form10-q.htm


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

FORM 10-Q

(Mark One)

T
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2009

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

Not Applicable
 
(Former name or former address, if changes since last report)

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, and (2) has been subject to such filing requirements for the past 90 days.
Yes  T          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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes  o          No  T

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 T      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  T

As of July 31, 2009 there were 5,216,868 shares of common stock outstanding.
 


 
Page - 1

 

TABLE OF CONTENTS


PART  I
FINANCIAL INFORMATION
 
     
Item 1
 
 
4
 
5
 
7
 
8
 
9
     
Item 2
21
     
Item 3
36
     
Item 4
36
     
PART II
OTHER INFORMATION
 
     
Item 1
37
     
Item 1A
37
     
Item 2
37
     
Item 3
37
     
Item 4
38
     
Item 5
38
     
Item 6
38
     
40
   
41

 
Page - 2





PART I FINANCIAL INFORMATION

Item 1.  Financial Statements




 
Page - 3


BANK OF MARIN BANCORP
CONSOLIDATED STATEMENT OF CONDITION
at June 30, 2009 and December 31, 2008
 
(in thousands, except share data; June 30, 2009 unaudited)
 
June 30, 2009
   
December 31, 2008
 
             
Assets
           
Cash and due from banks
  $ 46,376     $ 24,926  
Fed funds sold
    300       ---  
Cash and cash equivalents
    46,676       24,926  
                 
Investment securities
               
Held to maturity, at amortized cost
    30,655       23,558  
Available for sale (at fair market value, amortized cost $75,012 and $79,284 at June 30, 2009 and December 31, 2008, respectively)
    76,365       79,952  
Total investment securities
    107,020       103,510  
                 
Loans, net of allowance for loan losses of $10,135 and $9,950 at June 30, 2009 and December 31, 2008, respectively
    899,479       880,594  
Bank premises and equipment, net
    7,883       8,292  
Interest receivable and other assets
    33,301       32,235  
                 
Total assets
  $ 1,094,359     $ 1,049,557  
                 
Liabilities and Stockholders' Equity
               
                 
Liabilities
               
Deposits
               
Non-interest bearing
  $ 237,571     $ 201,363  
Interest bearing
               
Transaction accounts
    88,353       82,223  
Savings and money market
    437,713       440,496  
CDARS® reciprocal time
    60,234       42,892  
Other time
    98,734       85,316  
Total deposits
    922,605       852,290  
                 
Federal funds purchased and Federal Home Loan Bank borrowings
    55,000       56,800  
Subordinated debenture
    5,000       5,000  
Interest payable and other liabilities
    8,167       9,921  
                 
Total liabilities
    990,772       924,011  
                 
Stockholders' Equity
               
Preferred stock, no par value, $1,000 per share liquidation preference; Authorized - 5,000,000 shares; Issued and outstanding - none and 28,000 shares at June 30, 2009 and December 31, 2008, respectively
    ---       27,055  
Common stock, no par value
               
Authorized - 15,000,000 shares
               
Issued and outstanding - 5,205,538 and 5,146,798 at June 30, 2009 and December 31, 2008, respectively
    53,047       51,965  
Retained earnings
    49,755       46,138  
Accumulated other comprehensive income, net
    785       388  
                 
Total stockholders' equity
    103,587       125,546  
                 
Total liabilities and stockholders' equity
  $ 1,094,359     $ 1,049,557  

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

 
Page - 4


BANK OF MARIN BANCORP
CONSOLIDATED STATEMENT OF OPERATIONS
for the six months ended June 30, 2009 and 2008
 
(in thousands, except per share amounts; unaudited)
 
June 30, 2009
   
June 30, 2008
 
             
Interest income
           
Interest and fees on loans
  $ 27,085     $ 26,712  
Interest on investment securities
               
Securities of U.S. Government agencies
    1,677       1,749  
Obligations of state and political subdivisions (tax exempt)
    533       344  
Corporate debt securities and other
    116       167  
Interest on Federal funds sold
    3       113  
Total interest income
    29,414       29,085  
                 
Interest expense
               
Interest on interest bearing transaction accounts
    55       184  
Interest on savings and money market deposits
    1,607       3,774  
Interest on CDARS® reciprocal time deposits
    364       5  
Interest on other time deposits
    810       1,400  
Interest on borrowed funds
    737       523  
Total interest expense
    3,573       5,886  
                 
Net interest income
    25,841       23,199  
Provision for loan losses
    1,885       1,125  
Net interest income after provision for loan losses
    23,956       22,074  
                 
Non-interest income
               
Service charges on deposit accounts
    867       836  
Wealth Management Services
    667       646  
Net gain on redemption of shares in Visa, Inc.
    ---       457  
Other income
    976       1,042  
Total non-interest income
    2,510       2,981  
                 
Non-interest expense
               
Salaries and related benefits
    8,764       8,193  
Occupancy and equipment
    1,619       1,561  
Depreciation and amortization
    686       645  
FDIC insurance
    1,149       235  
Data processing
    773       875  
Professional services
    818       825  
Other expense
    2,348       1,807  
Total non-interest expense
    16,157       14,141  
Income before provision for income taxes
    10,309       10,914  
                 
Provision for income taxes
    3,947       4,252  
Net income
  $ 6,362     $ 6,662  
                 
Preferred stock dividends and accretion
  $ (1,299 )   $ ---  
Net income available to common stockholders
  $ 5,063     $ 6,662  
                 
Net income per common share:
               
Basic
  $ 0.98     $ 1.30  
Diluted
  $ 0.97     $ 1.27  
                 
Weighted average shares used to compute net income per common share:
               
Basic
    5,155       5,137  
Diluted
    5,199       5,232  
                 
Dividends declared per common share
  $ 0.28     $ 0.28  

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

 
Page - 5


BANK OF MARIN BANCORP
CONSOLIDATED STATEMENT OF OPERATIONS
for the three months ended June 30, 2009, March 31, 2009 and June 30, 2008
 
(in thousands, except per share amounts; unaudited)
 
June 30, 2009
   
March 31, 2009
   
June 30, 2008
 
                   
Interest income
                 
Interest and fees on loans
  $ 13,623     $ 13,462     $ 13,400  
Interest on investment securities
                       
Securities of U.S. Government agencies
    809       868       882  
Obligations of state and political subdivisions (tax exempt)
    287       246       183  
Corporate debt securities and other
    115       1       78  
Interest on Federal funds sold
    3       ---       1  
Total interest income
    14,837       14,577       14,544  
                         
