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EX-32.01 - EXHIBIT 32.01 - Bank of Marin Bancorpbmrc-ex3201_20160930x10q.htm
EX-31.02 - EXHIBIT 31.02 - Bank of Marin Bancorpbmrc-ex3102_20160930x10q.htm
EX-31.01 - EXHIBIT 31.01 - Bank of Marin Bancorpbmrc-ex3101_20160930x10q.htm
 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, 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 October 31, 2016, there were 6,123,181 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, 2016 and December 31, 2015
(in thousands, except share data; unaudited)
September 30, 2016

 
December 31, 2015

Assets
 

 
 
Cash and due from banks
$
96,930

 
$
26,343

Investment securities
 

 
 
Held-to-maturity, at amortized cost
46,423

 
69,637

Available-for-sale, at fair value
378,996

 
417,787

Total investment securities
425,419

 
487,424

Loans, net of allowance for loan losses of $15,713 and $14,999 at September 30, 2016 and December 31, 2015, respectively
1,451,950

 
1,436,229

Bank premises and equipment, net
8,611

 
9,305

Goodwill
6,436

 
6,436

Core deposit intangible
2,713

 
3,113

Interest receivable and other assets
62,762

 
62,284

Total assets
$
2,054,821

 
$
2,031,134

 
 
 
 
Liabilities and Stockholders' Equity
 

 
 

Liabilities
 

 
 

Deposits
 

 
 

Non-interest bearing
$
860,638

 
$
770,087

Interest bearing
 

 
 
Transaction accounts
91,979

 
114,277

Savings accounts
156,225

 
141,316

Money market accounts
533,682

 
541,089

Time accounts
158,945

 
161,457

Total deposits
1,801,469

 
1,728,226

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

 
67,000

Subordinated debentures
5,540

 
5,395

Interest payable and other liabilities
16,032

 
16,040

Total liabilities
1,823,041

 
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 - 6,123,181 and 6,068,543 at
    September 30, 2016 and December 31, 2015, respectively
86,926

 
84,727

Retained earnings
142,427

 
129,553

Accumulated other comprehensive income, net
2,427

 
193

Total stockholders' equity
231,780

 
214,473

Total liabilities and stockholders' equity
$
2,054,821

 
$
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
 
Nine months ended
(in thousands, except per share amounts; unaudited)
September 30, 2016
September 30, 2015
 
September 30, 2016
September 30, 2015
Interest income
 
 

 
 
 
Interest and fees on loans
$
17,840

$
15,498

 
$
51,078

$
46,164

Interest on investment securities
 
 
 
 
 

Securities of U.S. government agencies
1,283

1,223

 
3,826

3,248

Obligations of state and political subdivisions
569

527

 
1,743

1,578

Corporate debt securities and other
38

162

 
220

546

Interest on Federal funds sold and short-term investments
104

35

 
155

107

Total interest income
19,834

17,445

 
57,022

51,643

Interest expense
 

 

 
 

 

Interest on interest-bearing transaction accounts
27

28

 
82

88

Interest on savings accounts
15

12

 
43

37

Interest on money market accounts
112

125

 
330

375

Interest on time accounts
190

212

 
579

649

Interest on FHLB and other borrowings

80

 
478

236

Interest on subordinated debentures
109

105

 
325

314

Total interest expense
453

562

 
1,837

1,699

Net interest income
19,381

16,883

 
55,185

49,944

(Reversal of) provision for loan losses
(1,550
)

 
(1,550
)

Net interest income after provision for loan losses
20,931

16,883

 
56,735

49,944

Non-interest income
 

 
 
 

 

Service charges on deposit accounts
447

489

 
1,344

1,518

Wealth Management and Trust Services
506

568

 
1,599

1,809

Debit card interchange fees
393

372

 
1,112

1,087

Merchant interchange fees
114

171

 
355

430

Earnings on bank-owned life insurance
216

204

 
626

610

Dividends on FHLB stock
223

209

 
577

817

Gains on investment securities, net

72

 
394

80

Other income
215

213

 
691

744

Total non-interest income
2,114

2,298

 
6,698

7,095

Non-interest expense
 

 
 
 

 

