0001403475-17-000067.txt : 20171106 0001403475-17-000067.hdr.sgml : 20171106 20171106172636 ACCESSION NUMBER: 0001403475-17-000067 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 67 CONFORMED PERIOD OF REPORT: 20170930 FILED AS OF DATE: 20171106 DATE AS OF CHANGE: 20171106 FILER: COMPANY DATA: COMPANY CONFORMED NAME: Bank of Marin Bancorp CENTRAL INDEX KEY: 0001403475 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 208859754 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-33572 FILM NUMBER: 171180315 BUSINESS ADDRESS: STREET 1: 504 REDWOOD BOULEVARD, SUITE 100 CITY: NOVATO STATE: CA ZIP: 94947 BUSINESS PHONE: 415-763-7781 MAIL ADDRESS: STREET 1: 504 REDWOOD BOULEVARD, SUITE 100 CITY: NOVATO STATE: CA ZIP: 94947 10-Q 1 bmrc-20170930x10q.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 September 30, 2017
 
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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
         
Large accelerated filer o
 
     Accelerated filer x
Non-accelerated filer o
(Do not check if a smaller reporting company)
     Smaller reporting company o
Emerging growth company o
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
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 October 31, 2017, there were 6,177,990 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 September 30, 2017 and December 31, 2016
(in thousands, except share data; unaudited)
September 30, 2017

December 31, 2016

Assets
 

 
Cash and due from banks
$
149,124

$
48,804

Investment securities
 

 
Held-to-maturity, at amortized cost
155,122

44,438

Available-for-sale, at fair value
258,092

372,580

Total investment securities
413,214

417,018

Loans, net of allowance for loan losses of $15,248 and $15,442 at
September 30, 2017 and December 31, 2016, respectively
1,509,199

1,471,174

Bank premises and equipment, net
8,230

8,520

Goodwill
6,436

6,436

Core deposit intangible
2,226

2,580

Interest receivable and other assets
67,472

68,961

Total assets
$
2,155,901

$
2,023,493

 
 
 
Liabilities and Stockholders' Equity
 

 

Liabilities
 

 

Deposits
 

 

Non-interest bearing
$
924,073

$
817,031

Interest bearing
 

 
Transaction accounts
102,236

100,723

Savings accounts
169,488

163,516

Money market accounts
555,013

539,967

Time accounts
140,160

151,463

Total deposits
1,890,970

1,772,700

Subordinated debentures
5,703

5,586

Interest payable and other liabilities
14,179

14,644

Total liabilities
1,910,852

1,792,930

 
 
 
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 - 6,175,751 and 6,127,314 at
September 30, 2017 and December 31, 2016, respectively
90,052

87,392

Retained earnings
156,227

146,464

Accumulated other comprehensive loss, net
(1,230
)
(3,293
)
Total stockholders' equity
245,049

230,563

Total liabilities and stockholders' equity
$
2,155,901

$
2,023,493


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
 
Nine months ended
(in thousands, except per share amounts; unaudited)
September 30, 2017
September 30, 2016
 
September 30, 2017
September 30, 2016
Interest income
 
 

 
 
 
Interest and fees on loans
$
16,738

$
17,840

 
$
49,010

$
51,078

Interest on investment securities
 
 
 
 
 

Securities of U.S. government agencies
1,525

1,283

 
4,577

3,826

Obligations of state and political subdivisions
511

569

 
1,632

1,743

Corporate debt securities and other
31

38

 
104

220

Interest on Federal funds sold and short-term investments
406

104

 
623

155

Total interest income
19,211

19,834

 
55,946

57,022

Interest expense
 

 

 
 

 

Interest on interest-bearing transaction accounts
24

27

 
74

82

Interest on savings accounts
17

15

 
48

43

Interest on money market accounts
133

112

 
360

330

Interest on time accounts
138

190

 
423

579

Interest on Federal Home Loan Bank ("FHLB") and other borrowings
—

—

 
—

478

Interest on subordinated debentures
111

109

 
328

325

Total interest expense
423

453

 
1,233

1,837

Net interest income
18,788

19,381

 
54,713

55,185

(Reversal of) provision for loan losses
—

(1,550
)
 
—

(1,550
)
Net interest income after provision for loan losses
18,788

20,931

 
54,713

56,735

Non-interest income
 

 
 
 

 

Service charges on deposit accounts
438

447

 
1,337

1,344

Wealth Management and Trust Services
539

506

 
1,546

1,599

Debit card interchange fees
390

393

 
1,146

1,112

Merchant interchange fees
88

114

 
296

355

Earnings on bank-owned life insurance
209

216

 
628

626

Dividends on FHLB stock
177

223

 
585

577

Gains on investment securities, net
—

—

 
10

394

Other income
225

215

 
729

691

Total non-interest income
2,066

2,114

 
6,277

6,698

Non-interest expense
 

 
 
 

 

Salaries and related benefits
7,344

6,683

 
22,106

20,155

Occupancy and equipment
1,364

1,275

 
4,063

3,731

Depreciation and amortization
489

449

 
1,433

1,343

Federal Deposit Insurance Corporation insurance
167

253

 
490

760

Data processing
946

894

 
2,848

2,666

Professional services
801

476

 
1,845

1,528

Directors' expense
175

143

 
557

448

Information technology
179

307

 
563

665

Provision for losses on off-balance sheet commitments
100

—

 
57

150

Other expense
1,471

1,430

 
4,716

4,491

Total non-interest expense
13,036

11,910

 
38,678

35,937

Income before provision for income taxes
7,818

11,135

 
22,312

27,496

Provision for income taxes
2,686

4,171

 
7,446

10,049

Net income
$
5,132

$
6,964

 
$
14,866

$
17,447

Net income per common share:
 

 
 
 

