10-Q 1 bmrc-20160630x10q.htm 10-Q Document
 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 June 30, 2016
 
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 July 31, 2016, there were 6,122,987 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 June 30, 2016 and December 31, 2015
(in thousands, except share data; unaudited)
June 30, 2016

 
December 31, 2015

Assets
 

 
 
Cash and due from banks
$
55,438

 
$
26,343

Investment securities
 

 
 
Held-to-maturity, at amortized cost
58,491

 
69,637

Available-for-sale, at fair value
323,361

 
417,787

Total investment securities
381,852

 
487,424

Loans, net of allowance for loan losses of $15,087 and $14,999 at June 30, 2016 and December 31, 2015, respectively
1,433,312

 
1,436,229

Bank premises and equipment, net
8,650

 
9,305

Goodwill
6,436

 
6,436

Core deposit intangible
2,846

 
3,113

Interest receivable and other assets
61,918

 
62,284

Total assets
$
1,950,452

 
$
2,031,134

 
 
 
 
Liabilities and Stockholders' Equity
 

 
 

Liabilities
 

 
 

Deposits
 

 
 

Non-interest-bearing
$
804,447

 
$
770,087

Interest-bearing
 

 
 
Transaction accounts
88,365

 
114,277

Savings accounts
149,745

 
141,316

Money market accounts
502,476

 
541,089

Time accounts
160,582

 
161,457

Total deposits
1,705,615

 
1,728,226

   Federal Home Loan Bank ("FHLB") and other borrowings

 
67,000

 Subordinated debentures
5,493

 
5,395

   Interest payable and other liabilities
12,892

 
16,040

Total liabilities
1,724,000

 
1,816,661

 
 
 
 
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 - 6,120,684 and 6,068,543 at
    June 30, 2016 and December 31, 2015, respectively
86,569

 
84,727

Retained earnings
136,992

 
129,553

Accumulated other comprehensive income, net
2,891

 
193

Total stockholders' equity
226,452

 
214,473

Total liabilities and stockholders' equity
$
1,950,452

 
$
2,031,134


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

Page-3



BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
Three months ended
 
Six months ended
(in thousands, except per share amounts; unaudited)
June 30, 2016
June 30, 2015
 
June 30, 2016
June 30, 2015
Interest income
 
 

 
 
 
Interest and fees on loans
$
16,097

$
15,287

 
$
33,238

$
30,666

Interest on investment securities
 
 
 
 
 

Securities of U.S. government agencies
1,191

990

 
2,543

2,025

Obligations of state and political subdivisions
588

511

 
1,174

1,051

Corporate debt securities and other
77

179

 
182

384

Interest on Federal funds sold and short-term investments
40

51

 
51

72

Total interest income
17,993

17,018

 
37,188

34,198

Interest expense
 

 

 
 

 

Interest on interest-bearing transaction accounts
28

30

 
55

60

Interest on savings accounts
14

13

 
28

25

Interest on money market accounts
107

123

 
218

250

Interest on time accounts
193

215

 
389

437

Interest on FHLB and other borrowings
378

78

 
478

156

Interest on subordinated debentures
107

105

 
216

209

Total interest expense
827

564

 
1,384

1,137

Net interest income
17,166

16,454

 
35,804

33,061

Provision for loan losses


 


Net interest income after provision for loan losses
17,166

16,454

 
35,804

33,061

Non-interest income
 

 
 
 

 

Service charges on deposit accounts
441

504

 
897

1,029

Wealth Management and Trust Services
527

603

 
1,093

1,241

Debit card interchange fees
381

368

 
719

715

Merchant interchange fees
128

129

 
241

259

Earnings on bank-owned life insurance
209

203

 
410

406

Dividends on FHLB stock
185

461

 
354

608

Gains on investment securities, net
284


 
394

8

Other income
266

340

 
476

531

Total non-interest income
2,421

2,608

 
4,584

4,797

Non-interest expense
 

 
 
 

 

Salaries and related benefits
6,724

6,672

 
13,472

13,462

Occupancy and equipment
1,175

1,493

 
2,456

2,835

Depreciation and amortization
441

650

 
894

1,071

Federal Deposit Insurance Corporation insurance
246

253

 
507

489

Data processing
916

792

 
1,772

1,578

Professional services
554

515

 
1,052

1,079

Directors' expense
116

247

 
305

438

Information technology
165

216

 
358

368

Provision for (reversal of) losses on off-balance sheet commitments
150

(109
)
 
150

(310
)
Other expense
1,530

1,590

 
3,061

3,166

Total non-interest expense
12,017

12,319

 
24,027

24,176

Income before provision for income taxes
7,570

6,743

 
16,361

13,682

Provision for income taxes
2,733

2,457

 
5,878

4,939

Net income
$
4,837

$
4,286

 
$
10,483

$
8,743

Net income per common share:
 

 
 
 

