt Restructured Loans - Our loan portfolio includes certain loans modified in a troubled debt restructuring (“TDR”), where we have granted economic concessions to borrowers experiencing financial difficulties.
These concessions typically result from our loss mitigation activities and may include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. TDRs on non-accrual status at the time of restructure may be returned to accruing status after management considers the borrower’s sustained repayment performance for a reasonable period, generally six months, and obtains reasonable assurance of repayment and performance. Additionally, we may remove a loan from TDR designation if it meets all of the following conditions:
•The loan is subsequently refinanced or restructured at current market interest rates and the new terms are consistent with the treatment of creditworthy borrowers under regular underwriting standards;
•The borrower is no longer considered to be in financial difficulty;
•Performance on the loan is reasonably assured; and
•Existing loan did not have any forgiveness of principal or interest.
Section 4013 of the 2020 CARES Act, subsequently amended by section 541 of the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act of 2020 ("Economic Aid Act"), provided optional, temporary relief from evaluating loans that may have been considered TDRs under GAAP. This relief applies to loan modifications executed between March 1, 2020 and the earlier of 60 days after the national emergency is terminated or January 1, 2022. The Bank elected to apply these temporary accounting provisions to payment relief loans beginning in March 2020. Accordingly, modifications that met certain criteria of the CARES Act were not categorized as troubled debt restructurings during 2021 and 2020.
Collateral Dependent Loans - A loan is collateral dependent when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the sale or operation of the collateral. For collateral dependent loans, including those for which management determines foreclosure is probable, the allowance for credit losses is based on the fair value of the collateral, adjusted for estimated selling costs when repayment is expected from the sale of the collateral, less the loan's amortized cost. In determining the fair value, management considers such information as the appraised value of the collateral, observed and potential future changes in collateral value, and historical loss experience for loans that were secured by similar collateral. Generally, with problem credits that are collateral dependent, we obtain appraisals of the collateral at least annually. We may obtain appraisals more frequently if we believe the collateral value is subject to market volatility, if a specific event has affected the collateral, or if we believe foreclosure is imminent.
Allowance for Credit Losses on Loans ("ACL") - is a valuation account that is deducted from the amortized cost basis at the balance sheet date to present the net amount of loans expected to be collected. Amortized cost does not include accrued interest, which management elected to exclude from the estimate of expected credit losses (refer to the Past-Due and Non-Accrual Loan Policy section above). Management estimates the allowance quarterly using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Credit loss experience provides the basis for the estimation of expected credit losses.
The ACL model utilizes a discounted cash flow ("DCF") method to measure the expected credit losses on loans collectively evaluated that are sub-segmented by loan pools with similar credit risk characteristics, which are generally comprised of federal regulatory reporting codes (i.e., Call codes). Pooled segments include the following:
•Loans secured by real estate:
- 1-4 family residential construction loans
- Other construction loans and all land development and other land loans
- Secured by farmland (including residential and other improvements)
- Revolving, open-end loans secured by 1-4 family residential properties and extended under lines
of credit
- Closed-end loans secured by 1-4 family residential properties, secured by first liens
- Closed-end loans secured by 1-4 family residential properties, secured by junior liens
- Secured by multifamily (5 or more) residential properties
- Commercial real estate loans secured by owner-occupied non-farm nonresidential properties
- Commercial real estate loans secured by other non-farm nonresidential properties
•Loans to finance agricultural production and other loans to farmers
•Commercial and industrial loans
•Loans to individuals for household, family and other personal expenditures (i.e., consumer loans)
•Municipal entities
•Non-profit organizations
•Other loans (overdraft credit lines)
The DCF method incorporates assumptions for probability of default ("PD"), loss given default ("LGD"), and prepayments and curtailments over the contractual terms of the loans. Under the DCF method, the ACL reflects the difference between the amortized cost basis and the present value of the expected cash flows using the loan's effective rate. We elected to report the change in present values from one reporting period to the next due to the passage of time and changes in the estimate of future expected cash flows through the provision for credit losses, rather than though interest income.
In determining the PD for each pooled segment, the Bank utilized regression analyses to identify certain economic drivers that were considered highly correlated to historical Bank or peer loan default experience. As a result, management chose the California unemployment rate as the primary economic forecast driver for all segments, except for municipal loans. In addition, the annual percentage change in the California gross domestic product was used in the commercial and industrial loan segment. For municipal loans, the ACL model utilized a constant default rate obtained from a nationally recognized default rate study, which is updated annually. In the third quarter of 2021, we eliminated the use of the annual percentage change in California retail sales in the owner-occupied and investor-owned commercial real estate segments as we determined that it was not highly correlated to peer loan default experience when we performed our annual validation of our peer group and regression analyses. The change in methodology did not have a material impact on the ACL. A third party provides LGD estimates for each segment based on a banking industry Frye-Jacobs Risk Index approach. The ACL model incorporates a one-year reasonable and supportable forecast of economic factors, updated quarterly, which is based on Moody's Analytics' Baseline Forecast. For periods beyond the forecast horizon the economic factors revert to historical averages on a straight-line basis over a one-year period.
Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments and curtailments, when appropriate. The pooled loans' contractual loan terms exclude extensions, renewals, and modifications unless one or more of the following applies: 1) management has a reasonable expectation at the reporting date that a troubled debt restructuring will be executed with an individual borrower, 2) the extension or renewal options are included in the original or modified contract, or 3) an existing troubled debt restructuring is within six months of maturity.
Loans that do not share the same risk characteristics as pooled loans are evaluated individually for credit loss and generally include all non-accrual loans, collateral dependent loans, and certain troubled debt restructured loans and loans graded substandard or worse as determined by management.
Management considers whether adjustments to the quantitative portion of the ACL are needed for differences in segment-specific risk characteristics or to reflect the extent to which it expects current conditions and reasonable and supportable forecasts of economic conditions to differ from the conditions that existed during the historical period included in the development of PD and LGD. Qualitative internal and external risk factors include, but are not limited to, the following:
•Changes in the nature and volume of the loan portfolio
•Changes in the volume and severity of past due loans, the volume of non-accruals loans, and the volume and severity of adversely classified or graded loans
•The existence and effect of individual loan and loan segment concentrations
•Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere
•Changes in the experience, ability, and depth of lending management and other relevant staff
•Changes in the quality of our systematic loan review processes
•Changes in economic and business conditions, and developments that affect the collectability of the portfolio
•Changes in the value of underlying collateral, where applicable
•The effect of other external factors such as legal and regulatory requirements on the level of estimated credit losses in the portfolio
•The effect of acquisitions of other loan portfolios on our infrastructure, including risk associated with entering new geographic areas as a result of such acquisitions
•The presence of specialized lending segments in the portfolio
While we believe we use the best information available to determine the allowance for credit losses, our results of operations could be significantly affected if circumstances differ substantially from the assumptions used in determining the allowance. Our ACL model is sensitive to changes in unemployment rate forecasts and certain other assumptions that could result in material fluctuations in the allowance for credit losses and adversely affect our financial condition and results of operations.
For further information regarding the allowance for loan losses, see Note 3, Loans and Allowance for Loan Losses.
Allowance for Credit Losses on Unfunded Loan Commitments - We make commitments to extend credit to meet the financing needs of our customers in the form of loans or standby letters of credit. We are exposed to credit losses over a loan's contractual period in the event that a decline in credit quality of the borrower leads to nonperformance. We record an allowance for losses on unfunded loan commitments at the balance sheet date based on estimates of probability that these commitments will be drawn upon according to historical utilization experience of different types of commitments and expected loss severity and loss rates determined for pooled funded loans. The allowance for credit losses on unfunded commitments is a liability account included in interest payable and other liabilities on the consolidated statements of condition. Adjustments to the allowance for unfunded commitments are included in non-interest expense as a provision for (or reversal of) the allowance for unfunded commitments.
Transfers of Financial Assets - We have entered into certain loan participation agreements with other organizations. We account for these transfers of financial assets as sales when control over the transferred financial assets has been surrendered. Control over transferred assets is deemed to be surrendered when 1) the assets and liabilities have been isolated from us, 2) the transferee has the right to pledge or exchange the assets (or beneficial interests) it received, free of conditions that constrain it from taking advantage of that right, beyond a trivial benefit and 3) we do not maintain effective control over the transferred financial assets or third-party beneficial interests related to those transferred assets. No gain or loss has been recognized by us on the sale of these participation interests in 2021, 2020 and 2019.
Premises and Equipment - Land is carried at cost and not depreciated. Bank-owned buildings, leasehold improvements, furniture, fixtures, software and equipment and are stated at cost, less accumulated depreciation, and depreciated/amortized on a straight-line basis. Furniture and fixtures are depreciated over eight years and equipment is generally depreciated over three to twenty years. Bank-owned buildings are depreciated over twenty-five to thirty years. Leasehold improvements are amortized over the lesser of their estimated useful lives or the terms of the leases. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation or amortization are removed from the accounts and any resulting gain or loss is recognized in income for the period. The cost of maintenance and repairs is charged to expense as incurred.
Leases - We lease certain premises under long-term non-cancelable operating leases, most of which include escalation clauses and one or more options to extend the lease term, and some of which contain lease termination clauses. Only those renewal and termination options that management determines are reasonably certain of exercising are included in the calculation of the lease liability. In addition, we lease certain equipment under finance leases. The equipment finance lease terms do not contain renewal options, bargain purchase options or residual value guarantees. We did not have any significant short-term leases during the reported periods.
Lease right-of-use assets represent the right to use the underlying asset while lease liabilities represent the present value of future lease obligations. We elected not to separate non-lease components from lease components and to exclude short-term leases (i.e., lease term of 12 months or less at the commencement date) from right-of-use assets and lease liabilities for all lease classifications. When calculating the lease liability, because most lease contracts do not contain an implicit interest rate, we discount lease payments over a lease's expected term based on the collateralized Federal Home Loan Bank borrowing rate that was commensurate with lease terms and minimum payments at the lease commencement date. Right-of-use assets for operating leases are amortized over the lease term by amounts that represent the difference between periodic straight-line lease expense and periodic interest accretion on the related liability to make lease payments, whereas finance leases are amortized on a straight-line basis over the term of the lease. Expense recognition for operating leases is recorded on a straight-line basis while expense recognition for finance leases represents the sum of periodic amortization of the associated
right-of-use asset and the interest accretion on the lease liability. Refer to Note 12, Commitments and Contingencies, for further information.
Business Combinations - Business combinations are accounted for under the acquisition method of accounting in accordance with ASC 805, Business Combinations. A business is defined as a set of activities and assets that is both self-sustaining and managed to provide a return to investors and generally has three elements: inputs, processes and outputs. Under the acquisition method, the acquiring entity in a business combination recognizes the acquired assets and assumed liabilities at their estimated fair values as of the date of acquisition. Any excess of the purchase price over the fair value of net assets and other identifiable intangible assets acquired is recorded as goodwill. To the extent the fair value of net assets acquired, including other identifiable assets, exceed the purchase price, a bargain purchase gain is recognized. Assets acquired and liabilities assumed from a business combination are recognized at fair value, if the fair value can be determined during the measurement period. Results of operations of an acquired business are included in the consolidated statements of operations from the date of acquisition. Business acquisition-related costs, including conversion and restructuring charges, are expensed as incurred. If substantially all of an acquisition is made up of one asset or several similar assets, or without a substantive process that together contributes to the ability to create outputs, the acquisition is accounted for as an asset acquisition and acquisition costs will be capitalized as part of the assets acquired, rather than expensed in a business combinations.
Goodwill and Other Intangible Assets - Goodwill is determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill that arises from a business combination is periodically evaluated for impairment at the reporting unit level, at least annually. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Core deposit intangible ("CDI") represents the estimated future benefit of deposits related to an acquisition and is booked separately from the related deposits and evaluated periodically for impairment. The CDI asset is amortized on an accelerated method over its estimated useful life of ten years. At December 31, 2021, the future estimated amortization expense for the CDI arising from our past acquisitions is as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
(in thousands) | 2022 | 2023 | 2024 | 2025 | 2026 | Thereafter | Total |
Core deposit intangible amortization | $ | 1,489 | | $ | 1,350 | | $ | 975 | | $ | 875 | | $ | 773 | | $ | 1,143 | | $ | 6,605 | |
We make a qualitative assessment of whether it is more likely than not that the fair value of a reporting unit where goodwill is assigned is less than its carrying amount. If we conclude that it is more likely than not that the fair value is more than its carrying amount, no impairment is recorded. Goodwill is tested for impairment on an interim basis if circumstances change or an event occurs between annual tests that would more likely than not reduce the fair value of the reporting unit below its carrying amount. The qualitative assessment includes adverse events or circumstances identified that could negatively affect the reporting units’ fair value as well as positive and mitigating events. Such indicators may include, among others, significant changes in legal factors or in the general business climate, significant changes in our stock price and market capitalization, unanticipated competition, and an action or assessment by a regulator. If the fair value of a reporting unit is less than its carrying amount, an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value is recognized. The loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.
Other Real Estate Owned ("OREO") - OREO is comprised of property acquired through a business combination, foreclosure, in substance repossession or acceptance of deeds-in-lieu of foreclosure when the related loan receivable is de-recognized. OREO is recorded at fair value of the collateral less estimated costs to sell, establishing a new cost basis, and subsequently accounted for at the lower of cost or fair value less estimated costs to sell. Any shortfall of collateral value from the recorded investment of the related loan is recognized as loss at the time of foreclosure and is charged against the allowance for loan losses. Fair value of collateral is generally based on an independent appraisal of the property. Revenues and expenses associated with OREO, and subsequent adjustments to the fair value of the property and to the estimated costs of disposal, are realized and reported as a component of non-interest income and expense when incurred.
Bank Owned Life Insurance ("BOLI") - The Bank owns life insurance policies on certain key current and former officers. BOLI is recorded in interest receivable and other assets on the consolidated statements of condition at the
amount that can be realized under the insurance contract at period-end, which is the cash surrender value adjusted for other charges or amounts due that are probable at settlement.
Federal Home Loan Bank of San Francisco ("FHLB") Stock - The Bank is a member of the FHLB. Members are required to own a certain amount of stock based on the level of borrowings and other factors. As of December 31, 2021 and 2020 our investment in FHLB stock was carried at cost, as there was no impairment or changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. We periodically evaluate FHLB stock for impairment based on ultimate recovery of par value. FHLB stock is included as part of interest receivable and other assets on the consolidated statements of condition. Both cash and stock dividends are reported as non-interest income.
Investments in Low Income Housing Tax Credit Funds - We have invested in limited partnerships that were formed to develop and operate affordable housing projects for low or moderate-income tenants throughout California. Our ownership percentage in each limited partnership ranges from 1.0% to 3.5%. We account for the investments in qualified affordable housing tax credit funds using the proportional amortization method, where the initial cost of the investment is amortized in proportion to the tax credits and other tax benefits received. Low income housing tax credits and other tax benefits received, net of the amortization of the investment is recognized as part of income tax benefit. Each of the partnerships must meet the regulatory minimum requirements for affordable housing for a minimum 15-year compliance period to fully utilize the tax credits. If the partnerships cease to qualify during the compliance period, the credit may be denied for any period in which the project is not in compliance and a portion of the credit previously taken is subject to recapture with interest. We record an impairment charge if the value of the future tax credits and other tax benefits is less than the carrying value of the investments.
Employee Stock Ownership Plan (“ESOP”) - We recognize compensation cost for ESOP contributions when funds become committed for the purchase of Bancorp's common shares into the ESOP in the year in which the employees render service entitling them to the contribution. If we contribute stock, the compensation cost is the fair value of the shares when they are committed to be released (i.e., when the number of shares becomes known and formally approved). In 2021, 2020 and 2019, the Bank only made stock contributions to the ESOP.
Income Taxes - Income taxes reported in the consolidated financial statements are computed based on an asset and liability approach. We recognize the amount of taxes payable or refundable for the current year and we record deferred tax assets and liabilities for future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases using enacted tax rates in effect for the year in which the temporary differences are expected to reverse. We record net deferred tax assets to the extent it is more likely than not that they will be realized. In evaluating our ability to recover the deferred tax assets and the need to establish a valuation allowance against the deferred tax assets, management considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies. In projecting future taxable income, management develops assumptions including the amount of future state and federal pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates being used to manage the underlying business. Bancorp files consolidated federal and combined state income tax returns.
We recognize the financial statement effect of a tax position when it is more likely than not, based on the technical merits and all available evidence, that the position will be sustained upon examination, including the resolution through protests, appeals or litigation processes. For tax positions that meet the more likely than not threshold, we measure and record the largest amount of tax benefit that is greater than fifty percent likely of being realized upon ultimate settlement with the taxing authority. The remainder of the benefits associated with tax positions taken is recorded as unrecognized tax benefits, along with any related interest and penalties. Interest and penalties related to unrecognized tax benefits are recorded in tax expense.
In deciding whether or not our tax positions taken meet the more likely than not recognition threshold, we must make judgments and interpretations about the application of inherently complex state and federal tax laws. To the extent tax authorities disagree with tax positions taken by us, our effective tax rates could be materially affected in the period of settlement with the taxing authorities. Revision of our estimate of accrued income taxes also may
result from our own income tax planning, which may affect effective tax rates and results of operations for any reporting period.
We present an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss ("NOL") carryforward, or similar tax loss or tax credit carryforward, rather than as a liability, when (1) the uncertain tax position would reduce the NOL or other carryforward under the tax law of the applicable jurisdiction and (2) we intend to and are able to use the deferred tax asset for that purpose. Otherwise, the unrecognized tax benefit is presented as a liability instead of being netted with deferred tax assets.
Earnings per share (“EPS”) - are based upon the weighted average number of common shares outstanding during each year. The following table shows: 1) weighted average basic shares, 2) potentially dilutive weighted average common shares related to stock options and unvested restricted stock awards, and 3) weighted average diluted shares. Basic EPS are calculated by dividing net income by the weighted average number of common shares outstanding during each annual period, excluding unvested restricted stock awards. Diluted EPS are calculated using the weighted average number of potentially dilutive common shares. The number of potentially dilutive common shares included in year-to-date diluted EPS is a year-to-date weighted average of potentially dilutive common shares included in each quarterly diluted EPS computation. In computing diluted EPS, we exclude anti-dilutive shares such as options whose exercise prices exceed the current common stock price, as they would not reduce EPS under the treasury method. We have two forms of outstanding common stock: common stock and unvested restricted stock awards. Holders of unvested restricted stock awards receive non-forfeitable dividends at the same rate as common shareholders and they both share equally in undistributed earnings. Under the two-class method, the difference in EPS is nominal for these participating securities.
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(in thousands, except per share data)1 | 2021 | 2020 | 2019 |
Weighted average basic common shares outstanding | 14,340 | | 13,525 | | 13,620 | |
Potentially dilutive common shares related to: | | | |
Stock options | 62 | | 69 | | 148 | |
Unvested restricted stock awards | 20 | | 23 | | 26 | |
Weighted average diluted common shares outstanding | 14,422 | | 13,617 | | 13,794 | |
Net income | $ | 33,228 | | $ | 30,242 | | $ | 34,241 | |
Basic EPS | $ | 2.32 | | $ | 2.24 | | $ | 2.51 | |
Diluted EPS | $ | 2.30 | | $ | 2.22 | | $ | 2.48 | |
Weighted average anti-dilutive common shares not included in the calculation of diluted EPS | 97 | | 148 | | 35 | |
Share-Based Compensation - All share-based payments, including stock options and restricted stock, are recognized as stock-based compensation expense in the consolidated statements of comprehensive income based on the grant-date fair value of the award with a corresponding increase in common stock. The grant-date fair value of the award is amortized on a straight-line basis over the requisite service period, which is generally the vesting period. The stock-based compensation expense excludes stock grants to directors as compensation for their services, which are recognized as director expenses separately based on the grant-date value of the stock. We account for forfeitures as they occur. See Note 8, Stockholders' Equity and Stock Option Plans, for further discussion.
