10-Q 1 bmrc-20150331x10q.htm 10-Q BMRC-2015.03.31-10Q

 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 

FORM 10-Q


(Mark One)
 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2015
 
OR
 
 o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the transition period from __________________ to __________________
 
Commission File Number  001-33572

Bank of Marin Bancorp
(Exact name of Registrant as specified in its charter)
 
California  
 
20-8859754
(State or other jurisdiction of incorporation)  
 
(IRS Employer Identification No.)
 
 
 
504 Redwood Blvd., Suite 100, Novato, CA 
 
94947
(Address of principal executive office)
 
(Zip Code)
 
Registrant’s telephone number, including area code:  (415) 763-4520
 
Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x                    No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x                   No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
         
 Large accelerated filer   o
 Accelerated filer   x
 Non-accelerated filer   o
 Smaller reporting company   o
 
Indicate by check mark if the registrant is a shell company, as defined in Rule 12b-2 of the Exchange Act.
Yes   o     No  x
 
As of April 30, 2015, there were 5,973,424 shares of common stock outstanding.



TABLE OF CONTENTS
 
 
 
 
PART I
 
 
 
ITEM 1.
 
 
 
 
 
 
 
 
 
 
 
ITEM 2.
 
 
 
ITEM 3.
 
 
 
ITEM 4.
 
 
 
PART II
 
 
 
ITEM 1.
 
 
 
ITEM 1A.
 
 
 
ITEM 2.
 
 
 
ITEM 3.
 
 
 
ITEM 4.
 
 
 
ITEM 5.
 
 
 
ITEM 6.
 
 
 




Page-2



PART I       FINANCIAL INFORMATION
 
ITEM 1.  Financial Statements
 
BANK OF MARIN BANCORP CONSOLIDATED STATEMENTS OF CONDITION 
at March 31, 2015 and December 31, 2014
(in thousands, except share data; 2015 unaudited)
March 31, 2015

 
December 31, 2014

Assets
 

 
 
Cash and due from banks
$
103,164

 
$
41,367

Investment securities
 

 
 
Held-to-maturity, at amortized cost
107,476

 
116,437

Available-for-sale, at fair value (amortized cost $201,568 and $199,045 at March 31, 2015 and December 31, 2014, respectively)
204,680

 
200,848

Total investment securities
312,156

 
317,285

Loans, net of allowance for loan losses of $15,156 and $15,099 at March 31, 2015 and December 31, 2014, respectively
1,331,328

 
1,348,252

Bank premises and equipment, net
9,852

 
9,859

Goodwill
6,436

 
6,436

Core deposit intangible
3,577

 
3,732

Interest receivable and other assets
59,636

 
60,199

Total assets
$
1,826,149

 
$
1,787,130

 
 
 
 
Liabilities and Stockholders' Equity
 

 
 

Liabilities
 

 
 

Deposits
 

 
 

Non-interest-bearing
$
716,719

 
$
670,890

Interest-bearing
 

 


Transaction accounts
95,439

 
93,758

Savings accounts
133,792

 
133,714

Money market accounts
478,145

 
503,543

CDARS® time accounts
11,493

 

Other time accounts
149,532

 
149,714

Total deposits
1,585,120

 
1,551,619

   Federal Home Loan Bank ("FHLB") borrowings
15,000

 
15,000

 Subordinated debentures
5,238

 
5,185

   Interest payable and other liabilities
16,285

 
15,300

Total liabilities
1,621,643

 
1,587,104

 
 
 
 
Stockholders' Equity
 

 
 

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

 

Common stock, no par value
Authorized - 15,000,000 shares;
Issued and outstanding - 5,967,614 and 5,939,482 at
    March 31, 2015 and December 31, 2014, respectively
83,011

 
82,436

Retained earnings
119,652

 
116,502

Accumulated other comprehensive income, net
1,843

 
1,088

Total stockholders' equity
204,506

 
200,026

Total liabilities and stockholders' equity
$
1,826,149

 
$
1,787,130


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

Page-3



BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
Three months ended
(in thousands, except per share amounts; unaudited)
March 31, 2015

 
March 31, 2014

Interest income
 
 
 
Interest and fees on loans
$
15,379

 
$
16,319

Interest on investment securities


 


Securities of U.S. government agencies
1,035

 
1,232

Obligations of state and political subdivisions
540

 
634

Corporate debt securities and other
205

 
268

Interest on Federal funds sold and due from banks
21

 
51

Total interest income
17,180

 
18,504

Interest expense
 

 
 

Interest on interest-bearing transaction accounts
30

 
23

Interest on savings accounts
12

 
11

Interest on money market accounts
127

 
158

Interest on CDARS® time accounts
11

 

Interest on other time accounts
220

 
235

Interest on FHLB and overnight borrowings
78

 
78

Interest on subordinated debentures
104

 
105

Total interest expense
582

 
610

Net interest income
16,598

 
17,894

Provision for loan losses

 
150

Net interest income after provision for loan losses
16,598

 
17,744

Non-interest income
 

 
 

Service charges on deposit accounts
525

 
556

Wealth Management and Trust Services
638

 
564

Debit card interchange fees
347

 
300

Merchant interchange fees
130

 
198

Earnings on bank-owned life insurance
203

 
213

Gains (losses) on investment securities, net
8

 
(8
)
Other income
338

 
393

Total non-interest income
2,189

 
2,216

Non-interest expense
 

 
 

Salaries and related benefits
6,790

 
6,930

Occupancy and equipment
1,342

 
1,334

Depreciation and amortization
421

 
416

Federal Deposit Insurance Corporation insurance
236

 
250

Data processing
786

 
1,360

Professional services
564

 
628

Reversal of losses on off-balance sheet commitments
(201
)
 

Other expense
1,910

 
1,925

Total non-interest expense
11,848

 
12,843

Income before provision for income taxes
6,939

 
7,117

Provision for income taxes
2,482

 
2,584

Net income
$
4,457

 
$
4,533

Net income per common share:
 

 
 

Basic
$
0.75

 
$
0.77

Diluted
$
0.74

 
$
0.76

Weighted average shares used to compute net income per common share:


 
 

Basic
5,921

 
5,870

Diluted
6,048

 
5,980

Dividends declared per common share
$
0.22

 
$
0.19

Comprehensive income:
 
 
 
Net income
$
4,457

 
$
4,533

Other comprehensive income


 


Change in net unrealized gain on available-for-sale securities
1,317

 
1,415

     Reclassification adjustment for (gain) loss on available-for-sale securities included in net income
(8
)
 