Salaries and related benefits
6,683

6,300

 
20,155

19,762

Occupancy and equipment
1,275

1,346

 
3,731

4,181

Depreciation and amortization
449

441

 
1,343

1,512

Federal Deposit Insurance Corporation insurance
253

250

 
760

739

Data processing
894

835

 
2,666

2,413

Professional services
476

493

 
1,528

1,572

Directors' expense
143

182

 
448

620

Information technology
307

186

 
665

554

Provision for losses on off-balance sheet commitments

324

 
150

14

Other expense
1,430

1,281

 
4,491

4,447

Total non-interest expense
11,910

11,638

 
35,937

35,814

Income before provision for income taxes
11,135

7,543

 
27,496

21,225

Provision for income taxes
4,171

2,770

 
10,049

7,709

Net income
$
6,964

$
4,773

 
$
17,447

$
13,516

Net income per common share:
 

 
 
 

 
Basic
$
1.14

$
0.80

 
$
2.87

$
2.27

Diluted
$
1.14

$
0.79

 
$
2.86

$
2.23

Weighted average shares:
 
 

 
 

 

Basic
6,083

5,963

 
6,070

5,943

Diluted
6,117

6,067

 
6,106

6,059

Dividends declared per common share
$
0.25

$
0.22

 
$
0.75

$
0.66

Comprehensive income:
 
 
 
 


Net income
$
6,964

$
4,773

 
$
17,447

$
13,516

Other comprehensive income




 




Change in net unrealized (loss) gain on available-for-sale securities
(831
)
1,523

 
4,211

1,037

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


 
(394
)
(8
)
Net change in unrealized (loss) gain on available-for-sale securities, before tax
(831
)
1,523

 
3,817

1,029

Deferred tax (benefit) expense
(367
)
654

 
1,583

517

Other comprehensive (loss) income, net of tax
(464
)
869

 
2,234

512

Comprehensive income
$
6,500

$
5,642

 
$
19,681

$
14,028

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 nine months ended September 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


17,447


17,447

Other comprehensive income



2,234

2,234

Stock options exercised
32,117

1,087



1,087

Excess tax benefit - stock-based compensation

119



119

Stock issued under employee stock purchase plan
488

23



23

Restricted stock granted
16,910





Stock-based compensation - stock options

266



266

Stock-based compensation - restricted stock

444



444

Cash dividends paid on common stock


(4,573
)

(4,573
)
Stock purchased by directors under director stock plan
516

26



26

Stock issued in payment of director fees
4,607

234



234

Balance at September 30, 2016
6,123,181

$
86,926

$
142,427

$
2,427

$
231,780


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, 2016 and 2015
(in thousands; unaudited)
September 30, 2016

 
September 30, 2015

Cash Flows from Operating Activities:
 
 
 
Net income
$
17,447

 
$
13,516

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
150

 
14

Compensation expense via common stock for director fees
146

 
207

Stock-based compensation expense
710

 
477

Excess tax benefits from exercised or vested stock-based awards
(119
)
 
(150
)
Amortization of core deposit intangible
400

 
464

Amortization of investment security premiums, net of accretion of discounts
2,293

 
2,038

Accretion of discount on acquired loans
(1,526
)
 
(1,569
)
Accretion of discount on subordinated debentures
145

 
158

Net amortization of deferred loan origination costs/fees
100

 
(374
)
Write-down of other real estate owned
13

 
40

Gain on sale of investment securities
(394
)
 
(80
)
Depreciation and amortization
1,343

 
1,512

Loss on disposal of premises and equipment
3

 
4

Earnings on bank-owned life insurance policies
(626
)
 
(610
)
Net change in operating assets and liabilities:
 

 
 

Interest receivable
998

 
303

Interest payable
(49
)
 
(13
)
Deferred rent and other rent-related expenses
(287
)
 
42

Other assets
1,364

 
1,930

Other liabilities
(246
)
 
(819
)
Total adjustments
2,868

 
3,574

Net cash provided by operating activities
20,315

 
17,090

Cash Flows from Investing Activities:
 

 
 

Purchase of held-to-maturity securities
(2,424
)
 
(2,375
)
Purchase of available-for-sale securities
(138,432
)
 
(189,755
)
Proceeds from sale of available-for-sale securities
68,673

 
1,559

Proceeds from sale of held-to-maturity securities

 
1,015

Purchase of bank-owned life insurance policies
(2,133
)
 

Proceeds from paydowns/maturity of held-to-maturity securities
25,150

 
30,529

Proceeds from paydowns/maturity of available-for-sale securities
110,978

 
54,966

Proceeds from the sale of loan

 
1,502

Loans originated and principal collected, net
(11,723
)
 