We determine the fair value of stock options at the grant date using a Black-Scholes pricing model that takes into account the stock price at the grant date, exercise price, expected life of the option, volatility of the underlying stock, expected dividend yield and risk-free interest rate over the expected life of the option. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. Expected volatility is based on the historical volatility of the common stock over the most recent period that is generally commensurate with the expected life of the options. The Black-Scholes option valuation model requires the input of highly subjective assumptions, including the expected life of the stock-based award and stock price volatility. The assumptions used represent management's best estimates based on historical information, but these estimates involve inherent uncertainties and the application of management's judgment. As a result, if other assumptions had been used, the recorded stock-based compensation expense could have been materially different from that recorded in the consolidated financial statements. The fair value of restricted stock is based on the stock price on the grant date.
We record excess tax benefits resulting from the exercise of non-qualified stock options, the disqualifying disposition of incentive stock options and vesting of restricted stock awards as tax benefits in the consolidated statements of comprehensive income with a corresponding decrease to current taxes payable. In addition, we reflect excess tax benefits as an operating activity in the consolidated statements of cash flows.
Cash paid for tax withholdings when shares are surrendered in a cashless stock option exchange is classified as a financing activity in the consolidated statements of cash flows.
Derivative Financial Instruments and Hedging Activities - Fair Value Hedges - All of our interest rate swap contracts are designated and qualified as fair value hedges. The terms of our interest rate swap contracts are closely aligned to the terms of the designated fixed-rate loans. The hedging relationships are tested for effectiveness on a quarterly basis using a qualitative approach. The qualitative analysis includes verification that there are no changes to the derivative's or hedged item's key terms and conditions and no adverse developments regarding risk of counterparty default, and validation that we continue to have fair value hedge designation. The interest rate swaps are carried on the consolidated statements of condition at their fair value in other assets (when the fair value is positive) or in other liabilities (when the fair value is negative). The changes in the fair value of the interest rate swaps are recorded in interest income. The unrealized gains or losses due to changes in fair value of the hedged fixed-rate loans due to changes in benchmark interest rates are recorded as an adjustment to the hedged loans and offset in interest income. For derivative instruments executed with the same counterparty under a master netting arrangement, we do not offset fair value amounts of interest rate swaps in liability positions with the ones in asset positions.
From time to time, we make firm commitments to enter into long-term fixed-rate loans with borrowers backed by yield maintenance agreements and simultaneously enter into forward interest rate swap agreements with correspondent banks to mitigate the change in fair value of the yield maintenance agreement. Prior to loan funding, yield maintenance agreements with net settlement features that meet the definition of a derivative are considered as non-designated hedges and are carried on the consolidated statements of condition at their fair value in other assets (when the fair value is positive) or in other liabilities (when the fair value is negative). The offsetting changes in the fair value of the forward swap and the yield maintenance agreement are recorded in interest income. When the fixed-rate loans are originated, the forward swaps are designated to offset the change in fair value in the loans. Subsequent to the point of the swap designations, the fair value of the related yield maintenance agreements at the designation date that was recorded in other assets is amortized using the effective yield method over the life of the respective designated loans.
The net effect of the change in fair value of interest rate swaps, the amortization of the yield maintenance agreement and the change in the fair value of the hedged loans due to changes in benchmark interest rates result in an insignificant amount recognized in interest income. For further detail, see Note 14, Derivative Financial Instruments and Hedging Activities.
Revenue Recognition - We utilize the following five-step model for non-financial instrument related revenue that is in scope for ASC 606, Revenue from Contracts with Customers: 1) identify the contract, 2) identify the performance obligations in the contract, 3) determine the transaction price, 4) allocate the transaction price to the performance obligations in the contract, and, 5) recognize revenue when (or as) the entity satisfies the performance obligation. Our main revenue streams in scope for ASC 606 include:
•Wealth Management & Trust ("WM&T") fees - WM&T services include, but are not limited to: customized investment advisory and management; administrative services such as bill pay and tax reporting; trust administration, estate settlement, custody and fiduciary services. Performance obligations for investment advisory and management services are generally satisfied over time. Revenue is recognized monthly according to a tiered fee schedule based on the client's month-end market value of assets under our management. WM&T does not earn revenue based on performance or incentives. Costs associated with WM&T revenue-generating activities, such as payments to sub-advisors, are recorded separately as part of professional service expenses when incurred.
•Deposit account service charges - Service charges on deposit accounts consist of monthly maintenance fees, business account analysis fees, business online banking fees, check order charges, and other deposit
account-related fees. Performance obligations for monthly maintenance fees and account analysis fees are satisfied, and the related revenue recognized, when we complete our performance obligation each month. Performance obligations related to transaction-based services (such as check orders) are satisfied, and the related revenue recognized, at a point in time typically when the transaction is completed, except for business accounts subject to analysis where the transaction-based fees are part of the monthly account analysis fees.
•Debit card interchange fees - We issue debit cards to our consumer and small business customers that allow them to purchase goods and services from merchants in person, online, or via mobile devices using funds held in their demand deposit accounts held with us. Debit cards issued to our customers are part of global electronic payment networks (such as Visa) who pass a portion of the merchant interchange fees to debit card-issuing member banks like us when our customers make purchases through their networks. Performance obligations for debit card services are satisfied and revenue is recognized daily as the payment networks process transactions. Because we act in an agent capacity, we recognize network costs on a net basis with interchange fees in non-interest income.
Advertising Costs - are expensed as incurred. For the years ended December 31, 2021, 2020, and 2019, advertising costs totaled $908 thousand, $769 thousand, and $775 thousand, respectively.
Comprehensive Income (Loss) - includes net income, changes in the unrealized gains or losses on available-for-sale investment securities, and amortization of net unrealized gains or losses on securities transferred from available-for-sale to held-to-maturity, net of related taxes, reported on the consolidated statements of comprehensive income and as components of stockholders' equity.
Fair Value Measurements - We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. We base our fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e., exit price notion) reflecting factors such as a liquidity premium. Securities available-for-sale and derivatives are recorded at fair value on a recurring basis. Our equity investments that do not have readily determinable fair values are recorded at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. FHLB stock and Visa Inc. Class B common stock are carried at cost as of December 31, 2021 and 2020, as there was no impairment or changes resulting from observable price changes in orderly transactions for an identical or similar investment of the same issuer. Additionally, from time to time, we may be required to record certain assets and liabilities at fair value on a non-recurring basis, such as purchased loans and acquired deposits recorded at acquisition date, certain impaired loans, other real estate owned and securities held-to-maturity that are other-than-temporarily impaired. These non-recurring fair value adjustments typically involve write-downs of individual assets due to application of lower-of-cost or market accounting.
When we develop our fair value measurement process, we maximize the use of observable inputs. Whenever there is no readily available market data, we use our best estimates and assumptions in determining fair value, but these estimates involve inherent uncertainties and the application of management's judgment. As a result, if other assumptions had been used, our recorded earnings or disclosures could have been materially different from those reflected in these consolidated financial statements.
Other Recently Adopted Accounting Standards
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (ASC Topic 740): Simplifying the Accounting for Income Taxes. This ASU is intended to reduce the cost and complexity related to accounting for income taxes by removing certain exceptions to the guidance in ASC 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and simplifying aspects of the accounting for franchise taxes and enacted changes in tax laws or rates. We adopted this ASU prospectively on January 1, 2021, which did not have a material impact on our financial condition or results of operations.
In January 2020, the FASB issued ASU No. 2020-01, Investments - Equity Securities (ASC Topic 321), Investments - Equity Method and Joint Ventures (ASC Topic 323), and Derivatives and Hedging (ASC Topic 815) - Clarifying the Interactions between ASC 321, ASC 323, and ASC 815. Among other things, this ASU clarifies that a company should consider observable transactions that require a company to either apply or discontinue the equity method of
accounting under ASC 323, for the purposes of applying the measurement alternative in accordance with ASC 321. We adopted this ASU prospectively on January 1, 2021, which did not have a material impact on our financial condition or results of operations.
In October 2020, the FASB issued ASU No. 2020-08, Codification Improvements to Subtopic 310-20, Receivables—Nonrefundable Fees and Other Costs. This ASU was issued as part of the Board's ongoing project to improve codification or correct unintended application. This ASU adds clarification to ASU 2017-08, which the Bank early-adopted in 2017, and delineates whether an entity with callable debt securities that have multiple call dates should amortize the amount above that which is repayable, to the next call date. We adopted this ASU prospectively on January 1, 2021. Because this ASU was narrow in scope and for clarification purposes, it did not have a material impact on our financial condition and results of operations.
Accounting Standards Not Yet Effective
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848). The amendments in this ASU are elective and provide optional guidance for a limited period of time to ease the potential burden of accounting for, or recognizing the effects of reference rate reform. The amendments in this ASU provide optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The amendments in this ASU may be elected as of March 12, 2020 through December 31, 2022. An entity may choose to elect the amendments in this update at an interim period subsequent to March 12, 2020 with adoption methods varying based on transaction type. We have not elected to apply amendments at this time and will assess the applicability of this ASU to us as we continue to monitor guidance for reference rate reform from FASB and its impact on our financial condition and results of operations.
In January 2021, the FASB issued ASU No. 2021-01, Reference Rate Reform (Topic 848). The main amendments in this ASU are intended to clarify certain optional expedients and scope of derivative instruments. The amendments are elective and effective immediately upon issuance of this ASU. Amendments may be elected through December 31, 2022. We have four interest rate swap contracts with notional values totaling $13.0 million indexed to LIBOR that will 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. We have not elected to apply the amendments at this time and will continue to assess the applicability of this ASU to us as we monitor guidance for reference rate reform from FASB and its impact on our financial condition and results of operations.
In October 2021, the FASB issued ASU No. 2021-08, Accounting for Contract Assets and Contract Liabilities From Contracts With Customers (Topic 805). The amendments address diversity in accounting practices and requires acquiring companies to apply ASC 606, Revenue from Contracts with Customers to recognize and measure contract assets and contract liabilities from contracts with customers acquired in a business combination, as opposed to other methods such as fair value. The amendments improve comparability after the business combination by providing consistent recognition and measurement guidance for revenue contracts with customers acquired in a business combination. The amendments are to be applied prospectively to business combinations occurring on or after December 15, 2022 and early adoption is permitted. In the event of a future business combination, we will assess the impact of the ASU on our financial condition and results of operations.
Note 2: Investment Securities
Our investment securities portfolio consists of U.S. Treasury securities, obligations of state and political subdivisions, U.S. federal government agencies such as Government National Mortgage Association ("GNMA") and Small Business Administration ("SBA"), U.S. government-sponsored enterprises ("GSEs") such as Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC), Federal Farm Credit Banks Funding Corporation and FHLB, U.S. Corporations and one asset-backed security collateralized by student loan pools. We also invest in residential and commercial mortgage-backed securities ("MBS"/"CMBS") and collateralized mortgage obligations ("CMOs") issued or guaranteed by the GSEs, as reflected in the following table.
A summary of the amortized cost, fair value and allowance for credit losses related to securities held-to-maturity as of December 31, 2021 and December 31, 2020 is presented below.
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Held-to-maturity: | Amortized Cost 1 | Allowance for Credit Losses | Net Carrying Amount | Gross Unrealized | Fair Value |
(in thousands) | Gains | (Losses) |
December 31, 2021 | | | | | | |
Securities of U.S. government-sponsored enterprises: | | | | | | |
MBS pass-through securities issued by FHLMC and FNMA | $ | 126,990 | | $ | — | | $ | 126,990 | | $ | 2,110 | | $ | (712) | | $ | 128,388 | |
CMOs issued by FHLMC | 106,851 | | — | | 106,851 | | 668 | | (1,045) | | 106,474 | |
CMOs issued by FNMA | 4,866 | | — | | 4,866 | | 128 | | — | | 4,994 | |
SBA-backed securities | 4,840 | | — | | 4,840 | | 198 | | — | | 5,038 | |
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Debentures of government-sponsored agencies | 51,472 | | | 51,472 | | — | | (901) | | 50,571 | |
Obligations of state and political subdivisions | 47,203 | | — | | 47,203 | | 296 | | (209) | | 47,290 | |
Total held-to-maturity | $ | 342,222 | | $ | — | | $ | 342,222 | | $ | 3,400 | | $ | (2,867) | | $ | 342,755 | |
December 31, 2020 | | | | | | |
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Securities of U.S. government-sponsored enterprises: | | | | | | |
MBS pass-through securities issued by FHLMC and FNMA | $ | 65,579 | | $ | — | | $ | 65,579 | | $ | 3,924 | | $ | — | | $ | 69,503 | |
CMOs issued by FHLMC | 27,201 | | — | | 27,201 | | 1,441 | | — | | 28,642 | |
CMOs issued by FNMA
| 8,042 | | — | | 8,042 | | 363 | | — | | 8,405 | |
SBA-backed securities | 6,547 | | — | | 6,547 | | 400 | | — | | 6,947 | |
Obligations of state and political subdivisions | 1,667 | | — | | 1,667 | | 21 | | — | | 1,688 | |
Total held-to-maturity | $ | 109,036 | | $ | — | | $ | 109,036 | | $ | 6,149 | | $ | — | | $ | 115,185 | |
1 Amortized cost and fair values exclude accrued interest receivable of $1.1 million and $366 thousand at December 31, 2021 and 2020, respectively, which is included in interest receivable and other assets in the consolidated statements of condition. |
Management measures expected credit losses on held-to-maturity securities on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. With regard to MBSs and CMOs issued or guaranteed by the GSEs, and SBA-backed securities, we expect to receive all the contractual principal and interest on these securities as such securities are backed by the full faith and credit of and/or guaranteed by the U.S. government. Accordingly, no allowance for credit losses has been recorded for these securities. With regard to securities issued by states and political subdivisions, management considers (i) issuer and/or guarantor credit ratings, (ii) historical probability of default and loss given default rates for given bond ratings and remaining maturity,(iii) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities, (iv) internal and external credit review of the financial information, and (v) whether or not such securities have credit enhancements such as guarantees and/or insurance, contain a defeasance clause, or are pre-refunded by the issuers. Based on the comprehensive analysis, no credit losses are expected.
The following table summarizes the amortized cost of our portfolio of held-to-maturity securities issued by states and political subdivisions by Moody's and/or Standard & Poor's bond ratings as of December 31, 2021.
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| Obligations of state and political subdivisions | | | | |
Ratings by S&P / Moody's (in thousands) | December 31, 2021 | December 31, 2020 | | | | |
AAA / Aaa | $ | 34,229 | | $ | — | | | | | |
AA / Aa | 12,873 | | 1,461 | | | | | |
A | 101 | | 206 | | | | | |
Total | $ | 47,203 | | $ | 1,667 | | | | | |
A summary of the amortized cost, fair value and allowance for credit losses related to securities available-for-sale as of December 31, 2021 and December 31, 2020 is presented below.
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Available-for-sale: | Amortized Cost 1 | Gross Unrealized | Allowance for Credit Losses | Fair Value |
(in thousands) | Gains | (Losses) |
December 31, 2021 | | | | | |
Securities of U.S. government-sponsored enterprises: | | | | | |
MBS pass-through securities issued by FHLMC, FNMA and GNMA | $ | 316,090 | | $ | 1,224 | | $ | (2,784) | | $ | — | | $ | 314,530 | |
CMOs issued by FHLMC | 343,047 | | 3,209 | | (4,829) | | — | | 341,427 | |
CMOs issued by FNMA | 48,187 | | 152 | | (611) | | — | | 47,728 | |
CMOs issued by GNMA | 56,345 | | 99 | | (553) | | — | | 55,891 | |
SBA-backed securities | 32,640 | | 993 | | (155) | | — | | 33,478 | |
Debentures of government- sponsored agencies | 191,449 | | 25 | | (2,947) | | — | | 188,527 | |
U.S. Treasury securities | 11,886 | | — | | (256) | | — | | 11,630 | |
| | | | | |
Obligations of state and political subdivisions | 129,009 | | 5,372 | | (381) | | — | | 134,000 | |
Corporate bonds | 39,001 | | — | | (506) | | — | | 38,495 | |
Asset-backed securities | 1,866 | | — | | (4) | | — | | 1,862 | |
Total available-for-sale | $ | 1,169,520 | | $ | 11,074 | | $ | (13,026) | | $ | — | | $ | 1,167,568 | |
December 31, 2020 | | | | | |
Securities of U.S. government-sponsored enterprises: | | | | | |
MBS pass-through securities issued by FHLMC and FNMA | $ | 50,686 | | $ | 2,530 | | $ | — | | $ | — | | $ | 53,216 | |
CMOs issued by FHLMC | 143,267 | | 7,925 | | (1) | | — | | 151,191 | |
CMOs issued by FNMA | 16,450 | | 580 | | — | | — | | 17,030 | |
CMOs issued by GNMA | 6,863 | | 351 | | — | | — | | 7,214 | |
SBA-backed securities | 30,941 | | 1,976 | | (55) | | — | | 32,862 | |
Debentures of government- sponsored agencies | 19,944 | | 266 | | (24) | | — | | 20,186 | |
| | | | | |
Obligations of state and political subdivisions | 104,887 | | 5,765 | | — | | — | | 110,652 | |
Total available-for-sale | $ | 373,038 | | $ | 19,393 | | $ | (80) | | $ | — | | $ | 392,351 | |
1 Amortized cost and fair value exclude accrued interest receivable of $3.7 million and $1.9 million at December 31, 2021 and 2020, respectively, which is included in interest receivable and other assets in the consolidated statements of condition. |
The amortized cost and fair value of investment debt securities by contractual maturity at December 31, 2021 and 2020 are shown below. Expected maturities may differ from contractual maturities if the issuers of the securities have the right to call or prepay obligations with or without call or prepayment penalties.
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| December 31, 2021 | December 31, 2020 |
| Held-to-Maturity | Available-for-Sale | Held-to-Maturity | Available-for-Sale |
(in thousands) | Amortized Cost | Fair Value | Amortized Cost | Fair Value | Amortized Cost | Fair Value | Amortized Cost | Fair Value |
Within one year | $ | 101 | | $ | 103 | | $ | 10,785 | | $ | 10,841 | | $ | 246 | | $ | 250 | | $ | 11,530 | | $ | 11,687 | |
After one but within five years | 25,666 | | 26,559 | | 219,474 | | 219,957 | | 7,550 | | 7,961 | | 59,028 | | 62,397 | |
After five years through ten years | 182,604 | | 182,303 | | 299,937 | | 300,187 | | 52,113 | | 55,872 | | 144,908 | | 154,089 | |
After ten years | 133,851 | | 133,790 | | 639,324 | | 636,583 | | 49,127 | | 51,102 | | 157,572 | | 164,178 | |
Total | $ | 342,222 | | $ | 342,755 | | $ | 1,169,520 | | $ | 1,167,568 | | $ | 109,036 | | $ | 115,185 | | $ | 373,038 | | $ | 392,351 | |
Sales of investment securities and gross gains and losses are shown in the following table.
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(in thousands) | 2021 | 2020 | 2019 |
Available-for-sale: | | | |
Sales proceeds | $ | 6,632 | | $ | 33,756 | | $ | 66,081 | |
Gross realized gains | $ | 1 | | $ | 916 | | $ | 214 | |
Gross realized losses | $ | (17) | | $ | (1) | | $ | (159) | |
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Pledged investment securities are shown in the following table.