15

             Net change in unrealized gain on available-for-sale securities, before tax
1,309

 
1,430

Deferred tax expense
554

 
519

Other comprehensive income, net of tax
755

 
911

Comprehensive income
$
5,212

 
$
5,444

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

Page-4



BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
for the year ended December 31, 2014 and the three months ended March 31, 2015
(in thousands; 2015 unaudited)
 
Common Stock
 
Retained
Earnings

 
Accumulated Other
Comprehensive Income,
Net of Taxes

 
 Total

Shares

 
Amount

 
 
 
Balance at December 31, 2013
 
5,877,524

 
$
80,095

 
$
101,464

 
$
(672
)
 
$
180,887

Net income
 

 

 
19,771

 

 
19,771

Other comprehensive income
 

 

 

 
1,760

 
1,760

Stock options exercised
 
49,415

 
1,452

 

 

 
1,452

Excess tax benefit - stock-based compensation
 

 
172

 

 

 
172

Stock issued under employee stock purchase plan
 
521

 
23

 

 

 
23

Restricted stock granted
 
8,523

 

 

 

 

Restricted stock forfeited / cancelled
 
(2,067
)
 

 

 

 

Stock-based compensation - stock options
 

 
200

 

 

 
200

Stock-based compensation - restricted stock
 

 
246

 

 

 
246

Cash dividends paid on common stock
 

 

 
(4,733
)
 

 
(4,733
)
Stock purchased by directors under director stock plan
 
260

 
12

 

 

 
12

Stock issued in payment of director fees
 
5,306

 
236

 

 

 
236

Balance at December 31, 2014
 
5,939,482

 
$
82,436

 
$
116,502

 
$
1,088

 
$
200,026

Net income
 

 

 
4,457

 

 
4,457

Other comprehensive income
 

 

 

 
755

 
755

Stock options exercised
 
9,371

 
312

 

 

 
312

Excess tax benefit - stock-based compensation
 

 
28

 

 

 
28

Stock issued under employee stock purchase plan
 
96

 
5

 

 

 
5

Restricted stock granted
 
15,970

 

 

 

 

Stock-based compensation - stock options
 

 
36

 

 

 
36

Stock-based compensation - restricted stock
 

 
56

 

 

 
56

Cash dividends paid on common stock
 

 

 
(1,307
)
 

 
(1,307
)
Stock issued in payment of director fees
 
2,695

 
138

 

 

 
138

Balance at March 31, 2015
 
5,967,614

 
$
83,011

 
$
119,652

 
$
1,843

 
$
204,506


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

Page-5



BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the three months ended March 31, 2015 and 2014
(in thousands; unaudited)
March 31, 2015

 
March 31, 2014

Cash Flows from Operating Activities:
 
 
 
Net income
$
4,457

 
$
4,533

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Provision for loan losses

 
150

(Reversal of) provision for losses on off-balance sheet commitments
(201
)
 

Compensation expense--common stock for director fees
74

 
58

Stock-based compensation expense
92

 
99

Excess tax benefits from exercised stock options
(16
)
 
(37
)
Amortization of core deposit intangible
155

 
193

Amortization of investment security premiums, net of accretion of discounts
570

 
660

Accretion of discount on acquired loans
(490
)
 
(1,510
)
Accretion of discount on subordinated debentures
53

 
54

Net amortization of deferred loan origination costs/fees
(164
)
 
(81
)
Write-down of other real estate owned
40

 

(Gain) loss on sale of investment securities
(8
)
 
8

Depreciation and amortization
421

 
416

Earnings on bank owned life insurance policies
(203
)
 
(213
)
Net change in operating assets and liabilities:
 

 
 

Interest receivable
456

 
111

Interest payable
(5
)
 
(33
)
Deferred rent and other rent-related expenses
(11
)
 
76

Other assets
674

 
(479
)
Other liabilities
(8
)
 
(1,865
)
Total adjustments
1,429

 
(2,393
)
Net cash provided by operating activities
5,886

 
2,140

Cash Flows from Investing Activities:
 

 
 

Purchase of held-to-maturity securities
(2,375
)
 

Purchase of available-for-sale securities
(11,493
)
 
(9,872
)
Proceeds from sale of available-for-sale securities
1,559

 
2,023

Proceeds from sale of held-to-maturity securities

 
725

Proceeds from paydowns/maturity of held-to-maturity securities
11,043

 
3,678

Proceeds from paydowns/maturity of available-for-sale securities
7,133

 
8,429

Loans originated and principal collected, net
18,149

 
(7,750
)
Purchase of premises and equipment
(414
)
 
(342
)
Cash paid for low income housing tax credit investment
(218
)
 
(69
)
Net cash provided by (used in) investing activities
23,384

 
(3,178
)
Cash Flows from Financing Activities:
 

 
 

Net increase (decrease) in deposits
33,501

 
(10,762
)
Proceeds from stock options exercised
312

 
670

Proceeds from stock issued under employee and director stock purchase plans
5

 
7

Cash dividends paid on common stock
(1,307
)
 
(1,120
)
Excess tax benefits from exercised stock options
16

 
37

Net cash provided by (used in) financing activities
32,527

 
(11,168
)
Net increase (decrease) in cash and cash equivalents
61,797

 
(12,206
)
Cash and cash equivalents at beginning of period
41,367

 
103,773

Cash and cash equivalents at end of period
$
103,164

 
$
91,567

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
534

 
$
594

Cash paid for income taxes
$
30

 
$

Supplemental disclosure of non-cash investing and financing activities:
 

 
 

Change in unrealized gain on available-for-sale securities
$
1,309


$
1,430

Securities transferred from available-for-sale to held-to-maturity
$

 
$
14,297

Subscription in low income housing tax credit investment
$
1,023

 
$
1,000

Stock issued in payment of director fees
$
138

 
$
103


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

Page-6



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 

Note 1:  Basis of Presentation
 
The consolidated financial statements include the accounts of Bank of Marin Bancorp (“Bancorp”), a bank holding company, and its wholly-owned bank subsidiary, Bank of Marin (the “Bank”), a California state-chartered commercial bank. References to “we,” “our,” “us” mean the holding company and the Bank that are consolidated for financial reporting purposes. The accompanying unaudited consolidated interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles ("GAAP") have been condensed or omitted pursuant to those rules and regulations. Although we believe that the disclosures made are adequate to make the information not misleading, we suggest that these interim financial statements be read in conjunction with the financial statements and the notes thereto included in our 2014 Annual Report on Form 10-K.  In the opinion of Management, the unaudited consolidated financial statements reflect all adjustments which are necessary for a fair presentation of the consolidated financial position, the results of operations, changes in comprehensive income, changes in stockholders’ equity, and cash flows for the periods presented. All material intercompany transactions have been eliminated. The results of these interim periods may not be indicative of the results for the full year or for any other period. We have evaluated subsequent events through the date of filing with the SEC and have determined that there are no subsequent events that require additional recognition or disclosure.