 
Basic
$
0.84

$
1.14

 
$
2.43

$
2.87

Diluted
$
0.83

$
1.14

 
$
2.41

$
2.86

Weighted average shares:
 
 

 
 

 

Basic
6,123

6,083

 
6,109

6,070

Diluted
6,191

6,117

 
6,179

6,106

Dividends declared per common share
$
0.29

$
0.25

 
$
0.83

$
0.75

Comprehensive income:
 
 
 
 


Net income
$
5,132

$
6,964

 
$
14,866

$
17,447

Other comprehensive (loss) income




 




Change in net unrealized gain or loss on available-for-sale securities
(362
)
(831
)
 
3,273

4,211

Amortization of net unrealized loss on available for sale securities transferred to held-to-maturity securities
135

—

 
299

—

Reclassification adjustment for gains on available-for-sale securities included in net income
—

—

 
(10
)
(394
)
    Net change in unrealized loss on available-for-sale securities, before
    tax
(227
)
(831
)
 
3,562

3,817

          Tax effect
(96
)
(367
)
 
1,499

1,583

Other comprehensive (loss) income, net of tax
(131
)
(464
)
 
2,063

2,234

Comprehensive income
$
5,001

$
6,500

 
$
16,929

$
19,681

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, 2016 and the nine months ended September 30, 2017
(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, 2015
6,068,543

$
84,727

$
129,553

$
193

$
214,473

Net income
—

—

23,134

—

23,134

Other comprehensive loss
—

—

—

(3,486
)
(3,486
)
Stock options exercised
36,117

1,227

—

—

1,227

Excess tax benefit - stock-based compensation
—

161

—

—

161

Stock issued under employee stock purchase plan
621

32

—

—

32

Restricted stock granted
16,910

—

—

—

—

Stock-based compensation - stock options
—

347

—

—

347

Stock-based compensation - restricted stock
—

638

—

—

638

Cash dividends paid on common stock
—

—

(6,223
)
—

(6,223
)
Stock purchased by directors under director stock plan
516

26

—

—

26

Stock issued in payment of director fees
4,607

234

—

—

234

Balance at December 31, 2016
6,127,314

$
87,392

$
146,464

$
(3,293
)
$
230,563

Net income
—

—

14,866

—

14,866

Other comprehensive income
—

—

—

2,063

2,063

Stock options exercised, net of shares surrendered for cashless exercises and tax withholdings
8,786

28

—

—

28

Stock issued under employee stock purchase plan
280

17

—

—

17

Stock issued to employee stock ownership plan ("ESOP")
21,732

1,335

—

—

1,335

Restricted stock granted
14,230

—

—

—

—

Stock-based compensation - stock options
—

423

—

—

423

Stock-based compensation - restricted stock
—

634

—

—

634

Cash dividends paid on common stock
—

—

(5,103
)
—

(5,103
)
Stock purchased by directors under director stock plan
531

35

—

—

35

Stock issued in payment of director fees
2,878

188

—

—

188

Balance at September 30, 2017
6,175,751

$
90,052

$
156,227

$
(1,230
)
$
245,049


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 nine months ended September 30, 2017 and 2016
(in thousands; unaudited)
September 30, 2017
 
September 30, 2016
Cash Flows from Operating Activities:
 
 
 
Net income
$
14,866

 
$
17,447

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

 
 

Reversal of provision for loan losses
—

 
(1,550
)
Provision for losses on off-balance sheet commitments
57

 
150

Noncash expense - contribution to ESOP
637

 
—

Noncash director compensation expense - common stock
170

 
146

Stock-based compensation expense
1,057

 
710

Amortization of core deposit intangible
354

 
400

Amortization of investment security premiums, net of accretion of discounts
2,204

 
2,293

Accretion of discount on acquired loans
(706
)
 
(1,526
)
Accretion of discount on subordinated debentures
117

 
145

Net amortization of deferred loan origination costs/fees
85

 
100

Write-down of other real estate owned
—

 
13

Gain on sale of investment securities
(10
)
 
(394
)
Depreciation and amortization
1,433

 
1,343

Loss on disposal of premises and equipment
—

 
3

Gain on sale of repossessed assets
(1
)
 
—

Earnings on bank-owned life insurance policies
(628
)
 
(626
)
Net change in operating assets and liabilities:
 

 
 

Deferred rent and other rent-related expenses
38

 
(287
)
Interest receivable and other assets
421

 
2,362

Interest payable and other liabilities
350

 
(414
)
Total adjustments
5,578

 
2,868

Net cash provided by operating activities
20,444

 
20,315

Cash Flows from Investing Activities:
 

 
 

Purchase of held-to-maturity securities
(4,496
)
 
(2,424
)
Purchase of available-for-sale securities
(51,130
)
 
(138,432
)
Proceeds from sale of available-for-sale securities
1,321

 
68,673

Proceeds from paydowns/maturities of held-to-maturity securities
22,352

 
25,150

Proceeds from paydowns/maturities of available-for-sale securities
37,126

 
110,978

Loans originated and principal collected, net
(37,370
)
 
(11,723
)
Purchase of bank-owned life insurance policies
—

 
(2,133
)
Purchase of premises and equipment
(1,143
)
 
(652
)
Proceeds from sale of repossessed assets
170

 
—

Purchase of Federal Home Loan Bank stock
—

 
(1,792
)
Cash paid for low-income housing investment
(899
)
 
(298
)
Net cash (used in) provided by investing activities
(34,069
)
 
47,347

Cash Flows from Financing Activities:
 

 
 

Net increase in deposits
118,270

 
73,243

Proceeds from stock options exercised
88

 
1,206

Payment of tax withholdings for stock options exercised
(60
)
 
—

Proceeds from stock issued under employee and director stock purchase plans and ESOP
750

 
49

Federal Home Loan Bank repayments
—

 
(67,000
)
Cash dividends paid on common stock
(5,103
)
 