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(in thousands) | December 31, 2021 | December 31, 2020 |
Pledged to the State of California: | | |
Secure public deposits in compliance with the Local Agency Security Program | $ | 213,861 | | $ | 131,051 | |
Collateral for trust deposits | 729 | | 751 | |
Collateral for Wealth Management and Trust Services checking account | 614 | | 629 | |
Total investment securities pledged to the State of California | $ | 215,204 | | $ | 132,431 | |
Bankruptcy trustee deposits pledged with Federal Reserve Bank | $ | 2,645 | | $ | — | |
Total pledged investment securities | $ | 217,849 | | $ | 132,431 | |
There were 217 and 10 securities in unrealized loss positions at December 31, 2021 and 2020, respectively. Those securities are summarized and classified according to the duration of the loss period in the tables below.
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December 31, 2021 | < 12 continuous months | | ≥ 12 continuous months | | Total securities in a loss position |
(in thousands) | Fair value | Unrealized loss | | Fair value | Unrealized loss | | Fair value | Unrealized loss |
Held-to-maturity: | | | | | | | | |
MBS pass-through securities issued by FHLMC and FNMA | $ | 76,619 | | $ | (712) | | | $ | — | | $ | — | | | $ | 76,619 | | $ | (712) | |
| | | | | | | | |
| | | | | | | | |
CMOs issued by FHLMC | 54,811 | | (1,045) | | | — | | — | | | 54,811 | | (1,045) | |
Obligations of state and political subdivisions | 19,203 | | (209) | | | — | | — | | | 19,203 | | (209) | |
| | | | | | | | |
Debentures of government-sponsored agencies | 50,571 | | (901) | | | — | | — | | | 50,571 | | (901) | |
| | | | | | | | |
Total held-to-maturity | $ | 201,204 | | $ | (2,867) | | | $ | — | | $ | — | | | $ | 201,204 | | $ | (2,867) | |
Available-for-sale: | | | | | | | | |
MBS pass-through securities issued by FHLMC and FNMA | $ | 263,474 | | $ | (2,784) | | | $ | — | | $ | — | | | $ | 263,474 | | $ | (2,784) | |
SBA-backed securities | 7,478 | | (112) | | | 1,209 | | $ | (43) | | | 8,687 | | (155) | |
CMOs issued by FHLMC | 226,175 | | (4,677) | | | 4,415 | | (152) | | | 230,590 | | (4,829) | |
CMOs issued by GNMA | 44,790 | | (553) | | | — | | — | | | 44,790 | | (553) | |
CMOs issued by FNMA | 37,348 | | (611) | | | — | | — | | | 37,348 | | (611) | |
Debentures of government-sponsored agencies | 148,979 | | (2,527) | | | 8,549 | | (420) | | | 157,528 | | (2,947) | |
U.S. Treasury securities | 11,629 | | (256) | | | — | | — | | | 11,629 | | (256) | |
Obligations of state and political subdivisions | 17,552 | | (381) | | | — | | — | | | 17,552 | | (381) | |
Corporate bonds | 38,495 | | (506) | | | — | | — | | | 38,495 | | (506) | |
Asset-backed securities | 1,861 | | (4) | | | — | | — | | | 1,861 | | (4) | |
| | | | | | | | |
Total available-for-sale | $ | 797,781 | | $ | (12,411) | | | $ | 14,173 | | $ | (615) | | | $ | 811,954 | | $ | (13,026) | |
Total securities at a loss position | $ | 998,985 | | $ | (15,278) | | | $ | 14,173 | | $ | (615) | | | $ | 1,013,158 | | $ | (15,893) | |
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December 31, 2020 | < 12 continuous months | | > 12 continuous months | | Total securities in a loss position |
(in thousands) | Fair value | Unrealized loss | | Fair value | Unrealized loss | | Fair value | Unrealized loss |
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Available-for-sale: | | | | | | | | |
SBA-backed securities | $ | — | | $ | — | | | $ | 1,790 | | $ | (55) | | | $ | 1,790 | | $ | (55) | |
| | | | | | | | |
CMOs issued by FHLMC | 5,975 | | (1) | | | — | | — | | | 5,975 | | (1) | |
Debentures of government- sponsored agencies | 3,943 | | (24) | | | — | | — | | | 3,943 | | (24) | |
| | | | | | | | |
Total available-for-sale | 9,918 | | (25) | | | 1,790 | | (55) | | | 11,708 | | (80) | |
Total | $ | 9,918 | | $ | (25) | | | $ | 1,790 | | $ | (55) | | | $ | 11,708 | | $ | (80) | |
As of December 31, 2021, the investment portfolio included 9 investment securities that had been in a continuous loss position for twelve months or more and 208 investment securities had been in a loss position for less than twelve months.
Securities issued by government-sponsored agencies, such as FNMA and FHLMC, usually have implicit credit support by the U.S. federal government. However, since 2008, FNMA and FHLMC have been under government conservatorship and, therefore, contractual cash flows for these investments carry explicit guarantees by the U.S. federal government. Securities issued by the SBA and GNMA have explicit credit guarantees by the U.S. federal government, which protects us from credit losses on the contractual cash flows of the securities.
Our investment in obligations of state and political subdivisions bonds are deemed credit worthy after our comprehensive analysis of the issuers' latest financial information, credit ratings by major credit agencies, and/or credit enhancements.
At December 31, 2021, management determined that it did not intend to sell any investment securities with unrealized losses, and it is more likely than not that we will not be required to sell securities with unrealized losses before recovery of their amortized cost. No allowances for credit losses have been recognized on available-for-sale securities in an unrealized loss position as management does not believe any of the securities are impaired due to reasons of credit quality at December 31, 2021.
Non-Marketable Securities
FHLB Capital Stock
As a member bank of the FHLB, we are required to maintain a minimum investment in FHLB capital stock determined by the Board of Directors of the FHLB. The minimum investment requirements can increase in the event we increase our total asset size or borrowings with the FHLB. Shares cannot be purchased or sold except between the FHLB and its members at the $100 per share par value. We held $16.7 million and $11.9 million of FHLB stock included in other assets on the consolidated statements of condition at December 31, 2021 and 2020, respectively. The carrying amounts of these investments are reasonable estimates of fair value because the securities are restricted to member banks and they do not have a readily determinable market value. Based on our analysis of FHLB’s financial condition and certain qualitative factors, we determined that the FHLB stock was not impaired at December 31, 2021 and 2020. On February 16, 2022, FHLB announced a cash dividend for the fourth quarter of 2021 at an annualized dividend rate of 6.00% to be distributed in mid-March 2022. Cash dividends paid on FHLB capital stock are recorded as non-interest income.
Visa Inc. Class B Common Stock
As a member bank of Visa U.S.A., we held 10,439 shares of Visa Inc. Class B common stock at both December 31, 2021 and 2020. These shares have a carrying value of zero and are restricted from resale to non-member banks of Visa U.S.A. until their conversion into Class A (voting) shares upon the termination of Visa Inc.'s Covered Litigation escrow account. Because of the restriction and the uncertainty on the conversion rate to Class A shares, these shares lack a readily determinable fair value. When converting this Class B common stock to Class A common stock based on the conversion rate of 1.6181 and 1.6228, as of December 31, 2021 and 2020, respectively, and the closing stock price of Class A shares at those respective dates, the converted value of our shares of Class B common stock would have been $3.7 million at both December 31, 2021 and 2020. The conversion rate is subject to further adjustment upon the final settlement of the covered litigation against Visa Inc. and its member banks. As such, the fair value of these Class B shares can differ significantly from their converted values. For further information, refer to Note 12, Commitments and Contingencies.
Low Income Housing Tax Credits
We invest in low income housing tax credit funds as a limited partner, which totaled $3.0 million and $3.5 million recorded in other assets as of December 31, 2021 and 2020, respectively. In 2021, we recognized $645 thousand of low income housing tax credits and other tax benefits, net of $542 thousand of amortization expense of low income housing tax credit investment, as a component of income tax expense. As of December 31, 2021, our unfunded commitments for these low income housing tax credit funds totaled $422 thousand. We did not recognize
any impairment losses on these low income housing tax credit investments during 2021 or 2020, as the value of the future tax benefits exceeds the carrying value of the investments.
Note 3: Loans and Allowance for Credit Losses
We adopted the new current expected credit loss accounting guidance, CECL, and all related amendments as of December 31, 2020. Certain prior period credit quality disclosures related to impaired loans and individually and collectively evaluated loans were superseded with the current guidance and have not been included below. Refer to Note 3, Loans and Allowance for Loan Losses, under Part II, Item 8 of our 2019 Form 10-K for additional prior period information. Also refer to Note 1, Summary of Significant Accounting Policies, for additional information regarding the adoption of CECL.
The following table presents the amortized cost of loans by class as of December 31, 2021 and 2020.
| | | | | | | | |
| December 31, |
(in thousands) | 2021 | 2020 |
Commercial and industrial | $ | 301,602 | | $ | 498,408 | |
Real estate: | | |
Commercial owner-occupied | 392,345 | | 304,963 | |
Commercial investor-owned | 1,189,021 | | 961,208 | |
Construction | 119,840 | | 73,046 | |
Home equity | 88,746 | | 104,813 | |
Other residential | 114,558 | | 123,395 | |
Installment and other consumer loans | 49,533 | | 22,723 | |
Total loans, at amortized cost 1 | 2,255,645 | | 2,088,556 | |
Allowance for credit losses on loans | (23,023) | | (22,874) | |
Total loans, net of allowance for credit losses on loans | $ | 2,232,622 | | $ | 2,065,682 | |
1 Amortized cost includes net deferred loan origination (fees) costs of $(901) thousand and $(4.1) million at December 31, 2021 and 2020, respectively. Amounts are also net of unrecognized purchase discounts of $2.5 million and $815 thousand at December 31, 2021 and 2020, respectively. Amortized cost excludes accrued interest, which totaled $7.1 million and $8.8 million at December 31, 2021 and 2020, respectively, and is included in interest receivable and other assets in the consolidated statements of condition.
Lending Risks
Concentrations of Credit - Virtually all of our loans are from customers located in Northern California. Approximately 86% and 77%, of total loans were secured by real estate at December 31, 2021 and 2020, respectively. At December 31, 2021 and 2020, 70% and 61%, respectively, of our loans were for commercial real estate, the majority of which were secured by real estate located in Marin, Sonoma, Napa, Alameda, San Francisco, Sacramento, and Contra Costa counties (California). The increase in the percentages 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 Paycheck Protection Program ("PPP"), which are included in commercial and industrial loans.
Commercial and Industrial Loans - Commercial loans are generally made to established small and mid-sized businesses to provide financing for their growth and working capital needs, equipment purchases and acquisitions. Management examines historical, current, and projected cash flows to determine the ability of the borrower to repay obligations as agreed. Commercial loans are made based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral and guarantor support. The cash flows of borrowers, however, may not occur as expected, and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed, such as accounts receivable and inventory, and typically include personal guarantees. We target stable businesses with guarantors who provide additional sources of repayment and have proven to be resilient in periods of economic stress. A weakened economy, and resultant decreased consumer and/or business spending, will have an effect on the credit quality of commercial loans.
Pursuant to the 2020 CARES Act, Bank of Marin originated 2,876 SBA-guaranteed loans totaling $444.1 million under the PPP to eligible small businesses and non-profit organizations in two rounds of PPP loan financing. PPP loans have terms of two to five years and earn interest at 1%. In addition, the SBA paid the Bank a fee of 1%-5% depending on the loan amount, which was netted with loan origination costs and amortized into interest income
using the effective yield method over the contractual life of each loan. The recognition of fees and costs is accelerated when the loan is forgiven by the SBA and/or paid off prior to maturity. PPP loans are fully guaranteed by the SBA and are expected to be forgiven by the SBA if they meet the requirements of the program. PPP loans totaling $111.2 million (net of $2.5 million in unrecognized fees and costs) and $291.6 million (net of $5.4 million in unrecognized fees and costs) were included in commercial and industrial loan balances at December 31, 2021 and 2020, respectively. The December 31, 2021 amount includes 13 PPP loans totaling $2.8 million assumed in the ARB acquisition. In 2021 and 2020, respectively, Bank of Marin recognized $8.3 million and $3.8 million in PPP fees, net of costs.
Commercial Real Estate Loans - Commercial real estate loans, which include income producing investment properties and owner-occupied real estate used for business purposes, are subject to underwriting standards and processes similar to commercial loans discussed above. We underwrite these loans to be repaid from cash flow from either the business or investment property and supported by real property collateral. Underwriting standards for commercial real estate loans include, but are not limited to, debt coverage and loan-to-value ratios. Furthermore, a large majority of our loans are guaranteed by the owners of the properties. Conditions in the real estate markets or downturn in the general economy may adversely affect our commercial real estate loans. In the event of a vacancy, we expect guarantors to carry the loans until they find a replacement tenant. The owner's substantial equity investment provides a strong economic incentive to continue to support the commercial real estate projects. As such, we have generally experienced a relatively low level of loss and delinquencies in this portfolio.
Construction Loans - Construction loans are generally made to developers and builders to finance construction, renovation and occasionally land acquisitions in anticipation of near-term development. Construction loans include interest reserves that are used for the payment of interest during the development and marketing periods and are capitalized as part of the loan balance. When a construction loan is placed on nonaccrual status before the depletion of the interest reserve, we apply the interest funded by the interest reserve against the loan's principal balance. These loans are underwritten after evaluation of the borrower's financial strength, reputation, prior track record, and independent appraisals. We monitor all construction projects to determine whether they are on schedule, completed as planned and in accordance with the approved construction budgets. Significant events can affect the construction industry, including: the inherent volatility of real estate markets and vulnerability to delays due to weather, change orders, inability to obtain construction permits, labor or material shortages, and price changes. Estimates of construction costs and value associated with the completed project may be inaccurate. Repayment of construction loans is largely dependent on the ultimate success of the project.
Consumer Loans - Consumer loans primarily consist of home equity lines of credit, other residential loans, floating homes and indirect luxury auto loans along with a small number of installment loans. Our other residential loans include tenancy-in-common fractional interest loans ("TIC") located almost entirely in San Francisco County. We originate consumer loans utilizing credit score information, debt-to-income ratio and loan-to-value ratio analysis. Diversification among consumer loan types, coupled with relatively small loan amounts that are spread across many individual borrowers, mitigates risk. We do not originate sub-prime residential mortgage loans, nor is it our practice to underwrite loans commonly referred to as "Alt-A mortgages," the characteristics of which are reduced documentation, borrowers with low FICO scores or collateral with high loan-to-value ratios.
Credit Quality Indicators
We use a risk rating system to evaluate asset quality, and to identify and monitor credit risk in individual loans, and in the loan portfolio. Our definitions of “Special Mention” risk graded loans, or worse, are consistent with those used by the Federal Deposit Insurance Corporation ("FDIC"). Our internally assigned grades are as follows:
Pass and Watch - Loans to borrowers of acceptable or better credit quality. Borrowers in this category demonstrate fundamentally sound financial positions, repayment capacity, credit history and management expertise. Loans in this category must have an identifiable and stable source of repayment and meet the Bank’s policy regarding debt-service-coverage ratios. These borrowers are capable of sustaining normal economic, market or operational setbacks without significant financial consequences. Negative external industry factors are generally not present. The loan may be secured, unsecured or supported by non-real estate collateral for which the value is more difficult to determine and/or marketability is more uncertain. This category also includes “Watch” loans, where
the primary source of repayment has been delayed. “Watch” is intended to be a transitional grade, with either an upgrade or downgrade within a reasonable period.
Special Mention - Potential weaknesses that deserve close attention. If left uncorrected, those potential weaknesses may result in deterioration of the payment prospects for the asset. Special Mention assets do not present sufficient risk to warrant adverse classification.
Substandard - Inadequately protected by either the current sound worth and paying capacity of the obligor or the collateral pledged, if any. A Substandard asset has a well-defined weakness or weaknesses that jeopardize(s) the liquidation of the debt. Substandard assets are characterized by the distinct possibility that we will sustain some loss if such weaknesses or deficiencies are not corrected. Well-defined weaknesses include adverse trends or developments of the borrower’s financial condition, managerial weaknesses and/or significant collateral deficiencies.
Doubtful - Critical weaknesses that make collection or liquidation in full improbable. There may be specific pending events that work to strengthen the asset; however, the amount or timing of the loss may not be determinable. Pending events generally occur within one year of the asset being classified as Doubtful. Examples include: merger, acquisition, or liquidation; capital injection; guarantee; perfecting liens on additional collateral; and refinancing. Such loans are placed on non-accrual status and usually are collateral-dependent.
We regularly review our credits for accuracy of risk grades whenever we receive new information. Borrowers are generally required to submit financial information at regular intervals. Typically, commercial borrowers with lines of credit are required to submit financial information with reporting intervals ranging from monthly to annually depending on credit size, risk and complexity. In addition, investor commercial real estate borrowers with loans exceeding a certain dollar threshold are usually required to submit rent rolls or property income statements annually. We monitor construction loans monthly. We review home equity and other consumer loans based on delinquency. We also review loans graded “Watch” or worse, regardless of loan type, no less than quarterly.
The following tables present the loan portfolio by loan class, origination year and internal risk rating as of December 31, 2021 and 2020. Generally, existing term loans that were re-underwritten are reflected in the table in the year of renewal. Lines of credit that have a conversion feature at the time of origination, such as construction to perm loans, are presented by year of origination.