On November 29, 2013, we completed the merger of NorCal Community Bancorp ("NorCal"), parent company of Bank of Alameda, to enhance our market presence (the “Acquisition”). On the date of acquisition, Bancorp assumed ownership of NorCal Community Bancorp Trusts I and II, respectively (the "Trusts"), which were formed for the sole purpose of issuing trust preferred securities. Bancorp is not considered the primary beneficiary of the Trusts (variable interest entities), therefore the Trusts are not consolidated in our consolidated financial statements, but rather the subordinated debentures are shown as a liability on our consolidated statements of condition. Bancorp's investment in the common stock of the Trusts is accounted for under the equity method and is included in interest receivable and other assets on the consolidated statements of condition.
 
The following table shows: 1) weighted average basic shares, 2) potentially dilutive common shares related to stock options, unvested restricted stock awards and stock warrant, and 3) weighted average diluted shares. Basic earnings per share (“EPS”) are calculated by dividing net income by the weighted average number of common shares outstanding during each period, excluding unvested restricted stock awards. Diluted EPS are calculated using the weighted average diluted shares. The number of potentially dilutive common shares included in quarterly diluted EPS is computed using the average market prices during the three months included in the reporting period under the treasury stock method. The number of potentially dilutive common shares included in year-to-date diluted EPS is a year-to-date weighted average of potentially dilutive common shares included in each quarterly diluted EPS computation. We have two forms of outstanding 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. Therefore, under the two-class method, the difference in EPS is not significant for these participating securities.

Page-7



 
Three months ended
(in thousands, except per share data; unaudited)
March 31, 2015
March 31, 2014
Weighted average basic shares outstanding
5,921

5,870

Add: Potentially dilutive common shares related to stock options
47

43

 Potentially dilutive common shares related to unvested restricted stock
6

6

 Potentially dilutive common shares related to the warrant
74

61

Weighted average diluted shares outstanding
6,048

5,980

 
 
 
Net income
$
4,457

$
4,533

Basic EPS
$
0.75

$
0.77

Diluted EPS
$
0.74

$
0.76

 




Weighted average anti-dilutive shares not included in the calculation of diluted EPS
24

44


Page-8




Note 2: Recently Issued Accounting Standards
 
In January 2014, the FASB issued ASU No. 2014-04, Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40) Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. Current accounting literature on troubled debt restructurings includes guidance on the receipt of one or more collateral assets in satisfaction of all or part of a receivable. The accounting literature indicates that a creditor should reclassify a collateralized mortgage loan such that the loan should be de-recognized and the collateral asset recognized when it is determined that there has been in substance a repossession or foreclosure by the creditor. However, in substance repossession or foreclosure and physical possession were not defined, leaving uncertainty about when a creditor should de-recognize the loan receivable and recognize the real estate property. This ASU clarifies when an in substance repossession or foreclosure occurs. ASU 2014-04 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2014 for public entities. Since we currently do not hold any in substance foreclosures, the adoption of this ASU has not had any impact on our financial condition or results of operations.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). The ASU is a converged standard involving FASB and International Financial Reporting Standards that provides a single comprehensive revenue recognition model for all contracts with customers across transactions and industries. The guidance in this ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The core principal of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. For public entities, the ASU is effective on a retrospective basis for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2016. Since this ASU does not apply to financial instruments and we do not have a significant source of non-interest income subject to this ASU, we do not expect it to have a significant impact on our financial condition or results of operations.

In June 2014, the FASB issued ASU No. 2014-12, Compensation - Stock Compensation (Topic 718) Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. This ASU provides guidance for entities that grant their employees share-based payment awards where a performance target that affects vesting could be achieved after the requisite service period. That is the case when an employee is eligible to retire or otherwise terminate employment before the end of the period in which a performance target could be achieved and still be eligible to vest in the award if and when the performance target is achieved. This ASU stipulates that compensation expense should be recognized in the period where the performance target becomes probable of being achieved as opposed to the date that the award was granted. ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. As of March 31, 2015 we have not granted share-based payment awards where a performance target that affects vesting could be achieved after the requisite service period. We do not expect this ASU to have a material impact on our financial condition or results of operations.



Page-9



Note 3:  Fair Value of Assets and Liabilities
 
Fair Value Hierarchy and Fair Value Measurement
 
We group our assets and liabilities that are measured at fair value in three levels within the fair value hierarchy, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
 
Level 1: Valuations are based on quoted prices in active markets for identical assets or liabilities. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not involve a significant degree of judgment.
 
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 include Management judgment and estimation which may be significant.

Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with our monthly and/or quarterly valuation process.
 

Page-10



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)

At March 31, 2015 (unaudited):
 
 
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies
$
152,142

 
$

 
$
149,472

 
$
2,670

Debentures of government-sponsored agencies
$
26,174

 
$

 
$
26,174

 
$

Privately-issued collateralized mortgage obligations
$
5,493

 
$

 
$
5,493

 
$

Obligations of state and political subdivisions
$
15,850

 
$

 
$
15,850

 
$

Corporate bonds
$
5,021

 
$

 
5,021

 
$

Derivative financial assets (interest rate contracts)
$

 
$

 
$

 
$

Derivative financial liabilities (interest rate contracts)
$
2,481

 
$

 
$
2,481

 
$

At December 31, 2014:
 

 
 
 
 

 
 

Securities available-for-sale:
 

 
 
 
 

 
 

Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies
$
158,119

 
$

 
$
155,421

 
$
2,698

Debentures of government-sponsored agencies
$
14,557

 
$

 
$
14,557

 
$

Privately-issued collateralized mortgage obligations
$
7,294

 
$

 
$
7,294

 
$

Obligations of state and political subdivisions
$
15,880

 
$

 
$
15,771

 
$

Corporate bonds
$
4,998

 
$

 
$
5,437

 
$

Derivative financial assets (interest rate contracts)
$
61

 
$

 
$
61

 
$

Derivative financial liabilities (interest rate contracts)
$
1,996

 
$

 
$
1,996

 
$

 
Securities available-for-sale are recorded at fair value on a recurring basis. When available, quoted market prices (Level 1) are used to determine the fair value of securities available-for-sale. 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 U.S. agencies or government sponsored agencies' debt securities, mortgage-backed securities, government agency-issued and privately-issued collateralized mortgage obligations. As of March 31, 2015 and December 31, 2014, there are no securities that are considered Level 1 securities. As of March 31, 2015, we have one available-for-sale security that is considered a Level 3 security. The security is a U.S. government agency obligation collateralized by a small pool of business equipment loans guaranteed by the Small Business Administration program. This security is not actively traded and is owned only by a few investors. The significant unobservable data that is reflected in the fair value measurement include dealer quotes, projected prepayment speeds/average life and credit information, among other things. It was transferred to a Level 3 security during the second quarter of 2014. The increase in unrealized gain during the first quarter of 2015 is $10 thousand.