403

Purchase of FHLB stock
(1,792
)
 
(136
)
Purchase of premises and equipment
(652
)
 
(1,194
)
Cash paid for low income housing tax credit investment
(298
)
 
(645
)
Net cash provided by (used in) investing activities
47,347

 
(104,131
)
Cash Flows from Financing Activities:
 

 
 

Net increase in deposits
73,243

 
83,863

Proceeds from stock options exercised
1,087

 
888

Proceeds from stock issued under employee and director stock purchase plans
49

 
24

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

Cash dividends paid on common stock
(4,573
)
 
(3,936
)
Excess tax benefits from exercised or vested stock-based awards
119

 
150

Net cash provided by financing activities
2,925

 
80,989

Net increase (decrease) in cash and cash equivalents
70,587

 
(6,052
)
Cash and cash equivalents at beginning of period
26,343

 
41,367

Cash and cash equivalents at end of period
$
96,930

 
$
35,315

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
1,741

 
$
1,554

Cash paid for income taxes
$
9,095

 
$
6,603

Supplemental disclosure of non-cash investing and financing activities:
 

 
 

Change in unrealized gain on available-for-sale securities
$
3,817

 
$
(1,029
)
Transfer of loan to loans held-for-sale at fair value
$

 
$
1,502

Subscription in low income housing tax credit investment
$

 
$
1,023

Stock issued in payment of director fees
$
234

 
$
275

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
 
Nine months ended
(in thousands, except per share data)
September 30, 2016

September 30, 2015

 
September 30, 2016

September 30, 2015

Weighted average basic shares outstanding
6,083

5,963

 
6,070

5,943

Potentially dilutive common shares related to:
 
 
 
 
 
Stock options
27

35

 
30

41

Unvested restricted stock awards
7

5

 
6

5

Warrant

64

 

70

Weighted average diluted shares outstanding
6,117

6,067

 
6,106

6,059

Net income
$
6,964

$
4,773

 
$
17,447

$
13,516

Basic EPS
$
1.14

$
0.80

 
$
2.87

$
2.27

Diluted EPS
$
1.14

$
0.79

 
$
2.86

$
2.23

Weighted average anti-dilutive shares not included in the calculation of diluted EPS
71

42

 
65

35


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). 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.
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.

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 issues 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. We do not expect this ASU 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 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.
 

Page-9



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, 2016
 

 
 

 

Securities available-for-sale:
 
 
 
 
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies
$
252,824

$

$
252,199

$
625

Debentures of government-sponsored agencies
40,576


40,576


Privately-issued collateralized mortgage obligations
560


560


Obligations of state and political subdivisions
80,027


80,027


Corporate bonds
5,009


5,009


Derivative financial liabilities (interest rate contracts)
2,480


2,480


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 September 30, 2016 and December 31, 2015, there were no securities that were considered Level 1 securities. As of September 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 pay-off of one of the larger loans in the pool collateralizing the security. The unrealized gain or loss on this SBA-guaranteed security decreased by $15 thousand in the same period recorded as part of other comprehensive income.


Page-10



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 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 September 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)

September 30, 2016
 
 

 

 

Impaired loans 1
$
124

$

$

$
124

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 September 30, 2016, the $124 thousand carrying value of a consumer loan was net of a $52 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

Page-11



inputs as they are specific to the underlying collateral. There have been no significant changes in the valuation techniques during 2016.

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 nine 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 September 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 ("BOLI"). 
 
September 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
$
96,930

$
96,930

Level 1
 
$
26,343

$
26,343

Level 1
Investment securities held-to-maturity
46,423

47,867

Level 2
 
69,637

71,054

Level 2
Loans, net
1,451,950

1,471,861

Level 3
 
1,436,229

1,470,380

Level 3
Interest receivable
5,645

5,645

Level 2
 
6,643

6,643

Level 2
Financial liabilities
 

 

 
 
 

 

 
Deposits
1,801,469

1,801,932

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
5,540

5,156

Level 3
 
5,395

5,132

Level 3
Interest payable
138

138

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 September 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.