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December 31, 2021 | Term Loans - Amortized Cost by Origination Year | Revolving Loans Amortized Cost | |
(in thousands) | 2021 | 2020 | 2019 | 2018 | 2017 | Prior | Total |
Commercial and industrial: | | | | | | | | |
Pass and Watch | $ | 96,643 | | $ | 35,967 | | $ | 25,754 | | $ | 12,763 | | $ | 2,729 | | $ | 31,280 | | $ | 90,744 | | $ | 295,880 | |
Special Mention | — | | 1,700 | | 584 | | 273 | | — | | — | | 2,088 | | 4,645 | |
Substandard | — | | — | | — | | — | | — | | — | | 1,077 | | 1,077 | |
Total commercial and industrial | $ | 96,643 | | $ | 37,667 | | $ | 26,338 | | $ | 13,036 | | $ | 2,729 | | $ | 31,280 | | $ | 93,909 | | $ | 301,602 | |
Commercial real estate, owner-occupied: | | | | | | | | |
Pass and Watch | $ | 58,395 | | $ | 43,216 | | $ | 49,485 | | $ | 36,174 | | $ | 42,430 | | $ | 104,898 | | $ | — | | $ | 334,598 | |
Special Mention | 16,748 | | — | | — | | 7,846 | | — | | 16,996 | | — | | 41,590 | |
Substandard | — | | 7,155 | | 285 | | — | | — | | 8,603 | | — | | 16,043 | |
Doubtful | — | | 114 | | — | | — | | — | | — | | — | | 114 | |
Total commercial real estate, owner-occupied | $ | 75,143 | | $ | 50,485 | | $ | 49,770 | | $ | 44,020 | | $ | 42,430 | | $ | 130,497 | | $ | — | | $ | 392,345 | |
Commercial real estate, investor-owned: | | | | | | | | |
Pass and Watch | $ | 225,722 | | $ | 186,214 | | $ | 187,418 | | $ | 143,028 | | $ | 75,419 | | $ | 325,882 | | $ | 84 | | $ | 1,143,767 | |
Special Mention | — | | 1,214 | | 2,714 | | 11,773 | | 1,787 | | 9,540 | | — | | 27,028 | |
Substandard | — | | — | | — | | 695 | | — | | 17,531 | | — | | 18,226 | |
Total commercial real estate, investor-owned | $ | 225,722 | | $ | 187,428 | | $ | 190,132 | | $ | 155,496 | | $ | 77,206 | | $ | 352,953 | | $ | 84 | | $ | 1,189,021 | |
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December 31, 2021 | Term Loans - Amortized Cost by Origination Year | Revolving Loans Amortized Cost | |
(in thousands) | 2021 | 2020 | 2019 | 2018 | 2017 | Prior | Total |
Construction: | | | | | | | | |
Pass and Watch | $ | 31,269 | | $ | 70,528 | | $ | 8,935 | | $ | 9,108 | | $ | — | | $ | — | | $ | — | | $ | 119,840 | |
| | | | | | | | |
| | | | | | | | |
Total construction | $ | 31,269 | | $ | 70,528 | | $ | 8,935 | | $ | 9,108 | | $ | — | | $ | — | | $ | — | | $ | 119,840 | |
Home equity: | | | | | | | | |
Pass and Watch | $ | — | | $ | — | | $ | — | | $ | — | | $ | 10 | | $ | 268 | | $ | 87,693 | | $ | 87,971 | |
| | | | | | | | |
Substandard | — | | — | | — | | — | | — | | 377 | | 398 | | 775 | |
Total home equity | $ | — | | $ | — | | $ | — | | $ | — | | $ | 10 | | $ | 645 | | $ | 88,091 | | $ | 88,746 | |
Other residential: | | | | | | | | |
Pass and Watch | $ | 15,800 | | $ | 31,981 | | $ | 25,529 | | $ | 15,411 | | $ | 7,964 | | $ | 17,873 | | $ | — | | $ | 114,558 | |
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| | | | | | | | |
Total other residential | $ | 15,800 | | $ | 31,981 | | $ | 25,529 | | $ | 15,411 | | $ | 7,964 | | $ | 17,873 | | $ | — | | $ | 114,558 | |
Installment and other consumer: | | | | | | | | |
Pass and Watch | $ | 17,207 | | $ | 7,748 | | $ | 9,436 | | $ | 5,633 | | $ | 1,123 | | $ | 6,620 | | $ | 1,766 | | $ | 49,533 | |
| | | | | | | | |
| | | | | | | | |
Total installment and other consumer | $ | 17,207 | | $ | 7,748 | | $ | 9,436 | | $ | 5,633 | | $ | 1,123 | | $ | 6,620 | | $ | 1,766 | | $ | 49,533 | |
Total loans: | | | | | | | | |
Pass and Watch | $ | 445,036 | | $ | 375,654 | | $ | 306,557 | | $ | 222,117 | | $ | 129,675 | | $ | 486,821 | | $ | 180,287 | | $ | 2,146,147 | |
Total Special Mention | $ | 16,748 | | $ | 2,914 | | $ | 3,298 | | $ | 19,892 | | $ | 1,787 | | $ | 26,536 | | $ | 2,088 | | $ | 73,263 | |
Total Substandard | $ | — | | $ | 7,155 | | $ | 285 | | $ | 695 | | $ | — | | $ | 26,511 | | $ | 1,475 | | $ | 36,121 | |
Total Doubtful | $ | — | | $ | 114 | | $ | — | | $ | — | | $ | — | | $ | — | | $ | — | | $ | 114 | |
Totals | $ | 461,784 | | $ | 385,837 | | $ | 310,140 | | $ | 242,704 | | $ | 131,462 | | $ | 539,868 | | $ | 183,850 | | $ | 2,255,645 | |
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December 31, 2020 | Term Loans - Amortized Cost by Origination Year | Revolving Loans Amortized Cost | |
(in thousands) | 2020 | 2019 | 2018 | 2017 | 2016 | Prior | Total |
Commercial and industrial: | | | | | | | | |
Pass and Watch | $ | 308,237 | | $ | 22,589 | | $ | 12,596 | | $ | 4,508 | | $ | 5,915 | | $ | 34,282 | | $ | 85,889 | | $ | 474,016 | |
Special Mention | — | | 2,034 | | 1,318 | | 141 | | 11 | | 49 | | 19,092 | | 22,645 | |
Substandard | 1,747 | | — | | — | | — | | — | | — | | — | | 1,747 | |
Total commercial and industrial | $ | 309,984 | | $ | 24,623 | | $ | 13,914 | | $ | 4,649 | | $ | 5,926 | | $ | 34,331 | | $ | 104,981 | | $ | 498,408 | |
Commercial real estate, owner-occupied: | | | | | | | | |
Pass and Watch | $ | 31,029 | | $ | 27,581 | | $ | 32,603 | | $ | 43,843 | | $ | 12,768 | | $ | 101,014 | | $ | — | | $ | 248,838 | |
Special Mention | — | | — | | 11,764 | | 17,062 | | 7,343 | | 6,601 | | — | | 42,770 | |
Substandard | 7,147 | | — | | — | | — | | 6,208 | | — | | — | | 13,355 | |
Total commercial real estate, owner-occupied | $ | 38,176 | | $ | 27,581 | | $ | 44,367 | | $ | 60,905 | | $ | 26,319 | | $ | 107,615 | | $ | — | | $ | 304,963 | |
Commercial real estate, investor-owned: | | | | | | | | |
Pass and Watch | $ | 162,300 | | $ | 144,751 | | $ | 173,955 | | $ | 100,842 | | $ | 94,862 | | $ | 253,611 | | $ | 117 | | $ | 930,438 | |
Special Mention | — | | 10,695 | | — | | 1,819 | | — | | 8,124 | | — | | 20,638 | |
Substandard | — | | 2,716 | | 4,435 | | — | | 1,553 | | 1,428 | | — | | 10,132 | |
Total commercial real estate, investor-owned | $ | 162,300 | | $ | 158,162 | | $ | 178,390 | | $ | 102,661 | | $ | 96,415 | | $ | 263,163 | | $ | 117 | | $ | 961,208 | |
Construction: | | | | | | | | |
Pass and Watch | $ | 31,654 | | $ | 30,150 | | $ | 11,242 | | $ | — | | $ | — | | $ | — | | $ | — | | $ | 73,046 | |
| | | | | | | | |
| | | | | | | | |
Total construction | $ | 31,654 | | $ | 30,150 | | $ | 11,242 | | $ | — | | $ | — | | $ | — | | $ | — | | $ | 73,046 | |
Home equity: | | | | | | | | |
Pass and Watch | $ | — | | $ | — | | $ | — | | $ | — | | $ | 128 | | $ | 694 | | $ | 102,614 | | $ | 103,436 | |
Special Mention | — | | — | | — | | — | | — | | — | | 799 | | 799 | |
Substandard | — | | — | | — | | — | | — | | 391 | | 187 | | 578 | |
Total home equity | $ | — | | $ | — | | $ | — | | $ | — | | $ | 128 | | $ | 1,085 | | $ | 103,600 | | $ | 104,813 | |
Other residential: | | | | | | | | |
Pass and Watch | $ | 34,447 | | $ | 31,079 | | $ | 23,673 | | $ | 10,574 | | $ | 6,035 | | $ | 17,587 | | $ | — | | $ | 123,395 | |
| | | | | | | | |
| | | | | | | | |
Total other residential | $ | 34,447 | | $ | 31,079 | | $ | 23,673 | | $ | 10,574 | | $ | 6,035 | | $ | 17,587 | | $ | — | | $ | 123,395 | |
Installment and other consumer: | | | | | | | | |
Pass and Watch | $ | 2,361 | | $ | 4,382 | | $ | 3,483 | | $ | 1,543 | | $ | 3,423 | | $ | 4,921 | | $ | 2,593 | | $ | 22,706 | |
| | | | | | | | |
Substandard | — | | — | | — | | 17 | | — | | — | | — | | 17 | |
Total installment and other consumer | $ | 2,361 | | $ | 4,382 | | $ | 3,483 | | $ | 1,560 | | $ | 3,423 | | $ | 4,921 | | $ | 2,593 | | $ | 22,723 | |
Total loans: | | | | | | | | |
Pass and Watch | $ | 570,028 | | $ | 260,532 | | $ | 257,552 | | $ | 161,310 | | $ | 123,131 | | $ | 412,109 | | $ | 191,213 | | $ | 1,975,875 | |
Total Special Mention | $ | — | | $ | 12,729 | | $ | 13,082 | | $ | 19,022 | | $ | 7,354 | | $ | 14,774 | | $ | 19,891 | | $ | 86,852 | |
Total Substandard | $ | 8,894 | | $ | 2,716 | | $ | 4,435 | | $ | 17 | | $ | 7,761 | | $ | 1,819 | | $ | 187 | | $ | 25,829 | |
Totals | $ | 578,922 | | $ | 275,977 | | $ | 275,069 | | $ | 180,349 | | $ | 138,246 | | $ | 428,702 | | $ | 211,291 | | $ | 2,088,556 | |
The following table shows the amortized cost of loans by class, payment aging and non-accrual status as of December 31, 2021 and 2020.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Loan Aging Analysis by Class |
(in thousands) | Commercial and industrial | Commercial real estate, owner-occupied | Commercial real estate, investor-owned | Construction | Home equity | Other residential | Installment and other consumer | Total |
December 31, 2021 | | | | | | | | |
30-59 days past due | $ | 2 | | $ | — | | $ | — | | $ | — | | $ | 498 | | $ | — | | $ | 1,036 | | $ | 1,536 | |
60-89 days past due | 394 | | — | | — | | — | | 67 | | — | | — | | 461 | |
90 days or more past due | 229 | | — | | — | | — | | 88 | | — | | — | | 317 | |
Total past due | 625 | | — | | — | | — | | 653 | | — | | 1,036 | | 2,314 | |
Current | 300,977 | | 392,345 | | 1,189,021 | | 119,840 | | 88,093 | | 114,558 | | 48,497 | | 2,253,331 | |
Total loans 1 | $ | 301,602 | | $ | 392,345 | | $ | 1,189,021 | | $ | 119,840 | | $ | 88,746 | | $ | 114,558 | | $ | 49,533 | | $ | 2,255,645 | |
Non-accrual loans 2 | $ | — | | $ | 7,269 | | $ | 694 | | $ | — | | $ | 413 | | $ | — | | $ | — | | $ | 8,376 | |
Non-accrual loans with no allowance | $ | — | | $ | 7,269 | | $ | 694 | | $ | — | | $ | 413 | | $ | — | | $ | — | | $ | 8,376 | |
December 31, 2020 | | | | | | | | |
30-59 days past due | $ | — | | $ | — | | $ | 1,673 | | $ | — | | $ | 274 | | $ | — | | $ | 136 | | $ | 2,083 | |
60-89 days past due | — | | — | | — | | — | | — | | — | | 622 | | 622 | |
90 days or more past due | — | | — | | — | | — | | — | | — | | — | | — | |
Total past due | — | | — | | 1,673 | | — | | 274 | | — | | 758 | | 2,705 | |
Current | 498,408 | | 304,963 | | 959,535 | | 73,046 | | 104,539 | | 123,395 | | 21,965 | | 2,085,851 | |
Total loans 1 | $ | 498,408 | | $ | 304,963 | | $ | 961,208 | | $ | 73,046 | | $ | 104,813 | | $ | 123,395 | | $ | 22,723 | | $ | 2,088,556 | |
Non-accrual loans 2 | $ | — | | $ | 7,147 | | $ | 1,610 | | $ | — | | $ | 459 | | $ | — | | $ | 17 | | $ | 9,233 | |
Non-accrual loans with no allowance | $ | — | | $ | 7,147 | | $ | 1,610 | | $ | — | | $ | 459 | | $ | — | | $ | 17 | | $ | 9,233 | |
1 There were two SBA-PPP loans past due more than ninety days totaling $229 thousand accruing interest at December 31, 2021 for which we requested "guarantee" payment from the SBA. The SBA subsequently purchased both loans in January 2022. There were no loans past due more than ninety days accruing interest at December 31, 2020.
2 None of the non-accrual loans as of December 31, 2021 or 2020 were earning interest on a cash basis. We recognized no interest income on non-accrual loans for the years ended December 31, 2021, 2020 or 2019. There was no accrued interest reversed from interest income for the single loan that was placed on non-accrual status in 2021, as interest due was paid current. Accrued interest of $36 thousand was reversed from interest income for loans that were placed on non-accrual status during the year ended December 31, 2020.
Collateral Dependent Loans
The following table presents the amortized cost basis of individually analyzed collateral-dependent non-accrual loans by class at December 31, 2021 and 2020.
| | | | | | | | | | | | | | | | | | |
| Amortized Cost by Collateral Type | |
(in thousands) | Commercial Real Estate | Residential Real Estate | | Other | Total | Allowance for Credit Losses |
December 31, 2021 | | | | | | |
| | | | | | |
Commercial real estate, owner-occupied | $ | 7,269 | | $ | — | | | $ | — | | $ | 7,269 | | $ | — | |
Commercial real estate, investor-owned | 694 | | — | | | — | | 694 | | — | |
| | | | | | |
Home equity | — | | 413 | | | — | | 413 | | — | |
| | | | | | |
| | | | | | |
Total | $ | 7,963 | | $ | 413 | | | $ | — | | $ | 8,376 | | $ | — | |
December 31, 2020 | | | | | | |
Commercial real estate, owner-occupied | $ | 7,147 | | $ | — | | | $ | — | | $ | 7,147 | | $ | — | |
Commercial real estate, investor-owned | 1,610 | | — | | | — | | 1,610 | | — | |
| | | | | | |
Home equity | — | | 459 | | | — | | 459 | | — | |
| | | | | | |
Installment and other consumer | — | | — | | | 17 | | 17 | | — | |
Total | $ | 16,720 | | $ | 872 | | | $ | 17 | | $ | 17,609 | | $ | — | |
| | | | | | |
No collateral-dependent loans were in process of foreclosure at December 31, 2021 and 2020. In addition, the weighted average loan-to-value of collateral dependent loans was approximately 67% and 56% at December 31, 2021 and 2020, respectively.
Troubled Debt Restructuring
The following table summarizes the amortized cost of TDR loans by loan class as of December 31, 2021 and 2020.
| | | | | | | | |
| December 31, |
(in thousands) | 2021 | 2020 |
Commercial and industrial | $ | 1,183 | | $ | 1,021 | |
Commercial real estate, owner-occupied | 7,155 | | 7,147 | |
Commercial real estate, investor-owned | 179 | | 3,305 | |
| | |
Home equity | 386 | | 281 | |
| | |
Installment and other consumer | 607 | | 752 | |
Total 1 | $ | 9,510 | | $ | 12,506 | |
1 TDR loans on non-accrual status totaled $7.4 million at both December 31, 2021 and 2020. Unfunded commitments for TDR loans totaled $441 thousand and $704 thousand as of December 31, 2021 and 2020, respectively.
After meeting all of the conditions specified in Note 1, we removed one commercial loan with a remaining amortized cost of $2 thousand and an unfunded commitment of $600 thousand from TDR designation during 2021. There were no loans removed from TDR designation during 2020 and one commercial loan with an amortized cost of $3 thousand removed from TDR designation in 2019.
In accordance with section 4013 of the 2020 CARES Act, subsequently amended by section 541 of the 2020 Economic Aid Act, we elected to apply the temporary accounting relief provisions for loan modifications that met certain criteria, which would otherwise be designated as a TDR under existing GAAP. Since the onset of the pandemic, the Bank granted payment relief for 269 loans that included full payment deferral or interest-only payments on loan balances exceeding $402.9 million. As of December 31, 2020, there were 21 borrowing relationships with 29 loans totaling $71.0 million on payment relief. As of December 31, 2021, two borrowing relationships with three loans totaling $23.6 million were continuing to benefit from payment relief. The weighted average loan-to-value ratio of the remaining payment relief loans was approximately 44%. We accrue and recognize interest income on loans under payment relief based on the original contractual interest rates. When payments resume at the end of the relief period, the payments will generally be applied to accrued interest due until accrued interest is fully paid. We monitor the financial situation of these clients closely and expect them to resume payments as the economy continues to recover.
The following table presents information for loans modified in a TDR during the presented periods, including the number of modified contracts, the amortized cost of the loans prior to modification, and the amortized cost of the loans at period end after being restructured. The table excludes fully charged-off TDR loans and loans modified in a TDR and subsequently paid-off during the years presented, if applicable.
| | | | | | | | | | | | | | |
(dollars in thousands) | Number of Contracts Modified | Pre-Modification Amortized Cost | Post-Modification Amortized Cost | Post-Modification Amortized Cost at Period End |
TDRs modified during 2021: | | | | |
Commercial and industrial | 1 | | $ | 1,101 | | $ | 1,101 | | $ | 901 | |
| | | | |
Home equity | 1 | | 120 | | 120 | | 120 | |
| | | | |
Total | 2 | | $ | 1,221 | | $ | 1,221 | | $ | 1,021 | |
TDRs modified during 2020: | | | | |
Commercial and industrial | 1 | | $ | 170 | | $ | 162 | | $ | 96 | |
Commercial real estate, investor-owned | 1 | | 1,553 | | 1,553 | | 1,553 | |
Home equity | 1 | | 276 | | 276 | | 271 | |
Installment and other consumer | 2 | | 204 | | 204 | | 201 | |
Total | 5 | | $ | 2,203 | | $ | 2,195 | | $ | 2,121 | |
TDRs modified during 2019: | | | | |
Commercial and industrial | 1 | | $ | 298 | | $ | 298 | | $ | 150 | |
The loans modified during 2021 and 2020 reflected debt consolidation, interest rate concessions, and/or other loan term and payment modifications that did not meet the criteria specified by the 2020 CARES Act for temporary relief from TDR accounting. The loan modified during 2019 reflected a maturity extension and interest rate concession. During 2021, 2020 and 2019, there were no other defaults on loans that had been modified in a TDR within the prior
twelve-month period. We report defaulted TDRs based on a payment default definition of more than ninety days past due.
Purchased Loans with Credit Deterioration
For purchased loans with a more-than-insignificant amount of credit deterioration since origination ("PCD loans") the initial allowance for credit losses at the date of acquisition was added to the purchase price (or fair value) to determine the initial amortized cost basis. Subsequent changes in expected credit losses (favorable or unfavorable) are recognized through net income as adjustments to the allowance for credit losses on loans. Refer to Note 1, Summary of Significant Accounting Policies, for additional information regarding the accounting for PCD and non-PCD loans.