Securities held-to-maturity may be written down to fair value (determined using the same techniques discussed above for securities available-for-sale) as a result of an other-than-temporary impairment, if any.
 
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

Page-11



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 quality 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") cash rates 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 to determine future cash flows, then discount to present value using either LIBOR or OIS curves depending on the collateral posted as of the measurement date.  When the value of any collateral placed with counterparties is less than the interest rate derivative liability, an additional discount is applied to reflect our potential credit risk 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 credit-risk-related component of the discount rate of future cash flows from the collateral shortfall.

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 and other real estate owned ("OREO").
 
The following table presents the carrying value of financial instruments that were measured at fair value on a non-recurring basis and that were still held in the consolidated statements of condition at each respective period end, by level within the fair value hierarchy as of March 31, 2015 and December 31, 2014.
(in thousands)
Description of Financial Instruments
Carrying Value1

 
Quoted Prices in Active Markets for Identical Assets
(Level 1)

 
Significant Other Observable Inputs
(Level 2)

 
Significant Unobservable Inputs 
(Level 3) 1

At March 31, 2015 (unaudited):
 
 
 

 
 

 
 

Impaired loans carried at fair value:


 


 


 


Installment and other consumer
13

 

 

 
13

Total
$
13

 
$

 
$

 
$
13

 
 
 
 
 
 
 
 
At December 31, 2014:
 

 
 

 
 

 
 

Impaired loans carried at fair value:
 
 
 
 
 
 


Installment and other consumer
77

 

 

 
77

Total
$
77

 
$

 
$

 
$
77


1 Represents collateral-dependent loan principal balances that had been generally written down to the values of the underlying collateral, net of specific valuation allowances of $10 thousand and $26 thousand at March 31, 2015 and December 31, 2014, respectively. The carrying value of loans fully charged-off, which includes unsecured lines of credit, overdrafts and all other loans, is zero.

When a loan is identified as impaired, it is reported at the lower of cost or fair value, measured based on the loan's observable market price (Level 1) or the current net realizable value of the underlying collateral securing the loan, if the loan is collateral dependent (Level 3).  Net realizable value of the underlying collateral is the fair value of the collateral less estimated selling costs and any prior liens. Appraisals, recent comparable sales, offers and listing prices are factored in when valuing the collateral. We review and verify the qualifications and licenses of  the certified general appraisers used for appraising commercial properties or certified residential appraisers for residential properties. Real estate appraisals may utilize a combination of approaches including replacement cost, sales comparison and the income approach. Comparable sales and income data are analyzed by the appraisers and adjusted to reflect differences between them and the subject property such as type, leasing status and physical condition. When appraisals are received, Management reviews the assumptions and methodology utilized in the appraisal, as well as the overall resulting value in conjunction with independent data sources such as recent market data and industry-wide statistics. We generally use a 6% discount for selling costs which is applied to all properties, regardless of size. Appraised values may be adjusted to reflect changes in market conditions that have occurred subsequent to the appraisal date, or for revised estimates regarding the timing or cost of the property sale. These adjustments are based on qualitative judgments made by Management on a case-by-case basis and are generally unobservable valuation inputs as they are specific to the underlying collateral. There have been no significant changes in the valuation techniques during the quarter ended March 31, 2015.

Page-12




OREO represents collateral acquired through foreclosure and is initially recorded at fair value as established by a current appraisal, adjusted for disposition costs. Subsequently, OREO is measured at lower of cost or fair value. 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 determined based on independent appraisals, similar to the process used for impaired loans, discussed above, and is generally classified as Level 3. We had $421 thousand and $461 thousand of OREO as of March 31, 2015 and December 31, 2014, respectively, all of which was acquired from Bank of Alameda as part of the Acquisition. There was a $40 thousand decline in the estimated fair value of the OREO during the first three months ended March 31, 2015.

 Disclosures about Fair Value of Financial Instruments
 
The table below is a summary of fair value estimates for financial instruments as of March 31, 2015 and December 31, 2014, 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. We have excluded non-financial assets and non-financial liabilities defined by the Codification (ASC 820-10-15-1A), such as Bank premises and equipment, deferred taxes and other liabilities.  In addition, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements of the Financial Instruments Topic of the Codification (ASC 825-10-50-8), such as Bank-owned life insurance policies. 
 
March 31, 2015
 
December 31, 2014
(in thousands; 2015 unaudited)
Carrying Amounts

Fair Value

Fair Value Hierarchy
 
Carrying Amounts

Fair Value

Fair Value Hierarchy
Financial assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
103,164

$
103,164

Level 1
 
$
41,367

$
41,367

Level 1
Investment securities held-to-maturity
107,476

109,785

Level 2
 
116,437

118,643

Level 2
Loans, net
1,331,328

1,341,118

Level 3
 
1,348,252

1,361,244

Level 3
Interest receivable
5,453

5,453

Level 2
 
5,909

5,909

Level 2
Financial liabilities
 

 

 
 
 

 

 
Deposits
1,585,120

1,585,907

Level 2
 
1,551,619

1,552,446

Level 2
Federal Home Loan Bank borrowings
15,000

15,514

Level 2
 
15,000

15,484

Level 2
Subordinated debentures
5,238

5,274

Level 3
 
5,185

5,290

Level 3
Interest payable
208

208

Level 2
 
213

213

Level 2

Following is a description of methods and assumptions used to estimate the fair value of each class of financial instrument not recorded at fair value but required for disclosure purposes:
 
Cash and Cash Equivalents - The carrying amounts of cash and cash equivalents approximate their fair value because of the short-term nature of these instruments.
 