 
Basic
$
0.80

$
0.72

 
$
1.73

$
1.47

Diluted
$
0.79

$
0.71

 
$
1.72

$
1.44

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

 
 

 

Basic
6,078

5,945

 
6,063

5,933

Diluted
6,109

6,062

 
6,100

6,055

Dividends declared per common share
$
0.25

$
0.22

 
$
0.50

$
0.44

Comprehensive income:
 


 
 


Net income
$
4,837

$
4,286

 
$
10,483

$
8,743

Other comprehensive income




 




Change in net unrealized gain (loss) on available-for-sale securities
2,119

(1,803
)
 
5,042

(486
)
Reclassification adjustment for gain on available-for-sale securities
    included in net income
(284
)

 
(394
)
(8
)
             Net change in unrealized gain (loss) on available-for-sale securities,
            before tax
1,835

(1,803
)
 
4,648

(494
)
Deferred tax expense (benefit)
776

(691
)
 
1,950

(137
)
Other comprehensive income (loss), net of tax
1,059

(1,112
)
 
2,698

(357
)
Comprehensive income
$
5,896

$
3,174

 
$
13,181

$
8,386

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

Page-4



BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
for the year ended December 31, 2015 and the six months ended June 30, 2016
(in thousands, except share data; unaudited)
Common Stock
Retained
Earnings

Accumulated Other
Comprehensive Income (Loss),
Net of Taxes

 Total

Shares

Amount

Balance at December 31, 2014
5,939,482

$
82,436

$
116,502

$
1,088

$
200,026

Net income


18,441


18,441

Other comprehensive loss



(895
)
(895
)
Stock options exercised
37,071

1,139



1,139

Excess tax benefit - stock-based compensation

212



212

Stock issued under employee stock purchase plan
339

17



17

Restricted stock granted
15,970





Restricted stock forfeited / cancelled
(450
)




Stock-based compensation - stock options

252



252

Stock-based compensation - restricted stock

384



384

Cash dividends paid on common stock


(5,390
)

(5,390
)
Stock purchased by directors under director stock plan
245

12



12

Stock issued in payment of director fees
5,295

275



275

Stock issued from exercise of warrants
70,591





Balance at December 31, 2015
6,068,543

$
84,727

$
129,553

$
193

$
214,473

Net income


10,483


10,483

Other comprehensive income



2,698

2,698

Stock options exercised
32,117

1,087



1,087

Excess tax benefit - stock-based compensation

113



113

Stock issued under employee stock purchase plan
294

13



13

Restricted stock granted
16,910





Stock-based compensation - stock options

181



181

Stock-based compensation - restricted stock

297



297

Cash dividends paid on common stock


(3,044
)

(3,044
)
Stock purchased by directors under director stock plan
260

14



14

Stock issued in payment of director fees
2,560

137



137

Balance at June 30, 2016
6,120,684

$
86,569

$
136,992

$
2,891

$
226,452


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

Page-5



BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the six months ended June 30, 2016 and 2015
(in thousands; unaudited)
June 30, 2016

 
June 30, 2015

Cash Flows from Operating Activities:
 
 
 
Net income
$
10,483

 
$
8,743

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

 
 

Provision for (reversal of) losses on off-balance sheet commitments
150

 
(310
)
Compensation expense via common stock for director fees
97

 
138

Stock-based compensation expense
478

 
308

Excess tax benefits from exercised or vesting of stock based-awards
(113
)
 
(141
)
Amortization of core deposit intangible
267

 
309

Amortization of investment security premiums, net of accretion of discounts
1,466

 
1,217

Accretion of discount on acquired loans
(832
)
 
(1,076
)
Accretion of discount on subordinated debentures
98

 
106

Net amortization of deferred loan origination costs/fees
43

 
(294
)
Write-down of other real estate owned
13

 
40

Gain on sale of investment securities
(394
)
 
(8
)
Depreciation and amortization
894

 
1,071

Loss on disposal of premises and equipment

 
4

Earnings on bank-owned life insurance policies
(410
)
 
(406
)
Net change in operating assets and liabilities:
 

 
 

Interest receivable
676

 
109

Interest payable
(50
)
 
(4
)
Deferred rent and other rent-related expenses
(262
)
 
86

Other assets
1,763

 
1,504

Other liabilities
(3,872
)
 
(2,271
)
Total adjustments
12

 
382

Net cash provided by operating activities
10,495

 
9,125

Cash Flows from Investing Activities:
 

 
 

Purchase of held-to-maturity securities
(2,424
)
 
(2,375
)
Purchase of available-for-sale securities
(19,916
)
 
(76,708
)
Proceeds from sale of available-for-sale securities
68,673

 
1,559

Purchase of bank owned life insurance policies
(1,864
)
 

Proceeds from paydowns/maturity of held-to-maturity securities
13,243

 
23,723

Proceeds from paydowns/maturity of available-for-sale securities
49,576

 
20,814

Proceeds from the sale of loan

 
1,502

Loans originated and principal collected, net
4,996

 
22,818

Purchase of FHLB stock
(1,792
)
 