Page-12



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

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

Page-13



 
September 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
$
32,765

$
33,868

$
1,106

$
(3
)

$
42,919

$
44,146

$
1,246

$
(19
)
Corporate bonds
3,524

3,523

0

(1
)

15,072

15,098

42

(16
)
MBS pass-through securities issued by FHLMC and FNMA
10,134

10,476

342



11,646

11,810

171

(7
)
Total held-to-maturity
46,423

47,867

1,448

(4
)

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
196,987

198,999

2,239

(227
)

138,222

138,462

694

(454
)
CMOs issued by FNMA
14,885

15,104

219



18,266

18,219

97

(144
)
CMOs issued by FHLMC
30,555

30,887

332



22,889

22,932

82

(39
)
CMOs issued by GNMA
7,654

7,834

180



10,326

10,480

169

(15
)
Debentures of government- sponsored agencies
40,486

40,576

98

(8
)

161,690

160,892

28

(826
)
Privately issued CMOs
560

560

1

(1
)

3,960

4,150

190


Obligations of state and
political subdivisions
78,719

80,027

1,401

(93
)

57,110

57,673

580

(17
)
Corporate bonds
4,956

5,009

53



4,947

4,979

43

(11
)
Total available-for-sale
374,802

378,996

4,523

(329
)

417,410

417,787

1,883

(1,506
)
Total investment securities
$
421,225

$
426,863

$
5,971

$
(333
)

$
487,047

$
488,841

$
3,342

$
(1,548
)

The amortized cost and fair value of investment debt securities by contractual maturity at September 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.
 
September 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
$
14,037

$
14,115

 
$
17,067

$
17,080

 
$
18,853

$
18,920

 
$
12,135

$
12,176

After one year but within five years
16,583

17,212

 
67,087

67,487

 
31,677

32,360

 
188,007

187,326

After five years through ten years
4,467

4,739

 
87,774

88,871

 
8,580

8,969

 
64,899

64,999

After ten years
11,336

11,801

 
202,873

205,558

 
10,527

10,805

 
152,369

153,286

Total
$
46,423

$
47,867

 
$
374,801

$
378,996

 
$
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
 
Nine months ended
(in thousands)
September 30, 2016
 
September 30, 2015
 
September 30, 2016
 
September 30, 2015
Available-for-sale:
 
 
 
 
 
 
 
Sales proceeds
$

 
$

 
$
68,673

 
$
1,559

Gross realized gains

 

 
458

 
8

Gross realized losses

 

 
(64
)
 

 
 
 
 
 
 
 
 
Held-to-Maturity:
 
 
 
 
 
 
 
Sales proceeds
$

 
$
1,015

 
$

 
$
1,015

Gross realized gains

 
72

 

 
72

Gross realized losses

 

 

 



Page-14



Investment securities carried at $70.7 million and $87.9 million at September 30, 2016 and December 31, 2015, respectively, were pledged to the State of California: $69.9 million and $87.1 million to secure public deposits in compliance with the Local Agency Security Program at September 30, 2016 and December 31, 2015, respectively, and $827 thousand and $840 thousand to provide collateral for trust deposits at September 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 September 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 securities in our investment portfolio is other-than-temporarily impaired as of September 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 September 30, 2016 before recovery of the cost basis.
 
Thirty-seven and fifty-four investment securities were in unrealized loss positions at September 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:
September 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
$
547

$
(3
)
 
$

$

 
$
547

$
(3
)
Corporate bonds
3,523

(1
)
 


 
3,523

(1
)
Total held-to-maturity
4,070

(4
)
 


 
4,070

(4
)
Available-for-sale:
 
 
 
 
 
 
 
 
MBS pass-through securities issued by FHLMC and FNMA
69,229

(227
)
 


 
69,229

(227
)
Debentures of government- sponsored agencies
14,992

(8
)
 


 
14,992

(8
)
Privately issued CMOs
162

(1
)
 


 
162

(1
)
Obligations of state & political subdivisions
14,236

(93
)
 


 
14,236

(93
)
Total available-for-sale
98,619

(329
)
 


 
98,619

(329
)
Total temporarily impaired securities
$
102,689

$
(333
)
 
$

$

 
$
102,689

$
(333
)

Page-15



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
)

The thirty-seven investment securities in our portfolio in a temporary loss position for less than twelve months as of September 30, 2016 consisted of two debentures of U.S. government-sponsored agencies, twenty-three obligations of U.S. state and political subdivisions, ten MBS securities issued by government-sponsored agencies, one privately issued CMO and one corporate bond. The debentures 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 have concluded that these securities were not other-than-temporarily impaired at September 30, 2016.