Held-to-maturity Securities - Held-to-maturity securities, which generally consist of mortgage-backed securities, obligations of state and political subdivisions and corporate bonds, are recorded at their amortized cost. Their fair value for disclosure purposes is determined using methodologies similar to those described above for available-for-sale securities using Level 2 inputs. If Level 2 inputs are not available, we may utilize pricing models that incorporate unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities (Level 3).  As of March 31, 2015 and December 31, 2014, we did not hold any held-to-maturity securities whose fair value was measured using significant unobservable inputs.
 
Loans - The fair value of loans with variable interest rates approximates current carrying value, because their rates are regularly adjusted to current market rates. The fair value of fixed rate loans or variable loans at negotiated interest rate floors or ceilings with remaining maturities in excess of one year is estimated by discounting the future cash flows using current market rates at which similar loans would be made to borrowers with similar creditworthiness and similar remaining maturities. The allowance for loan losses (“ALLL”) is considered to be a reasonable estimate of the portion of loan discount attributable to credit risks.
 

Page-13



Interest Receivable and Payable - The interest receivable and payable balances approximate their fair value due to the short-term nature of their settlement dates.

Deposits - The fair value of deposits without stated maturity, such as transaction accounts, savings accounts and money market accounts, is the amount payable on demand at the reporting date. The fair value of time deposits is estimated by discounting the future cash flows using current rates offered for deposits of similar remaining maturities.
 
Federal Home Loan Bank Borrowings - The fair value is estimated by discounting the future cash flows using current rates offered by the Federal Home Loan Bank of San Francisco ("FHLB") for similar credit advances corresponding to the remaining duration of our fixed-rate credit advances.

Subordinated Debentures - As part of the Acquisition, we assumed two subordinated debentures from NorCal. See Note 6 for further information. The fair values of the subordinated debentures were estimated by discounting the future cash flows (interest payment at a rate of three-month LIBOR plus 3.05% and 1.40%, respectively) to their present values using current market rates at which similar debt securities would be issued with similar credit ratings as ours and similar remaining maturities. Each interest payment was discounted at the spot rate for the corresponding term, determined based on the yields and terms of comparable trust preferred securities, plus a liquidity premium. In July 2010, the Dodd-Frank Act was signed into law and limits the ability of certain bank holding companies to treat trust preferred security debt issuances as Tier 1 capital. This law effectively closed the trust-preferred securities markets for new issuance and led to the absence of observable or comparable transactions in the market place. Due to the use of unobservable inputs of trust preferred securities, we consider the fair value to be a Level 3 measurement.

Commitments - Loan commitments and standby letters of credit generate ongoing fees, which are recognized over the term of the commitment period. We record an allowance reserve for these off-balance sheet commitments which is based on an estimate of probabilities of these commitments being drawn upon according to our historical utilization experience on different types of commitments and expected loss severity. We have set aside an allowance for losses in the amount of $811 thousand and $1.0 million as of March 31, 2015 and December 31, 2014, respectively.


 
Note 4:  Investment Securities
 
Our investment securities portfolio consists of obligations of state and political subdivisions, corporate bonds, U.S. government agency securities, including mortgage-backed securities (“MBS”) and collateralized mortgage obligations (“CMOs”) issued or guaranteed by Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC"), or Government National Mortgage Association ("GNMA"), debentures issued by government-sponsored agencies such as FNMA and FHLMC, as well as privately issued CMOs, as reflected in the table below:
 
March 31, 2015
 
December 31, 2014
 
Amortized
Fair
Gross Unrealized
 
Amortized
Fair
Gross Unrealized
(in thousands; 2015 unaudited)
Cost
Value
Gains
(Losses)
 
Cost
Value
Gains
(Losses)
Held-to-maturity
 
 
 
 
 
 
 
 
 
  Obligations of state and
  political subdivisions
$
60,529

$
62,257

$
1,741

$
(13
)
 
$
63,425

$
65,121

$
1,736

$
(40
)
  Corporate bonds
32,175

32,345

173

(3
)
 
40,257

40,448

216

(25
)
MBS pass-through securities issued by FHLMC and FNMA
14,772

15,183

411


 
12,755

13,074

319


Total held-to-maturity
107,476
109,785
2,325
(16
)
 
116,437
118,643
2,271
(65
)
 
 
 
 
 
 
 
 
 
 
Available-for-sale
 
 
 
 
 
 
 
 
 
Securities of U.S. government agencies:
 
 
 
 
 
 
 
 
MBS pass-through securities issued by FHLMC and FNMA
90,215

92,057

1,842


 
92,963

94,214

1,262

(11
)
CMOs issued by FNMA
13,896

14,055

197

(38
)
 
14,771

14,790

77

(58
)
CMOs issued by FHLMC
29,482

29,799

339

(22
)

31,238

31,260

109

(87
)
CMOs issued by GNMA
15,933

16,231

308

(10
)

17,573

17,855

298

(16
)
Debentures of government- sponsored agencies
26,154

26,174

119

(99
)
 
14,694

14,557

95

(232
)
Privately issued CMOs
5,353

5,493

142

(2
)
 
7,137

7,294

172

(15
)
Obligations of state and
political subdivisions
15,596

15,850

256

(2
)
 
15,733

15,880

155

(8
)
Corporate bonds
4,939

5,021

82


 
4,936

4,998

66

(4
)
Total available-for-sale
201,568
204,680
3,285
(173
)
 
199,045

200,848

2,234

(431
)
 
 
 
 
 
 
 
 
 
 
Total investment securities
$
309,044

$
314,465

$
5,610

$
(189
)
 
$
315,482

$
319,491

$
4,505

$
(496
)
 
 
 
 
 
 
 
 
 
 

The amortized cost and fair value of investment debt securities by contractual maturity at March 31, 2015 are shown below. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.
 
 
March 31, 2015
 
December 31, 2014
 
Held-to-Maturity
 
Available-for-Sale
 
Held-to-Maturity
 
Available-for-Sale
(in thousands; 2015 unaudited)
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Within one year
$
36,925

 
$
37,015

 
$
5,769

 
$
5,816

 
$
39,778

 
$
39,913

 
$
2,378

 
$
2,388

After one year but within five years
44,701

 
45,804

 
50,411

 
50,686

 
50,983

 
51,953

 
43,866

 
43,919

After five years through ten years
12,216

 
12,871

 
9,312

 
9,471

 
11,679

 
12,426

 
9,644

 
9,749

After ten years
13,634

 
14,095

 
136,076

 
138,707

 
13,997

 
14,351

 
143,157

 
144,792

Total
$
107,476

 
$
109,785

 
$
201,568

 
$
204,680

 
$
116,437

 
$
118,643

 
$
199,045

 
$
200,848

 
We sold two available-for-sale securities in 2015 with total proceeds of $1.6 million and realized a gross gain of $8 thousand.