(4,573
)
Net cash provided by financing activities
113,945

 
2,925

Net increase in cash and cash equivalents
100,320

 
70,587

Cash and cash equivalents at beginning of period
48,804

 
26,343

Cash and cash equivalents at end of period
$
149,124

 
$
96,930

Supplemental disclosure of cash flow information:
 
 
 
Cash paid in interest
$
1,131

 
$
1,741

Cash paid in income taxes
$
6,815

 
$
9,095

Supplemental disclosure of noncash investing and financing activities:
 

 
 

Change in net unrealized gain or loss on available-for-sale securities
$
3,273

 
$
3,817

Securities transferred from available-for-sale to held-to-maturity
$
128,965

 
$
—

Amortization of net unrealized loss on available-for-sale securities transferred to held-to-maturity
$
299

 
$
—

Stock issued in payment of director fees and to ESOP
$
825

 
$
234


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 U.S. 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 2016 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.

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 and unvested restricted stock awards, 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. The number of potentially dilutive common shares included in the 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 common stock: common stock and unvested restricted stock awards. Holders of unvested restricted stock awards receive non-forfeitable dividends at the same rate as common shareholders and they both share equally in undistributed earnings. Under the two-class method, the difference in EPS is not significant for these participating securities.
 
Three months ended
 
Nine months ended
(in thousands, except per share data)
September 30, 2017
September 30, 2016
 
September 30, 2017
September 30, 2016
Weighted average basic shares outstanding
6,123

6,083

 
6,109

6,070

Potentially dilutive common shares related to:
 
 
 
 
 
Stock options
53

27

 
55

30

Unvested restricted stock awards
15

7

 
15

6

Weighted average diluted shares outstanding
6,191

6,117

 
6,179

6,106

Net income
$
5,132

$
6,964

 
$
14,866

$
17,447

Basic EPS
$
0.84

$
1.14

 
$
2.43

$
2.87

Diluted EPS
$
0.83

$
1.14

 
$
2.41

$
2.86

Weighted average anti-dilutive shares not included in the calculation of diluted EPS
23

71

 
19

65


Page-7


Note 2: Recently Adopted and Issued Accounting Standards

In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("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. We adopted the amendments prospectively effective January 1, 2017, which did not have a material impact on our financial condition or results of operations as there were no changes in counterparties.

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"). 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 equity or liabilities, forfeiture accounting, and classifications on the statement of cash flows. We adopted the requirements of this ASU effective January 1, 2017, which impacted the following areas:

Forfeiture rates: We have elected to account for forfeitures as they occur. Previously, we accounted for forfeitures based on an estimate of the number of awards expected to vest. The policy change was applied using a modified retrospective approach and did not have a material effect on our financial condition or results of operations.

Income taxes: We have recorded excess tax benefits (deficiencies) resulting from the exercise of non-qualified stock options, the disqualifying disposition of incentive stock options and vesting of restricted stock awards as tax benefits (expense) in the consolidated statements of comprehensive income with a corresponding decrease (increase) to current taxes payable. Previous to the adoption of this ASU, excess tax benefits (deficiencies) were recognized as an increase (decrease) to common stock in the consolidated statements of changes in stockholders' equity. In addition, we have reflected excess tax benefits as an operating activity in the consolidated statements of cash flows. Previous to the adoption of this ASU, excess tax benefits were shown as a financing activity. We applied the amendment prospectively and prior period financial statements have not been restated. For the three and nine months ended September 30, 2017, we recognized $40 thousand and $210 thousand, respectively, in excess tax benefits recorded as a reduction to income tax expense.

Statutory tax withholding: Cash paid for tax withholdings when shares are surrendered in a cashless stock option exchange has been classified as a financing activity in the consolidated statements of cash flows. There were no shares surrendered for tax withholdings prior to the adoption of ASU 2016-09.

In March 2017, the FASB issued ASU No. 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The amendments in this ASU shorten the amortization period for certain callable debt securities purchased at a premium and require the premium to be amortized to the earliest call date. The ASU is effective for annual periods beginning after December 15, 2018, including interim periods within those periods. We early adopted this ASU effective January 1, 2017, which did not have a material impact on our financial condition and results of operations.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). This 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.

Page-8


•
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.
•
December 2016 ASU No. 2016-20 - Technical Corrections and Improvements to Topic 606, further clarifies specific aspects of previously issued guidance or corrects unintended application of the guidance.

Our revenue is mainly comprised of interest income on financial instruments, which is explicitly excluded from the scope of ASU 2014-09. We have identified applicable sources of non-interest income and are gathering and reviewing related contracts and evaluating their potential impact to our revenue recognition under the new standards. While the recognition of certain components of our non-interest income may be affected by the ASU, we do not expect it to have a material impact 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 accounting standards related to financial instruments, including the following:
•
Requires equity investments, except for those accounted for under the equity method of accounting or those that result in consolidation of the investee, 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. When impairment exists, an entity is required to measure the investment at fair value.
•
Eliminates the requirement 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.
•
Requires public companies 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 (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements.
•
Clarifies that an 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 fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. This ASU may affect our financial statement presentation and related footnotes, but we do not expect it to have a material impact on our financial condition or results of operations.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The amendments in this ASU intend to increase transparency and comparability among organizations by recognizing an asset, which represents the right to use the asset for the lease term, and a lease liability, which is a lessee's obligation to make lease payments measured on a discounted basis. This ASU generally 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 of adoption. Early application of the amendments is permitted. We intend to adopt this ASU during the first quarter of 2019, as required, and are continuing to evaluate our lease agreements and potential accounting software solutions as they become available. As of September 30, 2017, our undiscounted operating lease obligations that were off-balance sheet totaled $18.4 million (See Note 8, Commitments and Contingencies). Upon adoption of this ASU, the present values of leases currently classified as operating leases will be recognized as lease assets and liabilities on our balance sheet. Additional disclosures of key information about our leasing arrangements will also be required. We do not expect that the ASU will have a material impact on our capital ratios or return on average assets when adopted and we are currently evaluating the effect that the ASU will have on other components of our financial condition and results of operations.