A reconciliation of the unpaid principal balance (or par value) to the purchase price (or fair value) for PCD loans as of the August 6, 2021 merger date is presented below.
| | | | | |
(in thousands) | |
Unpaid principal balance (par value) | $ | 92,029 | |
Non-credit discount | (1,662) | |
Amortized cost basis | 90,367 | |
Initial allowance for credit losses on PCD loans | (1,505) | |
Purchase price (PCD loans at fair value) | $ | 88,862 | |
Allowance for Credit Losses on Loans Rollforward
The following tables disclose activity in the allowance for credit losses.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Allowance for Credit Losses on Loans Rollforward |
(in thousands) | Commercial and industrial | Commercial real estate, owner-occupied | Commercial real estate, investor-owned | Construction | Home equity | Other residential | Installment and other consumer | Unallocated | Total |
Year ended December 31, 2021 | | | | | | | |
Beginning balance | $ | 2,530 | | $ | 2,778 | | $ | 12,682 | | $ | 1,557 | | $ | 738 | | $ | 998 | | $ | 291 | | $ | 1,300 | | $ | 22,874 | |
Provision (reversal) - CECL method | (1,240) | | (561) | | (476) | | 62 | | (193) | | (360) | | 333 | | 986 | | (1,449) | |
Initial allowance for PCD loans | 405 | | 559 | | 533 | | — | | — | | 6 | | 2 | | — | | 1,505 | |
(Charge-offs) | — | | — | | — | | — | | — | | — | | (5) | | — | | (5) | |
Recoveries | 14 | | — | | — | | 34 | | 50 | | — | | — | | — | | 98 | |
Ending balance | $ | 1,709 | | $ | 2,776 | | $ | 12,739 | | $ | 1,653 | | $ | 595 | | $ | 644 | | $ | 621 | | $ | 2,286 | | $ | 23,023 | |
Year ended December 31, 2020 | | | | | | | | | |
Beginning balance | $ | 2,334 | | $ | 2,462 | | $ | 8,483 | | $ | 638 | | $ | 850 | | $ | 973 | | $ | 284 | | $ | 653 | | $ | 16,677 | |
Provision - incurred loss method | 208 | | 673 | | 3,141 | | 219 | | 188 | | 287 | | 122 | | 612 | | 5,450 | |
(Charge-offs) | (30) | | — | | — | | — | | — | | — | | — | | — | | (30) | |
Recoveries | 13 | | — | | — | | 3 | | — | | — | | — | | — | | 16 | |
Balance at September 30, 2020 | 2,525 | | 3,135 | | 11,624 | | 860 | | 1,038 | | 1,260 | | 406 | | 1,265 | | 22,113 | |
Impact of CECL adoption | (278) | | 138 | | 1,755 | | 201 | | (361) | | (212) | | (125) | | 486 | | 1,604 | |
Post adoption balance at October 1, 2020 | 2,247 | | 3,273 | | 13,379 | | 1,061 | | 677 | | 1,048 | | 281 | | 1,751 | | 23,717 | |
Provision (reversal) - CECL method | 269 | | (495) | | (697) | | 496 | | 61 | | (50) | | 11 | | (451) | | (856) | |
(Charge-offs) | — | | — | | — | | — | | — | | — | | (1) | | — | | (1) | |
Recoveries | 14 | | — | | — | | — | | — | | — | | — | | — | | 14 | |
Ending balance | $ | 2,530 | | $ | 2,778 | | $ | 12,682 | | $ | 1,557 | | $ | 738 | | $ | 998 | | $ | 291 | | $ | 1,300 | | $ | 22,874 | |
Year ended December 31, 2019 | | | | | | | | | |
Beginning balance | $ | 2,436 | | $ | 2,407 | | $ | 7,703 | | $ | 756 | | $ | 915 | | $ | 800 | | $ | 310 | | $ | 494 | | $ | 15,821 | |
Provision (reversal) - incurred loss method | (49) | | 55 | | 768 | | (118) | | (65) | | 173 | | (23) | | 159 | | 900 | |
(Charge-offs) | (75) | | — | | — | | — | | — | | — | | (3) | | — | | (78) | |
Recoveries | 22 | | — | | 12 | | — | | — | | — | | — | | — | | 34 | |
Ending balance | $ | 2,334 | | $ | 2,462 | | $ | 8,483 | | $ | 638 | | $ | 850 | | $ | 973 | | $ | 284 | | $ | 653 | | $ | 16,677 | |
We adopted the CECL accounting standard on December 31, 2020, which we had previously postponed under the optional accounting relief provisions of the CARES Act passed in March 2020 to the earlier of the end of the national emergency or December 31, 2020. During the first nine months of 2020, we applied the incurred loss method under previous GAAP in determining the allowance for credit losses on loans. Refer to Note 1, Summary of Significant Accounting Policies, for additional information on the adoption of CECL.
Pledged Loans
Our FHLB line of credit is secured under terms of a blanket collateral agreement by a pledge of certain qualifying loans with unpaid principal balances of $1.330 billion and $1.165 billion at December 31, 2021 and 2020, respectively. In addition, we pledge eligible TIC loans, which totaled $106.2 million and $113.6 million at December 31, 2021 and 2020, respectively, to secure our borrowing capacity with the Federal Reserve Bank ("FRB"). For additional information, see Note 7, Borrowings.
Related Party Loans
The Bank has, and expects to have in the future, banking transactions in the ordinary course of its business with directors, officers, principal shareholders and their businesses or associates. These transactions, including loans, are granted on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with persons not related to us. Likewise, these transactions do not involve more than the normal risk of collectability or present other unfavorable features.
The following table shows changes in net loans to related parties for each of the three years ended December 31, 2021, 2020 and 2019.
| | | | | | | | | | | |
(in thousands) | 2021 | 2020 | 2019 |
Balance at beginning of year | $ | 6,423 | | $ | 8,333 | | $ | 10,635 | |
| | | |
| | | |
Assumed in the ARB acquisition | 4,037 | | — | | — | |
Repayments | (2,518) | | (1,910) | | (2,320) | |
Reclassified due to a change in borrower status | — | | — | | 18 | |
Balance at end of year | $ | 7,942 | | $ | 6,423 | | $ | 8,333 | |
Undisbursed commitments to related parties totaled $8.6 million and $9.1 million as of December 31, 2021 and 2020, respectively.
Note 4: Bank Premises and Equipment
A summary of Bank premises and equipment follows:
| | | | | | | | |
| December 31, |
(in thousands) | 2021 | 2020 |
Leasehold improvements | $ | 15,282 | | $ | 14,426 | |
Furniture and equipment | 11,384 | | 10,959 | |
Buildings 1 | 1,195 | | — | |
Land 1 | 1,170 | | — | |
Finance lease right-of-use assets 2 | 499 | | 365 | |
Subtotal | 29,530 | | 25,750 | |
Accumulated depreciation and amortization | (21,972) | | (20,831) | |
Bank premises and equipment, net | $ | 7,558 | | $ | 4,919 | |
1 Buildings and land were acquired in the merger with American River Bankshares. See Note 18, Merger, for more information. |
2 See Note 12, Commitments and Contingencies, for more information. |
The amount of depreciation and amortization totaled $1.7 million, $2.1 million and $2.2 million for the years ended December 31, 2021, 2020 and 2019, respectively.
Note 5: Bank Owned Life Insurance
We own life insurance policies on the lives of certain current and former officers designated by the Board of Directors to fund our employee benefit programs. Death benefits provided under the specific terms of these insurance policies are estimated to be $122.9 million at December 31, 2021. The benefits to employees' beneficiaries are limited to each employee's active service period. The investment in BOLI policies are reported at their cash surrender value, net of surrender charges, of $61.5 million and $43.6 million at December 31, 2021 and 2020, respectively. The cash surrender value includes both the original premiums paid for the life insurance policies and the accumulated accretion of policy income since inception of the policies, net of mortality costs and other fees. Earnings on BOLI totaled $2.2 million, $973 thousand and $1.2 million in 2021, 2020 and 2019, respectively. These earnings included death benefit proceeds in excess of the cash surrender values of the BOLI policies of $1.1 million in 2021 and $562 thousand in 2019. There were no death benefits on BOLI in 2020. We regularly monitor the financial information and credit ratings of our insurance carriers to ensure that they are credit worthy and comply with our policy.
Note 6: Deposits
A stratification of time deposits is presented in the following table:
| | | | | | | | |
| December 31, |
(in thousands) | 2021 | 2020 |
Time deposits of less than or equal to $250 thousand | $ | 96,214 | | $ | 66,789 | |
Time deposits of more than $250 thousand | 54,021 | | 30,644 | |
Total time deposits | $ | 150,235 | | $ | 97,433 | |
Interest on time deposits was $246 thousand, $554 thousand and $595 thousand in 2021, 2020 and 2019, respectively.
Scheduled maturities of time deposits at December 31, 2021 are presented as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
(in thousands) | 2022 | 2023 | 2024 | 2025 | 2026 | Thereafter | Total |
Scheduled time deposit maturities | $ | 109,785 | | $ | 15,963 | | $ | 8,187 | | $ | 8,357 | | $ | 7,943 | | $ | — | | $ | 150,235 | |
As of December 31, 2021, $213.9 million in securities were pledged as collateral for our local agency deposits.
Our deposit portfolio includes deposits offered through the Promontory Interfinancial Network that are comprised of Certificate of Deposit Account Registry Service® ("CDARS") balances included in time deposits and Insured Cash Sweep® ("ICS") balances included in money market deposits. In addition, we offer deposits through Reich & Tang Deposit Networks, LLC, comprised of Demand Deposit MarketplaceSM ("DDM") balances. Through these two networks we are able to offer our customers access to FDIC-insured deposit products in aggregate amounts exceeding current insurance limits. When we place funds through CDARS, ICS and DDM, on behalf of a customer, we have the option of receiving matching deposits through the network's reciprocal deposit program, or placing deposits "one-way" for which we receive no matching deposits. We consider the reciprocal deposits to be in-market deposits as distinguished from traditional out-of-market brokered deposits. The following table shows the composition of our network deposits at December 31, 2021 and 2020.
| | | | | | | | | | | | | | |
(in thousands) | December 31, 2021 | December 31, 2020 |
| Reciprocal 1 | One-Way 1 | Reciprocal 1 | One-Way 1 |
CDARS | $ | 21,413 | | $ | 2,160 | | $ | 7,622 | | $ | 2,434 | |
ICS | — | | 110,900 | | — | | 110,929 | |
DDM | 52,365 | | 60,000 | | 30,544 | | 60,000 | |
Total network deposits | $ | 73,778 | | $ | 173,060 | | $ | 38,166 | | $ | 173,363 | |
1 Reciprocal deposits are on-balance-sheet while one-way deposits are off-balance-sheet. |
The aggregate amount of deposit overdrafts that have been reclassified as loan balances was $346 thousand and $219 thousand at December 31, 2021 and 2020, respectively.
The Bank accepts deposits from shareholders, board of directors and employees in the normal course of business, and the terms are comparable to those with non-affiliated parties. The total deposits from board directors and their businesses, and executive officers were $25.3 million and $28.1 million at December 31, 2021 and 2020, respectively.
Note 7: Borrowings and Other Obligations
Federal Funds Purchased – The Bank had unsecured available lines of credit with correspondent banks for overnight borrowings totaling $150.0 million and $135.0 million at December 31, 2021 and 2020, respectively. In general, interest rates on these lines approximate the federal funds target rate. We had no overnight borrowings under these credit facilities at December 31, 2021 and 2020.
Federal Home Loan Bank Borrowings – As of December 31, 2021 and 2020, the Bank had available lines of credit with the FHLB totaling $820.5 million and $642.5 million, respectively, based on eligible collateral of certain loans. There were no FHLB overnight borrowings at December 31, 2021 and 2020. As part of our acquisition of ARB, we assumed FHLB advances in the amount of $13.9 million that we early redeemed on August 25, 2021.
Federal Reserve Line of Credit – The Bank has an available line of credit with the FRBSF secured by certain residential loans. At December 31, 2021 and 2020, the Bank had borrowing capacity under this line totaling $70.8 million and $78.7 million, respectively, and had no outstanding borrowings with the FRBSF.
Subordinated Debentures - As part of an acquisition in 2013, Bancorp assumed a subordinated debenture with a contractual balance of $4.1 million due to NorCal Community Bancorp Trust II (the "Trust"), established for the sole purpose of issuing trust preferred securities. On March 15, 2021, Bancorp redeemed in full the $2.8 million (book value) subordinated debenture due to the Trust, which had an effective rate of 5.7% for the twelve months ended December 31, 2020. The 251.5% effective rate for the twelve months ended December 31, 2021 included accelerated accretion of the $1.3 million remaining purchase discount due to the early redemption. Accretion on the subordinated debenture totaled $69 thousand and $68 thousand for the years ended December 31, 2020 and 2019, respectively.
Other Obligations - The Bank leases certain equipment under finance leases, which are included in borrowings and other obligations in the consolidated statements of condition. Refer to Note 12, Commitments and Contingencies, for additional information.
Borrowings and other obligations at and for the years ended December 31, 2021, 2020 and 2019 are summarized as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 2021 | | 2020 | | 2019 |
(dollars in thousands) | Carrying Value | Average Balance | Average Rate | | Carrying Value | Average Balance | Average Rate | | Carrying Value | Average Balance | Average Rate |
FHLB overnight borrowings | $ | — | | $ | — | | — | % | | $ | — | | $ | 42 | | 0.75 | % | | $ | — | | $ | 2,656 | | 2.55 | % |
Other obligations (finance leases) | $ | 419 | | $ | 250 | | 0.71 | % | | $ | 58 | | $ | 132 | | 2.62 | % | | $ | 212 | | $ | 279 | | 2.85 | % |
FHLB fixed-rate advances 1 | $ | — | | $ | 642 | | 1.18 | % | | $ | — | | $ | — | | — | % | | $ | — | | $ | — | | — | % |
Subordinated debenture | $ | — | | $ | 534 | | 251.54 | % | | $ | 2,777 | | $ | 2,741 | | 5.68 | % |
| $ | 2,708 | | $ | 2,673 | | 8.44 | % |
1 Average balance and rate consider $13.9 million in FHLB borrowings acquired from ARB on August 6, 2021 and redeemed on August 25, 2021.
Note 8: Stockholders' Equity and Stock Plans
Share-Based Awards
On May 12, 2020, our shareholders approved the 2020 Director Stock Plan, replacing and superseding the 2010 Director Stock Plan (collectively "the Plan"). The Plan provides for the payment of director fees in common shares of Bancorp's common stock not to exceed 250,000 shares and a way for directors to purchase shares at fair market
value. During 2021, 2020 and 2019 we issued 6,443, 5,723 and 5,544 shares of common stock, respectively, for director fees. As of December 31, 2021, 238,664 shares were available for future director fees and purchases.
The 2017 Employee Stock Purchase Plan ("ESPP") gives our employees an opportunity to purchase Bancorp's common shares through payroll deductions of between one percent and fifteen percent of their pay in each pay period. Shares are purchased quarterly at a five percent discount from the closing market price on the last day of the quarter. As of December 31, 2021, 377,475 shares were available for future purchases under the ESPP.
Under the 2017 Equity Plan, the Compensation Committee of the Board of Directors has the discretion to determine, among other things, which employees, advisors and non-employee directors will receive share-based awards, the number and timing of awards, the vesting schedule for each award, and the type of award to be granted. As of December 31, 2021, there were 868,222 shares available for future grants to employees, advisors and non-employee directors. Options are issued at an exercise price equal to the fair value of the stock at the date of grant. Options granted to officers and employees generally vest by one-third on each anniversary of the grant for three years and expire ten years from the grant date. Options granted to non-employee directors vest immediately and expire ten years from the grant date. Stock options and restricted stock may be net settled in a cashless exercise by a reduction in the number of shares otherwise deliverable upon exercise or vesting in satisfaction of the exercise payment and/or applicable tax withholding requirements. Shares withheld under net settlement arrangements are available for future grants. The table below depicts the total number of shares, amount, and weighted average price withheld for cashless exercises in each of the respective years.
| | | | | | | | | | | |
| 2021 | 2020 | 2019 |
Number of shares withheld | 27,929 | | 10,001 | | 7,795 | |
Total amount withheld (in thousands) | $ | 1,085 | | $ | 398 | | $ | 326 | |
Weighted-average price | $ | 38.85 | | $ | 39.83 | | $ | 41.84 | |
Performance-based stock awards (restricted stock) are issued to a selected group of employees under the 2017 Equity Plan. Stock award vesting is contingent upon the achievement of pre-established long-term performance goals set by the Compensation Committee of the Board of Directors. Performance is measured over a three-year period and cliff vested. These performance-based stock awards were granted at a maximum opportunity level, and based on the achievement of the pre-established goals, the actual payouts can range from 0% to 200% of the target award. For performance-based stock awards, an estimate is made of the number of shares expected to vest based on the probability that the performance criteria will be achieved to determine the amount of compensation expense to be recognized. The estimate is re-evaluated quarterly and total compensation expense is adjusted for any change in the current period.
A summary of stock option activity for the years ended December 31, 2021, 2020, and 2019 is presented in the following table. The intrinsic value of options outstanding and exercisable is calculated as the number of in-the-money options times the difference between the market price of our stock and the exercise prices of the in-the-money options as of each year-end period presented.
| | | | | | | | | | | | | | | | | |
| Number of Shares | Weighted Average Exercise Price | Aggregate Intrinsic Value (in thousands) | Weighted Average Grant-Date Fair Value | Weighted Average Remaining Contractual Term (in years) |
Options outstanding at December 31, 2018 | 425,700 | | $ | 25.01 | | $ | 6,910 | | | 5.85 |
Granted | 53,370 | | 44.01 | | | $ | 9.37 | | |
Cancelled, expired or forfeited | (13,580) | | 38.88 | | | | |
Exercised | (48,108) | | 16.11 | | 1,247 | | | |
Options outstanding at December 31, 2019 | 417,382 | | 28.01 | | 7,112 | | | 5.50 |
Exercisable (vested) at December 31, 2019 | 333,870 | | 25.34 | | 6,581 | | | 4.76 |
Options outstanding at December 31, 2019 | 417,382 | | 28.01 | | 7,112 | | | 5.50 |
Granted | 44,632 | | 39.18 | | | 6.84 | | |
Cancelled, expired or forfeited | (17,222) | | 40.31 | | | | |
Exercised | (73,208) | | 22.26 | | 1,370 | | | |
Options outstanding at December 31, 2020 | 371,584 | | 29.92 | | 2,262 | | | 5.12 |
Exercisable (vested) at December 31, 2020 | 315,377 | | 28.05 | | 2,254 | | | 4.53 |
Options outstanding at December 31, 2020 | 371,584 | | 29.92 | | 2,262 | | | 5.12 |
Granted | 55,861 | | 36.39 | | | 8.84 | | |
Cancelled, expired or forfeited | (2,008) | | 42.50 | | | | |
Exercised | (60,056) | | 23.01 | | 885 | | | |
Options outstanding at December 31, 2021 | 365,381 | | 31.97 | | 2,326 | | | 5.57 |
Exercisable (vested) at December 31, 2021 | 315,744 | | 30.85 | | 2,264 | | | 5.15 |
A summary of the options outstanding and exercisable by price range as of December 31, 2021 is presented in the following table:
| | | | | | | | | | | | | | | | | | | | |
| Stock Options Outstanding as of December 31, 2021 | | Stock Options Exercisable as of December 31, 2021 |
Range of Exercise Prices | Stock Options Outstanding | Remaining Contractual Life (in years) | Weighted Average Exercise Price | | Stock Options Exercisable | Weighted Average Exercise Price |
| | | | | | |
$10.00 - $20.00 | 32,852 | | 0.7 | $ | 19.34 | | | 32,852 | | $ | 19.34 | |
$20.01 - $30.00 | 102,374 | | 3.4 | $ | 24.47 | | | 102,374 | | $ | 24.47 | |
$30.01 - $40.00 | 156,415 | | 7.1 | $ | 34.67 | | | 133,131 | | $ | 34.18 | |
$40.01 - $50.00 | 73,740 | | 7.5 | $ | 42.29 | | | 47,387 | | $ | 42.62 | |
| 365,381 | | | | | 315,744 | | |
The following table summarizes non-vested restricted stock awards and changes during the years ended December 31, 2021, 2020, and 2019.
| | | | | | | | |
| Number of Shares | Weighted Average Grant-Date Fair Value |
Non-vested awards at December 31, 2018 | 87,388 | | $ | 31.26 | |
Granted | 29,110 | | 44.45 | |
Vested | (28,099) | | 27.88 | |
Cancelled or forfeited | (18,333) | | 32.34 | |
Non-vested awards at December 31, 2019 | 70,066 | | 37.81 | |
Granted | 29,100 | | 40.10 | |
Vested | (23,524) | | 36.35 | |
Cancelled or forfeited | (14,314) | | 37.63 | |
Non-vested awards at December 31, 2020 | 61,328 | | 39.50 | |
Granted | 30,742 | | 38.00 | |
Vested | (26,392) | | 36.81 | |
Cancelled or forfeited | (3,848) | | 33.96 | |
Non-vested awards at December 31, 2021 | 61,830 | | 40.25 | |
We determine the fair value of stock options at the grant date using the Black-Scholes pricing model that takes into account the stock price at the grant date, exercise price, and the following assumptions (weighted-average shown).
| | | | | | | | | | | |
| Years ended December 31, |
| 2021 | 2020 | 2019 |
Risk-free interest rate | 0.98 | % | 0.91 | % | 2.51 | % |
Expected dividend yield on common stock | 2.57 | % | 2.38 | % | 1.75 | % |
Expected life in years | 6.1 | 6.1 | 5.8 |
Expected price volatility | 33.12 | % | 24.43 | % | 22.71 | % |
The fair value of stock options as of the grant date is recorded as stock-based compensation expense in the consolidated statements of comprehensive income over the requisite service period, which is generally the vesting period, with a corresponding increase in common stock. Stock-based compensation also includes compensation expense related to the issuance of restricted stock awards. The grant-date fair value of the restricted stock awards, which equals the grant date price, is recorded as compensation expense over the requisite service period with a corresponding increase in common stock as the shares vest. Beginning in 2018, stock option and restricted stock awards issued include a retirement eligibility clause whereby the requisite service period is satisfied at the retirement eligibility date. For those awards, we accelerate the recording of stock-based compensation when the award holder is eligible to retire. However, retirement eligibility does not affect the vesting of restricted stock or the exercisability of the stock options, which are based on the scheduled vesting period. Total compensation expense for stock options and restricted stock awards was $972 thousand, $1.2 million, and $1.5 million during 2021, 2020, and 2019, respectively, and the total recognized deferred tax benefits related thereto were $213 thousand, $341 thousand, and $389 thousand, respectively.