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We sold one available-for-sale and three held-to-maturity securities in the first quarter of 2014 with total proceeds of $2.0 million and $725 thousand, respectively, and incurred a loss of $15 thousand and a gross gain of $7 thousand, respectively. The sales of the held-to-maturity securities were due to evidence of significant deterioration in issuer creditworthiness since purchase.

Investment securities carried at $69.2 million and $74.7 million at March 31, 2015 and December 31, 2014, respectively, were pledged to the State of California: $68.4 million and $73.8 million to secure public deposits in compliance with the Local Agency Security Program at March 31, 2015 and December 31, 2014, respectively, and $852 thousand and $856 thousand to provide collateral for trust deposits at March 31, 2015 and December 31, 2014, respectively. In addition, investment securities carried at $1.1 million were pledged to collateralize an internal Wealth Management and Trust Services (“WMTS”) checking account at both March 31, 2015 and December 31, 2014.

Other-Than-Temporarily Impaired Debt Securities
 
We have evaluated the credit of our investment securities and their issuer and/or insurers. Based on our evaluation, Management has determined that no investment security in our investment portfolio is other-than-temporarily impaired as of March 31, 2015. We do not have the intent, and it is more likely than not that we will not have to sell securities temporarily impaired at March 31, 2015 before recovery of the cost basis.
 
Twelve and twenty-eight investment securities were in unrealized loss positions at March 31, 2015 and December 31, 2014, respectively. Those securities are summarized and classified according to the duration of the loss period in the table below:
 
March 31, 2015
 
< 12 continuous months
 
 
> 12 continuous months
 
 
Total securities
 in a loss position
(in thousands; unaudited)
 
Fair value
 
Unrealized loss
 
Fair value
 
Unrealized loss
 
Fair value
 
Unrealized loss
Held-to-maturity
 
 
 
 
 
 
 
 
 
 
 
 
Obligations of state & political subdivisions
 
$
2,556

 
$
(3
)
 
361

 
(10
)
 
$
2,917

 
$
(13
)
Corporate bonds
 
1,997

 
(3
)
 

 

 
1,997

 
(3
)
Total held-to-maturity
 
4,553

 
(6
)
 
361

 
(10
)
 
4,914

 
(16
)
Available-for-sale
 
 
 
 
 
 
 
 
 
 
 
 
CMOs issued by FNMA
 

 

 
3,918

 
(38
)
 
3,918

 
(38
)
CMOs issued by FHLMC
 

 

 
2,232

 
(22
)
 
2,232

 
(22
)
CMOs issued by GNMA
 
3,074

 
(10
)
 

 

 
3,074

 
(10
)
Debentures of government- sponsored agencies
 

 

 
9,901

 
(99
)
 
9,901

 
(99
)
Privately issued CMOs
 
458

 
(2
)
 

 

 
458

 
(2
)
Obligations of state & political subdivisions
 

 

 
588

 
(2
)
 
588

 
(2
)
Total available-for-sale
 
3,532

 
(12
)
 
16,639

 
(161
)
 
20,171

 
(173
)
Total temporarily impaired securities
 
$
8,085

 
$
(18
)
 
$
17,000

 
$
(171
)
 
$
25,085

 
$
(189
)
 

Page-15



December 31, 2014
 
< 12 continuous months
 
 
> 12 continuous months
 
 
Total securities
 in a loss position
 
(dollars in thousands)
 
Fair value
 
Unrealized loss
 
Fair value
 
Unrealized loss
 
Fair value
 
Unrealized loss
Held-to-maturity
 
 
 
 
 
 
 
 
 
 
 
 
Obligations of state & political subdivisions
 
$
5,830

 
$
(27
)
 
$
359

 
$
(13
)
 
$
6,189

 
$
(40
)
Corporate bonds
 
3,009

 
(1
)
 
3,533

 
(24
)
 
6,542

 
(25
)
Total held-to-maturity
 
8,839

 
(28
)
 
3,892

 
(37
)
 
12,731

 
(65
)
Available-for-sale
 
 
 
 
 
 
 
 
 
 
 
 
MBS pass-through securities issued by FNMA and FHLMC
 
1,960

 
(11
)
 

 

 
1,960

 
(11
)
CMOs issued by FNMA
 

 

 
4,115

 
(58
)
 
4,115

 
(58
)
CMOs issued by FHLMC
 
17,157

 
(44
)
 
2,291

 
(43
)
 
19,448

 
(87
)
CMOs issued by GNMA
 
3,262

 
(16
)
 

 

 
3,262

 
(16
)
Debentures of government- sponsored agencies
 
494

 
(1
)
 
9,769

 
(231
)
 
10,263

 
(232
)
Privately issued CMOs
 
817

 
(15
)
 

 

 
817

 
(15
)
Obligations of state & political subdivisions
 
2,695

 
(3
)
 
1,112

 
(5
)
 
3,807

 
(8
)
Corporate bonds
 
1,002

 
(1
)
 
990

 
(3
)
 
1,992

 
(4
)
Total available-for-sale
 
27,387

 
(91
)
 
18,277

 
(340
)
 
45,664

 
(431
)
Total temporarily impaired securities
 
$
36,226

 
$
(119
)
 
$
22,169

 
$
(377
)
 
$
58,395

 
$
(496
)

As of March 31, 2015, there were six investment positions that had been in a continuous loss position for more than twelve months. These securities consisted of a government-sponsored agency debenture, obligations of U.S. state and political subdivisions, and CMOs. We have evaluated each of the bonds and believe that the decline in fair value is primarily driven by factors other than credit. It is probable that we will be able to collect all amounts due according to the contractual terms and no other-than-temporary impairment exists on these securities. The CMOs issued by FNMA and FHLMC are supported by the U.S. Federal Government to protect us from credit losses. Additionally, the obligations of state and political subdivisions were deemed creditworthy based on our review of the issuers' recent financial information and their insurers, if any. Based upon our assessment of the credit fundamentals and the credit enhancements, we concluded that these securities were not other-than-temporarily impaired at March 31, 2015.

Six investment securities in our portfolio were in a temporary loss position for less than twelve months as of March 31, 2015. They consisted of a U.S. Agency CMO, obligations of U.S. state and political subdivisions, a corporate bond and privately issued CMOs. We determine that the strengths of GNMA through the U.S. Federal Government guarantee is sufficient to protect us from credit losses. Other temporarily impaired securities are deemed creditworthy after internal analysis. Additionally, all are rated as investment grade by at least one major rating agency. As a result of this impairment analysis, we concluded that these securities were not other-than-temporarily impaired at March 31, 2015.