(136
)
Purchase of premises and equipment
(239
)
 
(889
)
Cash paid for low income housing tax credit investment
(225
)
 
(434
)
Net cash provided by (used in) investing activities
110,028

 
(10,126
)
Cash Flows from Financing Activities:
 

 
 

Net (decrease) increase in deposits
(22,611
)
 
78,864

Proceeds from stock options exercised
1,087

 
774

Proceeds from stock issued under employee and director stock purchase plans
27

 
8

Repayment of Federal Home Loan Bank borrowings
(67,000
)
 

Cash dividends paid on common stock
(3,044
)
 
(2,620
)
Excess tax benefits from exercised or vesting of stock based-awards
113

 
141

Net cash (used in) provided by financing activities
(91,428
)
 
77,167

Net increase in cash and cash equivalents
29,095

 
76,166

Cash and cash equivalents at beginning of period
26,343

 
41,367

Cash and cash equivalents at end of period
$
55,438

 
$
117,533

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
1,336

 
$
1,035

Cash paid for income taxes
$
7,095

 
$
5,270

Supplemental disclosure of non-cash investing and financing activities:
 

 
 

Change in unrealized gain on available-for-sale securities
$
4,648

 
$
(494
)
Subscription in low income housing tax credit investment
$

 
$
1,023

Stock issued in payment of director fees
$
137

 
$
138


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

Page-6



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
 
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 are adequate and the information presented is not misleading, we suggest that these interim financial statements be read in conjunction with the annual financial statements and the notes thereto included in our 2015 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.

The NorCal Community Bancorp Trusts I and II, respectively (the "Trusts") were formed for the sole purpose of issuing trust preferred securities. Bancorp is not considered the primary beneficiary of the Trusts (variable interest entities), therefore the Trusts are not consolidated in our consolidated financial statements, but rather the subordinated debentures are shown as a liability on our consolidated statements of condition (See Note 6, Borrowings). Bancorp's investment in the securities 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 weighted average 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 number of potentially dilutive common shares, which is based on average market prices during the three months of 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 our 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. Therefore, under the two-class method, the difference in EPS is not significant for these participating securities.
 
Three months ended
 
Six months ended
(in thousands, except per share data)
June 30, 2016

June 30, 2015

 
June 30, 2016

June 30, 2015

Weighted average basic shares outstanding
6,078

5,945

 
6,063

5,933

Potentially dilutive common shares related to:
 
 
 
 
 
Stock options
27

41

 
31

44

Unvested restricted stock awards
4

3

 
6

4

Warrant

73

 

74

Weighted average diluted shares outstanding
6,109

6,062

 
6,100

6,055

Net income
$
4,837

$
4,286

 
$
10,483

$
8,743

Basic EPS
$
0.80

$
0.72

 
$
1.73

$
1.47

Diluted EPS
$
0.79

$
0.71

 
$
1.72

$
1.44

Weighted average anti-dilutive shares not included in the calculation of diluted EPS
70

41

 
60

34


Page-7



Note 2: Recently Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (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 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 and at a time that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Subsequent updates related to Revenue from Contracts with Customers (Topic 606) are as follows:

August 2015 ASU No. 2015-14 - Deferral of the Effective Date, institutes a one-year deferral of the effective date of this amendment to annual reporting periods beginning after December 15, 2017. Early application is permitted only as of annual periods beginning after December 15, 2016, including interim reporting periods within that reporting period.
March 2016 ASU No. 2016-08 - Principal versus Agent Considerations (Reporting Revenue Gross versus Net), clarifies the implementation guidance on principal versus agent considerations and on the use of indicators that assist an entity in determining whether it controls a specified good or service before it is transferred to the customer.
April 2016 ASU No. 2016-10 - Identifying Performance Obligations and Licensing, provides guidance in determining performance obligations in a contract with a customer and clarifies whether a promise to grant a license provides a right to access or the right to use intellectual property.
May 2016 ASU No. 2016-12 - Narrow Scope Improvements and Practical Expedients, gives further guidance on assessing collectability, presentation of sales taxes, noncash consideration, and completed contracts and contract modifications at transition.

We are currently evaluating the provisions of these updates and will be monitoring developments and additional guidance to determine the potential impact the new standards will have on our financial condition and results of operations.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this ASU make improvements to GAAP related to financial instruments that include the following as applicable to us.
Equity investments, except for those accounted for under the equity method of accounting or those that result in consolidation of the investee, are required to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values 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.
Simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment - if impairment exists, this requires measuring the investment at fair value.
Eliminates the requirement for public companies to disclose the method(s) and significant assumptions used to estimate the fair value that is currently required to be disclosed for financial instruments measured at amortized cost on the balance sheet.
Public companies will be required to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes.
Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements.
The reporting entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity's other deferred tax assets.