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 and $8.4 million of FHLB stock recorded at cost in other assets on the consolidated statements of condition at September 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 October 19, 2016, FHLB declared a special cash dividend of $3.41 per share on capital stock outstanding during the third quarter of 2016. In addition, on October 27, 2016, FHLB announced a cash dividend for the third quarter of 2016 at an annualized dividend rate of 8.94%. Both dividends will be distributed in mid November 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 conversion rate of 1.6483, as of the latest SEC Form 10-Q filed by Visa, Inc. on July 25, 2016, and the closing stock price of Class A shares, the value of our shares of Class B common stock would have been $2.3 million at September 30, 2016 and $2.2 million at December 31, 2015. The conversion

Page-16



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 $2.5 million and $2.7 million recorded in other assets on the consolidated statements of condition at September 30, 2016 and December 31, 2015, respectively. In the first nine months of 2016, we recognized $223 thousand of low income housing tax credits and other tax benefits, net of $177 thousand of amortization expense of low income housing tax credit investment, as a component of income tax expense. As of September 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 nine months of 2016 or 2015.

Note 5:  Loans and Allowance for Loan Losses

Credit Quality of Loans
 
Outstanding loans by class and payment aging as of September 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

September 30, 2016
 

 

 

 

 

 

 

 

 30-59 days past due
$
2

$
135

$

$

$
90

$

$
83

$
310

 60-89 days past due








 90 days or more past due
44

176



99



319

Total past due
46

311



189


83

629

Current
221,161

237,227

715,051

80,491

111,022

77,769

24,313

1,467,034

Total loans 3
$
221,207

$
237,538

$
715,051

$
80,491

$
111,211

$
77,769

$
24,396

$
1,467,663

Non-accrual 2
$
44

$
176

$

$

$
260

$

$
60

$
540

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 September 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 loans more than ninety days past due at September 30, 2016 or December 31, 2015.
3 Amounts include net deferred loan costs of $869 thousand and $768 thousand at September 30, 2016 and December 31, 2015, respectively. Amounts are also net of unaccreted purchase discounts on non-PCI loans of $1.9 million and $3.2 million at September 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

Page-17



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 experienced a 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, 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. 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.

Page-18



Home equity and other consumer loans are reviewed based on delinquency.
Loans graded “Watch” or more severe, regardless of loan type, are reviewed no less than quarterly.

The following table represents an analysis of loans by internally assigned grades, including the PCI loans, at September 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

September 30, 2016
 
 
 
 
 
 
 
 
 
Pass
$
203,784

$
224,502

$
711,192

$
77,253

$
108,908

$
77,769

$
23,976

$
2,874

$
1,430,258

Special Mention
8,859

4,478

356


1,120




14,813

Substandard
8,524

7,505

1,793

3,238

1,112


420


22,592

Total loans
$
221,167

$
236,485

$
713,341

$
80,491

$
111,140

$
77,769

$
24,396

$
2,874

$
1,467,663

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 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 2016. During the first nine months of 2015, four loans with a recorded investment totaling $1.4 million were removed from TDR designation as they met our criteria outlined above.
 

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The table below summarizes outstanding TDR loans by loan class as of September 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
September 30, 2016

December 31, 2015

Commercial and industrial
$
2,964

$
4,698

Commercial real estate, owner-occupied
6,993

6,993

Commercial real estate, investor
2,299

514

Construction 2
3,238

3,238

Home equity
696

460

Other residential
1,974

2,010

Installment and other consumer
1,024

1,168

Total
$
19,188

$
19,081

1 Includes $19.1 million and $19.0 million of TDR loans that were accruing interest as of September 30, 2016 and December 31, 2015, respectively. Includes no acquired loans at September 30, 2016 and $137 thousand of acquired loans at December 31, 2015.
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.

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 September 30, 2016:
 
 
 

None

$

$

$










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

 

 



Commercial and industrial
1

$
700

$
700

$
700

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

 
 
 
 
 
Troubled Debt Restructurings during the nine months ended September 30, 2015:
 

 

 

 
Commercial and industrial
5

$
1,482

$
1,582

$
1,463

Commercial real estate, investor
1

222

221

217

Total
6

$
1,704

$
1,803

$
1,680

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

Modifications during the nine months ended September 30, 2016 primarily involved interest rate concessions, renewals, and other changes to loan terms. Modifications during the nine months ended September 30, 2015 primarily involved maturity extensions and other changes to loan terms. During the first nine 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

September 30, 2016
 

 

 

 

 

 

 

Recorded investment in impaired loans:
 
 
 
 
 
 
With no specific allowance recorded