Non-Marketable Securities

As a member of the FHLB, we are required to maintain a minimum investment in the 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 its $100 per share par value. We held $8.2 million of FHLB stock recorded at cost in other assets on the consolidated statements of condition at both March 31, 2015 and December 31, 2014. 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. Management does not believe that the FHLB stock is other-than-temporarily-impaired, as we expect to be able to redeem this stock at cost. On April 29, 2015, the FHLB distributed a cash dividend for the first quarter of 2015 at an annualized dividend rate of 7.67%.

Page-16




As a member bank of Visa U.S.A., we hold 16,939 shares of Visa Inc. Class B common stock with a carrying value of zero, which is equal to our cost basis. These shares are restricted from resale until their conversion into Class A (voting) shares upon the termination of Visa Inc.'s covered litigation escrow account. As a result of the restriction, these shares are not considered available-for-sale and are not carried at fair value. On January 28, 2015, Visa's Board of Directors approved a 4-for-1 split of Visa's Class A common stock. As Class B holders, the conversion rate was adjusted to 1.6483 when converting this Class B common stock to Class A common stock, the value would be $1.8 million at both March 31, 2015 and December 31, 2014. The conversion rate is subject to further reduction upon the final settlement of the covered litigation against Visa Inc. and its member banks. See Note 8 herein.

We invest in low income housing tax credit funds as a limited partner, which totaled $2.8 million and $1.8 million recorded in other assets as of March 31, 2015 and December 31, 2014, respectively. In the first three months of 2015, we recognized $72 thousand of low income housing tax credits and other tax benefits, net of $56 thousand of amortization expense of low income housing tax credit investment, as a component of income tax benefit. As of March 31, 2015, our unfunded commitments for these low income housing tax credit funds totaled $2.2 million. We did not recognize any impairment losses on these low income housing tax credit investments during the first three months of 2015, or the year ended December 31, 2014.


Note 5:  Loans and Allowance for Loan Losses

Credit Quality of Loans
 
Outstanding loans by class and payment aging as of March 31, 2015 and December 31, 2014 are as follows:
Loan Aging Analysis by Class as of March 31, 2015 and December 31, 2014
(dollars in thousands; 2015 unaudited)
Commercial and industrial

 
Commercial real estate, owner-occupied

 
Commercial real estate, investor

 
Construction

 
Home equity

 
Other residential 1

 
Installment and other consumer

 
Total

March 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 30-59 days past due
$
13

 
$

 
$

 
$

 
$
295

 
$
161

 
$
184

 
$
653

 60-89 days past due
296

 

 

 

 

 

 

 
296

Greater than 90 days past due (non-accrual) 2
373

 
1,403

 
2,354

 
5,107

 
166

 

 
79

 
9,482

Total past due
682

 
1,403

 
2,354

 
5,107

 
461

 
161

 
263

 
10,431

Current
195,760

 
233,934

 
651,494

 
51,943

 
112,816

 
73,214

 
16,892

 
1,336,053

Total loans 3
$
196,442

 
$
235,337

 
$
653,848

 
$
57,050

 
$
113,277

 
$
73,375

 
$
17,155

 
$
1,346,484

Non-accrual loans to total loans
0.2
%
 
0.6
%
 
0.4
%
 
9.0
%
 
0.1
%
 
%
 
0.5
%
 
0.7
%
December 31, 2014
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 30-59 days past due
$
183

 
$

 
$

 
$

 
$
646

 
$

 
$
180

 
$
1,009

 60-89 days past due

 

 

 

 

 

 

 

Greater than 90 days past due (non-accrual) 2

 
1,403

 
2,429

 
5,134

 
280

 

 
104

 
9,350

Total past due
183

 
1,403

 
2,429

 
5,134

 
926

 

 
284

 
10,359

Current
210,040

 
229,202

 
671,070

 
43,279

 
109,862

 
73,035

 
16,504

 
1,352,992

Total loans 3
$
210,223

 
$
230,605

 
$
673,499

 
$
48,413

 
$
110,788

 
$
73,035

 
$
16,788

 
$
1,363,351

Non-accrual loans to total loans
%
 
0.6
%
 
0.4
%
 
10.6
%
 
0.3
%
 
%
 
0.6
%
 
0.7
%
1 Our residential loan portfolio does not include sub-prime loans, nor is it our practice to underwrite loans commonly referred to as "Alt-A mortgages", the characteristics of which are loans lacking full documentation, borrowers having low FICO scores or higher loan-to-value ratios.

2 Amounts include $1.4 million of Purchased Credit Impaired ("PCI") loans that have stopped accreting interest at both March 31, 2015 and December 31, 2014. Amounts exclude accreting PCI loans of $3.7 million and $3.8 million at March 31, 2015 and December 31, 2014, respectively, as we have a reasonable expectation about future cash flows to be collected and we continue to recognize accretable yield on these loans in interest income. There were no accruing loans past due more than ninety days at March 31, 2015 or December 31, 2014.

3 Amounts include net deferred loan costs of $651 thousand and $487 thousand at March 31, 2015 and December 31, 2014, respectively. Amounts are also net of unaccreted purchase discounts on non-PCI loans of $4.2 million and $4.4 million at March 31, 2015 and December 31, 2014, respectively.

Our commercial loans are generally made to established small and mid-sized businesses to provide financing for their working capital needs, equipment purchases, acquisitions, or refinancings.  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 or

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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 or inventory, and include a personal guarantee. Some short-term loans may be made on an unsecured basis. We target stable local businesses with guarantors that have proven to be more resilient in periods of economic stress.  Typically, the guarantors provide an additional source of repayment for most of our credit extensions.
 
Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans discussed above. We underwrite these loans to be repaid from cash flow and to be supported by real property collateral. Repayment of commercial real estate loans is largely dependent on the successful operation of the property securing the loan, or of the business conducted on the property securing the loan. Underwriting standards for commercial real estate loans include, but are not limited to, conservative debt coverage and loan-to-value ratios. Furthermore, substantially all of our loans are guaranteed by the owners of the properties.  Commercial real estate loans may be adversely affected by conditions in the real estate markets or in the general economy. In the event of a vacancy, strong guarantors have historically carried the loans until a replacement tenant could be found.  The owner's substantial equity investment provides a strong economic incentive to continue to support the commercial real estate projects. As such, we have generally experienced a relatively low level of loss and delinquencies in this portfolio.