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In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. Under the new guidance, entities will be required to measure expected credit losses by utilizing forward-looking information to assess an entity's allowance for credit losses. The measurement of expected credit losses will be based on historical experience, current conditions and reasonable and supportable forecasts that affect the collectability of a credit over its remaining life. In addition, the ASU amends the accounting for potential credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. 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. Management refined our allowance for loan loss model in 2016 and enhanced our loan-level data collection and methodology for analyzing credit losses in preparation for the new accounting standards. We will continue our evaluation of the provisions of this ASU and will be monitoring developments, additional guidance and the potential outcome the amendments will have on our financial condition and results of operations upon adoption in the first quarter of 2020.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This ASU provides guidance on how to present and classify eight specific cash flow topics in the statement of cash flows. The ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The amendments should be applied using a retrospective transition method to each period presented, if practical. This ASU may affect our presentation of certain cash flows and their categorization as operating, investing or financing activities in the consolidated statements of cash flows, but we do not expect it to have a material impact on our financial condition or results of operations.

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The amendments are intended to help companies evaluate whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses and provide a more robust framework to use in determining when a set of assets and activities is a business. The amendments are effective for annual periods after December 31, 2017, including interim periods within those periods. The amendments will be adopted prospectively. We will consider these amendments in our evaluation of the accounting for any future business acquisitions or asset disposals.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This amendment simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test, which would measure a goodwill impairment loss by comparing the implied fair value of goodwill with the carrying amount of that goodwill. Instead, an entity will perform only Step 1 of its quantitative goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and then recognizing an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value. The loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The new guidance does not amend the optional qualitative assessment of goodwill impairment, which Bancorp currently uses. The ASU is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. We anticipate that this ASU will simplify our evaluation of the impairment of goodwill and do not expect it to have a material impact on our financial condition and results of operations.

In May 2017, the FASB issued ASU No. 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting. This ASU applies to entities that change the terms or conditions of a share-based payment award. The FASB adopted this ASU to provide clarity in what constitutes a modification and to reduce diversity in practice in applying Topic 718. In order for a change to a share-based arrangement to not require Topic 718 modification accounting treatment, all of the following must be met: no change in fair value, no change in vesting conditions and no change in the balance sheet classification of the modified award. The ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those periods. Early adoption is permitted, including adoption in an interim period. The amendments should be applied prospectively to an award modified on or after the adoption date. We do not expect this ASU to have a material impact on our financial condition or results of operations.

In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. This amendment changes both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. It is intended to more closely align hedge accounting with companies' risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. The ASU is effective for fiscal years beginning after

Page-10


December 15, 2018, and interim periods within those fiscal years. The amended presentation and disclosure guidance will be required prospectively. We expect this amendment to affect the presentation of our hedging activities, but we do not expect it to have a material impact on our financial condition or 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 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 unadjusted quoted prices in active markets for identical assets or liabilities.
 
Level 2: Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data.
 
Level 3: Valuations are based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Values are determined using pricing models and discounted cash flow models and may include significant Management judgment and estimation.

Transfers between levels of the fair value hierarchy are recognized through our monthly and/or quarterly valuation process in the reporting period during which the event or circumstances that caused the transfer occurred. 

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)

September 30, 2017
 

 
 

 

Securities available-for-sale:
 
 
 
 
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government agencies
$
147,370

$
—

$
146,818

$
552

Debentures of government sponsored agencies
30,382

—

30,382

—

Privately-issued collateralized mortgage obligations
128

—

128

—

Obligations of state and political subdivisions
75,181

—

75,181

—

Corporate bonds
5,031

—

5,031

—

Derivative financial assets (interest rate contracts)
38

—

38

—

Derivative financial liabilities (interest rate contracts)
909

—

909

—

December 31, 2016
 

 
 

 

Securities available-for-sale:
 

 
 

 

Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government agencies
$
254,041

$
—

$
253,434

$
607

Debentures of government sponsored agencies
35,403

—

35,403

—

Privately-issued collateralized mortgage obligations
419

—

419

—

Obligations of state and political subdivisions
77,701

—

77,701

—

Corporate bonds
5,016

—

5,016

—

Derivative financial assets (interest rate contracts)
55

—

55

—

Derivative financial liabilities (interest rate contracts)
933

—

933

—

 
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,

Page-11


we obtain pricing information from a reputable third-party service provider, who may utilize valuation techniques that use current market-based or independently sourced parameters, such as bid/ask prices, dealer-quoted prices, interest rates, benchmark yield curves, prepayment speeds, probability of default, loss severity and credit spreads (Level 2).   Level 2 securities include obligations of state and political subdivisions, U.S. agencies or government-sponsored agencies' debt securities, mortgage-backed securities, government agency-issued, privately-issued collateralized mortgage obligations, and corporate bonds. As of September 30, 2017 and December 31, 2016, there were no securities that were considered Level 1 securities. As of September 30, 2017, 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. The 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 unrealized loss on this SBA-guaranteed security recorded as part of other comprehensive income decreased by $2 thousand in the first nine months of 2017.

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 other-than-temporary impairment, and we did not record any write-downs during 2017 or 2016.
 