As of December 31, 2021, there was $652 thousand of total unrecognized compensation expense related to non-vested stock options and restricted stock awards, which is expected to be recognized over a weighted-average period of approximately 2.3 years. The total grant-date fair value of stock options vested during the years ended December 31, 2021, 2020, and 2019 was $514 thousand, $484 thousand, and $473 thousand, respectively. The total grant-date fair value of restricted stock awards vested was $1.0 million during 2021, and $1.2 million during both 2020 and 2019.
We record excess tax benefits (deficiencies) resulting from the exercise of non-qualified stock options, the disqualifying disposition of incentive stock options and vesting of restricted stock awards as income tax benefits (expense) in the consolidated statements of comprehensive income with a corresponding decrease (increase) to current taxes payable. In 2021, 2020, and 2019 we recognized $87 thousand, $120 thousand, and $145 thousand, respectively, in excess tax benefits recorded as a reduction to income tax expense related to these types of transactions. The tax benefits realized from disqualifying dispositions of incentive stock options were recognized in tax expense to the extent of the book compensation cost recorded.
Dividends
Presented below is a summary of cash dividends paid in 2021, 2020 and 2019 to common shareholders, recorded as a reduction from retained earnings. On January 21, 2022, the Board of Directors declared a $0.24 per share cash dividend, paid February 11, 2022 to the shareholders of record at the close of business on February 4, 2022.
| | | | | | | | | | | |
| Years ended December 31, |
(in thousands except per share data) | 2021 | 2020 | 2019 |
Cash dividends to common stockholders | $ | 13,107 | | $ | 12,506 | | $ | 10,958 | |
Cash dividends per common share | $ | 0.94 | | $ | 0.92 | | $ | 0.80 | |
The holders of unvested restricted stock awards are entitled to dividends on the same per-share ratio as holders of common stock. Tax benefits for dividends paid on unvested restricted stock awards are recorded as tax benefits in the consolidated statements of comprehensive income with a corresponding decrease to current taxes payable. Dividends on forfeited awards are included in stock-based compensation expense.
Under the California Corporations Code, payment of dividends by Bancorp to its shareholders is restricted to the amount of retained earnings immediately prior to the distribution or the amount of assets that exceeds the total liabilities immediately after the distribution. As of December 31, 2021, Bancorp's retained earnings and amount of total assets that exceeds total liabilities were $239.9 million and $450.4 million, respectively.
Under the California Financial Code, payment of dividends by the Bank to Bancorp is restricted to the lesser of retained earnings or the amount of undistributed net profits of the Bank from the three most recent fiscal years. Under this restriction, approximately $6.2 million of the Bank's retained earnings balance was available for payment of dividends to Bancorp as of December 31, 2021. Bancorp held $6.7 million in cash at December 31, 2021.
Preferred Stock and Shareholder Rights Plan
On July 6, 2017, Bancorp adopted a new shareholder rights agreement (“Rights Agreement”), which replaced the existing Rights Agreement that expired on July 23, 2017. The Rights Agreement, which expires on July 23, 2022, is designed to discourage takeovers that involve abusive tactics or do not provide fair value to shareholders. The Rights Agreement defines the percentage of share ownership of an "acquiring person" as 10% of the outstanding common shares. Currently, each right entitles the registered holder to purchase from Bancorp one two-hundredth of a share of Series A Junior Participating Preferred Stock, no par value, of Bancorp at an initial price of $90 per one one-hundredth of a preferred share, subject to adjustment upon the occurrence of certain events. As of December 31, 2021, Bancorp was authorized to issue five million shares of preferred stock with no par value, one million shares of which have been designated as Series A Junior Participating Preferred Stock, with no par value under the Rights Agreement. In the event of a proposed merger, tender offer or other attempt to gain control of Bancorp that the Board of Directors does not approve, the Board of Directors may authorize the issuance of shares of common or preferred stock that would impede the completion of such a transaction. An effect of the possible issuance of common or preferred stock, therefore, may be to deter a future takeover attempt. The Board of Directors has no present plans or understandings for the issuance of any common or preferred stock in connection with the Rights Agreement.
Share Repurchase Program
On April 23, 2018, Bancorp announced that its Board of Directors approved a Share Repurchase Program under which Bancorp may repurchase up to $25.0 million of its outstanding common stock through May 1, 2019. Bancorp's Board of Directors subsequently extended the Share Repurchase Program through February 28, 2020. 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. Bancorp repurchased 1,117,666 shares totaling $40.7 million in 2021.
Under the Share Repurchase Program, Bancorp may purchase shares of its common stock through various means such as open market transactions, including block purchases, and privately negotiated transactions. The number of shares repurchased and the timing, manner, price and amount of any repurchases will be determined at Bancorp's discretion. Factors include, but are not limited to, stock price, trading volume and general market conditions, along with Bancorp’s general business conditions. The program may be suspended or discontinued at any time and does not obligate Bancorp to acquire any specific number of shares of its common stock.
As part of the Share Repurchase Program, Bancorp entered into a trading plan adopted in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The 10b5-1 trading plan permits common stock to be repurchased at times that might otherwise be prohibited under insider trading laws or self-imposed trading restrictions. The 10b5-1 trading plan is administered by an independent broker and is subject to price, market volume and timing restrictions.
Note 9: Fair Value of Assets and Liabilities
Fair Value Hierarchy and Fair Value Measurement
We group our assets and liabilities that are measured at fair value 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. These levels are:
Level 1: Valuations are based on unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2: Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data.
Level 3: Valuations are based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Values are determined using pricing models and discounted cash flow models and may include significant management judgment and estimation.
Transfers between levels of the fair value hierarchy are recognized through our monthly and/or quarterly valuation process in the reporting period during which the event or circumstances that caused the transfer occurred. No such transfers occurred in the years presented.
The following table summarizes our assets and liabilities that were required to be recorded at fair value on a recurring basis.
| | | | | | | | | | | | | | | | | |
(in thousands) Description of Financial Instruments | Carrying Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Measurement Categories: Changes in Fair Value Recorded In1 |
December 31, 2021 | | | | | |
Securities available for sale: | | | | | |
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies | $ | 759,576 | | $ | — | | $ | 759,576 | | $ | — | | OCI |
SBA-backed securities | $ | 33,478 | | $ | — | | $ | 33,478 | | $ | — | | OCI |
Debentures of government sponsored agencies | $ | 188,527 | | $ | — | | $ | 188,527 | | $ | — | | OCI |
U.S. Treasury securities | $ | 11,630 | | $ | 11,630 | | $ | — | | $ | — | | OCI |
| | | | | |
Obligations of state and political subdivisions | $ | 134,000 | | $ | — | | $ | 134,000 | | $ | — | | OCI |
Corporate bonds | $ | 38,495 | | $ | — | | $ | 38,495 | | $ | — | | OCI |
Asset-backed securities | $ | 1,862 | | $ | — | | $ | 1,862 | | $ | — | | OCI |
| | | | | |
Derivative financial liabilities (interest rate contracts) | $ | 1,085 | | $ | — | | $ | 1,085 | | $ | — | | NI |
December 31, 2020 | | | | | |
Securities available for sale: | | | | | |
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies | $ | 228,651 | | $ | — | | $ | 228,651 | | $ | — | | OCI |
SBA-backed securities | $ | 32,862 | | $ | — | | $ | 32,862 | | $ | — | | OCI |
Debentures of government sponsored agencies | $ | 20,186 | | $ | — | | $ | 20,186 | | $ | — | | OCI |
| | | | | |
Obligations of state and political subdivisions | $ | 110,652 | | $ | — | | $ | 110,652 | | $ | — | | OCI |
| | | | | |
| | | | | |
Derivative financial liabilities (interest rate contracts) | $ | 1,912 | | $ | — | | $ | 1,912 | | $ | — | | NI |
1Other comprehensive income ("OCI") or net income ("NI").
Available-for-sale securities are recorded at fair value on a recurring basis. When available, quoted market prices (Level 1) are used to determine the fair value of available-for-sale securities. Level 1 securities include U.S.
Treasury securities. If quoted market prices are not available, we obtain pricing information from a reputable third-party service provider, who may utilize valuation techniques that use current market-based or independently sourced parameters, such as bid/ask prices, dealer-quoted prices, interest rates, benchmark yield curves, prepayment speeds, probability of default, loss severity and credit spreads (Level 2). Level 2 securities include obligations of state and political subdivisions, U.S. agencies or government-sponsored agencies' debt securities, mortgage-backed securities, government agency-issued, privately-issued collateralized mortgage obligations, corporate bonds and asset-backed securities. As of December 31, 2021 and 2020, there were no Level 3 securities.
Held-to-maturity securities may be written down to fair value as a result of an other-than-temporary impairment, and we did not record any write-downs during 2021 or 2020. Fair value of held-to-maturity securities is determined using the same techniques discussed above for available-for-sale securities.
On a recurring basis, derivative financial instruments are recorded at fair value, which is based on the income approach using observable Level 2 market inputs, reflecting market expectations of future interest rates as of the measurement date. Standard valuation techniques are used to calculate the present value of the future expected cash flows assuming an orderly transaction. Valuation adjustments may be made to reflect both our own credit risk and the counterparties’ credit risk in determining the fair value of the derivatives. Level 2 inputs for the valuations are limited to observable market prices for London Interbank Offered Rate (“LIBOR”) and Overnight Index Swap ("OIS") rates (for the very short term), quoted prices for LIBOR futures contracts, observable market prices for LIBOR and OIS swap rates, and one-month and three-month LIBOR basis spreads at commonly quoted intervals. Mid-market pricing of the inputs is used as a practical expedient in the fair value measurements. We project spot rates at reset days specified by each swap contract to determine future cash flows, then discount to present value using OIS curves as of the measurement date. When the value of any collateral placed with counterparties is less than the interest rate derivative liability, a credit valuation adjustment ("CVA") is applied to reflect the credit risk we pose to counterparties. We have used the spread between the Standard & Poor's BBB rated U.S. Bank Composite rate and LIBOR for the closest maturity term corresponding to the duration of the swaps to derive the CVA. A similar credit risk adjustment, correlated to the credit standing of the counterparty, is made when collateral posted by the counterparty does not fully cover their liability to the Bank. For further discussion on our methodology in valuing our derivative financial instruments, refer to Note 14, Derivative Financial Instruments and Hedging Activities.
Certain financial assets may be measured at fair value on a non-recurring basis. These assets are subject to fair value adjustments that result from the application of the lower of cost or fair value accounting or write-downs of individual assets, such as impaired loans that are collateral dependent and other real estate owned ("OREO").
OREO represents collateral acquired through foreclosure and is initially recorded at fair value as established by a current appraisal of the collateral. Subsequent to foreclosure, OREO is carried at the lower of cost or fair value, less estimated costs to sell. OREO values are reviewed on an ongoing basis and any subsequent decline in fair value is recorded as a foreclosed asset expense in the current period. The value of OREO is classified as Level 3. Our current OREO resulted from the ARB Merger.
The following table presents the carrying value of assets measured at fair value on a non-recurring basis and that were held in the consolidated statements of condition at each respective period end, by level within the fair value hierarchy as of December 31, 2021 and December 31, 2020.
| | | | | | | | | | | | | | |
(in thousands) | Carrying Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) |
December 31, 2021 | | | | |
Other real estate owned | $ | 800 | | $ | — | | $ | — | | $ | 800 | |
December 31, 2020 | | | | |
Other real estate owned | $ | — | | $ | — | | $ | — | | $ | — | |
Disclosures about Fair Value of Financial Instruments
The table below is a summary of fair value estimates for financial instruments as of December 31, 2021 and 2020, excluding financial instruments recorded at fair value on a recurring basis (summarized in the first table in this note). The carrying amounts in the following table are recorded in the consolidated statements of condition under the indicated captions. Further, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements such as BOLI and non-maturity deposit liabilities. Additionally, we held shares of FHLB stock and Visa Inc. Class B common stock, both recorded at cost, as there was no impairment or changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer as of December 31, 2021 and 2020. See further discussion on values within Note 2, Investment Securities, above.
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 | | December 31, 2020 |
(in thousands) | Carrying Amounts | Fair Value | Fair Value Hierarchy | | Carrying Amounts | Fair Value | Fair Value Hierarchy |
Financial assets (recorded at amortized cost) | | | | | | |
Cash and cash equivalents | $ | 347,641 | | $ | 347,641 | | Level 1 | | $ | 200,320 | | $ | 200,320 | | Level 1 |
Investment securities held-to-maturity | 342,222 | | 342,755 | | Level 2 | | 109,036 | | 115,185 | | Level 2 |
Loans, net of allowance for credit losses | 2,232,622 | | 2,234,430 | | Level 3 | | 2,065,682 | | 2,089,192 | | Level 3 |
Interest receivable | 11,889 | | 11,889 | | Level 2 | | 10,922 | | 10,922 | | Level 2 |
Financial liabilities (recorded at amortized cost) | | | | | | |
Time deposits | 150,235 | | 150,475 | | Level 2 | | 97,433 | | 97,769 | | Level 2 |
| | | | | | | |
Subordinated debenture | — | | — | | Level 3 | | 2,777 | | 3,115 | | Level 3 |
Interest payable | 81 | | 81 | | Level 2 | | 97 | | 97 | | Level 2 |
Commitments - The value of unrecognized financial instruments is estimated based on the fee income associated with the commitments which, in the absence of credit exposure, is considered to approximate their settlement value. The fair value of commitment fees was not material as of December 31, 2021 and 2020.
Note 10: Benefit Plans
Deferred Compensation Plan
We established a Deferred Compensation Plan which allows certain key management personnel designated by the Board of Directors of the Bank to defer up to 80% of their salary and 100% of their annual bonus. Amounts deferred earn interest that is equal to the prime rate as published in the Wall Street Journal, on the first business day of the year, which was 3.25% on January 1, 2021 and 4.75% on January 1, 2020.
As part of the acquisition of ARB in August 2021, we assumed $2.9 million of deferred compensation plans for former members of ARB's management team and non-employee directors. Amounts deferred earn interest based on the 5 year U.S. Government Treasury rate plus 4.0%. This rate was 4.36% for 2021. Beginning January 1, 2022, the rate will convert to the prime rate.
Our deferred compensation obligation totaled $7.7 million and $4.7 million at December 31, 2021 and 2020, respectively, and is included in interest payable and other liabilities.
A similar Deferred Director Fee Plan, which allows members of the Board of Directors to defer the cash portion of their director compensation, went into effect on January 1, 2021, and the first deferral of their fees was in July 2021. Our deferred compensation obligation for members of the Board of Directors totaled $237 thousand at December 31, 2021.
401(k) Defined Contribution Plan
Our 401(k) Defined Contribution Plan, which includes a Roth 401(k) option (the “401(k) Plan”), is available to all regular employees at least eighteen years of age who complete ninety days of service, and enter the plan during one of the four open enrollment dates (January 1, April 1, July 1, and October 1) of each year. Under the 401(k) Plan, employees can defer between 1% and 50% of their eligible compensation, up to the maximum amount
allowed by the Internal Revenue Code. The Bank provides employer-match of 70% of each participant's contribution, with a maximum of $5 thousand of matching contribution per participant per year. Employer matching contributions to the 401(k) Plan vest at a rate of 20% per year over five years, per plan provisions. Employer contributions totaled $991 thousand, $929 thousand and $874 thousand for the years ended December 31, 2021, 2020 and 2019, respectively and are recorded as part of salaries and benefits expense.
Employee Stock Ownership Plan
Our Employee Stock Ownership Plan (the “Plan”) is also available to all employees under the same eligibility criteria of the 401(k) Plan, while employee contribution is not permitted. The Board of Directors determines a specific portion of the Bank's profits to be contributed to the employee stock ownership each year either in common stock or in cash for the purchase of Bancorp stock to be allocated to all eligible employees based on a percentage of their salaries, regardless of whether an employee is participating in the 401(k) plan or not. For all participants, employer contributions vest over a five year service period, per plan provisions. After five years of service, all employer contributions vest immediately.
Bancorp issued shares of common stock, contributed them to the ESOP and recognized expenses of $1.3 million in 2021 and 2020 and $1.2 million in 2019, based on the quoted market price on the date of contribution. Cash dividends paid on Bancorp stock held by the ESOP are used to purchase additional shares in the open market. All shares of Bancorp stock held by the ESOP are included in the calculations of basic and diluted earnings per share. The employer contributions to the ESOP are included in salaries and benefits expense.
Salary Continuation Plan
A Salary Continuation Plan was established for a select group of executive management, who, upon retirement, will receive twenty-five percent of their estimated salary at retirement as salary continuation benefit payments that are fixed and will be made between seven to fifteen years, depending on the executives' service period at the Bank. Each participant will need to participate in this plan for five years before vesting begins. After five years, the participant will vest ratably in the benefit over the remaining period until age 65. This Plan is unfunded and nonqualified for tax purposes and for purposes of Title I of the Employee Retirement Income Security Act of 1974.
As part of the acquisition of Bank of Napa in November 2017, we assumed the salary continuation agreements for four former executive officers of Bank of Napa, under which, fixed annual retirement benefit payments will be made for ten years beginning the first day of the month following the executive reaching the age of 65.
As part of the acquisition of ARB in August 2021, we assumed $1.7 million of salary continuation agreements for six former executive officers and directors of ARB, under which, fixed annual retirement benefit payments will be made following separation from service with varying payment end dates, the latest being fifteen years.
At December 31, 2021 and 2020, respectively, our liability under the Salary Continuation Plan was $5.3 million and $3.2 million recorded in interest payable and other liabilities.