Construction loans are generally made to developers and builders to finance construction, renovation and occasionally land acquisitions. These loans are underwritten after evaluation of the borrower's financial strength, reputation, prior track record, and independent appraisals. The construction industry can be impacted by significant events, 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 complete project may be inaccurate. Repayment of construction loans is largely dependent on the ultimate success of the project.
 
Consumer loans primarily consist of home equity lines of credit, other residential (tenancy-in-common, or “TIC”) loans, and installment and other consumer loans. We originate consumer loans utilizing credit score information, debt-to-income ratio and loan-to-value ratio analysis. Diversification, coupled with relatively small loan amounts that are spread across many individual borrowers, mitigates risk. Additionally, trend reports are reviewed by Management on a regular basis. Underwriting standards for home equity lines of credit include, but are not limited to, a conservative loan-to-value ratio, the number of such loans a borrower can have at one time, and documentation requirements. Our residential loan portfolio includes TIC units in San Francisco. These loans tend to have more equity in their properties than conventional residential mortgages, which mitigates risk. Installment and other consumer loans include mostly floating home loans and mobile home loans along with a small number of installment loans.
 
We use a risk rating system to evaluate asset quality, and to identify and monitor credit risk in individual loans, and ultimately in the portfolio. Definitions of loans that are risk graded “Special Mention” or worse are consistent with those used by the Federal Deposit Insurance Corporation ("FDIC").  Our internally assigned grades are as follows:
 
Pass – 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 impacts.  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.
 

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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 nonaccrual status and usually are collateral-dependent.
 
We regularly review our credits for accuracy of risk grades whenever new information is received. Borrowers are required to submit financial information at regular intervals:

Generally, 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.
Investor commercial real estate borrowers are generally required to submit rent rolls or property income statements at least annually.
Construction loans are monitored monthly, and reviewed on an ongoing basis.
Home equity and other consumer loans are reviewed based on delinquency.
Loans graded “Watch” or more severe, regardless of loan type, are reviewed no less than quarterly.

The following table represents an analysis of loans by internally assigned grades, including the PCI loans, at March 31, 2015 and December 31, 2014:
 
(in thousands; 2015 unaudited)
Commercial and industrial

 
Commercial real estate, owner-occupied

 
Commercial real estate, investor

 
Construction

 
Home equity

 
Other residential

 
Installment and other consumer

 
Purchased credit-impaired

 
Total

Credit Risk Profile by Internally Assigned Grade:
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
181,842

 
$
211,551

 
$
640,656

 
$
50,305

 
$
111,227

 
$
71,768

 
$
16,816

 
$
2,202

 
$
1,286,367

Special Mention
9,424

 
10,281

 
3,853

 
1,078

 
321

 

 

 
1,031

 
25,988

Substandard
4,974

 
10,876

 
7,175

 
5,657

 
1,662

 
1,607

 
339

 
1,839

 
34,129

Total loans
$
196,240

 
$
232,708

 
$
651,684

 
$
57,040

 
$
113,210

 
$
73,375

 
$
17,155

 
$
5,072

 
$
1,346,484

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2014
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Pass
$
197,659

 
$
205,820

 
$
651,548

 
$
41,710

 
$
107,933

 
$
70,987

 
$
16,101

 
$
2,210

 
$
1,293,968

Special Mention
6,776

 
10,406

 
13,304

 
1,008

 
322

 

 
190

 
1,140

 
33,146

Substandard
5,464

 
11,763

 
6,473

 
5,684

 
2,466

 
2,048

 
497

 
1,842

 
36,237

Total loans
$
209,899

 
$
227,989

 
$
671,325

 
$
48,402

 
$
110,721

 
$
73,035

 
$
16,788

 
$
5,192

 
$
1,363,351

 
Troubled Debt Restructuring
 
Our loan portfolio includes certain loans that have been modified in a Troubled Debt Restructuring (“TDR”), where economic concessions have been granted to borrowers experiencing financial difficulties. These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. TDRs on nonaccrual status at the time of restructure may be returned to accruing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months, and there is reasonable assurance of repayment and performance.
 
When a loan is modified, Management evaluates any possible impairment based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral. In these cases Management uses the current fair value of the collateral, less selling costs, instead of discounted cash flows. If Management determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs and unamortized premium or discount), impairment is recognized through a specific allowance or a charge-off of the loan.

A loan may no longer be reported as a TDR if it is subsequently refinanced or restructured at market terms through the normal underwriting process, the borrower is no longer considered to be in financial difficulty and performance on the loan is reasonably assured. The removal of TDR status must be approved by the same management level that approved the upgrading of the loan classification. During the first quarter of 2015, a loan with a recorded investment

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of $108 thousand was removed from TDR designation. There were no loans removed from TDR designation during 2014.
 
The table below summarizes outstanding TDR loans by loan class as of March 31, 2015 and December 31, 2014. The summary includes both TDRs that are on non-accrual status and those that continue to accrue interest.
(in thousands; 2015 unaudited)
 
As of
Recorded investment in Troubled Debt Restructurings 1
 
March 31, 2015

 
December 31, 2014

 
 
 
 
 
Commercial and industrial
 
$
3,477

 
$
3,584

Commercial real estate, owner-occupied
 
8,427

 
8,459

Commercial real estate, investor
 
522

 
524

Construction
 
5,657

 
5,684

Home equity
 
561

 
694

Other residential
 
2,037

 
2,045

Installment and other consumer
 
1,636

 
1,713

Total
 
$
22,317

 
$
22,703


1 Includes $15.6 million and $15.9 million of TDR loans that were accruing interest as of March 31, 2015 and December 31, 2014, respectively. Includes $1.6 million and $1.8 million of acquired loans at March 31, 2015 and December 31, 2014, respectively.

The table below presents the following information for loans modified in a TDR during the quarter ended March 31, 2014: number of contracts modified, the recorded investment in the loans prior to modification, and the recorded investment in the loans after the loans were restructured. The table below excludes fully paid-off and fully charged-off TDR loans. There were no loans modified in a TDR during 2015.
(dollars in thousands; unaudited)
Number of Contracts Modified


Pre-Modification Outstanding Recorded Investment


Post-Modification Outstanding Recorded Investment


Post-Modification Outstanding Recorded Investment at period end

Troubled Debt Restructurings during the three months ended March 31, 2014:
 


 


 




Commercial and industrial
3

 
$
1,420

 
$
1,405

 
$
1,405

Home equity
1

 
150

 
150

 
150

Installment and other consumer
3


170


168