form10q.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 March 31, 2010
 
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 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o   No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b(2) of the Exchange Act.
Large accelerated filer o    Accelerated filer x    Non-accelerated filer o    Smaller reporting company o
 
Indicate by check mark if the registrant is a shell company, as defined in Rule 12b(2) of the Exchange Act.
Yes o   No x
 
As of April 30, 2010 there were 5,252,853 shares of common stock outstanding.
 


 
 
 
 
 
TABLE OF CONTENTS
       
 
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Page-2

 
PART I FINANCIAL INFORMATION
 
ITEM 1.  Financial Statements
 
 
Page-3

 
BANK OF MARIN BANCORP
at March 31, 2010 and December 31, 2009
 
(in thousands, except share data; March 31, 2010 unaudited)
 
March 31, 2010
   
December 31, 2009
 
             
Assets
           
Cash and due from banks
  $ 35,811     $ 23,660  
Short-term investments and Federal funds sold
    49,632       15,000  
      Cash and cash equivalents
    85,443       38,660  
                 
Investment securities
               
Held to maturity, at amortized cost
    30,360       30,396  
Available for sale (at fair market value, amortized cost $94,434, and $96,752 at March 31, 2010 and December 31, 2009, respectively)
    97,176       97,818  
Total investment securities
    127,536       128,214  
                 
Loans, net of allowance for loan losses of $10,648 and $10,618 at March 31, 2010 and December 31, 2009, respectively
    909,708       907,130  
Bank premises and equipment, net
    7,938       8,043  
Interest receivable and other assets
    38,152       39,625  
                 
Total assets
  $ 1,168,777     $ 1,121,672  
                 
Liabilities and Stockholders Equity
               
                 
Liabilities
               
Deposits
               
Non-interest bearing
  $ 247,881     $ 230,551  
Interest-bearing
               
Transaction accounts
    93,604       89,660  
Savings accounts
    51,903       47,871  
Money market accounts
    402,799       416,481  
CDARS® time accounts
    72,906       51,819  
Other time accounts
    118,205       107,679  
Total deposits
    987,298       944,061  
                 
Federal funds purchased and Federal Home Loan Bank borrowings
    55,000       55,000  
Subordinated debenture
    5,000       5,000  
Interest payable and other liabilities
    8,967       8,560  
                 
Total liabilities
    1,056,265       1,012,621  
                 
Stockholders Equity
               
Preferred stock, no par value, $1,000 per share liquidation preference Authorized - 5,000,000 shares; none issued
           
Common stock, no par value
               
      Authorized - 15,000,000 shares                
Issued and outstanding - 5,240,044 and 5,229,529 at March 31, 2010 and December 31, 2009, respectively
    54,116       53,789  
Retained earnings
    56,806       54,644  
Accumulated other comprehensive income, net
    1,590       618  
                 
Total stockholders equity
    112,512       109,051  
                 
Total liabilities and stockholders equity
  $ 1,168,777     $ 1,121,672  
   
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
Page-4

 
BANK OF MARIN BANCORP
for the three months ended March 31, 2010, December 31, 2009, and March 31, 2009
 
                   
(in thousands, except per share amounts; unaudited)
 
March 31, 2010
   
December 31, 2009
   
March 31, 2009
 
                   
Interest income
                 
Interest and fees on loans
  $ 13,681     $ 13,871     $ 13,462  
Interest on investment securities
                       
Securities of U.S. Government agencies
    728       833       868  
Obligations of state and political subdivisions
    286       285       246  
Corporate debt securities and other
    170       214       1  
Interest on Federal funds sold and short-term investments
    22       1        
Total interest income
    14,887       15,204       14,577  
                         
Interest expense
                       
Interest on interest-bearing transaction accounts
    23       29       24  
Interest on savings accounts
    25       25       21  
Interest on money market accounts
    797       876       769  
Interest on CDARS® time accounts
    209       171       181  
Interest on other time accounts
    354       353       413  
Interest on borrowed funds
    351       360       361  
Total interest expense
    1,759       1,814       1,769  
                         
Net interest income
    13,128       13,390       12,808  
Provision for loan losses
    1,550       2,525       1,185  
Net interest income after provision for loan losses
    11,578       10,865       11,623  
                         
Non-interest income
                       
Service charges on deposit accounts
    446       459       435  
Wealth Management Services
    395       366       316  
Other income
    508       516       486  
Total non-interest income
    1,349       1,341       1,237  
                         
Non-interest expense
                       
Salaries and related benefits
    4,606       3,951       4,346  
Occupancy and equipment
    898       947       777  
Depreciation and amortization
    338       349       350  
FDIC insurance
    362       344       317  
Data processing
    446       477       381  
Professional services
    432       543       423  
Other expense
    1,140       1,152       963  
Total non-interest expense
    8,222       7,763       7,557  
 Income before provision for income taxes
    4,705       4,443       5,303  
                         
Provision for income taxes
    1,758       1,641       2,074  
Net income
  $ 2,947     $ 2,802     $ 3,229  
                         
Preferred stock dividends and accretion
              $ (1,299 )
Net income available to common stockholders
  $ 2,947     $ 2,802     $ 1,930  
                         
Net income per common share:
                       
Basic
  $ 0.56     $ 0.54     $ 0.38  
Diluted
  $ 0.56     $ 0.53     $ 0.37  
                         
Weighted average shares used to compute net income per common share:
                       
Basic
    5,218       5,210       5,146  
Diluted
    5,295       5,295       5,184  
                         
Dividends declared per common share
  $ 0.15     $ 0.15     $ 0.14  
 
 
Page-5


BANK OF MARIN BANCORP
for the year ended December 31, 2009 and the three months ended March 31, 2010
 
                     
Accumulated Other
       
                     
Comprehensive
       
   
Preferred
   
Common Stock
   
Retained
   
Income,
       
(dollars in thousands; 2010 unaudited )
  Stock    
Shares
   
Amount
   
Earnings
   
Net of Taxes
   
Total
 
Balance at December 31, 2008
    27,055       5,146,798     $ 51,965     $ 46,138     $ 388     $ 125,546  
Comprehensive income:
                                               
Net income
                      12,765             12,765  
Other comprehensive income
                                               
Net change in unrealized gain (loss) on available for sale securities (net of tax effect of $168)
                            230       230  
Comprehensive income
                      12,765       230       12,995  
Accretion of preferred stock
    945                   (945 )            
Repurchase of preferred stock
    (28,000 )                             (28,000 )
Stock options exercised
          61,175       873                   873  
Excess tax benefit - stock-based compensation
                291                   291  
Stock issued under employee stock purchase plan
          894       24                   24  
Restricted stock granted
          11,575                          
Stock-based compensation - stock options
                330                   330  
Stock-based compensation - restricted stock
                73                   73  
Cash dividends paid on common stock
                      (2,960 )           (2,960 )
Dividends on preferred stock
                      (354 )           (354 )
Stock issued in payment of director fees
          9,087       233                   233  
Balance at December 31, 2009
          5,229,529       53,789       54,644       618       109,051  
Net income
                      2,947             2,947  
Other comprehensive income
                                               
Net change in unrealized gain on available for sale securities (net of tax effect of $704)
                            972       972  
Comprehensive income
                      2,947       972       3,919  
Stock options exercised
          7,303       83                   83  
Excess tax benefit - stock-based compensation
                47                   47  
Stock issued under employee stock purchase plan
          182       6                   6  
Stock-based compensation - stock options
                69                   69  
Stock-based compensation - restricted stock
                22                   22  
Cash dividends paid on common stock
                      (785 )           (785 )
Stock issued in payment of director fees
          3,030       100                   100  
Balance at March 31, 2010
          5,240,044     $ 54,116     $ 56,806     $ 1,590     $ 112,512  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
Page-6

 
BANK OF MARIN BANCORP
for the three months ended March 31, 2010 and 2009
 
(in thousands, unaudited)
 
March 31, 2010
   
March 31, 2009
 
             
Cash Flows from Operating Activities:
           
Net income
  $ 2,947     $ 3,229  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
    1,550       1,185  
Compensation expense--common stock for director fees
    50       65  
Stock-based compensation expense
    91       96  
Excess tax benefits from exercised stock options
    (35 )     (2 )
Amortization of investment security premiums, net of accretion of discounts
     299        132  
Depreciation and amortization
    338       350  
Loss on sale of repossessed assets
    17        
Net change in operating assets and liabilities:
               
Interest receivable
    125       50  
Interest payable
    40       1  
Deferred rent and other rent-related expenses
    57       35  
Other assets
    573       (648 )
Other liabilities
    186       1,616  
Total adjustments
    3,291       2,880  
Net cash provided by operating activities
    6,238       6,109  
                 
Cash Flows from Investing Activities:
               
Purchase of securities held-to-maturity
          (3,644 )
Purchase of securities available-for-sale
    (6,762 )     (10,889 )
Proceeds from paydowns/maturity of:
               
Securities held-to-maturity
          200  
Securities available-for-sale
    8,817       14,937  
Loans originated and principal collected, net
    (3,930 )     (32,282 )
Purchase of premises and equipment
    (233 )     (90 )
Proceeds from sale of repossessed assets
    77        
Net cash used in investing activities
    (2,031 )     (31,768 )
                 
Cash Flows from Financing Activities:
               
Net increase in deposits
    43,237       7,159  
Proceeds from stock options exercised
    83       26  
Net increase in Federal Funds purchased and Federal Home Loan Bank borrowings
          42,300  
Preferred stock repurchased
          (28,000 )
Cash dividends paid on common stock
    (785 )     (722 )
Cash dividends paid on preferred stock
          (451 )
Stock issued under employee stock purchase plan
    6       6  
Excess tax benefits from exercised stock options
    35       2  
Net cash provided by financing activities
    42,576       20,320  
                 
Net increase (decrease) in cash and cash equivalents
    46,783       (5,339 )
Cash and cash equivalents at beginning of period
    38,660       24,926  
                 
Cash and cash equivalents at end of period
  $ 85,443     $ 19,587  
 
Non-Cash Transactions: The three months ended March 31, 2010 reflects a non-cash financing item of $100 thousand for stock issued to pay director fees and a non-cash investing item of $23 thousand of loans transferred to repossessed assets. The three months ended March 31, 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 accompanying notes are an integral part of these consolidated financial statements.
 
 
Page-7

 
BANK OF MARIN BANCORP
 
 
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 through the date of filing with the Securities and Exchange Commission (“SEC”), and has determined that there are 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 2009 Annual Report on Form 10-K.  The results of operations for the three months ended March 31, 2010 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.  Diluted EPS are calculated using the weighted average diluted shares. 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. 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-8

 
BANK OF MARIN BANCORP
 
   
Three months ended
 
(in thousands, except per share data; unaudited)
 
March 31, 2010
   
December 31, 2009
   
March 31, 2009
 
Weighted average basic shares outstanding
    5,218       5,210       5,146  
Add: Potential common shares related to stock options
    49       55       38  
  Potential common shares related to non-vested restricted stock
    5       4        
  Potential common shares related to warrant
    23       26        
Weighted average diluted shares outstanding
    5,295       5,295       5,184  
                         
Net income
  $ 2,947     $ 2,802     $ 3,229  
Preferred stock dividends and accretion
                (1,299 )
Net income available to common stockholders
  $ 2,947     $ 2,802     $ 1,930  
                         
Basic EPS
  $ 0.56     $ 0.54     $ 0.38  
Diluted EPS
  $ 0.56     $ 0.53     $ 0.37  
                         
Weighted average anti-dilutive shares not included in the calculation of diluted
  EPS
                       
  Stock options
    188       156       283  
  Non-vested restricted stock
                7  
  Warrant
                154  
Total anti-dilutive shares
    188       156       444  
 
Note 2: Recently Issued Accounting Standards
 
In April 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-18, Receivables (Topic 310): Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset. This ASU codifies the consensus reached in Emerging Issues Task Force (“EITF”) Issue No. 09-I, “Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset.” The amendments to the FASB Accounting Standards Codification™ (the “Codification” or “ASC”) provide that modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. ASU 2010-18 does not affect the accounting for loans under the scope of Subtopic 310-30 that are not accounted for within pools. Loans accounted for individually under Subtopic 310-30 continue to be subject to the troubled debt restructuring accounting provisions within Subtopic 310-40.
 
ASU 2010-18 is effective prospectively for modifications of loans accounted for within pools under Subtopic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. Early application is permitted. Upon initial adoption of ASU 2010-18, an entity may make a one-time election to terminate accounting for loans as a pool under Subtopic 310-30. This election may be applied on a pool-by-pool basis and does not preclude an entity from applying pool accounting to subsequent acquisitions of loans with credit deterioration.  We do not expect this ASU to have an impact on our financial condition or results of operations.
 
On April 16, 2010, the FASB issued ASU No. 2010-13, Compensation—Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades. The ASU codifies the consensus reached in EITF Issue No. 09-J. The amendments to the Codification clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity shares trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. As our current share-based payment awards are equity awards (exercise price is denominated in dollars in the U.S. where our stock is traded), this ASU does not have an impact on our financial condition or results of operations.
 
On February 24, 2010, the FASB issued ASU No. 2010-09, Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements. The amendments in this ASU remove the requirement for an SEC filer to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements. Revised financial statements include financial statements revised as a result of either correction of an error or retrospective application of U.S. generally accepted accounting principles. The FASB believes these amendments remove potential conflicts with the SEC’s literature. All of the amendments in the ASU were effective upon issuance.
 
 
Page-9

 
BANK OF MARIN BANCORP
 
In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This ASU requires: (1) disclosure of the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurement categories and the reasons for the transfers; and (2) separate presentation of purchases, sales, issuances, and settlements in the reconciliation for fair value measurements using significant unobservable inputs (Level 3). In addition, ASU 2010-06 clarifies the requirements of the following existing disclosures set forth in the Codification Subtopic 820-10: (1) For purposes of reporting fair value measurement for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities; and (2) a reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and non-recurring fair value measurements. ASU 2010-06 is effective for interim and annual reporting periods beginning January 1, 2010, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements, which are effective for fiscal years beginning January 1, 2011, and for interim periods within those fiscal years. As ASU 2010-06 is disclosure-related only, our adoption of this ASU in the first quarter of 2010 did not impact 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.

(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 March 31, 2010 (unaudited):
                   
Securities available for sale
  $ 97,176     $ 898     $ 96,278     $  
                                 
Derivative financial assets
  $ 13     $     $ 13     $  
                                 
Derivative financial liabilities
  $ 1,823     $     $ 1,823     $  
                                 
Balance at December 31, 2009:
                               
Securities available for sale
  $ 97,818     $     $ 97,818     $  
                                 
Derivative financial assets
  $ 35     $     $ 35     $  
                                 
Derivative financial liabilities
  $ 1,624     $     $ 1,624     $  
 
 
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BANK OF MARIN BANCORP
 
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 and equity securities (e.g. Visa Inc. common stock).  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 between the Standard & Poors BBB rated U.S. Bank Composite rate and LIBOR with maturity term 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, for which a non-recurring change in fair value has been recorded.

(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
March 31,
2010 (c)
   
Losses for
the three months
ended
March 31,
2009 (c)
 
At March 31, 2010:
                                   
Impaired loans carried at fair value (d)
  $ 7,349     $     $ 673     $ 6,676     $ 1,643     $ 952  
                                                 
At December 31, 2009:
                                               
Impaired loans carried at fair value (d)
  $ 7,620     $     $ 406     $ 7,214                  
 
(a) Represents impaired loan principal balances net of specific valuation allowance of $69 thousand, determined using the discounted cash flow method.
 
(b) Represents collateral-dependent loan principal balances that had been generally written down to the appraised value of the underlying collateral, net of specific valuation allowance of $100 thousand. The carrying value of loans fully charged-off, which includes unsecured lines of credit, overdrafts and all other loans, is zero.
 
(c) Represents net charge-offs during the period presented and the specific valuation allowance established on loans during the period.
       
(d) Represents the portion of impaired loans that have been written down to their fair value.
     
 
 
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BANK OF MARIN BANCORP
 
Disclosures about Fair Value of Financial Instruments
 
The table below is a summary of fair value estimates for financial instruments as of March 31, 2010 and December 31, 2009, 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 excluded non-financial assets and non-financial liabilities defined by the Codification (ASC 820-10-15-1A), such as Bank premises and equipment, deferred taxes and other liabilities.  In addition, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements of the Financial Instruments Topic of the Codification (ASC 825-10-50-8), such as Bank-owned life insurance policies.
 
   
March 31, 2010
   
December 31, 2009
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
(in thousands; 2010 amounts unaudited)
 
Amounts
   
Value
   
Amounts
   
Value
 
Financial assets
                       
Cash and cash equivalents
  $ 85,443     $ 85,443     $ 38,660     $ 38,660  
Investment securities held to maturity
    30,360       30,834       30,396       30,786  
Loans, net
    909,708       898,959       907,130       891,117  
Interest receivable
    4,213       4,213       4,338       4,338  
Financial liabilities
                               
Deposits
    987,298       987,598       944,061       944,469  
Federal Home Loan Bank long-term borrowings
    55,000       56,411       55,000       54,058  
Subordinated debenture
    5,000       4,582       5,000       4,146  
Interest payable
    1,015       1,015       975       975  
 
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 March 31, 2010, we did not hold any 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 credit worthiness and similar remaining maturities.
 
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 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.
 
 
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BANK OF MARIN BANCORP
 
Federal Home Loan Bank Long-term Borrowings - The fair value is estimated by discounting the future cash flows using current rates offered by the Federal Home Loan Bank San Francisco (“FHLB”) for similar credit advances corresponding to the remaining duration of our fixed-rate credit advances.
 
Subordinated Debenture - The fair value of the subordinated debenture is estimated by discounting the future cash flows (interest payment at a rate of three-month LIBOR plus 2.48%) using current market rates at which similar bonds would be issued with similar credit ratings as ours and similar remaining maturities. We have used the spread of the ten-year BBB rated U.S. Bank Composite over LIBOR to calculate this credit-risk-related discount of future cash flows.
 
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 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 such as FHLB, as well as corporate CMOs and equity securities, as reflected in the table below.
                                                 
   
March 31, 2010
   
December 31, 2009
 
(in thousands; March 31, 2010
   unaudited)
 
Amortized
Cost
   
Fair
Value
   
Gross Unrealized
   
Amortized
Cost
   
Fair
Value
   
Gross Unrealized
 
         
Gains
   
(Losses)
           
Gains
   
(Losses)
 
Held-to-maturity
                                               
Obligations of state and political subdivisions
  $ 30,360     $ 30,834     $ 756     $ (282 )   $ 30,396     $ 30,786     $ 774     $ (384 )
                                                                 
Available-for-sale
                                                               
Securities of U. S. government agencies:
                                                               
MBS pass-through securities issued by FNMA and FHLMC
    12,805       13,114       332       (23 )     12,882       13,086       253       (49 )
CMOs issued by FNMA
    17,034       17,513       511       (32 )     18,207       18,527       479       (159 )
CMOs issued by FHLMC
    28,881       29,427       624       (78 )     30,664       30,912       530       (282 )
CMOs issued by GNMA
    20,598       21,172       577       (3 )     15,180       15,657       477          
Debentures of government sponsored agencies
    2,000       2,028       28             5,000       5,040       46       (6 )
Corporate CMOs
    13,116       13,024       27       (119 )     14,819       14,596       1       (224 )
Equity security
          898       898                                
Total securities available for sale
    94,434       97,176       2,997       (255 )     96,752       97,818       1,786       (720 )
                                                                 
Total investment securities
  $ 124,794     $ 128,010     $ 3,753     $ (537 )   $ 127,148     $ 128,604     $ 2,560     $ (1,104 )
 
As a member bank of Visa U.S.A., 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 the later of March 25, 2011 or the termination of Visa Inc.’s covered litigation escrow account. The conversion rate will be determined upon the final resolution of the Visa Inc. covered litigation described in Note 13 to the Consolidated Financial Statements in our 2009 Form 10-K.  We expect our shares of Class B common stock to qualify for sale within one year.  As such, on March 31, 2010, the stock was classified as available-for-sale securities and reported at fair value, with the unrealized gain, net of tax, recognized in other comprehensive income.  The fair value of the Class B common stock we own was $898 thousand based on the Class A as-converted rate of 0.5824.
 
The amortized cost and fair value of investment securities by contractual maturity at March 31, 2010 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. Equity securities with a zero cost basis and a fair value of $898 thousand are excluded from the following table as they have no maturity.
 
 
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BANK OF MARIN BANCORP
                                 
   
March 31, 2010
 
   
Held to Maturity
   
Available for Sale
 
(in thousands; unaudited)
 
Amortized Cost
   
Fair Value
   
Amortized Cost
   
Fair Value
 
Within one year
  $ 668     $ 677     $     $  
After one but within five years
    3,853       3,995       2,000       2,028  
After five years through ten years
    14,234       14,646       20,753       20,911  
After ten years
    11,605       11,516       71,681       73,339  
Total
  $ 30,360     $ 30,834     $ 94,434     $ 96,278  
 
At March 31, 2010, investment securities carried at $1.3 million were pledged with the Federal Reserve Bank of San Francisco (“FRB”) to secure our Treasury, Tax and Loan account.  At March 31, 2010, investment securities carried at $27.4 million were pledged with the State of California:  $26.6 million to secure public deposits in compliance with the Local Agency Security Program and $766 thousand to provide collateral for trust deposits. In addition, at March 31, 2010, investment securities carried at $1.4 million were pledged to collateralize an internal Wealth Management Services checking account and $3.1 million were pledged to collateralize interest rate swap as discussed in Note 9.  At March 31, 2010, our FHLB line of credit was secured under terms of a blanket collateral agreement by a pledge of certain qualifying collateral, including investment securities. See Note 6 for further details.
 
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.
 
Twenty-five and thirty investment securities were in unrealized loss positions at March 31, 2010 and December 31, 2009, respectively.  They are summarized and classified according to the duration of the loss period as follows:
 
 
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BANK OF MARIN BANCORP
                                     
March 31, 2010
 
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
  $ 5,363     $ (48 )   $ 1,825     $ (234 )   $ 7,188     $ (282 )
                                                 
Available-for-sale
                                               
Securities of U.S. government agencies
    23,982       (136 )                 23,982       (136 )
Corporate CMOs
    9,995       (119 )                 9,995       (119 )
Total available for sale
    33,977       (255 )                 33,977       (255 )
Total temporarily impaired securities
  $ 39,340     $ (303 )   $ 1,825     $ (234 )   $ 41,165     $ (537 )

December 31, 2009
 
≤ 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
  $ 6,351     $ (76 )   $ 1,753     $ (308 )   $ 8,104     $ (384 )
                                                 
Available-for-sale
                                               
Securities of U. S. government agencies
    25,737       (496 )                 25,737       (496 )
Corporate CMOs
    14,384       (224 )                 14,384       (224 )
Total available for sale
    40,121       (720 )                 40,121       (720 )
Total temporarily impaired securities
  $ 46,472     $ (796 )   $ 1,753     $ (308 )   $ 48,225     $ (1,104 )
 
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. Federal Government. Obligations of U.S. states and political subdivisions in our portfolio are all investment grade without delinquency history. The security in a loss position for more than twelve continuous months relates to one debenture issued by a local subdivision 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 March 31, 2010.
 
The unrealized losses associated with corporate CMO’s are primarily related to securities backed by residential mortgages. All 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 March 31, 2010.
 
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. Shares cannot be purchased or sold except between the FHLB and its members at its $100 per share par value.  We held $4.7 million of FHLB stock recorded at cost in other assets at March 31, 2010 and December 31, 2009. On February 22, 2010, FHLB declared a cash dividend for the fourth quarter of 2009 at an annualized dividend rate of 0.27%.  Management expects to be able to redeem this stock at cost, and therefore does not believe the FHLB stock to be other-than-temporarily impaired.
 
 
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BANK OF MARIN BANCORP
 
Note 5:  Allowance for Loan Losses and Impaired 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 the level of problem loans, economic conditions, 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
 
(Dollars in thousands; unaudited)
 
March 31, 2010
   
December 31, 2009
   
March 31, 2009
 
Beginning balance
  $ 10,618     $ 11,118     $ 9,950  
Provision for loan loss charged to expense
    1,550       2,525       1,185  
Loans charged off
    (1,547 )     (3,124 )     (875 )
Loan loss recoveries
    27       99       29  
Ending balance
  $ 10,648     $ 10,618     $ 10,289  
                         
Total loans outstanding at period end, before deducting for loan losses
  $ 920,356     $ 917,748     $ 921,559  
                         
Ratio of allowance for loan losses to total loans
    1.16 %     1.16 %     1.12 %
                         
Non-accrual loans at period end:                        
Construction
  $ 5,671     $ 6,520     $ 5,183  
Commercial real estate
    3,711       3,722        
Commercial
    1,094       910       1,803  
Installment and other consumer
    838       313       433  
Home equity
    100       100      
   —
 
Total non-accrual loans
    11,414       11,565       7,419  
Accruing restructured loans:
                       
Installment and other consumer
    742       566       199  
Commercial
          49        
Total accruing restructured loans
    742       615       199  
Total impaired loans
  $ 12,156     $ 12,180     $ 7,618  
                         
Allowance for loan losses to non-accrual loans at period end
    93.29 %     91.81 %     138.68 %
                         
Non-accrual loans to total loans
    1.24 %     1.26 %     0.81 %
                         
Average recorded investment in impaired loans
  $ 12,356     $ 8,701     $ 7,783  
 
The gross interest income that would have been recorded had non-accrual loans been current totaled $236 thousand, $145 thousand and $147 thousand in the quarters ended March 31, 2010, December 31, 2009, and March 31, 2009, respectively. We recognized interest income of $1 thousand, $337 thousand and zero for cash payments received in the quarters ended March 31, 2010, December 31, 2009, and March 31, 2009, respectively. There were no accruing loans past due more than 90 days at March 31, 2010, December 31, 2009 or March 31, 2009.
 
Impaired loan balances totaled $12.2 million, $12.2 million, and $7.6 million at March 31, 2010, December 31, 2009 and March 31, 2009, respectively, with a specific valuation allowance of $169 thousand, $45 thousand and $118 thousand, respectively.  The amount of the recorded investment in impaired loans for which there is no related specific valuation allowance for loan losses totaled $9.5 million, $11.4 million and $4.7 million at March 31, 2010, December 31, 2009 and March 31, 2009, respectively. Generally, we charge off our estimated losses related to specifically-identified impaired loans as the losses are identified. The charged-off portion of impaired loans outstanding at March 31, 2010 totaled approximately $4.9 million. At March 31, 2010, there were no 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 $903 thousand, $781 thousand and $199 thousand at March 31, 2010, December 31, 2009 and March 31, 2009, respectively, of which $742 thousand, $615 thousand and $199 thousand, respectively, were accruing interest. These restructured loan amounts have been included in the impaired loan totals noted above.
 
 
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BANK OF MARIN BANCORP
 
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 March 31, 2010 and December 31, 2009, we had no overnight borrowings outstanding under these credit facilities.
 
Federal Home Loan Bank Borrowings – As of March 31, 2010 and December 31, 2009, we had lines of credit with the FHLB totaling $215.3 million and $236.2 million, respectively.  At March 31, 2010 and December 31, 2009, we had no FHLB overnight borrowings.
 
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 May 5, 2010 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 March 31, 2010, $160.3 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 FRB. On March 30, 2009, we pledged a certain residential loan portfolio that increased our borrowing capacity with the FRB.  At March 31, 2010 and December 31, 2009, we have borrowing capacity under this line totaling $43.6 and $38.0 million, respectively, and had no outstanding borrowings with the FRB.
 
Subordinated Debt – On September 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 March 31, 2010 was 2.74%. 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 for $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. We expect the U.S. Treasury to sell the warrant through auction.
 
Dividends
 
Presented below is a summary of preferred dividends on preferred stock issued under the TCPP, as well as cash dividends paid to common shareholders, both of which are recorded as a reduction of retained earnings.
                         
   
Three months ended
 
(in thousands except per share data)
 
March 31, 2010
   
December 31, 2009
   
March 31, 2009
 
Preferred dividends
  $     $     $ 354  
Cash dividends to common shareholders
  $ 785     $ 784     $ 722  
Cash dividends per common share
  $ 0.15     $ 0.15     $ 0.14  
 
Share-Based Payments
 
The fair value of stock options on the grant date is recorded as a stock-based compensation expense in the statement of operations over the requisite service period with a corresponding increase in common stock. 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 equals its intrinsic value on that date, is being recorded as compensation expense over the requisite service period with a corresponding increase in common stock as the shares vest. In addition, we record excess tax benefits on the exercise of non-qualified stock options, the disqualifying disposition of incentive stock options and vesting of restricted stock as an addition to common stock with 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.
 
 
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BANK OF MARIN BANCORP
 
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 fully drawn upon, the total commitment amount does not necessarily represent future cash requirements.
 
We are exposed to credit loss equal to the contract amount of the commitment in the event of nonperformance by the borrower. 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 contractual amount of loan commitments and standby letters of credit not reflected on the consolidated statement of condition was $231.3 million at March 31, 2010 at rates ranging from 2.25% to 9.75%.  This amount included $134.4 million under commercial lines of credit (these commitments are contingent upon customers maintaining specific credit standards), $73.3 million under revolving home equity lines, $11.1 million under undisbursed construction loans, $4.3 million under standby letters of credit, and a remaining $8.2 million under personal and other lines of credit. We have set aside an allowance for losses in the amount of $463 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 $1.8 million, $2.1 million, $2.1 million, $2.1 million and $1.9 million for 2010 (April through December), 2011, 2012, 2013, and 2014 respectively, and $15.3 million for all years thereafter.
 
Capital Purchase Commitment
 
In March 2010, we contracted with a construction company managed and owned by a member of the Board of Directors of the Bank and Bancorp for the construction of leasehold improvements to a new branch office for an estimated amount of $700 thousand.
 
Litigation and Regulatory Matters
 
We may be party to legal actions which arise from time to time as part of the normal course of our business.  We believe, after consultation with legal counsel, that we have meritorious defenses in these actions, and that litigation contingency liability, if any, will not have a material adverse effect on our financial position, results of operations, or cash flows. We are responsible for our proportionate share of certain litigation indemnifications provided to Visa U.S.A. by its member banks in connection with lawsuits related to anti-trust charges and interchange fees. Also refer to Note 13 to the Consolidated Financial Statements of the Bancorp’s 2009 Annual Report on Form 10-K.
 
 
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BANK OF MARIN BANCORP
 
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. Converting our fixed-rate interest stream for a floating-rate interest stream, generally benchmarked to the one-month U.S. dollar LIBOR index, protects 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).
 
Prior to loan funding, a yield maintenance agreement with net settlement features that met the definition of a derivative was carried on the balance sheet in other assets or other liabilities. The change in its fair value was recorded in interest income.  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 of $69 thousand was recorded in other assets at the date of designation.  Since designation, it has been amortized using the effective yield method over the life of the designated loan.
 
The net effect of the change in fair value of interest rate swaps, the amortization of the yield maintenance agreement and the change in the fair value of the hedged loans results in an insignificant amount of hedge ineffectiveness recognized in interest income.
 
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 in an amount determined by the agreements (generally when our derivative liability position is greater than $100 thousand or $1.3 million, depending upon the counterparty).  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 that are in a liability position and have collateral requirements on March 31, 2010 is $1.8 million, for which we have posted collateral in the form of securities available for sale totaling $3.1 million.
 
As of March 31, 2010, 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. Our interest rate swaps are settled monthly with counterparties. Accrued interest on the swaps totaled $63 thousand as of March 31, 2010. Information on our derivatives follows:
 
 
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BANK OF MARIN BANCORP
                                 
   
Asset derivatives designated
as fair value hedges
   
Liability derivatives designated as fair
value hedges
 
(in thousands; March 31, 2010 unaudited)
 
March 31, 2010
   
December 31, 2009
   
March 31, 2010
   
December 31, 2009
 
Interest rate swap notional amount
  $ 1,867     $ 1,905     $ 16,962     $ 17,076  
Credit risk amount
    13       35              
Interest rate swap fair value (1)
    13       35       1,823       1,624  
Balance sheet location
 
Other assets
   
Other assets
   
Other liabilities
   
Other liabilities
 

    Three months ended  
(in thousands; unaudited)
 
March 31, 2010
   
December 31, 2009
   
March 31, 2009
 
(Decrease) increase in value of designated interest rate swaps recognized in interest income
  $ (221 )   $ 598     $ 381  
Payment on interest rate swap recorded in interest income
    (213 )     (219 )     (197 )
Increase (decrease) in value of hedged loans recognized in interest income
    221       (643 )     (421 )
Decrease in value of yield maintenance agreement recognized against interest income
    (5 )     (5 )     (3 )
Net loss on derivatives recognized in interest income (2)
  $ (218 )   $ (269 )   $ (240 )
 
(1) See Note 3 for valuation methodology.
               
                 
(2) Ineffectiveness of ($5) thousand, ($50) thousand, and ($43) thousand was recorded in interest income during the three months ended March 31, 2010, December 31, 2009 and March 31, 2009, 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 first quarter of 2010 compared to the first quarter of 2009 and to the prior quarter (fourth quarter of 2009). This discussion should be read in conjunction with the related consolidated financial statements in this Form 10-Q and with the audited consolidated financial statements and accompanying notes included in our 2009 Annual Report on Form 10-K.  Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances.
 
Forward-Looking Statements
 
This discussion of financial results includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, (the “1933 Act”) and Section 21E of the Securities Exchange Act of 1934, as amended, (the “1934 Act”).  Those sections of the 1933 Act and 1934 Act provide a “safe harbor” for forward-looking statements to encourage companies to provide prospective information about their financial performance so long as they provide meaningful, cautionary statements identifying important factors that could cause actual results to differ significantly from projected results.
 
Our forward-looking statements include descriptions of plans or objectives of Management for future operations, products or services, and forecasts of its revenues, earnings or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include the words “believe,” “expect,” “intend,” “estimate” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could” or “may.”
 
Forward-looking statements are based on Management’s current expectations regarding economic, legislative, and regulatory issues that may impact our earnings in future periods. A number of factors—many of which are beyond Management’s control—could cause future results to vary materially from current Management expectations. Such factors include, but are not limited to, general economic conditions; the current financial downturn in the U.S. and abroad; changes in interest rates, deposit flows, real estate values and competition; changes in accounting principles, policies or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services. These and other important factors are detailed in the Risk Factors section of our 2009 Form 10-K as filed with the SEC, copies of which are available from us at no charge. Forward-looking statements speak only as of the date they are made. We do not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events.
 
Executive Summary
 
We continued to deliver steady quarterly financial results reflecting our focus on the fundamentals of responsible banking and our commitment to building strong customer relationships.
 
Our first quarter 2010 earnings totaled $2.9 million, compared to $2.8 million in the fourth quarter of 2009 and $3.2 million in the first quarter of 2009.  Diluted earnings per share were $0.56, up $0.03 from the fourth quarter of 2009 and up $0.19 from the first quarter of 2009.  The first quarter of 2009 earnings per share were reduced by $0.25 as a result of the non-recurring accelerated accretion of the redemption premium resulting from our early repurchase of the TCPP preferred stock, and dividends on the preferred stock.
 
The increase in earnings from the fourth quarter of 2009 primarily reflects a lower provision for loan losses (primarily representing a decrease in the volume of newly identified problem credits during the first quarter of 2010), partially offset by higher salaries and benefits, as well as slightly lower net interest income.
 
The decrease in earnings compared to the first quarter of 2009 primarily reflects a higher provision for loan losses, primarily related to declines in collateral values on certain specifically-identified land loans related to the construction of residential subdivisions. In addition, earnings in the first quarter of 2010 reflected higher salaries and benefits and occupancy costs associated with branch expansion, partially offset by slightly higher net interest income and income from Wealth Management Services.
 
 
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BANK OF MARIN BANCORP
 
Total loans reached $920.4 million at March 31, 2010, representing an increase of $2.6 million, or 0.3%, from December 31, 2009.  Our loan growth has slowed, reflecting a decline in demand and intensified competition for creditworthy borrowers in our service area.
 
Non-performing loans totaled $11.4 million, or 1.2% of Bancorp’s loan portfolio at March 31, 2010 compared to $11.6 million, or 1.3% of Bancorp’s loan portfolio at December 31, 2009.  Accruing loans past due 30 to 89 days increased to $1.0 million at March 31, 2010 from $835 thousand at December 31, 2009.
 
The provision for loan losses totaled $1.6 million in the first quarter of 2010, compared to $2.5 million in the prior quarter, and $1.2 million in the same quarter a year ago.  Net charge-offs in the first quarter of 2010 totaled $1.5 million compared to $3.0 million in the prior quarter, and $846 thousand in the same quarter a year ago.  The allowance for loan losses of $10.6 million totaled 1.16% of loans at March 31, 2010 and December 31, 2009, compared to $10.3 million, or 1.12% of loans a year ago.
 
Total deposits grew $43.2 million or 4.6% from December 31, 2009, with the most notable increases in Certificate of Deposit Account Registry Service deposits (“CDARS®”), demand deposits and other time deposits, partially offset by a decrease in money market accounts.
 
Critical Accounting Policies
 
Critical accounting policies are those that are both most important to the portrayal of our financial condition and results of operations and require Management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
 
Management has determined the following five accounting policies to be critical: Allowance for Loan Losses, Other-than-temporary Impairment of Investment Securities, Share-Based Payment, Accounting for Income Taxes and Fair Value Measurements.
 
Allowance for Loan Losses
 
Allowance for loan losses is based upon estimates of loan losses and is maintained at a level considered adequate to provide for probable losses inherent in the outstanding loan portfolio. The allowance is increased by provisions charged to expense and reduced by net charge-offs.  In periodic evaluations of the adequacy of the allowance balance, Management considers our past loan loss experience by type of credit, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, current economic conditions and other factors. We formally assess the adequacy of the allowance for loan losses on a quarterly basis. These assessments include the periodic re-grading of loans based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment, and other factors as warranted. Loans are initially graded when originated. They are reviewed as they are renewed, when there is a new loan to the same borrower and/or when identified facts demonstrate heightened risk of default. Confirmation of the quality of our grading process is obtained by independent reviews conducted by outside consultants specifically hired for this purpose and by periodic examination by various bank regulatory agencies. Management monitors delinquent loans continuously and identifies problem loans to be evaluated individually for impairment testing. For loans that are determined impaired, formal impairment measurement is performed at least quarterly on a loan-by-loan basis.
 
Our method for assessing the appropriateness of the allowance includes specific allowances for identified problem loans, an allowance factor for categories of credits, and allowances for changing environmental factors (e.g., portfolio trends, concentration of credit, growth, economic factors). Allowances for identified problem loans are based on specific analysis of individual credits. Loss estimation factors for loan categories are based on analysis of local economic factors applicable to each loan category. Allowances for changing environmental factors are Management’s best estimate of the probable impact these changes have had on the loan portfolio as a whole.
 
 
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BANK OF MARIN BANCORP
 
Other-than-temporary Impairment of Investment Securities
 
At each financial statement date, we assess whether declines in the fair value of held-to-maturity and available-for-sale securities below their costs are deemed to be other than temporary.  We consider, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value. Evidence evaluated includes, but is not limited to, the remaining payment terms of the instrument and economic factors that are relevant to the collectability of the instrument, such as: current prepayment speeds, the current financial condition of the issuer(s), industry analyst reports, credit ratings, credit default rates, interest rate trends and the value of any underlying collateral. Credit-related other-than-temporary-impairment results in a charge to earnings and the corresponding establishment of a new cost basis for the security.  Non-credit-related other-than-temporary impairment results in a charge to other comprehensive income, net of applicable taxes, and the corresponding establishment of a new cost basis for the security. The other-than-temporary impairment recognized in other comprehensive income for debt securities classified as held-to-maturity is accreted from other comprehensive income to the amortized cost of the debt security over the remaining life of the debt security in a prospective manner on the basis of the amount and timing of future estimated cash flows.
 
Share-Based Payment
 
We recognize all share-based payments, including stock options and non-vested restricted common shares, as an expense in the income statement based on the grant-date fair value of the award with a corresponding increase to common stock.
 
We determine the fair value of stock options at the grant date using the Black-Scholes pricing model that takes into account the stock price at the grant date, the exercise price, the expected dividend yield, stock price volatility and the risk-free interest rate over the expected life of the option. The Black-Scholes model requires the input of highly subjective assumptions, including the expected life of the stock-based award (derived from historical data on employee exercise and post-vesting employment termination behavior) and stock price volatility (based on the historical volatility of the common stock). The estimates used in the model involve inherent uncertainties and the application of Management’s judgment.  As a result, if other assumptions had been used, our recorded stock-based compensation expense could have been materially different from that reflected in these financial statements. The fair value of non-vested restricted common shares generally equals the stock price at grant date.  In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those share-based awards expected to vest.  If our actual forfeiture rate is materially different from the estimate, the share-based compensation expense could be materially different.
 
Accounting for Income Taxes
 
Income taxes reported in the financial statements are computed based on an asset and liability approach. We recognize the amount of taxes payable or refundable for the current year, and deferred tax assets and liabilities for the expected future tax consequences that have been recognized in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We record net deferred tax assets to the extent it is more likely than not that they will be realized.  In evaluating our ability to recover the deferred tax assets, Management considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations.  In projecting future taxable income, Management develops assumptions including the amount of future state and federal pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates being used to manage the underlying business. Bancorp files consolidated federal and combined state income tax returns.
 
We recognize the financial statement effect of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. For tax positions that meet the more-likely-than-not threshold, we may recognize only the largest amount of tax benefit that is greater than fifty percent likely of being realized upon ultimate settlement with the taxing authority. Management believes that all of our tax positions taken meet the more-likely-than-not recognition threshold.  To the extent tax authorities disagree with these tax positions, our effective tax rates could be materially affected in the period of settlement with the taxing authorities.
 
 
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BANK OF MARIN BANCORP
 
Fair Value Measurements
 
We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. We base our fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Securities available for sale, derivatives, and loans held for sale, if any, are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record certain assets at fair value on a non-recurring basis, such as certain impaired loans held for investment and securities held to maturity  that are other-than-temporarily impaired. These non-recurring fair value adjustments typically involve write-downs of individual assets due to application of lower-of-cost or market accounting.
 
We have established and documented a process for determining fair value. We maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. Whenever there is no readily available market data, Management uses its best estimate and assumptions in determining fair value, but these estimates involve inherent uncertainties and the application of Management’s judgment. As a result, if other assumptions had been used, our recorded earnings or disclosures could have been materially different from those reflected in these financial statements. For detailed information on our use of fair value measurements and our related valuation methodologies, see Note 3 to Consolidated Financial Statements in this Form 10-Q.
 
 
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BANK OF MARIN BANCORP
 
RESULTS OF OPERATIONS
 
Overview
 
Highlights of the financial results are presented in the following table:
 
   
As of and for the three months ended
 
(dollars in thousands, except per share data; unaudited)
 
March 31, 2010
   
December 31, 2009
   
March 31, 2009
 
For the period:
                 
Net income
  $ 2,947     $ 2,802     $ 3,229  
Net income per share
                       
Basic
  $ 0.56     $ 0.54     $ 0.38  
Diluted
  $ 0.56     $ 0.53     $ 0.37  
Return on average assets
    1.04 %     0.97 %     1.23 %
Return on average equity
    10.75 %     10.15 %     10.28 %
Common stock dividend payout ratio
    26.79 %     27.78 %     36.84 %
Average equity to  average asset ratio
    9.72 %     9.52 %     12.01 %
Efficiency ratio
    56.79 %     52.70 %     53.81 %
At period end:
                       
Book value per common share
  $ 21.47     $ 20.85     $ 19.46  
Total assets
  $ 1,168,777     $ 1,121,672     $ 1,074,828  
Total loans
  $ 920,356     $ 917,748     $ 921,559  
Total deposits
  $ 987,298     $ 944,061     $ 859,449  
Loan-to-deposit ratio
    93.2 %     97.2 %     107.2 %
 
Net Interest Income
 
Net interest income is the difference between the interest earned on loans, investments and other interest-earning assets and the interest expense incurred on deposits and other interest-bearing liabilities. Net interest income is impacted by changes in general market interest rates and by changes in the amounts and composition of interest-earning assets and interest-bearing liabilities. Interest rate changes can create fluctuations in the net interest margin due to an imbalance in the timing of repricing or maturity of assets or liabilities. We manage interest rate risk exposure with the goal of minimizing the impact of interest rate volatility on net interest margin.
 
Net interest margin is expressed as net interest income divided by average interest-earning assets. Net interest rate spread is the difference between the average rate earned on total interest-earning assets and the average rate incurred on total interest-bearing liabilities. Both of these measures are reported on a taxable-equivalent basis.  Net interest margin is the higher of the two because it reflects interest income earned on assets funded with non-interest-bearing sources of funds, which include demand deposits and stockholders’ equity.
 
The following table, Distribution of Average Statements of Condition and Analysis of Net Interest Income, compares interest income and interest-earning assets with interest expense and interest-bearing liabilities for the periods presented. The table also indicates net interest income, net interest margin and net interest rate spread for each period presented.
 
 
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BANK OF MARIN BANCORP
 
Average Statements of Condition and Analysis of Net Interest Income
                                                       
   
Three months ended
March 31, 2010