Note 11: Income Taxes
The current and deferred components of the income tax provision for each of the three years ended December 31 are as follows:
| | | | | | | | | | | |
(in thousands) | 2021 | 2020 | 2019 |
Current tax provision | | | |
Federal | $ | 6,627 | | $ | 7,108 | | $ | 7,838 | |
State | 4,815 | | 4,895 | | 5,183 | |
Total current tax provision | 11,442 | | 12,003 | | 13,021 | |
Deferred tax provision (benefit) | | | |
Federal | 274 | | (964) | | (907) | |
State | (58) | | (694) | | (461) | |
Total deferred tax provision (benefit) | 216 | | (1,658) | | (1,368) | |
Total income tax provision | $ | 11,658 | | $ | 10,345 | | $ | 11,653 | |
The following table shows the tax effect of our cumulative temporary differences as of December 31:
| | | | | | | | |
(in thousands) | 2021 | 2020 |
Deferred tax assets: | | |
Operating and finance lease liabilities | $ | 7,642 | | $ | 8,018 | |
Allowance for credit losses on loans and unfunded loan commitments | 7,335 | | 7,584 | |
Deferred compensation plan and salary continuation plan | 3,911 | | 2,343 | |
Accrued but unpaid expenses | 1,884 | | 1,103 | |
| | |
Net operating loss carryforwards | 1,406 | | 1,660 | |
State franchise tax | 930 | | 1,017 | |
Fair value adjustment on acquired loans | 894 | | 254 | |
Stock-based compensation | 599 | | 658 | |
Depreciation and disposals on premises and equipment | 188 | | 635 | |
| | |
| | |
Interest received on non-accrual loans | 24 | | 23 | |
Other | 120 | | 100 | |
Total gross deferred tax assets | 24,933 | | 23,395 | |
Deferred tax liabilities: | | |
Operating and finance lease right-of-use assets | (7,098) | | (7,589) | |
Core deposit intangible assets | (1,953) | | (1,133) | |
Deferred loan origination costs and fees | (1,526) | | (1,945) | |
Net unrealized gains on securities available-for-sale | (745) | | (5,237) | |
Accretion on investment securities | (33) | | (33) | |
Unaccreted discount on subordinated debenture | — | | (398) | |
Other | (259) | | (132) | |
Total gross deferred tax liabilities | (11,614) | | (16,467) | |
Net deferred tax assets | $ | 13,319 | | $ | 6,928 | |
As of December 31, 2021, federal and California net operating loss carryforwards ("NOLs") of $304 thousand and $15.7 million, respectively, corresponded to the total $1.4 million deferred tax asset above. If not fully utilized, the federal NOLs will begin to expire in 2031 and the California NOLs will begin to expire in 2030. Based upon the level of historical taxable income and projections for future taxable income over the periods during which the deferred tax assets are expected to be deductible, management believes it is more likely than not we will realize the benefit of the remaining deferred tax assets. Accordingly, no valuation allowance has been established as of December 31, 2021 or 2020.
The effective tax rate for 2021, 2020 and 2019 differs from the current federal statutory income tax rate as follows:
| | | | | | | | | | | |
| 2021 | 2020 | 2019 |
Federal statutory income tax rate | 21.0 | % | 21.0 | % | 21.0 | % |
Increase (decrease) due to: | | | |
California franchise tax, net of federal tax benefit | 8.4 | % | 8.1 | % | 8.2 | % |
| | | |
Tax exempt interest on municipal securities and loans | (2.5) | % | (2.4) | % | (1.8) | % |
Tax exempt earnings on bank owned life insurance | (1.0) | % | (0.5) | % | (0.6) | % |
Non-deductible acquisition related expenses | 0.6 | % | — | % | — | % |
Non-deductible executive compensation | 0.4 | % | — | % | — | % |
Low income housing and qualified zone academy bond tax credits | (0.4) | % | (0.5) | % | (0.4) | % |
Stock-based compensation and excess tax benefits | (0.1) | % | (0.2) | % | (0.1) | % |
Other | (0.4) | % | — | % | (0.9) | % |
Effective Tax Rate | 26.0 | % | 25.5 | % | 25.4 | % |
Bancorp and the Bank have entered into a tax allocation agreement, which provides that income taxes shall be allocated between the parties on a separate entity basis. The intent of this agreement is that each member of the consolidated group will incur no greater tax liability than it would have incurred on a stand-alone basis.
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. We are no longer subject to examinations by tax authorities for years before 2018 for federal income tax and before 2017 for California. At December 31, 2021 and 2020, there were no unrecognized tax benefits, and neither the Bank nor Bancorp had accruals for interest and penalties related to unrecognized tax benefits.
Note 12: Commitments and Contingencies
Leases
We lease premises under long-term non-cancelable operating leases with remaining terms of approximately 6 months to 11 years, most of which include escalation clauses and one or more options to extend the lease term, and some of which contain lease termination clauses. Lease terms may include certain renewal options that were considered reasonably certain to be exercised.
We lease certain equipment under finance leases with initial terms of 3 years to 5 years. The equipment finance leases do not contain renewal options, bargain purchase options or residual value guarantees.
The following table shows the balances of operating and finance lease right-of-use assets and lease liabilities as of December 31, 2021 and 2020.
| | | | | | | | |
(in thousands) | December 31, 2021 | December 31, 2020 |
Operating leases: | | |
Operating lease right-of-use assets | $ | 23,604 | | $ | 25,612 | |
Operating lease liabilities | 25,429 | | 27,062 | |
Finance leases: | | |
Finance lease right-of-use assets | 499 | | 365 | |
Accumulated amortization | (93) | | (307) | |
Finance lease right-of-use assets, net1 | $ | 406 | | $ | 58 | |
Finance lease liabilities2 | $ | 419 | | $ | 58 | |
1 Included in premises and equipment in the consolidated statements of condition. | |
2 Included in borrowings and other obligations in the consolidated statements of condition. | |
The following table shows supplemental disclosures of noncash investing and financing activities for the years ended December 31, 2021, 2020 and 2019.
| | | | | | | | | | | |
(in thousands) | 2021 | 2020 | 2019 |
Right-of-use assets obtained in exchange for operating lease liabilities | $ | 2,376 | | $ | 18,633 | | $ | 1,661 | |
Right-of-use assets obtained in exchange for finance lease liabilities | $ | 444 | | $ | 18 | | $ | 31 | |
Reclassification of deferred rent and unamortized lease incentives from other liabilities to operating lease right-of-use assets upon adoption of ASC 842 | $ | — | | $ | — | | $ | 1,967 | |
The following table shows components of operating and finance lease cost for the years ended December 31, 2021, 2020 and 2019.
| | | | | | | | | | | |
(in thousands) | 2021 | 2020 | 2019 |
Operating lease cost1 | $ | 4,823 | | $ | 4,498 | | $ | 4,144 | |
Variable lease cost | — | | 5 | | — | |
Total operating lease cost | $ | 4,823 | | $ | 4,503 | | $ | 4,144 | |
Finance lease cost: | | | |
Amortization of right-of-use assets2 | $ | 96 | | $ | 169 | | $ | 172 | |
Interest on finance lease liabilities3 | 2 | | 3 | | 8 | |
Total finance lease cost | $ | 98 | | $ | 172 | | $ | 180 | |
Total lease cost | $ | 4,921 | | $ | 4,675 | | $ | 4,324 | |
1 Included in occupancy and equipment expense in the consolidated statements of comprehensive income. |
2 Included in depreciation and amortization in the consolidated statements of comprehensive income. |
3 Included in interest on borrowings and other obligations in the consolidated statements of comprehensive income. |
The following table shows the future minimum lease payments, weighted average remaining lease terms, and weighted average discount rates under operating and finance lease arrangements as of December 31, 2021.
| | | | | | | | | | | |
(in thousands) | December 31, 2021 |
Year | Operating Leases | | Finance Leases |
2022 | $ | 5,203 | | | $ | 127 | |
2023 | 4,377 | | | 117 | |
2024 | 3,667 | | | 113 | |
2025 | 3,152 | | | 66 | |
2026 | 2,354 | | | — | |
Thereafter | 8,330 | | | — | |
Total minimum lease payments | 27,083 | | | 423 | |
Amounts representing interest (present value discount) | (1,654) | | | (4) | |
Present value of net minimum lease payments (lease liability) | $ | 25,429 | | | $ | 419 | |
| | | |
Weighted average remaining term (in years) | 7.0 | | 3.5 |
Weighted average discount rate | 1.69 | % | | 0.63 | % |
Litigation Matters
Bancorp may be party to legal actions that arise from time to time in the normal course of business. Bancorp's management is not aware of any pending legal proceedings to which either it or the Bank may be a party or has recently been a party that will have a material adverse effect on the financial condition or results of operations of Bancorp or the Bank.
The Bank is responsible for a proportionate share of certain litigation indemnifications provided to Visa U.S.A. ("Visa") by its member banks in connection with Visa's lawsuits related to anti-trust charges and interchange fees ("Covered Litigation"). Our proportionate share of the litigation indemnification liability does not change or transfer upon the sale of our Class B Visa shares to member banks. Visa established an escrow account to pay for settlements or judgments in the Covered Litigation. Under the terms of the U.S. retrospective responsibility plan, when Visa funds the litigation escrow account, it triggers a conversion rate reduction of the Class B common stock to shares of Class A common stock, effectively reducing the aggregate value of the Class B common stock held by Visa's member banks like us.
In 2012, Visa had reached a $4.0 billion interchange multidistrict litigation class settlement agreement with plaintiffs representing a class of U.S. retailers. The escrow balance of $1.1 billion as of December 31, 2021, combined with funds previously deposited with the court, are expected to cover the settlement payment obligations.
The outcome of the Covered Litigation affects the conversion rate of Visa Class B common stock held by us to Visa Class A common stock, as discussed above and in Note 2, Investment Securities. The final conversion rate is subject to change depending on the final settlement payments, and the full effect on member banks is still uncertain. Litigation is ongoing and until the court approval process is complete, there is no assurance that Visa will resolve the claims as contemplated by the amended class settlement agreement, and additional lawsuits may arise from individual merchants who opted out of the class settlement. However, until the escrow account is fully depleted and the conversion rate of Class B to Class A common stock is reduced to zero, no future cash settlement payments are required by the member banks, such as us, on the Covered Litigation. Therefore, we are not required to record any contingent liabilities for the indemnification related to the Covered Litigation, as we consider the probability of losses to be remote. For further information, including a discussion of a reduction to our holdings of Class B Visa shares, refer to Note 2, Investment Securities.
Note 13: Concentrations of Credit Risk
Concentration of credit risk is the risk associated with a lack of diversification, such as having substantial investments in a few individual issuers, thereby exposing us to greater risks resulting from adverse economic,
political, regulatory, geographic, industrial or credit developments. Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash and cash equivalents, investment securities and loans.
Our cash in correspondent bank accounts, at times, may exceed FDIC insured limits. We place cash and cash equivalents with the Federal Reserve Bank and other high credit quality financial institutions, periodically monitor their credit worthiness and limit the amount of credit exposure to any one institution according to regulations. Concentrations of credit risk with respect to investment securities primarily related to the U.S. government and GSEs, which accounted for $1.277 billion, or 85% of our total investment portfolio at December 31, 2021 and $389.1 million, or 78% at December 31, 2020. The increase is due to both the acquired ARB investment security portfolio, including U.S. government and GSEs totaling $261.3 million at the date of acquisition, as well as the deployment of excess liquidity throughout 2021 into securities with purchases of $827.9 million in this security type. Our largest investment security issued by a non-GSE issuer accounted for approximately 2% of our total investment portfolio at December 31, 2021, and 3% at December 31, 2020.
We also manage our credit exposure related to our loan portfolio to avoid the risk of undue concentration of credits in a particular industry by reducing significant exposure to highly leveraged transactions or to any individual customer or counterparty, and by obtaining collateral as appropriate. No single borrower relationship accounts for more than 3% of outstanding loan balances at December 31, 2021 or 2020. The largest loan concentration group by industry of the borrowers is real estate, which accounted for 84% and 76% of our loan portfolio at December 31, 2021 and 2020, respectively. The increase in the percentage in real estate from 2020 to 2021 was primarily due to a $180.4 million reduction in unsecured loans guaranteed by the SBA under the Paycheck Protection Program ("PPP"), which are included in commercial and industrial loans.
Note 14: Derivative Financial Instruments and Hedging Activities
We entered into interest rate swap agreements, primarily as an asset/liability management strategy, in order to mitigate the changes in the fair value of specified long-term fixed-rate loans (or firm commitments to enter into long-term fixed-rate loans) caused by changes in interest rates. These hedges allow us to offer long-term fixed rate loans to customers without assuming the interest rate risk of a long-term asset. Converting our fixed-rate interest payments to floating-rate interest payments, generally benchmarked to the one-month U.S. dollar LIBOR index, protects us against changes in the fair value of our loans associated with fluctuating interest rates.
Our credit exposure, if any, on interest rate swap asset positions is limited to the fair value (net of any collateral pledged to us) and interest payments of all swaps by each counterparty. Conversely, when an interest rate swap is in a liability position exceeding a certain threshold, we may be required to post collateral to the counterparty in an amount determined by the agreements. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values.
As of December 31, 2021, we had four interest rate swap agreements, which are scheduled to mature in June 2031, October 2031, July 2032 and October 2037. All of our derivatives are accounted for as fair value hedges. The notional amounts of the interest rate contracts are equal to the notional amounts of the hedged loans. Our interest rate swap payments are settled monthly with counterparties. Accrued interest on the swaps totaled $11 thousand at both December 31, 2021 and 2020. Information on our derivatives follows:
| | | | | | | | | | | | | | |
| Asset derivatives | Liability derivatives |
(in thousands) | December 31, 2021 | December 31, 2020 | December 31, 2021 | December 31, 2020 |
Fair value hedges: | | | | |
Interest rate contracts notional amount | $ | — | | $ | — | | $ | 13,037 | | $ | 13,991 | |
Interest rate contracts fair value 1 | $ | — | | $ | — | | $ | 1,085 | | $ | 1,912 | |
1 Refer to Note 9, Fair Value of Assets and Liabilities, for valuation methodology.
The following table presents the carrying amount associated cumulative basis adjustment related to the application of fair value hedge accounting that is included in the carrying amount of hedged assets as of December 31, 2021 and 2020:
| | | | | | | | | | | | | | |
| Carrying Amounts of Hedged Assets | Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Loans |
(in thousands) | December 31, 2021 | December 31, 2020 | December 31, 2021 | December 31, 2020 |
Loans | $ | 13,976 | | $ | 15,745 | | $ | 939 | | $ | 1,753 | |
The following table presents the net losses recognized in interest income on loans on the consolidated statements of comprehensive income related to our derivatives designated as fair value hedges:
| | | | | | | | | | | |
| Years ended December 31, |
(in thousands) | 2021 | 2020 | 2019 |
Interest and fees on loans 1 | $ | 91,612 | | $ | 84,674 | | $ | 84,331 | |
Increase (decrease) in value of designated interest rate swaps due to LIBOR interest rate movements | $ | 827 | | $ | (734) | | $ | (964) | |
Payment on interest rate swaps | (369) | | (360) | | (90) | |
(Decrease) increase in value of hedged loans | (814) | | 809 | | 938 | |
Decrease in value of yield maintenance agreement | (11) | | (12) | | (13) | |
Net losses on fair value hedging derivatives recognized in interest income | $ | (367) | | $ | (297) | | $ | (129) | |
1 Represents the income line item in the statements of comprehensive income in which the effects of fair value hedges are recorded.
Our derivative transactions with counterparties are under International Swaps and Derivative Association (“ISDA”) master agreements that include “right of set-off” provisions. “Right of set-off” provisions are legally enforceable rights to offset recognized amounts and there may be an intention to settle such amounts on a net basis. We do not offset such financial instruments for financial reporting purposes.
Information on financial instruments that are eligible for offset in the consolidated statements of condition follows:
| | | | | | | | | | | | | | | | | | | | |
Offsetting of Financial Liabilities and Derivative Liabilities |
| | | | Gross Amounts Not Offset in the Statements of Condition | |
| | Gross Amounts | Net Amounts of | | | |
| Gross Amounts | Offset in the | Liabilities Presented | | | |
| of Recognized | Statements of | in the Statements of | Financial | Cash Collateral | |
(in thousands) | Liabilities1 | Condition | Condition1 | Instruments | Pledged | Net Amount |
December 31, 2021 | | | | | | |
Derivatives by Counterparty: | | | | | | |
Counterparty A | $ | 1,085 | | $ | — | | $ | 1,085 | | $ | — | | (1,085) | | $ | — | |
| | | | | | |
| | | | | | |
December 31, 2020 | | | | | | |
Derivatives by Counterparty: | | | | | | |
Counterparty A | $ | 1,912 | | $ | — | | $ | 1,912 | | $ | — | | (1,912) | | $ | — | |
| | | | | | |
| | | | | | |
1 Amounts exclude accrued interest on swaps.
Note 15: Regulatory Matters
We are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements as set forth in the following tables can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on our consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and the Bank’s prompt corrective action classification are also subject to qualitative judgments by the regulators about components of capital, risk weightings and other factors.
Management reviews capital ratios on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet our anticipated future needs. For all periods presented, the Bank’s ratios exceed the regulatory definition of “well-capitalized” under the regulatory framework for prompt corrective action and Bancorp’s ratios exceed the required minimum ratios to be considered a well-capitalized bank holding company. In
addition, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action as of December 31, 2021. There are no conditions or events since that notification that management believes have changed the Bank’s categories and we expect the Bank to remain well capitalized for prompt corrective action purposes.
In August 2018, the Board of Governors of the Federal Reserve System changed the definition of a "Small Bank Holding Company" by increasing the asset threshold from $1.0 billion to $3.0 billion. Bancorp's total assets were $4.3 billion and $2.9 billion at December 31, 2021 and 2020, respectively. As a result, Bancorp was only subject to separate minimum capital requirements for year ending December 31, 2021; however, we disclosed comparative capital ratios for Bancorp, which would have exceeded well-capitalized levels had Bancorp been subject to the same minimum capital requirements as of December 31, 2020.