On a recurring basis, derivative financial instruments are recorded at fair value, which is based on the income approach using observable Level 2 market inputs, reflecting market expectations of future interest rates as of the measurement date.  Standard valuation techniques are used to calculate the present value of the future expected cash flows assuming an orderly transaction.  Valuation adjustments may be made to reflect both our own credit risk and the counterparties’ credit risk in determining the fair value of the derivatives. Level 2 inputs for the valuations are limited to observable market prices for London Interbank Offered Rate ("LIBOR") and Overnight Index Swap ("OIS") rates (for the very short term), quoted prices for LIBOR futures contracts, observable market prices for LIBOR and OIS swap rates, and one-month and three-month LIBOR basis spreads at commonly quoted intervals.  Mid-market pricing of the inputs is used as a practical expedient in the fair value measurements.  We project spot rates at reset days specified by each swap contract to determine future cash flows, then discount to present value using 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 the Bank. For further discussion on our methodology in valuing our derivative financial instruments, refer to Note 9, Derivative Financial Instruments and Hedging Activities.

Certain financial assets may be measured at fair value on a non-recurring basis. These assets are subject to fair value adjustments that result from the application of the lower of cost or fair value accounting or write-downs of individual assets, such as impaired loans and other real estate owned ("OREO").
 
The following table presents the carrying value of assets measured at fair value on a non-recurring basis and that were held in the consolidated statements of condition at each respective period end, by level within the fair value hierarchy as of September 30, 2017 and December 31, 2016.
(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)

September 30, 2017
 
 

 

 

Other real estate owned
238

—

—

238

December 31, 2016
 

 

 

 

Other real estate owned
408

—

—

408


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

Page-12


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 2017. As of September 30, 2017 and December 31, 2016, there were no collateral-dependent loans whose principal balances had been written down to or below the values of the underlying collateral.

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. There was no change in the estimated fair values of OREO during the first nine months of 2017 and a decrease of $13 thousand in 2016.

Disclosures about Fair Value of Financial Instruments
 
The table below is a summary of fair value estimates for financial instruments as of September 30, 2017 and December 31, 2016, excluding financial instruments recorded at fair value on a recurring basis (summarized in the first table in this note). The carrying amounts in the following table are recorded in the consolidated statements of condition under the indicated captions. Further, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements such as bank-owned life insurance policies ("BOLI"). Additionally, we hold shares of FHLB stock and Visa Inc. Class B common stock at cost. These shares are restricted from resale, except among member banks, and their values are discussed in Note 4, Investment Securities.
 
September 30, 2017
 
December 31, 2016
(in thousands)
Carrying Amounts

Fair Value

Fair Value Hierarchy
 
Carrying Amounts

Fair Value

Fair Value Hierarchy
Financial assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
149,124

$
149,124

Level 1
 
$
48,804

$
48,804

Level 1
Investment securities held-to-maturity
155,122

156,149

Level 2
 
44,438

45,097

Level 2
Loans, net
1,509,199

1,491,306

Level 3
 
1,471,174

1,473,360

Level 3
Interest receivable
5,978

5,978

Level 2
 
6,319

6,319

Level 2
Financial liabilities
 

 

 
 
 

 

 
Deposits
1,890,970

1,891,097

Level 2
 
1,772,700

1,773,102

Level 2
Subordinated debentures
5,703

5,089

Level 3
 
5,586

5,083

Level 3
Interest payable
120

120

Level 2
 
134

134

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. 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

Page-13


September 30, 2017 and December 31, 2016, 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.

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 Borrowing - The fair value is estimated by discounting the future cash flows using current rates offered by the 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 are 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 is discounted at the spot rate of 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, Borrowings, 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 September 30, 2017 and December 31, 2016, 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 residential and commercial 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:

Page-14


 
September 30, 2017
 
December 31, 2016
 
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
$
20,213

$
20,790

$
577

$
—


$
30,856

$
31,544

$
694

$
(6
)
Corporate bonds
—

—

—

—


3,519

3,518

—

(1
)
MBS pass-through securities issued by FHLMC and FNMA
103,624

103,904

425

(145
)

10,063

10,035

126

(154
)
  CMOs issued by FHLMC
31,285

31,455

173

(3
)
 
—

—

—

—

Total held-to-maturity
155,122

156,149

1,175

(148
)

44,438

45,097

820

(161
)
Available-for-sale:
 
 
 
 
 
 
 
 
 
Securities of U.S. government agencies:
 
 
 
 
 
 
 
 
 
MBS pass-through securities issued by FHLMC and FNMA
91,404

91,716

551

(239
)

193,998

190,566

145

(3,577
)
CMOs issued by FNMA
11,504

11,529

68

(43
)

13,790

13,772

91

(109
)
CMOs issued by FHLMC
35,317

35,360

56

(13
)

43,452

42,758

37

(731
)
CMOs issued by GNMA
8,754

8,765

62

(51
)

6,844

6,945

102

(1
)
Debentures of government- sponsored agencies
30,492

30,382

—

(110
)

35,486

35,403

7

(90
)
Privately issued CMOs
127

128

1

—


419

419

1

(1
)
Obligations of state and
political subdivisions
74,903

75,181

675

(397
)

79,306

77,701

135

(1,740
)
Corporate bonds
4,967

5,031

64

—


4,959

5,016

57

—

Total available-for-sale
257,468

258,092

1,477

(853
)

378,254

372,580

575

(6,249
)
Total investment securities
$
412,590

$
414,241

$
2,652

$
(1,001
)

$
422,692

$
417,677

$
1,395

$
(6,410
)

The amortized cost and fair value of investment debt securities by contractual maturity at September 30, 2017 are shown below. Expected maturities may differ from contractual maturities if the issuers of the securities have the right to call or prepay obligations with or without call or prepayment penalties.
 
September 30, 2017
 
December 31, 2016
 
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
$
2,092

$
2,132

 
$
8,884

$
8,893

 
$
13,473

$
13,506

 
$
20,136

$
20,109

After one but within five years
15,206

15,565

 
67,085

67,065

 
16,706

17,150

 
58,334

58,267

After five years through ten years
56,607

56,979

 
101,756

101,880

 
3,000

3,125

 
113,576

110,842

After ten years
81,217

81,473

 
79,743

80,254

 
11,259

11,316

 
186,208

183,362

Total
$
155,122

$
156,149

 
$
257,468

$
258,092

 
$
44,438

$
45,097

 
$
378,254

$
372,580

 
Sales of investment securities and gross gains and losses are shown in the following table.
 