Interest expense
                       
Interest on interest bearing transaction accounts
    31       24       96  
Interest on savings and money market deposits
    817       790       1,583  
Interest on CDARS® reciprocal time deposits
    183       181       4  
Interest on other time deposits
    397       413       650  
Interest on borrowed funds
    376       361       302  
Total interest expense
    1,804       1,769       2,635  
                         
Net interest income
    13,033       12,808       11,909  
Provision for loan losses
    700       1,185       510  
Net interest income after provision for loan losses
    12,333       11,623       11,399  
                         
Non-interest income
                       
Service charges on deposit accounts
    432       435       430  
Wealth Management Services
    351       316       310  
Other income
    490       486       539  
Total non-interest income
    1,273       1,237       1,279  
                         
Non-interest expense
                       
Salaries and related benefits
    4,418       4,346       4,035  
Occupancy and equipment
    842       777       793  
Depreciation and amortization
    336       350       327  
FDIC insurance
    832       317       112  
Data processing
    392       381       430  
Professional services
    395       423       419  
Other expense
    1,385       963       1,024  
Total non-interest expense
    8,600       7,557       7,140  
Income before provision for income taxes
    5,006       5,303       5,538  
                         
Provision for income taxes
    1,873       2,074       2,152  
Net income
  $ 3,133     $ 3,229     $ 3,386  
                         
Preferred stock dividends and accretion
  $ ---     $ (1,299 )   $ ---  
Net income available to common stockholders
  $ 3,133     $ 1,930     $ 3,386  
                         
Net income per common share:
                       
Basic
  $ 0.61     $ 0.38     $ 0.66  
Diluted
  $ 0.60     $ 0.37     $ 0.65  
                         
Weighted average shares used to compute net income per common share:
                       
Basic
    5,164       5,146       5,139  
Diluted
    5,214       5,184       5,226  
                         
Dividends declared per common share
  $ 0.14     $ 0.14     $ 0.14  

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

 
Page - 6


BANK OF MARIN BANCORP
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
for the year ended December 31, 2008 and the six months ended June 30, 2009
 
                     
Accumulated Other
       
                           
Comprehensive
       
     Preferred    
Common Stock
   
Retained
   
Income (Loss),
       
(dollars in thousands; activities in 2009 unaudited )
 
 Stock
   
Shares
   
Amount
   
Earnings
   
Net of Taxes
   
Total
 
Balance at December 31, 2007
    ---       5,122,971     $ 51,059     $ 36,983     $ (268 )   $ 87,774  
Comprehensive income:
                                               
Net income
    ---       ---       ---       12,150       ---       12,150  
Other comprehensive income
                                               
Net change in unrealized gain (loss) on available for sale securities (net of tax effect of $475)
    ---       ---       ---       ---       656       656  
Comprehensive income
    ---       ---       ---       12,150       656       12,806  
Issuance of preferred stock
    27,039       ---       ---       ---       ---       27,039  
Issuance of common stock warrant
    ---       ---       961       ---       ---       961  
Stock options exercised
    ---       95,298       1,384       ---       ---       1,384  
Excess tax benefit - stock-based compensation
    ---       ---       380       ---       ---       380  
Common stock repurchased, including commission costs
    ---       (88,316 )     (2,526 )     ---       ---       (2,526 )
Stock issued under employee stock purchase plan
    ---       1,253       32       ---       ---       32  
Stock-based compensation - stock options
    ---       ---       404       ---       ---       404  
Restricted stock granted
    ---       6,700       ---       ---       ---       ---  
Stock-based compensation - restricted stock
    ---       ---       24       ---       ---       24  
Cash dividends paid on common stock
    ---       ---       ---       (2,882 )     ---       (2,882 )
Dividends on preferred stock
    ---       ---       ---       (97 )     ---       (97 )
Accretion of preferred stock
    16       ---       ---       (16 )     ---       ---  
Stock issued in payment of director fees
    ---       8,892       247       ---       ---       247  
Balance at December 31, 2008
    27,055       5,146,798       51,965       46,138       388       125,546  
Net income
    ---       ---       ---       6,362       ---       6,362  
Other comprehensive income
                                               
Net change in unrealized gain on available for sale securities (net of tax effect of $288)
    ---       ---       ---       ---       397       397  
Comprehensive income
    ---       ---       ---       6,362       397       6,759  
Accretion of preferred stock
    945       ---       ---       (945 )     ---       ---  
Repurchase of preferred stock
    (28,000 )     ---       ---       ---       ---       (28,000 )
Stock options exercised
    ---       41,460       530       ---       ---       530  
Excess tax benefit - stock-based compensation
    ---       ---       220       ---       ---       220  
Stock issued under employee stock purchase plan
    ---       501       11       ---       ---       11  
Restricted stock granted
    ---       11,575       ---       ---       ---       ---  
Stock-based compensation - stock options
    ---       ---       167       ---       ---       167  
Stock-based compensation - restricted stock
    ---       ---       31       ---       ---       31  
Cash dividends paid on common stock
    ---       ---       ---       (1,446 )     ---       (1,446 )
Dividends on preferred stock
    ---       ---       ---       (354 )     ---       (354 )
Stock issued in payment of director fees
    ---       5,204       123       ---       ---       123  
Balance at June 30, 2009
    ---       5,205,538     $ 53,047     $ 49,755     $ 785     $ 103,587  

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

 
Page - 7


BANK OF MARIN BANCORP
CONSOLIDATED STATEMENT OF CASH FLOWS
for the six months ended June 30, 2009 and 2008
 
(in thousands, unaudited)
 
June 30, 2009
   
June 30, 2008
 
             
Cash Flows from Operating Activities:
           
Net income
  $ 6,362     $ 6,662  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
    1,885       1,125  
Compensation payable in common stock for director fees
    110       140  
Stock-based compensation expense
    198       228  
Excess tax benefits from exercised stock options
    (122 )     (59 )
Amortization and accretion of investment security premiums, net
    220       135  
Loss on sale of investment securities
    19       2  
Depreciation and amortization
    686       645  
Net gain on redemption of shares in Visa, Inc.
    ---       (457 )
Loss on disposal of premises and equipment
    ---       14  
Net change in operating assets and liabilities:
               
Interest receivable
    106       199  
Interest payable
    58       3  
Deferred rent and other rent-related expenses
    125       79  
Other assets
    (1,459 )     2,872  
Other liabilities
    98       472  
Total adjustments
    1,924       5,398  
Net cash provided by operating activities
    8,286       12,060  
                 