The Bancorp’s and Bank's capital adequacy ratios as of December 31, 2021 and 2020 are presented in the following tables. The decrease in capital ratios as of December 31, 2021 from December 31, 2020 was largely attributable to shares repurchased totaling $40.7 million during 2021. Tier 1 Capital to average assets was also reduced by an increase in cash driven by deposit growth over and above that attributable to the Merger. In addition, as of December 31, 2020, Bancorp's Tier 1 capital included a subordinated debenture, which was not included at the Bank level. On March 15, 2021, Bancorp redeemed in full our last subordinated debenture due to NorCal Community Bancorp Trust II. Partially offsetting those factors, the Merger served to increase capital ratios as the proportion of risk-weighted assets to total assets was lower for ARB.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Capital Ratios for Bancorp (dollars in thousands) | Actual Ratio | | Adequately Capitalized Threshold | | Ratio to be a Well Capitalized Bank Holding Company |
December 31, 2021 | Amount | Ratio | | Amount | Ratio | | Amount | Ratio |
Total Capital (to risk-weighted assets) | $ | 397,101 | | 14.58 | % | | ≥ $ | 286,035 | | ≥ 10.50 | % | | ≥ $ | 272,414 | | ≥ 10.00 | % |
Tier 1 Capital (to risk-weighted assets) | $ | 373,286 | | 13.70 | % | | ≥ $ | 231,552 | | ≥ 8.50 | % | | ≥ $ | 217,931 | | ≥ 8.00 | % |
Tier 1 Capital (to average assets) | $ | 373,286 | | 8.85 | % | | ≥ $ | 168,750 | | ≥ 4.00 | % | | ≥ $ | 210,937 | | ≥ 5.00 | % |
Common Equity Tier 1 (to risk-weighted assets) | $ | 373,286 | | 13.70 | % | | ≥ $ | 190,690 | | ≥ 7.00 | % | | ≥ $ | 177,069 | | ≥ 6.50 | % |
December 31, 2020 | | | | | | | | |
Total Capital (to risk-weighted assets) | $ | 339,544 | | 16.03 | % | | ≥ $ | 222,393 | | ≥ 10.50 | % | | ≥ $ | 211,802 | | ≥ 10.00 | % |
Tier 1 Capital (to risk-weighted assets) | $ | 313,891 | | 14.82 | % | | ≥ $ | 180,032 | | ≥ 8.50 | % | | ≥ $ | 169,442 | | ≥ 8.00 | % |
Tier 1 Capital (to average assets) | $ | 313,891 | | 10.80 | % | | ≥ $ | 116,224 | | ≥ 4.00 | % | | ≥ $ | 145,280 | | ≥ 5.00 | % |
Common Equity Tier 1 (to risk-weighted assets) | $ | 311,114 | | 14.69 | % | | ≥ $ | 148,262 | | ≥ 7.00 | % | | ≥ $ | 137,672 | | ≥ 6.50 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Capital Ratios for the Bank (dollars in thousands) | Actual Ratio | | Adequately Capitalized Threshold | | Ratio to be Well Capitalized under Prompt Corrective Action Provisions |
December 31, 2021 | Amount | Ratio | | Amount | Ratio | | Amount | Ratio |
Total Capital (to risk-weighted assets) | $ | 390,924 | | 14.35 | % | | ≥ $ | 286,009 | | ≥ 10.50 | % | | ≥ $ | 272,390 | | ≥ 10.00 | % |
Tier 1 Capital (to risk-weighted assets) | $ | 367,109 | | 13.48 | % | | ≥ $ | 231,531 | | ≥ 8.50 | % | | ≥ $ | 217,912 | | ≥ 8.00 | % |
Tier 1 Capital (to average assets) | $ | 367,109 | | 8.70 | % | | ≥ $ | 168,724 | | ≥ 4.00 | % | | ≥ $ | 210,905 | | ≥ 5.00 | % |
Common Equity Tier 1 (to risk-weighted assets) | $ | 367,109 | | 13.48 | % | | ≥ $ | 190,673 | | ≥ 7.00 | % | | ≥ $ | 177,053 | | ≥ 6.50 | % |
December 31, 2020 | | | | | | | | |
Total Capital (to risk-weighted assets) | $ | 334,686 | | 15.80 | % | | ≥ $ | 222,391 | | ≥ 10.50 | % | | ≥ $ | 211,801 | | ≥ 10.00 | % |
Tier 1 Capital (to risk-weighted assets) | $ | 309,033 | | 14.59 | % | | ≥ $ | 180,031 | | ≥ 8.50 | % | | ≥ $ | 169,441 | | ≥ 8.00 | % |
Tier 1 Capital (to average assets) | $ | 309,033 | | 10.64 | % | | ≥ $ | 116,224 | | ≥ 4.00 | % | | ≥ $ | 145,280 | | ≥ 5.00 | % |
Common Equity Tier 1 (to risk-weighted assets) | $ | 309,033 | | 14.59 | % | | ≥ $ | 148,261 | | ≥ 7.00 | % | | ≥ $ | 137,671 | | ≥ 6.50 | % |
Note 16: Financial Instruments with Off-Balance Sheet Risk
We make commitments to extend credit in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because various commitments will expire without being fully drawn, the total commitment amount does not necessarily represent future cash requirements.
Our credit loss exposure is equal to the contractual amount of the commitment in the event of nonperformance by the borrower. We use the same credit underwriting criteria for all credit exposure. The amount of collateral obtained, if deemed necessary by us, is based on management's credit evaluation of the borrower. Collateral types pledged may include accounts receivable, inventory, other personal property and real property.
The contractual amount of unfunded loan commitments and standby letters of credit not reflected in the consolidated statements of condition are as follows:
| | | | | | | | |
(in thousands) | December 31, 2021 | December 31, 2020 |
Commercial lines of credit | $ | 330,234 | | $ | 297,898 | |
Revolving home equity lines | 210,938 | | 191,969 | |
Undisbursed construction loans | 78,381 | | 101,307 | |
Personal and other lines of credit | 11,001 | | 10,611 | |
Standby letters of credit | 3,657 | | 2,657 | |
Total unfunded loan commitments and standby letters of credit | $ | 634,211 | | $ | 604,442 | |
As of December 31, 2021, approximately 39% of the commitments expire in 2022, 49% expire between 2023 and 2029 and 12% expire thereafter.
We record an allowance for credit losses on unfunded loan commitments at the balance sheet date based on estimates of the probability that these commitments will be drawn upon according to historical utilization experience of the different types of commitments and expected loss rates determined for pooled funded loans. The allowance for credit losses on unfunded commitments totaled $1.8 million and $2.8 million as of December 31, 2021 and December 31, 2020, respectively, which is included in interest payable and other liabilities in the consolidated statements of condition.
The $993 thousand decrease in the allowance for unfunded commitments in 2021 was largely due to ongoing improvements in the underlying economic forecasts under the CECL accounting method.
We adopted the CECL accounting standard on December 31, 2020, which was previously postponed under the optional accounting relief provisions of the CARES Act (refer to Note 1, Summary of Significant Accounting Policies and Note 3, Loans and Allowance for Credit Losses for additional information). During the first nine months of 2020, we increased the allowance for credit losses on unfunded loan commitments under the incurred loss method ("previous GAAP") by $610 thousand. Upon adoption of the CECL standard, we increased the allowance for unfunded loan commitments by $1.1 million, which represented the difference between the allowance calculated under the CECL method as of December 31, 2020 and the incurred loss method as of September 30, 2020. The $1.1 million increase in the allowance for unfunded loan commitments included approximately $550 thousand related to a $36.9 million increase in available commitments during the fourth quarter of 2020. The remaining increase was due to changes in credit loss assumptions between the CECL and incurred loss methods.
Note 17: Condensed Bank of Marin Bancorp Parent Only Financial Statements
Presented below is financial information for Bank of Marin Bancorp, parent holding company only.
| | | | | | | | |
CONDENSED UNCONSOLIDATED STATEMENTS OF CONDITION |
December 31, 2021 and 2020 |
(in thousands) | 2021 | 2020 |
Assets | | |
Cash and due from Bank of Marin | $ | 6,624 | | $ | 5,329 | |
Investment in bank subsidiary | 444,191 | | 356,172 | |
Other assets | 243 | | 336 | |
Total assets | $ | 451,058 | | $ | 361,837 | |
| | |
Liabilities and Stockholders' Equity | | |
Subordinated debenture | $ | — | | $ | 2,777 | |
Accrued expenses payable | 318 | | 74 | |
Other liabilities | 372 | | 733 | |
Total liabilities | 690 | | 3,584 | |
Stockholders' equity | 450,368 | | 358,253 | |
Total liabilities and stockholders' equity | $ | 451,058 | | $ | 361,837 | |
| | | | | | | | | | | |
CONDENSED UNCONSOLIDATED STATEMENTS OF INCOME |
Years ended December 31, 2021, 2020 and 2019 |
(in thousands) | 2021 | 2020 | 2019 |
Income | | | |
Dividends from bank subsidiary | $ | 64,000 | | $ | 16,200 | | $ | 17,600 | |
Miscellaneous Income | — | | 3 | | 5 | |
Total income | 64,000 | | 16,203 | | 17,605 | |
Expense | | | |
Interest expense | 1,361 | | 158 | | 229 | |
Non-interest expense | 4,025 | | 1,325 | | 1,399 | |
Total expense | 5,386 | | 1,483 | | 1,628 | |
Income before income taxes and equity in undistributed net income of subsidiary | 58,614 | | 14,720 | | 15,977 | |
Income tax benefit | 1,235 | | 437 | | 480 | |
Income before equity in undistributed net income of subsidiary | 59,849 | | 15,157 | | 16,457 | |
Earnings of bank subsidiary (less) greater than dividends received from bank subsidiary | (26,621) | | 15,085 | | 17,784 | |
Net income | $ | 33,228 | | $ | 30,242 | | $ | 34,241 | |
| | | | | | | | | | | |
CONDENSED UNCONSOLIDATED STATEMENTS OF CASH FLOWS |
Years ended December 31, 2021, 2020 and 2019 |
(in thousands) | 2021 | 2020 | 2019 |
Cash Flows from Operating Activities: | | | |
Net income | $ | 33,228 | | $ | 30,242 | | $ | 34,241 | |
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | | | |
Earnings of bank subsidiary less (greater) than dividends received from bank subsidiary | 26,621 | | (15,085) | | (17,784) | |
Accretion of discount on subordinated debentures | 1,347 | | 69 | | 68 | |
Noncash director compensation expense | 35 | | 31 | | 30 | |
Net changes in: | | | |
Other assets | (1,655) | | (4) | | — | |
Other liabilities | (88) | | 59 | | 80 | |
Net cash provided by operating activities | 59,488 | | 15,312 | | 16,635 | |
Cash Flows from Investing Activities: | | | |
Capital contribution to bank subsidiary | (619) | | (1,464) | | (747) | |
| | | |
Net cash used in investing activities | (619) | | (1,464) | | (747) | |
Cash Flows from Financing Activities: | | | |
Proceeds from stock options exercised and stock issued under employee and director stock purchase plans | 587 | | 1,419 | | 747 | |
Repayment of subordinated debenture including execution costs | (4,126) | | — | | — | |
Payment of tax withholdings for vesting of restricted stock | (166) | | (73) | | (220) | |
Dividends paid on common stock | (13,107) | | (12,506) | | (10,958) | |
Stock repurchased, net of commissions | (40,762) | | (6,898) | | (15,062) | |
Net cash used in financing activities | (57,574) | | (18,058) | | (25,493) | |
Net increase (decrease) in cash and cash equivalents | 1,295 | | (4,210) | | (9,605) | |
Cash and cash equivalents at beginning of year | 5,329 | | 9,539 | | 19,144 | |
Cash and cash equivalents at end of year | $ | 6,624 | | $ | 5,329 | | $ | 9,539 | |
Supplemental schedule of non-cash investing and financing activities: | | | |
Stock issued in payment of director fees | $ | 217 | | $ | 217 | | $ | 231 | |
Repurchase of stock not yet settled | $ | 373 | | $ | 413 | | $ | 103 | |
Stock issued to ESOP | $ | 1,330 | | $ | 1,289 | | $ | 1,245 | |
| | | |
| | | |
| | | |
| | | |
Note 18: Merger
Bancorp completed its merger with American River Bankshares ("AMRB") on August 6, 2021 (the "merger date"), with Bancorp continuing as the surviving entity, followed thereafter at 12:05 a.m. on August 7, 2021 by the merger of American River Bank with and into Bank of Marin (collectively, the "Merger"), with Bank of Marin surviving.
On August 6, 2021, each share of AMRB's common stock issued and outstanding immediately prior to the Merger was converted into 0.575 shares of Bancorp's common stock resulting in the issuance of 3,441,235 shares of Bancorp common stock. In addition, merger consideration included cash paid for outstanding stock options and cash paid in lieu of fractional shares, as summarized in the following table.
| | | | | |
(in thousands) | Merger Consideration
|
Value of common stock consideration paid to shareholders (0.575 fixed exchange ratio, stock price $36.15) | $ | 124,401 | |
Cash consideration for stock options | 63 |
Cash paid in lieu of fractional shares | 13 |
Total merger consideration | $ | 124,477 | |
Bancorp accounted for the Merger using the acquisition method of accounting in accordance with ASC 805, Business Combinations. We recorded the estimated fair values of acquired assets and liabilities based on initial valuations as of August 6, 2021. Under ASC 805, during the measurement period of up to one year, the acquirer is allowed to adjust the amounts recognized at the acquisition date and may recognize additional assets or liabilities to reflect new information obtained from facts and circumstances that existed as of the merger date that, if known, would have affected the measurement of the amounts recognized as of that date. Measurement period adjustments are recognized in the reporting period in which they are determined. As such, the estimated fair values are
considered preliminary and subject to adjustment for up to one year after August 6, 2021 (as of December 31, 2021 we have not needed to make any adjustments). Fair value amounts subject to change include, but are not limited to, loans, certain deposits, deferred tax assets and liabilities and certain other assets and other liabilities.
The following table presents the preliminary fair values of the assets acquired and liabilities assumed, and the resulting goodwill as of August 6, 2021.
| | | | | |
(in thousands) | |
Total merger consideration | $ | 124,477 | |
Assets acquired: | |
Cash and cash equivalents | 140,577 | |
Investment securities | 297,797 | |
Loans | 419,435 | |
Bank-owned life insurance | 16,259 | |
Operating lease right-of-use assets | 2,376 | |
Bank premises and equipment, net | 2,891 | |
Core deposit intangible | 3,909 | |
Other real estate owned | 800 | |
Interest receivable and other assets | 14,377 | |
Total assets acquired | 898,421 | |
Liabilities assumed: | |
Deposits: | |
Non-interest bearing | 331,459 | |
Interest bearing | 458,563 | |
Total deposits | 790,022 | |
FHLB borrowings | 13,885 | |
Operating lease liabilities | 2,798 | |
Interest payable and other liabilities | 9,853 | |
Total liabilities assumed | 816,558 | |
Fair value of net assets acquired | 81,863 | |
Goodwill | $ | 42,614 | |
We recorded $42.6 million in goodwill, which represents the excess of the total merger consideration paid over the fair value of the assets acquired, net of the fair values of liabilities assumed. Goodwill mainly reflects expected value created through the combined operations of AMRB and Bancorp. It is evaluated for impairment annually.
The following are descriptions of the methods used to determine the fair values of significant assets and liabilities presented above.
Cash and cash equivalents - The carrying amount of cash and cash equivalents is a reasonable estimate of fair value based on the short-term nature of these assets.
Investment securities - Fair values for securities are based on quoted market prices, where available. If quoted market prices are not available, fair value estimates are based on observable inputs including quoted market prices for similar instruments, quoted market prices that are not in an active market or other inputs that are observable in the market. In the absence of observable inputs, fair value is estimated based on pricing models and/or discounted cash flow methodologies.
Loans - The loan valuation methodology was based on a discounted cash flow approach that considered factors including the type of loan, risk classification status, fixed or variable interest rates, term, amortization status and current discount rates. Loans were grouped according to similar credit risk characteristics when applying various valuation techniques. The discount rates applied were based on current market rates for new originations of comparable loans and included adjustments for interest rate risk, equity return, servicing, credit and liquidity risk. ARB's allowance for credit losses and any existing deferred fees or costs and premiums and discounts were not carried over at the merger date.
Bank-owned life insurance - The cash surrender values of bank-owned life insurance policies approximated fair value.
Operating lease right-of-use assets and lease liabilities - Operating lease right-of-use assets were measured at the present value of the remaining lease payments, as if the acquired leases commenced on the merger date, and adjusted to reflect favorable and unfavorable terms of the leases when compared to current market terms. Lease liabilities were measured at the present value of the remaining lease payments.
Bank premises and equipment - The value of the land and buildings acquired were based on independent third-party appraisals. The fair values of other premises and equipment, such as tenant improvements, furniture and fixtures and equipment, approximated their carrying values.
Core deposit Intangible - The core deposit intangible ("CDI") represents the estimated future benefits of acquired deposits and is recorded separately from the related deposits. The value of the core deposit intangible asset was calculated using a discounted cash flow approach to arrive at the cost differential between the core deposits (non-maturity deposits such as transaction, savings and money market accounts) and alternative funding sources. It was calculated as the present value of the difference in cash flows between maintaining the core deposits (interest and net maintenance costs) and the cost of an equal amount of funds with a similar term from an alternative source. The core deposit intangible is amortized on an accelerated basis over an estimated ten-year life, and is evaluated periodically for impairment.
We recorded a core deposit intangible asset of $3.9 million at acquisition, of which $318 thousand was amortized from the merger date to December 31, 2021. The future amortization expense for the CDI arising from the Merger is as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
(in thousands) | 2022 | 2023 | 2024 | 2025 | 2026 | Thereafter | Total |
Core deposit intangible amortization | $ | 707 | | $ | 630 | | $ | 552 | | $ | 475 | | $ | 397 | | $ | 830 | | $ | 3,591 | |
Other real estate owned - The value of other real estate owned was based on an independent third-party appraisal.
Deposits - The fair values for the demand and savings deposits equaled the amount payable on demand at the merger date. The fair values for time deposits were estimated using a discounted cash flow calculation using current offering rates on time deposits with similar remaining maturities.
FHLB borrowings - The estimated fair value of Federal Home Loan Bank borrowings was the contractual repayment amount adjusted for prepayment penalty fees.
Pro Forma Results of Operations (Unaudited)
AMRB's unaudited contributions to net interest income and net income from the August 6, 2021 merger date to December 31, 2021 included in the consolidated statements of comprehensive income are presented in the following table.
| | | | | |
(in thousands) | |
Net interest income 1 | $ | 9,167 | |
Net loss 1 | $ | (1,444) | |
1 AMRB's net interest income and net loss include merger-related costs incurred from the merger date to December 31, 2021, accretion of the net purchase discount on acquired loans, premises fair value adjustment depreciation, CDI amortization and time deposit premium amortization, as applicable. The pro forma net loss does not include allowance for credit losses adjustments related to acquired loans. |
The following table presents certain unaudited pro forma net interest income and net income for illustrative purposes only for the years ended December 31, 2021 and 2020 as if AMRB was acquired on January 1, 2020. This unaudited pro forma information combines Bancorp's and AMRB's historical results and includes adjustments reflecting the estimated impact of certain fair value adjustments for the respective periods. The pro forma information is not indicative of what would have occurred had the acquisition consummated as of the beginning of the year prior to the acquisition. The unaudited pro forma information does not consider any changes to the provision for credit losses resulting from recording loans at fair value, cost savings, or business synergies. As a
result, actual amounts would have differed from the unaudited pro forma information presented, and the differences could be significant.
| | | | | | | | |
| Year ended |
(in thousands) | December 31, 2021 | December 31, 2020 |
Net interest income - Pro forma | $ | 120,513 | | $ | 122,608 | |
Net interest income - Actual | $ | 104,951 | | $ | 96,659 | |
| | |
Net income - Pro forma 1 | $ | 42,997 | | $ | 28,445 | |
Net income - Actual | $ | 33,228 | | $ | 30,242 | |
1 The 2021 pro forma combined net income was adjusted to exclude merger-related costs of $4.9 million (net of tax benefits), incurred by Bancorp and $3.0 million (net of tax benefits) incurred by AMRB. These merger-related costs were included in the combined net income for the year ended December 31, 2020 as if the merger occurred on January 1, 2020. |
Merger-related one-time and conversion costs are recognized as incurred and continue until all systems have been converted and operational functions are fully integrated. Bancorp's pretax merger-related costs reflected in the consolidated statements of comprehensive income are summarized in the following table.
| | | | | | | | |
| Year ended |
(in thousands) | December 31, 2021 | December 31, 2020 |
Personnel and severance | $ | 3,005 | | $ | — | |
Professional services | 1,976 | | — | |
Data processing | 1,127 | | — | |
Other expense | 350 | | — | |
Total merger-related one-time and conversion costs | $ | 6,458 | | $ | — | |
End of 2021 Audited Consolidated Financial Statements