Three months ended
 
Nine months ended
(in thousands)
September 30, 2017
 
September 30, 2016
 
September 30, 2017
 
September 30, 2016
Available-for-sale:
 
 
 
 
 
 
 
Sales proceeds
$
—

 
$
—

 
$
1,321

 
$
68,673

Gross realized gains
—

 
—

 
13

 
458

Gross realized losses
—

 
—

 
(3
)
 
(64
)

For the respective periods of September 30, 2017 and December 31, 2016, investment securities carried at $112.4 million and $109.1 million were pledged with the State of California: $111.6 million and $108.3 million to secure public deposits in compliance with the Local Agency Security Program, and $777 thousand and $822 thousand to provide collateral for trust deposits. In addition, investment securities carried at $2.0 million and $2.1 million were pledged to collateralize a Wealth Management and Trust Services (“WMTS”) checking account at September 30, 2017 and December 31, 2016, respectively.

Page-15



As part of our ongoing review of our investment securities portfolio, we reassessed the classification of certain MBS pass-through and CMOs securities issued by FHLMC and FNMA. Effective February 24, 2017, we transferred $129 million of these securities, which we intend and have the ability to hold to maturity, from available-for-sale securities to held-to-maturity at fair value. The unrealized pre-tax loss of $3.0 million at the date of transfer remained in accumulated other comprehensive income and is amortized over the remaining lives of the securities.

Other-Than-Temporarily Impaired ("OTTI") 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 September 30, 2017. We do not have the intent and it is more likely than not that we will not have to sell the remaining securities temporarily impaired at September 30, 2017 before recovery of the amortized cost basis.
 
There were 67 and 134 investment securities in unrealized loss positions at September 30, 2017 and December 31, 2016, respectively. Those securities are summarized and classified according to the duration of the loss period in the tables below:
September 30, 2017
< 12 continuous months
 
≥ 12 continuous months
 
Total securities
 in a loss position
(in thousands)
Fair value
Unrealized loss
 
Fair value
Unrealized loss
 
Fair value
Unrealized loss
Held-to-maturity:
 
 
 
 
 
 
 
 
MBS pass-through securities issued by FHLMC and FNMA
17,764

(115
)
 
31,501

(30
)
 
49,265

(145
)
CMOs issued by FHLMC
—

—

 
1,505

(3
)
 
1,505

(3
)
Total held-to-maturity
17,764

(115
)
 
33,006

(33
)
 
50,770

(148
)
Available-for-sale:
 
 
 
 
 
 
 
 
MBS pass-through securities issued by FHLMC and FNMA
21,619

(229
)
 
2,321

(10
)
 
23,940

(239
)
CMOs issued by FNMA
8,005

(43
)
 
—

—

 
8,005

(43
)
CMOs issued by FHLMC
15,014

(13
)
 
—

—

 
15,014

(13
)
CMOs issued by GNMA
4,807

(51
)
 
—

—

 
4,807

(51
)
Debentures of government- sponsored agencies
19,929

(64
)
 
9,953

(46
)
 
29,882

(110
)
Obligations of state and political subdivisions
6,129

(38
)
 
18,010

(359
)
 
24,139

(397
)
Total available-for-sale
75,503

(438
)
 
30,284

(415
)
 
105,787

(853
)
Total temporarily impaired securities
$
93,267

$
(553
)
 
$
63,290

$
(448
)
 
$
156,557

$
(1,001
)

Page-16


December 31, 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
$
2,250

$
(154
)
 
$
—

$
—

 
$
2,250

$
(154
)
Corporate bonds
3,362

(6
)
 
—

—

 
3,362

(6
)
MBS pass-through securities issued by FHLMC and FNMA
3,518

(1
)
 
—

—

 
3,518

(1
)
Total held-to-maturity
9,130

(161
)
 
—

—

 
9,130

(161
)
Available-for-sale:




 




 




MBS pass-through securities issued by FHLMC and FNMA
162,016

(3,577
)
 
—

—

 
162,016

(3,577
)
CMOs issued by FNMA
9,498

(109
)
 
—

—

 
9,498

(109
)
CMOs issued by FHLMC
31,545

(731
)
 
—

—

 
31,545

(731
)
CMOs issued by GNMA
1,583

(1
)
 
—

—

 
1,583

(1
)
Debentures of government- sponsored agencies
19,951

(38
)
 
9,946

(52
)
 
29,897

(90
)
Obligations of state and political subdivisions
59,567

(1,740
)
 
—

—

 
59,567

(1,740
)
Corporate bonds
154

(1
)
 
—

—

 
154

(1
)
Total available-for-sale
284,314

(6,197
)
 
9,946

(52
)
 
294,260

(6,249
)
Total temporarily impaired securities
$
293,444

$
(6,358
)
 
$
9,946

$
(52
)
 
$
303,390

$
(6,410
)

As of September 30, 2017, there was one debenture of government-sponsored agency security, one CMO issued by FHLMC, five MBS pass-through securities issued by FNMA and thirty obligations of U.S. state and political subdivisions securities that have been in a continuous loss position for twelve months or more. We have evaluated the securities 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 debenture of government-sponsored agency security 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 these securities were not other-than-temporarily impaired at September 30, 2017.

There were thirty investment securities in our portfolio that had been in temporary loss positions for less than twelve months as of September 30, 2017, and their temporary loss positions mainly arose from changes in interest rates since purchase. They consisted of one debenture of a U.S. government-sponsored agency, eight obligations of U.S. state and political subdivisions, twelve MBS securities and nine CMOs issued by government-sponsored agencies. Securities of government-sponsored agencies are 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 concluded that these securities were not other-than-temporarily impaired at September 30, 2017.