ASU 2016-01 is effective for public business entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. This ASU will impact our financial statement disclosures, however, we do not expect it to have a material impact on our financial condition or results of operations.


Page-8



In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This ASU was issued to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities, including leases classified as operating leases under previous GAAP, on the balance sheet and requiring additional disclosures of key information about leasing arrangements. This ASU applies to leasing arrangements exceeding a twelve month term. ASU 2016-02 is effective for annual periods, including interim periods within those annual periods beginning after December 15, 2018 and requires a modified retrospective method upon adoption. Early application of the amendments is permitted. We are currently evaluating the provisions of this ASU and will be monitoring developments and additional guidance to determine the timing of our adoption and the potential outcome the amendments will have on our financial condition and results of operations.

In March 2016, the FASB issued ASU No. 2016-05, Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships. A contract novation refers to replacing one of the parties to a derivative instrument with a new party. This ASU clarifies that a change in counterparty in a derivative instrument does not, in and of itself, require dedesignation of that hedging relationship and therefore discontinue the application of hedge accounting. ASU 2016-05 is effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted in any interim or annual period. We do not expect this ASU to have a material impact on our financial condition or results of operations.

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This ASU identifies areas for simplification involving several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, forfeiture accounting, and classifications on the statement of cash flows. ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted in any interim or annual period. We are currently evaluating the the provisions of this ASU and will be monitoring developments and additional guidance to determine the potential outcome the amendments will have on our financial condition and results of operations.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses, requiring a financial asset measured at amortized cost basis to be presented at the net amount expected to be collected. Under the new guidance, an entity recognizes as an allowance its estimate of expected credit losses, which is likely to result in more timely recognition of such losses. In addition, the accounting for purchased credit impaired financial assets will make the allowance for credit losses more comparable between originated assets and purchased financial assets, as well as reduce complexity with the accounting for interest income. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We are currently evaluating the provisions of this ASU and will be monitoring developments and additional guidance to determine the timing of our adoption and the potential outcome the amendments will have on our financial condition and results of operations.

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 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.


Page-9



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. 

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)

June 30, 2016
 

 
 

 

Securities available-for-sale:
 
 
 
 
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies
$
167,407

$

$
166,750

$
657

Debentures of government-sponsored agencies
83,758


83,758


Privately-issued collateralized mortgage obligations
768


768


Obligations of state and political subdivisions
66,452


66,452


Corporate bonds
4,976


4,976


Derivative financial liabilities (interest rate contracts)
2,721


2,721


December 31, 2015
 

 
 

 

Securities available-for-sale:
 

 
 

 

Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies
$
190,093

$

$
188,381

$
1,712

Debentures of government-sponsored agencies
160,892


160,892


Privately-issued collateralized mortgage obligations
4,150


4,150


Obligations of state and political subdivisions
57,673


57,673


Corporate bonds
4,979


4,979


Derivative financial assets (interest rate contracts)
3


3


Derivative financial liabilities (interest rate contracts)
1,658


1,658


 
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 obligations of state and political subdivisions, U.S. agencies or government sponsored agencies' debt securities, mortgage-backed securities, government agency-issued and privately-issued collateralized mortgage obligations. As of June 30, 2016 and December 31, 2015, there were no securities that were considered Level 1 securities. As of June 30, 2016, we had one available-for-sale security that was considered a Level 3 security. The security is a U.S. government agency obligation collateralized by a small number of business equipment loans guaranteed by the Small Business Administration ("SBA") 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. The decrease in fair value during 2016 was due to the payoff of one of the larger loans in the pool collateralizing the security. The unrealized gain on this SBA-guaranteed security decreased by $2 thousand in the same period recorded as part of other comprehensive income.

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 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

Page-10



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 either LIBOR or OIS curves depending on whether the swap positions are fully collateralized 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 Bank of Marin. For further discussion on our methodology in valuing our derivative financial instruments, refer to Note 9.

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 assets and liabilities 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 June 30, 2016 and December 31, 2015.
(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)

June 30, 2016
 
 

 

 

Impaired loans 1
$
171

$

$

$
171

Other real estate owned
408



408

December 31, 2015
 

 

 

 

Impaired loans
$

$

$

$

Other real estate owned
421



421

1Represents collateral-dependent loan principal balances that had been generally written down to the values of the underlying collateral and reflected net of specific valuation allowances. At June 30, 2016, the $171 thousand carrying value of a consumer loan was net of a $5 thousand specific valuation allowance. 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 property characteristics, leasing status and physical condition. When appraisals are received, Management reviews the underlying assumptions and methodology utilized, 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 2016.








Page-11



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 classified as Level 3. All OREO resulted from an acquisition. Decreases in the estimated fair value of OREO totaled $13 thousand and $40 thousand during the first six months of 2016 and 2015, respectively.

 Disclosures about Fair Value of Financial Instruments
 
The table below is a summary of fair value estimates for financial instruments as of June 30, 2016 and December 31, 2015, 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. 
 
June 30, 2016
 
December 31, 2015
(in thousands)
Carrying Amounts

Fair Value

Fair Value Hierarchy
 
Carrying Amounts

Fair Value

Fair Value Hierarchy
Financial assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
55,438

$
55,438

Level 1
 
$
26,343

$
26,343

Level 1
Investment securities held-to-maturity
58,491

60,160

Level 2
 
69,637

71,054

Level 2
Loans, net
1,433,312

1,453,254

Level 3
 
1,436,229

1,470,380

Level 3
Interest receivable
5,968

5,968

Level 2
 
6,643

6,643

Level 2
Financial liabilities
 

 

 
 
 

 

 
Deposits
1,705,615

1,705,937

Level 2
 
1,728,226

1,728,717

Level 2
Federal Home Loan Bank and other borrowings


Level 2
 
67,000

67,279

Level 2
Subordinated debentures
5,493

5,108

Level 3
 
5,395

5,132

Level 3
Interest payable
137

137

Level 2
 
187

187

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 obligations of state and political subdivisions and corporate bonds, are recorded at their amortized cost. The 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 June 30, 2016 and December 31, 2015, 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 their 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.
 
Interest Receivable and Payable - The interest receivable and payable balances approximate their fair value due to the short-term nature of their settlement dates.


Page-12



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 term of our fixed-rate credit advances.

Subordinated Debentures - 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%) to their present values using current market rates at which similar bonds 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 issuances 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. See Note 6 for further information.

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 at June 30, 2016 and December 31, 2015, 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, Federal Farm Credit Bureau, FHLB and FHLMC, as well as privately issued CMOs, as reflected in the table below:
 
June 30, 2016
 
December 31, 2015
 
Amortized
Fair
Gross Unrealized
 
Amortized
Fair
Gross Unrealized
(in thousands)
Cost
Value
Gains
(Losses)
 
Cost
Value
Gains
(Losses)
Held-to-maturity:
 
 
 
 
 
 
 
 
 
Obligations of state and
  political subdivisions
$
39,009

$
40,337

$
1,336

$
(8
)

$
42,919

$
44,146

$
1,246

$
(19
)
Corporate bonds
8,529

8,534

6

(1
)

15,072

15,098

42

(16
)
MBS pass-through securities issued by FHLMC and FNMA
10,953

11,289

336



11,646

11,810

171

(7
)
Total held-to-maturity
58,491

60,160

1,678

(9
)

69,637

71,054

1,459

(42
)
Available-for-sale:
 
 
 
 
 
 
 
 
 
Securities of U.S. government or government-sponsored agencies:
 
 
 
 
 
 
 
 
 
MBS pass-through securities issued by FHLMC and FNMA
111,682

113,877

2,195



138,222

138,462

694

(454
)
CMOs issued by FNMA
23,061

23,387

331

(5
)

18,266

18,219

97

(144
)
CMOs issued by FHLMC
21,110

21,451

341



22,889

22,932

82

(39
)
CMOs issued by GNMA
8,470

8,692

222



10,326

10,480

169

(15
)
Debentures of government- sponsored agencies
83,566

83,758

193

(1
)

161,690

160,892

28

(826
)
Privately issued CMOs
768

768

1

(1
)

3,960

4,150

190


Obligations of state and
political subdivisions
64,725

66,452

1,729

(2
)

57,110

57,673

580

(17
)
Corporate bonds
4,954

4,976

25

(3
)

4,947

4,979

43

(11
)
Total available-for-sale
318,336

323,361

5,037

(12
)

417,410

417,787

1,883

(1,506
)
Total investment securities
$
376,827

$
383,521

$
6,715

$
(21
)

$
487,047

$
488,841

$
3,342

$
(1,548
)

Page-13



The amortized cost and fair value of investment debt securities by contractual maturity at June 30, 2016 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.
 
June 30, 2016
 
December 31, 2015
 
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
$
19,481

$
19,545

 
$
2,412

$
2,416

 
$
18,853

$
18,920

 
$
12,135

$
12,176

After one year but within five years
21,203

21,929

 
114,702

115,207

 
31,677

32,360

 
188,007

187,326

After five years through ten years
5,646

6,068

 
65,766

67,170

 
8,580

8,969

 
64,899

64,999

After ten years
12,161

12,618

 
135,456

138,568

 
10,527

10,805

 
152,369

153,286

Total
$
58,491

$
60,160

 
$
318,336

$
323,361

 
$
69,637

$
71,054

 
$
417,410

$
417,787

 
Sales of investment securities and gross realized gains and losses are shown in the following table.
 
Three months ended
 
Six months ended
(in thousands)
June 30, 2016
 
June 30, 2015
 
June 30, 2016
 
June 30, 2015
Available-for-sale:
 
 
 
 
 
 
 
Sales proceeds
$
13,688

 
$
1,559

 
$
68,673

 
$
1,559

Gross realized gains
284

 
8

 
458

 
8

Gross realized losses

 

 
(64
)
 


Investment securities carried at $96.7 million and $87.9 million at June 30, 2016 and December 31, 2015, respectively, were pledged to the State of California: $95.9 million and $87.1 million to secure public deposits in compliance with the Local Agency Security Program at June 30, 2016 and December 31, 2015, respectively, and $831 thousand and $840 thousand to provide collateral for trust deposits at June 30, 2016 and December 31, 2015, respectively. In addition, investment securities carried at $2.1 million and $1.1 million were pledged to collateralize a Wealth Management and Trust Services (“WMTS”) checking account at June 30, 2016 and December 31, 2015, respectively.

Other-Than-Temporarily Impaired Debt Securities
 
We have evaluated the credit of our investment securities and their issuers 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 June 30, 2016. We do not have the intent and it is more likely than not that we will not have to sell securities temporarily impaired at June 30, 2016 before recovery of the cost basis.
 

Page-14



Ten and fifty-four investment securities were in unrealized loss positions at June 30, 2016 and December 31, 2015, respectively. Those securities are summarized and classified according to the duration of the loss period in the tables below:
June 30, 2016
< 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:
 
 
 
 
 
 
 
 
Obligations of state and political subdivisions
$
1,058

$
(8
)
 
$

$

 
$
1,058

$
(8
)
Corporate bonds
5,000

(1
)
 


 
5,000

(1
)
MBS pass-through securities issued by FHLMC and FNMA


 


 


Total held-to-maturity
6,058

(9
)
 


 
6,058

(9
)
Available-for-sale:
 
 
 
 
 
 
 
 
MBS pass-through securities issued by FHLMC and FNMA


 


 


CMOs issued by FNMA


 
2,811

(5
)
 
2,811

(5
)
CMOs issued by FHLMC


 


 


CMOs issued by GNMA


 


 


Debentures of government- sponsored agencies
9,997

(1
)
 


 
9,997

(1
)
Privately issued CMOs
182

(1
)
 


 
182

(1
)
Obligations of state & political subdivisions
1,918

(2
)
 


 
1,918

(2
)
Corporate bonds
1,990

(3
)
 


 
1,990

(3
)
Total available-for-sale
14,087

(7
)
 
2,811

(5
)
 
16,898

(12
)
Total temporarily impaired securities
$
20,145

$
(16
)
 
$
2,811

$
(5
)
 
$
22,956

$
(21
)
December 31, 2015
< 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:
 
 
 
 
 
 
 
 
Obligations of state and political subdivisions
$
8,297

$
(19
)
 
$

$

 
$
8,297

$
(19
)
Corporate bonds
3,523

(15
)
 
1,999

(1
)
 
5,522

(16
)
MBS pass-through securities issued by FHLMC and FNMA
2,332

(7
)
 


 
2,332

(7
)
Total held-to-maturity
14,152

(41
)
 
1,999

(1
)
 
16,151

(42
)
Available-for-sale:




 




 




MBS pass-through securities issued by FHLMC and FNMA
68,809

(454
)
 


 
68,809

(454
)
CMOs issued by FNMA
9,277

(80
)
 
3,158

(64
)
 
12,435

(144
)
CMOs issued by FHLMC


 
1,989

(39
)
 
1,989

(39
)
CMOs issued by GNMA
164


 
2,374

(15
)
 
2,538

(15
)
Debentures of government- sponsored agencies
136,064

(713
)
 
9,887

(113
)
 
145,951

(826
)
Obligations of state & political subdivisions
4,557

(15
)
 
579

(2
)
 
5,136

(17
)
Corporate bonds
2,986

(11
)
 


 
2,986

(11
)
Total available-for-sale
221,857

(1,273
)
 
17,987

(233
)
 
239,844

(1,506
)
Total temporarily impaired securities
$
236,009

$
(1,314
)
 
$
19,986

$
(234
)
 
$
255,995

$
(1,548
)


Page-15



As of June 30, 2016, there was one CMO issued by FNMA that had been in a continuous loss position for twelve months or more. We have evaluated it 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 as it is supported by the U.S. Federal Government, which protects us from credit losses. Based upon our assessment of the credit fundamentals, we concluded that this security was not other-than-temporarily impaired at June 30, 2016.

Nine investment securities in our portfolio were in a temporary loss position for less than twelve months as of June 30, 2016. They consisted of one debenture of U.S. government-sponsored agency, three obligations of U.S. state and political subdivisions, one privately issued CMO and four corporate bonds. The government-sponsored agency debenture is supported by the U.S. Federal Government, which protects us from credit losses. Other temporarily impaired securities are deemed creditworthy after internal analysis of the issuers' latest financial information and credit enhancement. Additionally, all are rated as investment grade by at least one major rating agency. As a result of this impairment analysis, we have concluded that these securities were not other-than-temporarily impaired at June 30, 2016.

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 the $100 per share par value. We held $10.2 million and $8.4 million of FHLB stock recorded at cost in other assets on the consolidated statements of condition at June 30, 2016 and December 31, 2015, 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. 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 July 28, 2016, FHLB announced a cash dividend for the second quarter of 2016 at an annualized dividend rate of 9.17% to be distributed in mid August 2016. Cash dividends paid on FHLB capital stock are recorded as non-interest income.

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. When converting this Class B common stock to Class A common stock under the current conversion rate of 1.6483 and the closing stock price of Class A shares, the value of our shares of Class B common stock would have been $2.1 million at June 30, 2016 and $2.2 million at December 31, 2015. 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 $2.6 million and $2.7 million recorded in other assets as of June 30, 2016 and December 31, 2015, respectively. In the first half of 2016, we recognized $164 thousand of low income housing tax credits and other tax benefits, net of $127 thousand of amortization expense of low income housing tax credit investment, as a component of income tax expense. As of June 30, 2016, our unfunded commitments for these low income housing tax credit funds totaled $1.5 million. We did not recognize any impairment losses on these low income housing tax credit investments during the first half of 2016 or 2015.


Page-16



Note 5:  Loans and Allowance for Loan Losses

Credit Quality of Loans
 
Outstanding loans by class and payment aging as of June 30, 2016 and December 31, 2015 were as follows:
Loan Aging Analysis by Loan Class
(in thousands)
Commercial and industrial

Commercial real estate, owner-occupied

Commercial real estate, investor

Construction

Home equity

Other residential 1

Installment and other consumer

Total

June 30, 2016
 

 

 

 

 

 

 

 

 30-59 days past due
$
44

$

$

$

$
780

$

$

$
824

 60-89 days past due


1,676




63

1,739

 90 days or more past due
21

176



99



296

Total past due
65

176

1,676


879


63

2,859

Current
215,192

241,927

701,782

77,024

111,361

73,761

24,493

1,445,540

Total loans 3
$
215,257

$
242,103

$
703,458

$
77,024

$
112,240

$
73,761

$
24,556

$
1,448,399

Non-accrual 2
$
21

$
176

$
1,676

$

$
789

$

$
63

$
2,725

December 31, 2015
 

 

 

 

 

 

 

 

 30-59 days past due
$
36

$

$
1,096

$
1

$

$

$
249

$
1,382

 60-89 days past due




633


89

722

 90 days or more past due
21




99



120

Total past due
57


1,096

1

732


338

2,224

Current
219,395

242,309

714,783

65,494

111,568

73,154

22,301

1,449,004

Total loans 3
$
219,452

$
242,309

$
715,879

$
65,495

$
112,300

$
73,154

$
22,639

$
1,451,228

Non-accrual 2
$
21

$

$
1,903

$
1

$
171

$

$
83

$
2,179

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 thousand of Purchased Credit Impaired ("PCI") loans that had stopped accreting interest at December 31, 2015. Amounts exclude accreting PCI loans of $2.9 million and $3.7 million at June 30, 2016 and December 31, 2015, 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. These accreting PCI loans are included in current loans. There were no accruing past due loans more than ninety days at June 30, 2016 or December 31, 2015.
3 Amounts include net deferred loan costs of $726 thousand and $768 thousand at June 30, 2016 and December 31, 2015, respectively. Amounts are also net of unaccreted purchase discounts on non-PCI loans of $2.5 million and $3.2 million at June 30, 2016 and December 31, 2015, respectively.

Our 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/or 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/or 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/or inventory, and typically include a personal guarantee. We target stable businesses with guarantors that have proven to be 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. Underwriting standards for commercial real estate loans include, but are not limited to, debt coverage and loan-to-value ratios. Furthermore, the vast majority 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, guarantors are expected to carry the loans until a replacement tenant can be found.  Regardless of the guaranty status, the owner's 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 in anticipation of near-term development. These loans are underwritten after evaluation of the borrower's financial strength, reputation, prior track record, and independent appraisals. The construction industry can be affected 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.

Page-17



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 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. Our residential loan portfolio includes TIC units almost entirely 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 loans for floating homes and mobile homes 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 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 in 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 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 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.


Page-18



The following table represents an analysis of loans by internally assigned grades, including the PCI loans, at June 30, 2016 and December 31, 2015:
Credit Risk Profile by Internally Assigned Grade
(in thousands)
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

June 30, 2016
 
 
 
 
 
 
 
 
 
Pass
$
199,923

$
230,799

$
697,897

$
73,786

$
109,408

$
73,761

$
24,162

$
2,863

$
1,412,599

Special Mention
11,818

2,101

362


1,120




15,401

Substandard
3,477

8,165

3,484

3,238

1,641


394


20,399

Total loans
$
215,218

$
241,065

$
701,743

$
77,024

$
112,169

$
73,761

$
24,556

$
2,863

$
1,448,399

December 31, 2015
 

 

 

 

 

 

 

 

 

Pass
$
192,560

$
219,060

$
710,042

$
62,255

$
109,959

$
73,154

$
22,307

$
3,260

$
1,392,597

Special Mention
22,457

12,371

372


1,100




36,300

Substandard
4,260

9,167

3,739

3,239

1,173


332

421

22,331

Total loans
$
219,277

$
240,598

$
714,153

$
65,494

$
112,232

$
73,154

$
22,639

$
3,681

$
1,451,228

 
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 Management considers the borrower’s sustained repayment performance for a reasonable period, generally six months, and obtains reasonable assurance of repayment and performance.
 
A loan may no longer be reported as a TDR if all of the following conditions are met:
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.

The removal of TDR status must be approved by the same management level that approved the upgrading of the loan classification.

There were no loans removed from TDR designation during 2016. During the first six months of 2015, three loans with a recorded investment totaling $396 thousand were removed from TDR designation.
 
The table below summarizes outstanding TDR loans by loan class as of June 30, 2016 and December 31, 2015. The summary includes both TDRs that are on non-accrual status and those that continue to accrue interest.
(in thousands)
 
Recorded investment in Troubled Debt Restructurings 1
June 30, 2016

December 31, 2015

Commercial and industrial
$
3,676

$
4,698

Commercial real estate, owner-occupied
6,992

6,993

Commercial real estate, investor
2,317

514

Construction 2
3,238

3,238

Home equity
677

460

Other residential
1,987

2,010

Installment and other consumer
1,079

1,168

Total
$
19,966

$
19,081

1 Includes $19.9 million and $19.0 million of TDR loans that were accruing interest as of June 30, 2016 and December 31, 2015, respectively. Includes $618 thousand and $137 thousand of acquired loans at June 30, 2016 and December 31, 2015, respectively.
2 In June 2015, one TDR loan was transferred to loans held-for-sale at fair value totaling $1.5 million, net of an $839 thousand charge-off to the allowance for loan losses. The loan was subsequently sold in June 2015 for no additional gain or loss.

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The table below presents the following information for loans modified in a TDR during the presented periods: number of contracts modified, the recorded investment in the loans prior to modification, and the recorded investment in the loans after being restructured. The table below excludes fully charged-off TDR loans and loans modified in a TDR and subsequently paid-off during the years presented.
(dollars in thousands)
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 June 30, 2016:
 
 
 

Commercial real estate, investor
1

$
281

$
281

$
281

Home equity 1
1

87

222

222

Total
2

$
368

$
503

$
503










Troubled Debt Restructurings during the three months ended June 30, 2015:
 

 

 



Commercial and industrial
4

$
782

$
882

$
882

Commercial real estate, investor
1

222

221

221

Total
5

$
1,004

$
1,103

$
1,103

Troubled Debt Restructurings during the six months ended June 30, 2016:
 
 
 
 
Commercial real estate, investor
2

$
1,830

$
1,826

$
1,808

Home equity 1
1

87

222

222

Total
3

$
1,917

$
2,048

$
2,030

 
 
 
 
 
Troubled Debt Restructurings during the six months ended June 30, 2015:
 

 

 

 
Commercial and industrial
4

$
782

$
882

$
882

Commercial real estate, investor
1

222

221

221

Total
5

$
1,004

$
1,103

$
1,103

1 The home equity TDR modification during the second quarter of 2016 included debt consolidation which increased the post-modification balance.

Modifications during the six months ended June 30, 2016 primarily involved interest rate concessions, renewals, and other changes to loan terms. Modifications during the six months ended June 30, 2015 primarily involved maturity extensions and renewals. During the first six months of 2016 and 2015, there were no 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.


Page-20



Impaired Loan Balances and Their Related Allowance by Major Classes of Loans

The tables below summarize information on impaired loans and their related allowance. Total impaired loans include non-accrual loans, accruing TDR loans and accreting PCI loans that have experienced post-acquisition declines in cash flows expected to be collected.
(in thousands)
Commercial and industrial

Commercial real estate, owner-occupied

Commercial real estate, investor

Construction

Home equity

Other residential

Installment and other consumer

Total

June 30, 2016
 

 

 

 

 

 

 

Recorded investment in impaired loans:
 
 
 
 
 
 
With no specific allowance recorded
$
1,059

$

$
1,676

$
2,688

$
789

$
1,198

$
159

$
7,569

With a specific allowance recorded
2,637

7,169

2,317

550

606

789

982

15,050

Total recorded investment in impaired loans
$
3,696

$
7,169

$
3,993

$
3,238

$
1,395

$
1,987

$
1,141

$
22,619

Unpaid principal balance of impaired loans
$
3,697

$
7,169

$
5,984

$
3,238

$
1,411

$
1,987

$
1,142

$
24,628

Specific allowance
671

98

472

5

12

64

99

1,421

Average recorded investment in impaired loans during the quarter ended
June 30, 2016
3,771

7,081

3,917

3,238

1,286

1,993

1,184

22,470