Cash Flows from Investing Activities:
               
Purchase of securities held-to-maturity
    (8,438 )     (8,135 )
Purchase of securities available-for-sale
    (19,394 )     (40,607 )
Proceeds from sale of securities
    1,065       21,489  
Proceeds from paydowns/maturity of:
               
Securities held-to-maturity
    200       765  
Securities available-for-sale
    23,502       34,388  
Loans originated and principal collected, net
    (22,475 )     (74,808 )
Additions to premises and equipment
    (277 )     (1,473 )
Net cash used in investing activities
    (25,817 )     (68,381 )
                 
Cash Flows from Financing Activities:
               
Net increase (decrease) in deposits
    70,315       (33,422 )
Proceeds from stock options exercised
    530       901  
Net (decrease) increase  in Federal Funds purchased and Federal Home Loan Bank borrowings
    (1,800 )     46,800  
Preferred stock repurchased
    (28,000 )     ---  
Common stock repurchased
    ---       (1,701 )
Cash dividends paid on common stock
    (1,446 )     (1,442 )
Cash dividends paid on preferred stock
    (451 )     ---  
Stock issued under employee stock purchase plan
    11       16  
Excess tax benefits from exercised stock options
    122       59  
Net cash provided by financing activities
    39,281       11,211  
                 
Net increase (decrease) in cash and cash equivalents
    21,750       (45,110 )
Cash and cash equivalents at beginning of period
    24,926       76,265  
                 
Cash and cash equivalents at end of period
  $ 46,676     $ 31,155  

Non-Cash Transactions: The six months ended June 30, 2009 reflects non-cash financing items of $123 thousand for stock issued to pay director fees and $945 thousand for accretion of preferred stock. The six months ended June 30, 2008 reflects a non-cash financing item of $117 thousand for stock issued to pay director fees.

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

 
Page - 8


BANK OF MARIN BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Introductory Explanation

References in this report to “Bancorp” mean the Bank of Marin Bancorp as the parent holding company for Bank of Marin, the wholly-owned subsidiary (the “Bank”). References to “we,” “our,” “us” mean the holding company and the Bank that are consolidated for financial reporting purposes.

Note 1:  Basis of Presentation

The consolidated financial statements include the accounts of Bancorp and its only wholly-owned bank subsidiary, the Bank. All material intercompany transactions have been eliminated. In the opinion of Management, the unaudited interim consolidated financial statements contain all adjustments necessary to present fairly our financial position, results of operations, changes in stockholders' equity and cash flows. All adjustments are of a normal, recurring nature. Management has evaluated subsequent events for potential recognition and/or disclosure through the issuance date of this Form 10-Q, and has determined that there were no subsequent events that require recognition or disclosure.

Certain information and footnote disclosures presented in the annual financial statements are not included in the interim consolidated financial statements.  Accordingly, the accompanying unaudited interim consolidated financial statements should be read in conjunction with our 2008 Annual Report on Form 10-K.  The results of operations for the six months ended June 30, 2009 are not necessarily indicative of the operating results for the full year.

The following table shows: 1) weighted average basic shares, 2) potential common shares related to stock options, non-vested restricted stock and stock warrant, and 3) weighted average diluted shares. Net income available to common stockholders is calculated as net income reduced by dividends accumulated on preferred stock and amortization of discounts on the preferred stock. Basic earnings per share (“EPS”) are calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during each period.  The number of potential common shares included in quarterly diluted EPS is computed using the average market prices during the three months included in the reporting period. For year-to-date diluted EPS, the number of potential common shares included in the denominator is determined by computing a year-to-date weighted average of the number of potential common shares included in each quarterly diluted EPS computation. Our calculation of weighted average shares includes two classes of our outstanding common stock: common stock and unvested restricted stock awards. Holders of restricted stock awards receive non-forfeitable dividends at the same rate as common stockholders and they both share equally in undistributed earnings.

 
Page - 9


BANK OF MARIN BANCORP

   
Three months ended
   
Six months ended
 
(in thousands, except per share data; unaudited)
 
June 30, 2009
   
March 31, 2009
   
June 30, 2008
   
June 30, 2009
   
June 30, 2008
 
Weighted average basic shares outstanding
    5,164       5,146       5,139       5,155       5,137  
Add:  Potential common shares related to stock options
     49        38        87        43        95  
         Potential common shares related to nonvested restricted stock
    1       ---       ---       1       ---  
Weighted average diluted shares outstanding
    5,214       5,184       5,226       5,199       5,232  
                                         
Net income
  $ 3,133     $ 3,229     $ 3,386     $ 6,362     $ 6,662  
Preferred stock dividends and accretion
    ---       (1,299 )     ---       (1,299 )     ---  
Net income available to common stockholders
  $ 3,133     $ 1,930     $ 3,386     $ 5,063     $ 6,662  
                                         
Basic EPS
  $ 0.61     $ 0.38     $ 0.66     $ 0.98     $ 1.30  
Diluted EPS
  $ 0.60     $ 0.37     $ 0.65     $ 0.97     $ 1.27  
                                         
Weighted average anti-dilutive shares not included in the calculation of diluted EPS
                                       
Stock options
    299       283       236       290       227  
Nonvested restricted stock
    5       7       ---       17       ---  
Warrants
    154       154       ---       154       ---  
Total anti-dilutive shares
    458       444       236       461       227  

Note 2: Recently Issued Accounting Standards

In June 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 168, The FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted Accounting Principles (“SFAS No. 168”). SFAS No. 168 establishes the FASB Accounting Standards CodificationTM (the “Codification” or “ASC”) to become the source of authoritative U.S. generally accepted accounting principles (“U.S. GAAP”) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also included in the Codification as sources of authoritative U.S. GAAP for SEC registrants. SFAS No. 168 and the Codification are effective for financial statements issued for interim and annual periods ending after September 15, 2009.  When effective, the Codification will supersede all existing non-SEC accounting and reporting standards. Following Statement 168, the FASB will not issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts. Instead, the FASB will issue Accounting Standards Updates, which will serve only to: (a) update the Codification; (b) provide background information about the guidance; and (c) provide the bases for conclusions on the change(s) in the Codification. We will follow the guidelines in the Codification beginning July 1, 2009.

In May 2009, the FASB issued FASB Statement No. 165, Subsequent Events (“SFAS No. 165”, ASC 855), which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, it sets forth: a) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; b) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and c) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. We have adopted SFAS No. 165 in the quarter ended June 30, 2009 and the adoption of SFAS No. 165 did not have a significant impact on our financial condition or results of operations.

On April 9, 2009, FASB issued three FASB Staff Positions (“FSP”) intended to provide additional application guidance and enhance disclosures regarding fair value measurements and impairments of securities:

1. FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (ASC 825-10-50), amends FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments (“SFAS No. 107”), to require an entity to provide quantitative and qualitative disclosures about fair value of any financial instruments for interim reporting periods as well as in annual financial statements. Prior to issuing this FSP, fair values for these assets and liabilities were only disclosed annually. This FSP also amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods. We have adopted FSP 107-1 and APB 28-1 in the quarter ended June 30, 2009 and the adoption did not have a significant impact on our financial condition or results of operations. See Note 3 below for further information.

 
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BANK OF MARIN BANCORP
 
2. FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (ASC 320-10-35), is intended to bring greater consistency to the timing of impairment recognition, and provide greater clarity to investors about the credit and non-credit components of impaired debt securities that are not expected to be sold. Further, it replaces the existing requirement that the entity’s management assert it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert: (a) it does not have the intent to sell the security; and (b) it is more likely than not it will not have to sell the security before recovery of its cost basis. The FSP also requires increased and more timely disclosures sought by investors regarding expected cash flows, credit losses, and an aging of securities with unrealized losses. When adopting FSP FAS 115-2 and FAS 124-2, an entity is required to record a cumulative-effect adjustment as of the beginning of the period of adoption to reclassify the non-credit component of a previously recognized other-than-temporary impairment from retained earnings to accumulated other comprehensive income if the entity does not intend to sell the security and it is more likely than not that the entity will not be required to sell the security before recovery. We have adopted FSP FAS 115-2 and FAS 124-2 FSP for the quarter ended June 30, 2009 and the adoption did not have a significant impact on our financial condition or results of operations. See Note 4 for further information.
 
3. FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (ASC 820-10-35-15A), reaffirms the objective of fair value measurement stated in FASB Statement No. 157, Fair Value Measurements (“SFAS No. 157”) — to reflect how much an asset would be sold for in an orderly transaction (as opposed to a distressed or forced transaction) at the date of the financial statements under current market conditions. Specifically, it reaffirms the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets have become inactive. It also requires an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence. Adoption of FSP FAS 157-4 did not have a significant 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 recorded at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1: Valuations are based on quoted prices in active markets for identical assets or liabilities. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

Level 2: Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data.

Level 3: Valuations are based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Values are determined using pricing models and discounted cash flow models and include management judgment and estimation which may be significant.

The following table summarizes our assets and liabilities that were required to be recorded at fair value on a recurring basis at June 30, 2009. All of our assets or liabilities recorded at fair value on a recurring basis were valued using Level 2 inputs as of June 30, 2009.

 
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BANK OF MARIN BANCORP

(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)
 
Balance at June 30, 2009 (unaudited):
                       
Securities available for sale
  $ 76,365     $ ---     $ 76,365     $ ---  
                                 
Derivative financial assets
  $ 38     $ ---     $ 38     $ ---  
                                 
Derivative financial liabilities
  $ 1,853     $ ---     $ 1,853     $ ---  
                                 
Balance at December 31, 2008:
                               
Securities available for sale
  $ 79,952     $ ---     $ 79,952     $ ---  
                                 
Derivative financial liabilities
  $ 3,456     $ ---     $ 3,456     $ ---  

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, and credit spreads (Level 2).  Level 1 securities include those traded on active markets, including U.S. Treasury securities.  Level 2 securities include U.S. agencies’ debt securities, mortgage-backed securities and corporate collateralized mortgage obligations.

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 quality in determining the fair value of the derivatives. Level 2 inputs for the valuations are limited to observable market prices for London Interbank Offered Rate (“LIBOR”) cash rates (for the very short term), quoted prices for LIBOR futures contracts, observable market prices for LIBOR 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.  Key inputs for interest rate valuations are used to project spot rates at resets specified by each swap, as well as to discount those future cash flows to present value at the measurement date.  When the value of any collateral placed with counterparties is less than the interest rate derivative liability, the interest rate liability position is further discounted to reflect our potential credit risk to counterparties.  We have used the spread over LIBOR on the Federal Home Loan Bank San Francisco (“FHLB”) fixed-rate credit advance corresponding to the duration of the swaps to calculate this credit-risk-related discount of future cash flows.

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. For example, 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), the present value of expected future cash flows discounted at the loan’s original effective interest rate (Level 2), or the current appraised value of the underlying collateral securing the loan if the loan is collateral dependent (Level 3).  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.

The following table presents the carrying value of financial instruments by level within the fair value hierarchy as of June 30, 2009, for which a non-recurring change in fair value has been recorded.

 
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BANK OF MARIN BANCORP

   
At June 30, 2009
             
(in thousands; unaudited)
Description of Financial Instruments
 
Carrying Value
   
Quoted Prices in Active Markets for Identical Assets (Level 1)
   
Significant Other Observable Inputs (Level 2) (a)
   
Significant Unobservable Inputs (Level 3) (b)
   
Losses for the three months ended June 30, 2009 (c)
   
Losses for the six months ended June 30, 2009 (c)
 
Loans carried at fair value
  $ 4,417     $ ---     $ 326     $ 4,091     $ 1,003     $ 1,955  

(a) Represents impaired loan principal balances net of specific valuation allowance of $32 thousand, determined using the discounted cash flow method.
(b) Represents collateral-dependent loan principal balances that had been written down to the appraised value of the underlying collateral. The carrying value of loans fully charged-off, which includes unsecured lines of credit, overdrafts and all other loans, is zero.
(c) Represents charge-offs during the period presented and the specific valuation allowance established on loans during the period.

Disclosures about Fair Value of Financial Instruments

The table below is a summary of fair value estimates for financial instruments as of June 30, 2009 and December 31, 2008, excluding financial instruments recorded at fair value on a recurring basis (summarized in a separate table). The carrying amounts in the following table are recorded in the statement of condition under the indicated captions. We have not included assets and liabilities that are not defined as financial instruments under U.S. GAAP, 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, such as Bank-owned life insurance policies.

   
June 30, 2009
   
December 31, 2008
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
(in thousands; 2009 amounts unaudited)
 
Amounts
   
Value
   
Amounts
   
Value
 
Financial assets
                       
Cash and cash equivalents
  $ 46,676     $ 46,676     $ 24,926     $ 24,926  
Investment securities held to maturity
    30,655       30,375       23,558       23,135  
Loans, net
    899,479       891,165       880,594       896,628  
Interest receivable
    3,975       3,975       4,081       4,081  
Financial liabilities
                               
Deposits
    922,605       923,717       852,290       853,187  
Federal funds purchased overnight and Federal Home Loan Bank short-term borrowings
    ---       ---       21,800       21,800  
Federal Home Loan Bank long-term borrowings
    55,000       52,919       35,000       34,137  
Subordinated debenture
    5,000       5,000       5,000       5,000  
Interest payable
    976       976       918       918  

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 & political subdivisions, 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 June 30, 2009, we did not hold any securities whose fair value were 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 credit ratings and similar remaining maturities.

 
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BANK OF MARIN BANCORP

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

Deposits - The fair value of non-interest bearing deposits, interest bearing 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 Funds Purchased Overnight and Federal Home Loan Bank Short-term Borrowings - The balance represents its fair value as these borrowings settle overnight.

Federal Home Loan Bank Long-term Borrowings - 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 duration of our fixed-rate credit advances.

Subordinated Debenture - The carrying amount approximates its fair value as it has a variable interest rate indexed to the three-month LIBOR.

Commitments - Loan commitments and standby letters of credit generate ongoing fees, which are recognized over the term of the commitment period. In situations where the borrower's credit quality has declined, we record a reserve for these off-balance sheet commitments. Given the uncertainty in the likelihood and timing of a commitment being drawn upon, a reasonable estimate of the fair value of these commitments is the carrying value of the related unamortized loan fees plus the reserve, which is not material.

Note 4:  Investment Securities

Our investment securities portfolio at June 30, 2009 consists primarily of U.S. government agency securities, including mortgage-backed securities (“MBS”) and collateralized mortgage obligations (“CMOs”) issued or guaranteed by FNMA, FHLMC, or GNMA. Our portfolio also includes obligations of state and political subdivisions, debentures issued by government-sponsored agencies including FHLB, Federal Farm Credit Bank and FNMA, as well as corporate CMOs, as reflected in the table below.

   
June 30, 2009
   
December 31, 2008
 
   
Amortized
   
Fair
   
Gross Unrealized
   
Amortized
   
Fair
   
Gross Unrealized
 
(in thousands; June 30, 2009 unaudited)
 
Cost
   
Value
   
Gains
   
(Losses)
   
Cost
   
Value
   
Gains
   
(Losses)
 
Held to maturity
                                               
Obligations of state and political subdivisions
  $ 30,655     $ 30,375     $ 468     $ (748 )   $ 23,558     $ 23,135     $ 373     $ (796 )
                                                                 
Available for sale
                                                               
Securities of U. S. government agencies:
                                                               
MBS pass-through securities issued by FNMA and FHLMC
    9,670       9,845       189       (14 )     8,135       8,249       114       ---  
CMOs issued by FNMA
    18,519       18,939       420       ---       15,289       15,468       183       (4 )
CMOs issued by FHLMC
    20,261       20,702       441       ---       24,308       24,452       165       (21 )
CMOs issued by GNMA
    14,761       15,049       304       (16 )     13,160       13,341       219       (38 )
Debentures of government sponsored agencies
    5,000       5,062       74       (12 )     17,000       17,072       116       (44 )
Corporate CMOs
    6,801       6,768       2       (35 )     1,392       1,370       ---       (22 )
Total available for sale
    75,012       76,365       1,430       (77 )     79,284       79,952       797       (129 )
                                                                 
Total investment securities
  $ 105,667     $ 106,740     $ 1,898     $ (825 )   $ 102,842     $ 103,087     $ 1,170     $ (925 )

The amortized cost and fair value of investment securities at June 30, 2009 by contractual maturity 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.

 
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BANK OF MARIN BANCORP

   
June 30, 2009
 
   
Held to Maturity
   
Available for Sale
 
(in thousands; unaudited)
 
Amortized Cost
   
Fair Value
   
Amortized Cost
   
Fair Value
 
After one but within five years
  $ 4,391     $ 4,531     $ 2,000     $ 2,075  
After five years through ten years
    10,882       10,977       12,745       13,025  
After ten years
    15,382       14,867       60,267       61,265  
Total
  $ 30,655     $ 30,375     $ 75,012     $ 76,365  

Investment securities carried at $29.2 million and $28.4 million were pledged at June 30, 2009 and December 31, 2008, respectively. In June 2009, four held-to-maturity securities issued by the same issuer with a combined carrying value of $1.1 million were sold due to evidence of significant deterioration of creditworthiness.  The proceeds from the sale totaled $1.1 million and the transaction resulted in a loss of $19 thousand recorded in earnings.
 
Other-Than-Temporarily Impaired Debt Securities

For each security in an unrealized loss position, we assess whether we intend to sell the security, or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, we separate the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is calculated as the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is deemed to be due to factors that are not credit related and is recognized in other comprehensive income.

We do not have the intent to sell the securities that are temporarily impaired, and it is more likely than not that we will not have to sell those securities before recovery of the cost basis. Additionally, we have evaluated the credit ratings of our investment securities and their issuers and/or insurers, if applicable. Based on our evaluation, Management has determined that no investment security in our investment portfolio is other-than-temporarily impaired.

Thirty-four and thirty-seven investment securities were in unrealized loss positions at June 30, 2009 and December 31, 2008, respectively. They are summarized and classified according to the duration of the loss period as follows:
                   
June 30, 2009
 
< 12 continuous months
   
> 12 continuous months
   
Total Securities in a loss position
 
(In thousands; unaudited)
 
Fair value
   
Unrealized loss
   
Fair value
   
Unrealized loss
   
Fair value
   
Unrealized loss
 
Held-to-maturity
                                   
Obligations of state & political subdivisions
  $ 14,514     $ (321 )   $ 2,674     $ (427 )   $ 17,188     $ (748 )
                                                 
Available for sale
                                               
Securities of U. S. Government Agencies
    7,126       (42 )     ---       ---       7,126       (42 )
Corporate CMOs
    6,205       (34 )     103       (1 )     6,308       (35 )
Total available for sale
    13,331       (76 )     103       (1 )     13,434       (77 )
Total temporarily impaired securities
  $ 27,845     $ (397 )   $ 2,777     $ (428 )   $ 30,622     $ (825 )
                                                 
December 31, 2008
 
< 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 & political subdivisions
  $ 10,449     $ (430 )   $ 1,819     $ (366 )   $ 12,268     $ (796 )
                                                 
Available for sale
                                               
Securities of U. S. Government Agencies
    23,369       (107 )     ---       ---       23,369       (107 )
Corporate CMOs
    643       (15 )     727       (7 )     1,370       (22 )
Total available for sale
    24,012       (122 )     727       (7 )     24,739       (129 )
Total temporarily impaired securities
  $ 34,461     $ (552 )   $ 2,546     $ (373 )   $ 37,007     $ (925 )

 
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BANK OF MARIN BANCORP

The unrealized losses associated with debt securities of U.S. government agencies are primarily driven by changes in interest rates and not due to the credit quality of the securities. Further, securities backed by GNMA, FNMA, or FHLMC have the guarantee of the full faith and credit of the U.S. Government. Obligations of U.S. states and political subdivisions in our portfolio are all investment grade without delinquency history. The majority of the unrealized loss amount of the obligations of state and political subdivisions relates to one debenture with payments collected through property tax assessments in an affluent community.  These securities will continue to be monitored as part of our ongoing impairment analysis, but are expected to perform. As a result, we concluded that these securities were not other-than-temporarily impaired at June 30, 2009.

The unrealized losses associated with corporate CMO’s are primarily related to securities backed by residential mortgages. A majority of these securities were AAA-rated by at least one major rating agency. We estimate loss projections for each security by assessing loans collateralizing the security and determining expected default rates and loss severities. Based upon our assessment of expected credit losses of each security given the performance of the underlying collateral and credit enhancements where applicable, we concluded that these securities were not other-than-temporarily impaired at June 30, 2009.

Securities Carried at Cost

As a member of the FHLB, we are required to maintain a minimum investment in the FHLB capital stock determined by the Board of Directors of the FHLB. The minimum investment requirements can also increase in the event we need to increase our borrowing capacity with the FHLB. We held $4.7 million and $3.9 million of FHLB stock recorded at cost in other assets at June 30, 2009 and December 31, 2008, respectively. In January 2009, the FHLB notified us that they temporarily suspended dividend payments on stock in order to build up higher retained earnings and to preserve their capital. On July 30, 2009, the FHLB declared a cash dividend for the second quarter of 2009 at an annualized dividend rate of 0.84%.  Management does not believe that the temporary suspension and/or reduction of dividends on FHLB stock resulted in other-than-temporary-impairment on our investment in FHLB stock, as we expect to be able to redeem this stock at cost.

In addition, as a member bank of Visa Inc., we hold 16,939 shares of Visa Inc. Class B common stock at a zero cost basis.  These shares are restricted from resale until their conversion into Class A (voting) shares on March 25, 2011.

Note 5:  Allowance for Loan Losses and Non Accrual Loans

The allowance for loan losses is maintained at levels considered adequate by Management to provide for probable loan losses inherent in the portfolio. The allowance is based on Management's assessment of various factors affecting the loan portfolio, including problem loans, economic conditions and loan loss experience, and an overall evaluation of the quality of the underlying collateral.

Activity in the allowance for loan losses follows:

   
Three months ended
   
Six months ended
 
(in thousands; unaudited)
 
June 30, 2009
   
March 31, 2009
   
June 30, 2008
   
June 30, 2009
   
June 30, 2008
 
Beginning balance
  $ 10,289     $ 9,950     $ 8,199     $ 9,950     $ 7,575  
Provision for loan loss charged to expense
    700       1,185       510       1,885       1,125  
Loans charged off
    (971 )     (875 )     (156 )     (1,846 )     (158 )
Loan loss recoveries
    117       29       2       146       13  
Ending balance
  $ 10,135     $ 10,289     $ 8,555     $ 10,135     $ 8,555  
                                         
Total loans held in portfolio at end of period, before deducting allowance for loan losses
  $ 909,614     $ 921,559     $ 799,510       909,614     $ 799,510  
                                         
Ratio of allowance for loan losses to loans held in portfolio
    1.11 %     1.12 %     1.07 %     1.11 %     1.07 %
Non-accrual loans at period end
  $ 5,909     $ 7,419     $ 236     $ 5,909     $ 236  
Average recorded investmnet in impaired loans
  $ 7,916     $ 7,782     $ 321     $ 7,855     $ 267  

The gross interest income that would have been recorded had non-accrual loans been current totaled $199 thousand in the quarter ended June 30, 2009, $147 thousand in the quarter ended March 31, 2009, and $6 thousand in the quarter ended June 30, 2008.  We recognized $10 thousand of interest income on non-accrual loans during the quarter and six-month period ended June 30, 2009, as cash payments were received.

 
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BANK OF MARIN BANCORP

Impaired loan balances totaled $6.2 million, $7.6 million and $236 thousand at June 30, 2009, March 31, 2009 and June 30, 2008, respectively, with a specific valuation allowance of $32 thousand, $118 thousand and zero, respectively. The amount of the recorded investment in impaired loans for which there is no related specific valuation allowance for loan losses totaled $5.8 million, $4.7 million and $236 thousand at June 30, 2009, March 31, 2009 and June 30, 2008, respectively. We charged off substantially all of our estimated losses related to specific loans during each time period presented. The charged-off portion of impaired loans outstanding at June 30, 2009 totaled approximately $2.2 million.  These impaired loans were primarily comprised of collateral dependent construction, commercial real estate, and commercial loans.  At June 30, 2009, we had no available commitments to extend credit on impaired loans.  The principal balance on loans whose contractual terms have been restructured in a manner which grants a concession to a borrower experiencing financial difficulties was $251 thousand at June 30, 2009, $199 thousand at March 31, 2009 and zero at June 30, 2008.  These amounts have been included in the impaired loan totals noted above.  All such loans were current in their payments and accruing interest at each period end.

Note 6: Borrowings

Federal Funds Purchased– We have unsecured lines of credit totaling $75.0 million with correspondent banks for overnight borrowings.  In general, interest rates on these lines approximate the Federal funds target rate. At June 30, 2009 and December 31, 2008, we had no overnight borrowings outstanding under these credit facilities.

Federal Home Loan Bank Borrowings – As of June 30, 2009 and December 31, 2008, we had lines of credit with the FHLB totaling $235.0 million and $195.8 million, respectively.  At June 30, 2009 and December 31, 2008, FHLB overnight borrowings totaled zero and $21.8 million, respectively.

On February 5, 2008, we entered into a ten-year borrowing agreement under the same FHLB line of credit for $15.0 million at a fixed rate of 2.07%. Interest-only payments are required every three months until maturity. Although the entire principal is due on February 5, 2018, the FHLB has the unconditional right to accelerate the due date on November 5, 2009 and every three months thereafter (the “put dates”). If the FHLB exercises its right to accelerate the due date, the FHLB will offer replacement funding at the current market rate, subject to certain conditions. We must comply with the put date, but are not required to accept replacement funding.

On December 16, 2008, we entered into a five-year borrowing agreement under the FHLB line of credit for $20.0 million at a fixed rate of 2.54%. Interest-only payments are required every month until maturity.

On January 23, 2009, we entered into a three-year borrowing agreement under the FHLB line of credit for $20.0 million at a fixed rate of 2.29%.  Interest-only payments are required every month until maturity.

At June 30, 2009, $180.0 million was remaining as available for borrowing from the FHLB under a formula based on eligible collateral, mainly a portfolio of loans. The FHLB overnight borrowing and the FHLB line of credit are secured by essentially all of our financial assets, including loans, investment securities, cash and cash equivalents under a blanket lien.

Federal Reserve Line of Credit – We also have a line of credit with the Federal Reserve Bank of San Francisco (“FRB”), collateralized by an agency security. On March 30, 2009, we also pledged a certain residential loan portfolio that increased our borrowing capacity with the FRB.  At June 30, 2009 and December 31, 2008, we have borrowing capacity under this line totaling $31.8 and $2.9 million, respectively, and had no outstanding borrowings with the FRB.

Subordinated Debt – On June 17, 2004 we issued a 15-year, $5.0 million subordinated debenture through a pooled trust preferred program, which matures on June 17, 2019.  We have the right to redeem the debenture, in whole or in part, at the redemption price at principal amounts in multiples of $1.0 million on any interest payment date on or after June 17, 2009.  The interest rate on the debenture changes quarterly and is paid quarterly at the three-month LIBOR plus 2.48%. The rate at June 30, 2009 was 3.09%. The debenture is subordinated to the claims of depositors and our other creditors.

Note 7:  Stockholders' Equity

Preferred Stock

Pursuant to the U.S. Treasury Capital Purchase Program (the “TCPP”), on December 5, 2008, we issued to the U.S. Treasury 28,000 shares of senior preferred stock with a zero par value and a $1,000 per share liquidation preference, along with a warrant to purchase 154,242 shares of common stock at a per share exercise price of $27.23, in exchange for aggregate consideration of $28.0 million.  The proceeds of $28 million were allocated between the preferred stock and the warrant with $27.0 million allocated to preferred stock and $961 thousand allocated to the warrant, based on their relative fair value at the time of issuance. The discount on the preferred stock (i.e., difference between the initial carrying amount and the liquidation amount) was calculated to be amortized over the five-year period preceding the 9% perpetual dividend, using the effective yield method. The preferred stock called for a 5% coupon dividend rate for the first five years and 9% thereafter. The warrant was immediately exercisable and expires 10 years after the issuance date.

 
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BANK OF MARIN BANCORP

Under the American Recovery and Reinvestment Act of 2009, which allows participants in the TCPP to withdraw from the program, we repurchased all 28,000 shares of outstanding preferred stock from the U.S. Treasury at $28 million plus accrued but unpaid dividends of $179 thousand on March 31, 2009. At the time of repurchase, we accelerated the remaining accretion of the preferred stock totaling $945 thousand through retained earnings in accordance with accounting requirements, reducing our net income available to common stockholders.  The warrant to purchase 154,242 shares of our common stock remains outstanding. On June 26, 2009, the Treasury issued guidance on the process banks can use to repurchase warrants under the TCPP. We currently do not intend to repurchase the warrant from the Treasury under these guidelines.

Common Dividends

A summary of cash dividends paid to common stockholders, which are recorded as a reduction of retained earnings, is presented below.

   
Three months ended
   
Six months ended
 
(in thousands, except per share data; unaudited)
 
June 30, 2009
   
March 31, 2009
   
June 30, 2008
   
June 30, 2009
   
June 30, 2008
 
Cash dividends
  $ 724     $ 722     $ 722     $ 1,446     $ 1,442  
Cash dividends per share
  $ 0.14     $ 0.14     $ 0.14     $ 0.28     $ 0.28  

Share-Based Payments

The fair value of stock options on the grant date is recorded as a stock-based compensation expense in the income statement over the requisite service period with a corresponding increase in common stock.  In addition, we record excess tax benefits on the exercise of non-qualified stock options, disqualifying disposition of incentive stock options or vesting of restricted stock as an addition to common stock with a corresponding decrease in current taxes payable.

Stock-based compensation also includes compensation expense related to the issuance of non-vested restricted common shares pursuant to the 2007 Equity Plan.  The grant-date fair value of the restricted common shares, which is equal to its intrinsic value, is recorded as compensation expense over the requisite service period with a corresponding increase in common stock as the shares vest. Any excess tax benefit on the vesting of these shares will also be recorded as increase in common stock and a corresponding decrease in current taxes payable. The holders of the non-vested restricted common shares are entitled to dividends on the same per-share ratio as the holders of common stock. Dividends paid on the portion of share-based awards not expected to vest are also included in stock-based compensation expense. Tax benefits on dividends paid on the portion of share-based awards expected to vest are recorded as increase to common stock with a corresponding decrease in current taxes payable.

Stock-based compensation and tax benefits on exercised options are shown below.

   
Three months ended
   
Six months ended
 
(in thousands; unaudited)
 
June 30, 2009
   
March 31, 2009
   
June 30, 2008
   
June 30, 2009
   
June 30, 2008
 
Stock-based compensation
  $ 102     $ 96     $ 108     $ 198     $ 228  
Excess (deficient) tax benefits on exercised options
  $ 215     $ 5     $ (22 )   $ 220     $ 59  

Note 8:  Commitments and Contingencies

Financial Instruments with Off-Balance Sheet Risk

We make commitments to extend credit in the normal course of business to meet the financing needs of our customers.  These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit.  Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements.

 
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BANK OF MARIN BANCORP

We are exposed to credit loss equal to the contract amount of the commitment in the event of nonperformance by the borrower. We use the same credit policies in making commitments as we do for on-balance-sheet instruments and we evaluate each customer's creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by us, is based on Management's credit evaluation of the borrower.  Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and real property.

The contract amount of loan commitments and standby letters of credit not reflected on the consolidated statement of condition was $250.3 million at June 30, 2009 at rates ranging from 2.25% to 8.25%.  This amount included $139.6 million under commercial lines of credit (these commitments are contingent upon customers maintaining specific credit standards), $74.3 million under revolving home equity lines, $24.2 million under undisbursed construction loans, $4.5 million under standby letters of credit, and a remaining $7.7 million under personal and other lines of credit. We have set aside an allowance for losses in the amount of $501 thousand for these commitments, which is recorded in interest payable and other liabilities.

Operating Leases

We rent certain premises and equipment under long-term non-cancelable operating leases expiring at various dates through the year 2024. Commitments under these leases approximate $1.1 million, $2.4 million, $2.1 million, $2.0 million and $2.0 million for 2009, 2010, 2011, 2012 and 2013, respectively, and $16.8 million for all years thereafter.

Capital Purchase Commitment

In April 2009, after completing a formal bidding process, we contracted with McDevitt & McDevitt Construction Corporation (“MMC”), a construction company managed and owned by a member of the Board of Directors of the Bank and Bancorp. Under the contract, MMC will construct tenant improvements for a new branch office for the total contract amount of $335 thousand. We have paid $18 thousand to MMC under the contract through June 30, 2009.

Litigation and Regulatory Matters

There have been no changes to the disclosure regarding litigation and regulatory matters in Note 13 – Commitments and Contingencies to the Consolidated Financial Statements of the Bancorp’s 2008 Annual Report on Form 10-K.

Note 9:  Derivative Financial Instruments and Hedging Activities

We have entered into interest-rate swap agreements, primarily as an asset/liability management strategy, in order to mitigate the changes in the fair value of specified long-term fixed-rate loans and firm commitments to enter into long-term fixed-rate loans caused by changes in interest rates.  These hedges allow us to offer long-term fixed rate loans to customers without assuming the interest rate risk of a long-term asset by swapping our fixed-rate interest stream for a floating-rate interest stream, generally benchmarked to the one-month U.S. dollar LIBOR index, thus protecting us against changes in the net interest margin otherwise associated with fluctuating interest rates.

The fixed-rate payment features of the interest rate swap agreements are generally structured at inception to mirror all of the provisions of the hedged loan agreements. These interest rate swaps, designated and qualified as fair value hedges, are carried on the balance sheet at their fair value in other assets (when the fair value is positive) or in other liabilities (when the fair value is negative). One of our interest rate swap agreements qualifies for shortcut hedge accounting treatment. The change in fair value of the swap using the shortcut accounting treatment is recorded in other non-interest income, while the change in fair value of swaps using non-shortcut accounting is recorded in interest income.  The unrealized gain or loss in market value of the hedged fixed-rate loan is recorded as an adjustment to the hedged loan and offset in other non-interest income (for shortcut accounting treatment) or interest income (for non-shortcut accounting treatment).

 
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BANK OF MARIN BANCORP

During the third quarter of 2007, a forward swap was designated to offset the change in fair value of a loan originated during the period. The fair value of the related yield maintenance agreement totaling $69 thousand at the date of designation, recorded in other assets, is being amortized to interest income using the effective yield method over the life of the loan.

Our credit exposure, if any, on interest rate swaps is limited to the net favorable value (net of any collateral pledged) and interest payments of all swaps by each counterparty. Conversely, when an interest rate swap is in a liability position exceeding a certain threshold, we are required to post collateral to the counterparty (generally when our derivative liability position is greater than $100 thousand or $1.3 million, depending upon the counterparty, at which time posting of collateral in an amount up to the liability position is required).  Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values. The aggregate fair value of all derivative instruments with collateral requirements that are in a liability position on June 30, 2009 is $1.9 million, for which we have posted collateral in the form of securities available for sale totaling $1.9 million and cash of $1.9 million.

As of June 30, 2009, we had four interest rate swap agreements, which are scheduled to mature in September 2018, April 2019, June 2020 and May 2022.  All of our derivatives are accounted for as fair value hedges under SFAS No. 133. As our interest rate swaps are settled monthly with counterparties, accrued interest on the swaps, if any, is minimal. Information on our derivatives follows:

   
Asset derivatives designated as fair value hedges under SFAS No. 133
   
Liability derivatives designated as fair value hedges under SFAS No. 133
       
(in thousands; June 30, 2009 unaudited)
 
June 30, 2009
   
December 31, 2008
   
June 30, 2009
   
December 31, 2008
       
                               
Interest rate swap notional amount
  $ 1,979     $ ---     $ 17,457     $ 17,833        
Credit risk amount
    38       ---       ---       ---        
Interest rate swap fair value (1)
    38       ---       1,853       3,456        
Balance sheet location
 
Other assets
      ---    
Other liabilites
   
Other liabilites
       
                                       
                   
Three months ended
 
(in thousands; unaudited)
                 
June 30, 2009
   
March 31, 2009
   
June 30, 2008
 
Increase in value of designated interest rate swaps recognized in interest income
          $ 1,259     $ 381     $ 665  
Payment on interest rate swap recorded in interest income
              (214 )     (197 )     (93 )
Decrease in value of hedged loans recognized in interest income
              (1,284 )     (421 )     (663 )
Decrease in value of yield maintenance agreement recognized against interest income
      (6 )     (3 )     (4 )
Net loss on derivatives recognized in interest income (2)
            $ (245 )   $ (240 )   $ (95 )
                                         
                   
Six months ended
         
(in thousands; unaudited)
                 
June 30, 2009
   
June 30, 2008
         
Increase (decrease) in value of designated interest rate swaps recognized in interest income
          $ 1,640     $ (24 )        
Payment on interest rate swap recorded in interest income
              (411 )     (145 )        
(Decrease) increase in value of hedged loans recognized in interest income
      (1,705 )     31          
Decrease in value of yield maintenance agreement recognized against interest income
      (9 )     (9 )        
Net loss on derivatives recognized in interest income (2)
            $ (485 )   $ (147 )        

(1) See Note 3 for valuation methodology.
(2) Ineffectiveness of ($31) thousand, ($43) thousand, and $(2) thousand was recorded in interest income during the three months ended June 30, 2009,  March 31, 2009, and June 30, 2008, respectively. Ineffectiveness of $(74) thousand, and $(2) thousand was recorded in interest income during the six-month periods ended June 30, 2009 and 2008, respectively. The full change in value of swaps was included in the assessment of hedge effectiveness.

 
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BANK OF MARIN BANCORP

Item 2.        Management’s Discussion and Analysis of Financial Condition and Results of Operations

In the following pages, Management discusses its analysis of the financial condition and results of operations for the second quarter of 2009 compared to the second quarter of 2008 and to the prior quarter (first quarter of 2009) as well as the six-month period ended June 30, 2009 compared to the same period in 2008. This discussion should be read in conjunction with the related co