Non-Marketable Securities

As a member of the FHLB, we are required to maintain a minimum investment in FHLB capital stock determined by the Board of Directors of the FHLB. The minimum investment requirements can increase in the event we increase our total asset size or borrowings with the FHLB. Shares cannot be purchased or sold except between the FHLB and its members at the $100 per share par value. We held $10.2 million of FHLB stock recorded at cost in other assets on the consolidated statements of condition at both September 30, 2017 and December 31, 2016. 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, due to FHLB's current financial condition. On October 26, 2017, FHLB announced a cash dividend to be distributed in mid-November 2017 at an annualized dividend rate of 7.00%. Cash dividends paid on FHLB capital stock are recorded as non-interest income.


Page-17


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 based on the 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 $2.9 million and $2.2 million at September 30, 2017 and December 31, 2016, respectively. The conversion rate is subject to further reduction upon the final settlement of the covered litigation against Visa Inc. and its member banks. For further information, see Note 8, Commitments and Contingencies.

We invest in low-income housing tax credit funds as a limited partner, which totaled $2.3 million and $2.5 million recorded in other assets as of September 30, 2017 and December 31, 2016, respectively. In the first nine months of 2017, we recognized $249 thousand of low-income housing tax credits and other tax benefits, net of $199 thousand of amortization expense of low-income housing tax credit investment, as a component of income tax expense. As of September 30, 2017, our unfunded commitments for these low-income housing tax credit funds totaled $549 thousand. We did not recognize any impairment losses on these low-income housing tax credit investments during the first nine months of 2017 or 2016.

Note 5:  Loans and Allowance for Loan Losses

Credit Quality of Loans
 
The following table shows outstanding loans by class and payment aging as of September 30, 2017 and December 31, 2016.
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

September 30, 2017
 

 

 

 

 

 

 

 

 30-59 days past due
$
—

$
—

$
—

$
—

$
100

$
—

$
5

$
105

 60-89 days past due
—

—

—

—

307

—

1

308

 90 days or more past due
—

—

—

—

—

—

—

—

Total past due
—

—

—

—

407

—

6

413

Current
218,681

264,732

721,576

76,179

120,959

96,937

24,970

1,524,034

Total loans 3
$
218,681

$
264,732

$
721,576

$
76,179

$
121,366

$
96,937

$
24,976

$
1,524,447

Non-accrual loans 2
$
—

$
—

$
1,024

$
—

$
292

$
—

$
—

$
1,316

December 31, 2016
 

 

 

 

 

 

 

 

 30-59 days past due
$
283

$
—

$
—

$
—

$
77

$
—

$
2

$
362

 60-89 days past due
—

—

—

—

—

—

49

49

 90 days or more past due
—

—

—

—

91

—

—

91

Total past due
283

—

—

—

168

—

51

502

Current
218,332

247,713

724,228

74,809

117,039

78,549

25,444

1,486,114

Total loans 3
$
218,615

$
247,713

$
724,228

$
74,809

$
117,207

$
78,549

$
25,495

$
1,486,616

Non-accrual loans 2
$
—

$
—

$
—

$
—

$
91

$
—

$
54

$
145

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 There were no purchased credit impaired ("PCI") loans that had stopped accreting interest at September 30, 2017 and December 31, 2016. Amounts exclude accreting PCI loans of $2.3 million and $2.9 million at September 30, 2017 and December 31, 2016, 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 September 30, 2017 or December 31, 2016.
3 Amounts include net deferred loan origination costs of $798 thousand and $883 thousand at September 30, 2017 and December 31, 2016, respectively. Amounts are also net of unaccreted purchase discounts on non-PCI loans of $1.3 million and $1.8 million at September 30, 2017 and December 31, 2016, 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 acquisitions.  Management examines historical, current, and projected cash flows to determine the ability of the borrower to repay obligations as agreed. Commercial loans are made based primarily on the identified cash flows of the borrower and secondarily on the underlying collateral and guarantor support. The cash flows of borrowers, however, may not occur as expected, and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed,

Page-18


such as accounts receivable and 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, 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, guarantors are expected to carry the loans until a replacement tenant can 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 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. 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 and other residential tenancy-in-common fractional interest loans ("TIC"), floating homes and mobile homes along with a small number of installment loans. We originate consumer loans utilizing credit score information, debt-to-income ratio and loan-to-value ratio analysis. Diversification among consumer loan types, coupled with relatively small loan amounts that are spread across many individual borrowers, mitigates risk. Our other residential loans include TIC units located almost entirely in San Francisco County.

We use a risk rating system to evaluate asset quality, and to identify and monitor credit risk in individual loans, and in the loan portfolio. 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 and Watch: Loans to borrowers of acceptable or better credit quality. Borrowers in this category demonstrate fundamentally sound financial positions, repayment capacity, credit history, and management expertise.  Loans in this category must have an identifiable and stable source of repayment and meet the Bank’s policy regarding debt service coverage ratios.  These borrowers are capable of sustaining normal economic, market or operational setbacks without significant financial consequences.  Negative external industry factors are generally not present.  The loan may be secured, unsecured or supported by non-real estate collateral for which the value is more difficult to determine and/or marketability is more uncertain. This category also includes “Watch” loans, where the primary source of repayment has been delayed. “Watch” is intended to be a transitional grade, with either an upgrade or downgrade within a reasonable period.
 
Special Mention: Potential weaknesses that deserve close attention. If left uncorrected, those potential weaknesses may result in deterioration of the payment prospects for the asset. Special Mention assets do not present sufficient risk to warrant adverse classification.
 
Substandard: Inadequately protected by either the current sound worth and paying capacity of the obligor or the collateral pledged, if any. A Substandard asset has a well-defined weakness or weaknesses that jeopardize(s) the liquidation of the debt. Substandard assets are characterized by the distinct possibility that we will sustain some loss if such weaknesses or deficiencies are not corrected. Well-defined weaknesses include adverse trends or developments of the borrower’s financial condition, managerial weaknesses and 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

Page-19


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 worse, regardless of loan type, are reviewed no less than quarterly.

The following table represents an analysis of the carrying amount in loans, net of deferred fees and costs and purchase premiums or discounts, by internally assigned risk grades, including PCI loans, at September 30, 2017 and December 31, 2016.
Credit Risk Profile by Internally Assigned Risk 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

September 30, 2017
 
 
 
 
 
 
 
 
 
Pass
$
195,500

$
244,100

$
717,760

$
73,210

$
119,856

$
96,937

$
24,739

$
2,272

$
1,474,374

Special Mention
6,153

10,437

—

—

—

—

—

—

16,590

Substandard
16,991

9,055

2,818

2,969

1,413

—

237

—

33,483

Total loans
$
218,644

$
263,592

$
720,578

$
76,179

$
121,269

$
96,937

$
24,976

$
2,272

$
1,524,447

December 31, 2016
 

 

 

 

 

 

 

 

 

Pass
$
201,987

$
234,849

$
720,417

$
71,564

$
115,680

$
78,549

$
25,083

$
2,920

$
1,451,049

Special Mention
9,197

4,799

607

—

1,334

—

—

—

15,937

Substandard
7,391

6,993

1,498

3,245

91

—

412

—

19,630

Total loans
$
218,575

$
246,641

$
722,522

$
74,809

$
117,105

$
78,549

$
25,495

$
2,920

$
1,486,616

 
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 non-accrual status at the time of restructure may be returned to accruing status after Management considers the borrower’s sustained repayment performance for a reasonable period, generally six months, and obtains reasonable assurance of repayment and performance.
 
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 2017 and 2016.
 
The following table summarizes the carrying amount of TDR loans by loan class as of September 30, 2017 and December 31, 2016.
(in thousands)
 
Recorded investment in Troubled Debt Restructurings 1
September 30, 2017

December 31, 2016

Commercial and industrial
$
2,050

$
2,207

Commercial real estate, owner-occupied
6,999

6,993

Commercial real estate, investor
2,193

2,256

Construction
2,969

3,245

Home equity
348

625

Other residential
1,159

1,965

Installment and other consumer
666

877

Total
$
16,384

$
18,168

1 There were no TDR loans on non-accrual status at September 30, 2017 and December 31, 2016.

Page-20



The following table presents information for loans modified in a TDR during the presented periods, including the 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 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 September 30, 2017:
 
 
 

None
—

$
—

$
—

$
—

Troubled Debt Restructurings during the three months ended September 30, 2016:
 

 

 



None
—

$
—

$
—

$
—

Troubled Debt Restructurings during the nine months ended
September 30, 2017:
 
 
 
 
Installment and consumer
1

$
50

$
50

$
49

Troubled Debt Restructurings during the nine months ended
September 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


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

The modifications during the nine months ended September 30, 2017 and 2016 primarily involved interest rate concessions, renewals, and other changes to loan terms. During the first nine months of 2017 and 2016, 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.

Impaired Loans

The following tables summarize information by class on impaired loans and their related allowances. 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.

Page-21


(in thousands)
Commercial and industrial

Commercial real estate, owner-occupied

Commercial real estate, investor

Construction

Home equity

Other residential

Installment and other consumer

Total

September 30, 2017
 

 

 

 

 

 

 

Recorded investment in impaired loans:
 
 
 
 
 
 
With no specific allowance recorded
$
311

$
—

$
1,024

$
2,691

$
292

$
998

$
47

$
5,363

With a specific allowance recorded
1,740

6,999

2,193

278

348

160

619

12,337

Total recorded investment in impaired loans
$
2,051

$
6,999

$
3,217

$
2,969

$
640

$
1,158

$
666

$
17,700

Unpaid principal balance of impaired loans
$
2,030

$
6,993

$
3,230

$
2,963

$
637

$
1,157

$
665

$
17,675

Specific allowance
35

84

369

5

6

2

85

586

Average recorded investment in impaired loans during the quarter ended
September 30, 2017
2,063

7,000

3,236

3,104

607

1,164

802

17,976

Interest income recognized on impaired loans during the quarter ended
September 30, 2017 1
27

67

22

39

5

14

9

183

Average recorded investment in impaired loans during the nine months ended
September 30, 2017
2,100

6,998

3,010

3,174

660

1,367

871

18,180

Interest income recognized on impaired loans during the nine months ended
September 30, 2017 1
74

199

65

110

19

48

29

544

Average recorded investment in impaired loans during the quarter ended
September 30, 2016
3,352

7,169

3,146

3,238

1,140

1,981

1,113

21,139

Interest income recognized on impaired loans during the quarter ended
September 30, 2016 1
44

67

1,385

32

38

22

12

1,600

Average recorded investment in impaired loans during the nine months ended
September 30, 2016
3,802

7,081

3,397

3,238

1,098

1,993

1,179

21,788

Interest income recognized on impaired loans during the nine months ended
September 30, 2016 1
142

133

1,489

105

48

67

37

2,021

1 No interest income on impaired loans was recognized on a cash basis during the three and nine months ended September 30, 2017. Interest income recognized on a cash basis totaled $1.4 million for the three and nine months ended September 30, 2016 and was primarily related to an interest recovery upon the pay-off of a partially charged-off non-accrual commercial real estate loan during the third quarter.
(in thousands)
Commercial and industrial

Commercial real estate, owner-occupied

Commercial real estate, investor

Construction

Home equity

Other residential

Installment and other consumer

Total

December 31, 2016
 

 

 

 

 

 

 

Recorded investment in impaired loans: