form10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
DRAFT 7/29/2010 8:05 PM
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, 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  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  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 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 30, 2010 there were 5,258,187 shares of common stock outstanding.
 


 
 

 

TABLE OF CONTENTS


PART I
3
     
ITEM 1.
3
     
 
4
 
5
 
7
 
8
 
9
     
ITEM 2.
23
     
ITEM 3.
38
     
ITEM 4.
39
     
PART II
39
     
ITEM 1
39
     
ITEM 1A
39
     
ITEM 2
40
     
ITEM 3
40
     
ITEM 4
40
     
ITEM 5
40
     
ITEM 6
41
     
43
     
44

 
Page -2


PART I FINANCIAL INFORMATION

ITEM 1.  Financial Statements

 
Page -3


BANK OF MARIN BANCORP
CONSOLIDATED STATEMENT OF CONDITION
at June 30, 2010 and December 31, 2009

(in thousands, except share data; June 30, 2010 unaudited)
 
June 30, 2010
   
December 31, 2009
 
             
Assets
           
Cash and due from banks
  $ 50,477     $ 23,660  
Short-term investments and Federal funds sold
    18,706       15,000  
Cash and cash equivalents
    69,183       38,660  
                 
Investment securities
               
Held to maturity, at amortized cost
    30,324       30,396  
Available for sale (at fair market value, amortized cost $108,004,and $96,752 at June 30, 2010 and December 31, 2009, respectively)
    111,781       97,818  
Total investment securities
    142,105       128,214  
                 
Loans, net of allowance for loan losses of $11,773 and $10,618at June 30, 2010 and December 31, 2009, respectively
    927,520       907,130  
Bank premises and equipment, net
    8,047       8,043  
Interest receivable and other assets
    38,681       39,625  
                 
Total assets
  $ 1,185,536     $ 1,121,672  
                 
Liabilities and Stockholders' Equity
               
                 
Liabilities
               
Deposits
               
Non-interest bearing
  $ 257,643     $ 230,551  
Interest-bearing
               
Transaction accounts
    98,375       89,660  
Savings accounts
    52,041       47,871  
Money market accounts
    382,277       416,481  
CDARS® time accounts
    81,463       51,819  
Other time accounts
    127,379       107,679  
Total deposits
    999,178       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
    10,390       8,560  
                 
Total liabilities
    1,069,568       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 - 5,256,174 and 5,229,529 at June 30, 2010 and December 31, 2009, respectively
    54,420       53,789  
Retained earnings
    59,357       54,644  
Accumulated other comprehensive income, net
    2,191       618  
                 
Total stockholders' equity
    115,968       109,051  
                 
Total liabilities and stockholders' equity
  $ 1,185,536     $ 1,121,672  

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

 
Page -4


BANK OF MARIN BANCORP
CONSOLIDATED STATEMENT OF INCOME
for the six months ended June 30, 2010, and June 30, 2009

(in thousands, except per share amounts; unaudited)
 
June 30, 2010
   
June 30, 2009
 
             
Interest income
           
Interest and fees on loans
  $ 27,850     $ 27,085  
Interest on investment securities
               
Securities of U.S. Government agencies
    1,613       1,677  
Obligations of state and political subdivisions
    571       533  
Corporate debt securities and other
    308       116  
Interest on short-term investments and Federal funds sold
    50       3  
Total interest income
    30,392       29,414  
                 
Interest expense
               
Interest on interest-bearing transaction accounts
    49       55  
Interest on savings accounts
    52       45  
Interest on money market accounts
    1,526       1,562  
Interest on CDARS® time accounts
    442       364  
Interest on other time accounts
    731       810  
Interest on borrowed funds
    707       737  
Total interest expense
    3,507       3,573  
                 
Net interest income
    26,885       25,841  
Provision for loan losses
    2,900       1,885  
Net interest income after provision for loan losses
    23,985       23,956  
                 
Non-interest income
               
Service charges on deposit accounts
    909       867  
Wealth Management Services
    763       667  
Other income
    1,182       976  
Total non-interest income
    2,854       2,510  
                 
Non-interest expense
               
Salaries and related benefits
    9,167       8,764  
Occupancy and equipment
    1,812       1,619  
Depreciation and amortization
    698       686  
FDIC insurance
    737       1,149  
Data processing
    931       773  
Professional services
    886       818  
Other expense
    2,582       2,348  
Total non-interest expense
    16,813       16,157  
Income before provision for income taxes
    10,026       10,309  
                 
Provision for income taxes
    3,741       3,947  
Net income
  $ 6,285     $ 6,362  
                 
Preferred stock dividends and accretion
  $ ---     $ (1,299 )
Net income available to common stockholders
  $ 6,285     $ 5,063  
                 
Net income per common share:
               
Basic
  $ 1.20     $ 0.98  
Diluted
  $ 1.19     $ 0.97  
                 
Weighted average shares used to compute net income per common share:
               
Basic
    5,226       5,155  
Diluted
    5,302       5,199  
                 
Dividends declared per common share
  $ 0.30     $ 0.28  

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

 
Page -5


BANK OF MARIN BANCORP
CONSOLIDATED STATEMENT OF INCOME
for the three months ended June 30, 2010, March 31, 2010, and June 30, 2009

(in thousands, except per share amounts; unaudited)
 
June 30, 2010
   
March 31, 2010
   
June 30, 2009
 
                   
Interest income
                 
Interest and fees on loans
  $ 14,169     $ 13,681     $ 13,623  
Interest on investment securities
                       
Securities of U.S. Government agencies
    885       728       809  
Obligations of state and political subdivisions
    285       286       287  
Corporate debt securities and other
    138       170       115  
Interest on short-term investments and Federal funds sold
    28       22       3  
Total interest income
    15,505       14,887       14,837  
                         
Interest expense
                       
Interest on interest-bearing transaction accounts
    26       23       31  
Interest on savings accounts
    27       25       23  
Interest on money market accounts
    729       797       794  
Interest on CDARS® time accounts
    233       209       183  
Interest on other time accounts
    377       354       397  
Interest on borrowed funds
    356       351       376  
Total interest expense
    1,748       1,759       1,804  
                         
Net interest income
    13,757       13,128       13,033  
Provision for loan losses
    1,350       1,550       700  
Net interest income after provision for loan losses
    12,407       11,578       12,333  
                         
Non-interest income
                       
Service charges on deposit accounts
    463       446       432  
Wealth Management Services
    368       395       351  
Other income
    674       508       490  
Total non-interest income
    1,505       1,349       1,273  
                         
Non-interest expense
                       
Salaries and related benefits
    4,561       4,606       4,418  
Occupancy and equipment
    914       898       842  
Depreciation and amortization
    360       338       336  
FDIC insurance
    375       362       832  
Data processing
    485       446       392  
Professional services
    454       432       395  
Other expense
    1,442       1,140       1,385  
Total non-interest expense
    8,591       8,222       8,600  
Income before provision for income taxes
    5,321       4,705       5,006  
                         
Provision for income taxes
    1,983       1,758       1,873  
Net income
  $ 3,338     $ 2,947     $ 3,133  
                         
                         
Net income per common share:
                       
Basic
  $ 0.64     $ 0.56     $ 0.61  
Diluted
  $ 0.63     $ 0.56     $ 0.60  
                         
Weighted average shares used to compute net income per common share:
                       
Basic
    5,234       5,218       5,164  
Diluted
    5,308       5,295       5,214  
                         
Dividends declared per common share
  $ 0.15     $ 0.15     $ 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, 2009 and the six months ended June 30, 2010

   
Preferred Stock
   
Common Stock
   
Retained Earnings
   
Accumulated Other Comprehensive Income, Net of Taxes
   
Total
 
(dollars in thousands; 2010 unaudited )
     
Shares
   
Amount
             
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 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
    ---       ---       ---       6,285       ---       6,285  
Other comprehensive income
                                               
Net change in unrealized gain on available for sale securities (net of tax effect of $1,138)
    ---       ---       ---       ---       1,573       1,573  
Comprehensive income
    ---       ---       ---       6,285       1,573       7,858  
Stock options exercised
    ---       17,173       226       ---       ---       226  
Excess tax benefit - stock-based compensation
    ---       ---       77       ---       ---       77  
Stock issued under employee stock purchase plan
    ---       292       9       ---       ---       9  
Restricted stock granted
    ---       6,150       ---       ---       ---       ---  
Stock-based compensation - stock options
    ---       ---       166       ---       ---       166  
Stock-based compensation - restricted stock
    ---       ---       53       ---       ---       53  
Cash dividends paid on common stock
    ---       ---       ---       (1,572 )     ---       (1,572 )
Stock issued in payment of director fees
    ---       3,030       100       ---       ---       100  
Balance at June 30, 2010
    ---       5,256,174     $ 54,420     $ 59,357     $ 2,191     $ 115,968  

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, 2010 and 2009

(in thousands, unaudited)
 
June 30, 2010
   
June 30, 2009
 
             
Cash Flows from Operating Activities:
           
Net income
  $ 6,285     $ 6,362  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
    2,900       1,885  
Compensation expense--common stock for director fees
    100       110  
Stock-based compensation expense
    219       198  
Excess tax benefits from exercised stock options
    (63 )     (122 )
Amortization of investment security premiums, net of accretion of discounts
    563       220  
Depreciation and amortization
    698       686  
Loss on sale of investment securities
    ---       19  
Loss on sale of repossessed assets
    5       ---  
Net change in operating assets and liabilities:
               
Interest receivable
    140       106  
Interest payable
    100       58  
Deferred rent and other rent-related expenses
    124       125  
Other assets
    (318 )     (1,459 )
Other liabilities
    528       98  
Total adjustments
    4,996       1,924  
Net cash provided by operating activities
    11,281       8,286  
                 
Cash Flows from Investing Activities:
               
Purchase of securities held-to-maturity
    ---       (8,438 )
Purchase of securities available-for-sale
    (27,390 )     (19,394 )
Proceeds from sale of securities
    ---       1,065  
Proceeds from paydowns/maturity of:
               
Securities held-to-maturity
    ---       200  
Securities available-for-sale
    15,647       23,502  
Loans originated and principal collected, net
    (22,270 )     (22,475 )
Purchase of premises and equipment
    (702 )     (277 )
Proceeds from sale of repossessed assets
    114       ---  
Net cash used in investing activities
    (34,601 )     (25,817 )
                 
Cash Flows from Financing Activities:
               
Net increase in deposits
    55,117       70,315  
Proceeds from stock options exercised
    226       530  
Net increase  in Federal Funds purchased and Federal Home Loan Bank borrowings
    ---       (1,800 )
Preferred stock repurchased
    ---       (28,000 )
Cash dividends paid on common stock
    (1,572 )     (1,446 )
Cash dividends paid on preferred stock
    ---       (451 )
Stock issued under employee stock purchase plan
    9       11  
Excess tax benefits from exercised stock options
    63       122  
Net cash provided by financing activities
    53,843       39,281  
                 
Net increase in cash and cash equivalents
    30,523       21,750  
Cash and cash equivalents at beginning of period
    38,660       24,926  
                 
Cash and cash equivalents at end of period
  $ 69,183     $ 46,676  

Non-Cash Transactions: The six months ended June 30, 2010 reflects a non-cash financing item of $100 thousand for stock issued to pay director fees and a non-cash investing item of $135 thousand of loans transferred to repossessed assets.  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 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 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 six months ended June 30, 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. 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, 2010
   
March 31, 2010
   
June 30, 2009
   
June 30, 2010
   
June 30, 2009
 
Weighted average basic shares outstanding
    5,234       5,218       5,164       5,226       5,155  
Add: Potential common shares related to stock options
    45       49       49       47       43  
Potential common shares related to non-vested restricted stock
    3       5       1       4       1  
Potential common shares related to warrant
    26       23       ---       25       ---  
Weighted average diluted shares outstanding
    5,308       5,295       5,214       5,302       5,199  
                                         
Net income
  $ 3,338     $ 2,947     $ 3,133     $ 6,285     $ 6,362  
Preferred stock dividends and accretion
    ---       ---       ---       ---       (1,299 )
Net income available to common stockholders
  $ 3,338     $ 2,947     $ 3,133     $ 6,285     $ 5,063  
                                         
Basic EPS
  $ 0.64     $ 0.56     $ 0.61     $ 1.20     $ 0.98  
Diluted EPS
  $ 0.63     $ 0.56     $ 0.60     $ 1.19     $ 0.97  
                                         
Weighted average anti-dilutive shares not included in the calculation of diluted EPS
                                       
Stock options
    170       188       299       163       290  
Non-vested restricted stock
    ---       ---       5       ---       17  
Warrant
    ---       ---       154       ---       154  
Total anti-dilutive shares
    170       188       458       163       461  

Note 2: Recently Issued Accounting Standards

In July 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The ASU amends FASB Accounting Standards Codification™ (the “Codification” or “ASC”) Topic 310, Receivables, to improve the disclosures about the credit quality of an entity’s financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate, by portfolio segment or class of financing receivable, certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses.

Existing disclosures are amended to require an entity to provide the following disclosures about its financing receivables on a disaggregated basis:

(1) A rollforward schedule of the allowance for credit losses from the beginning of the reporting period to the end of the reporting period on a portfolio segment basis, with the ending balance further disaggregated on the basis of the impairment method;

(2) For each disaggregated ending balance in item (1) above, the related recorded investment in financing receivables;

(3) The nonaccrual status of financing receivables by class of financing receivables;

(4) Impaired financing receivables by class of financing receivables.

The amendments in the ASU also require an entity to provide the following additional disclosures about its financing receivables:

(1) Credit quality indicators of financing receivables at the end of the reporting period by class of financing receivables;

(2) The aging of past due financing receivables at the end of the reporting period by class of financing receivables;

 
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BANK OF MARIN BANCORP

(3) The nature and extent of troubled debt restructurings that occurred during the period by class of financing receivables and their effect on the allowance for credit losses;

(4) The nature and extent of financing receivables modified as troubled debt restructurings within the previous twelve months that defaulted during the reporting period by class of financing receivables and their effect on the allowance for credit losses; and

(5)Significant purchases and sales of financing receivables during the reporting period disaggregated by portfolio segments.

The disclosures as of the end of a reporting period will be effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period will be effective for interim and annual reporting periods beginning on or after December 15, 2010. As this ASU is disclosure-related only, we do not expect it to have an impact on our financial condition or results of operations.

In April 2010, the FASB issued 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 Codification 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 a significant 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.

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.

 
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BANK OF MARIN BANCORP

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; June 30, 2010 unaudited)
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, 2010:
                       
Securities available for sale
  $ 111,781     $ 698     $ 111,083     $ ---  
                                 
Derivative financial assets
  $ 199     $ ---     $ 199     $ ---  
                                 
Derivative financial liabilities
  $ 2,916     $ ---     $ 2,916     $ ---  
                                 
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     $ ---  

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.

 
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BANK OF MARIN BANCORP

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 terms 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, which is 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; June 30, 2010 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, 2010 (c)
   
Losses for the six months ended June 30, 2010 (c)
 
At June 30, 2010:
                                   
Impaired loans carried at fair value (d)
  $ 7,098     $ ---     $ 810     $ 6,288     $ 557     $ 2,200  
                                                 
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 $383 thousand and $34 thousand at June 30, 2010 and December 31, 2009, respectively, 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 $118 thousand and $11 thousand at June 30, 2010 and December 31, 2009, respectively. The carrying value of loans fully charged-off, which includes unsecured lines of credit, overdrafts and all other loans, is zero at the end of each period presented.

(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.

Disclosures about Fair Value of Financial Instruments

The table below is a summary of fair value estimates for financial instruments as of June 30, 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.

 
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BANK OF MARIN BANCORP

   
June 30, 2010
   
December 31, 2009
 
(in thousands; June 30, 2010 unaudited)
 
Carrying Amounts
   
Fair Value
   
Carrying Amounts
   
Fair Value
 
Financial assets
                       
Cash and cash equivalents
  $ 69,183     $ 69,183     $ 38,660     $ 38,660  
Investment securities held to maturity
    30,324       31,094       30,396       30,786  
Loans, net
    927,520       918,708       907,130       891,117  
Interest receivable
    4,198       4,198       4,338       4,338  
Financial liabilities
                               
Deposits
    999,178       999,580       944,061       944,469  
Federal Home Loan Bank long-term borrowings
    55,000       56,951       55,000       54,058  
Subordinated debenture
    5,000       4,785       5,000       4,146  
Interest payable
    1,075       1,075       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 due to 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, 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.

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.

 
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BANK OF MARIN BANCORP

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 Federal National Mortgage Association (“FNMA”), Federal Home Loan Mortgage Corporation (“FHLMC”), or Government National Mortgage Association (“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.

   
June 30, 2010
   
December 31, 2009
 
               
Gross Unrealized
               
Gross Unrealized
 
(in thousands; June 30, 2010 unaudited)
 
Amortized Cost
   
Fair Value
   
Gains
   
(Losses)
   
Amortized Cost
   
Fair Value
   
Gains
   
(Losses)
 
Held-to-maturity
                                               
Obligations of state and political subdivisions
  $ 30,324     $ 31,094     $ 973     $ (203 )   $ 30,396     $ 30,786     $ 774     $ (384 )
                                                                 
Available-for-sale
                                                               
Securities of U. S. government agencies:
                                                               
MBS pass-through securities issued by FNMA and FHLMC
    12,347       12,968       621       ---       12,882       13,086       253       (49 )
CMOs issued by FNMA
    14,513       15,171       658       ---       18,207       18,527       479       (159 )
CMOs issued by FHLMC
    27,569       28,368       799       ---       30,664       30,912       530       (282 )
CMOs issued by GNMA
    39,770       40,681       911       ---       15,180       15,657       477       ---  
Debentures of government sponsored agencies
    2,000       2,010       10       ---       5,000       5,040       46       (6 )
Corporate CMOs
    11,805       11,885       131       (51 )     14,819       14,596       1       (224 )
Equity security
    ---       698       698       ---       ---       ---       ---       ---  
Total securities available for sale
    108,004       111,781       3,828       (51 )     96,752       97,818       1,786       (720 )
                                                                 
Total investment securities
  $ 138,328     $ 142,875     $ 4,801     $ (254 )   $ 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 June 30, 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 $698 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 June 30, 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 $698 thousand are excluded from the following table as they have no maturity.

   
June 30, 2010
 
   
Held to Maturity
   
Available for Sale
 
(in thousands; unaudited)
 
Amortized Cost
   
Fair Value
   
Amortized Cost
   
Fair Value
 
Within one year
  $ 666     $ 670     $ ---     $ ---  
After one but within five years
    4,348       4,539       2,000       2,010  
After five years through ten years
    15,512       16,046       19,128       19,452  
After ten years
    9,798       9,839       86,876       89,621  
Total
  $ 30,324     $ 31,094     $ 108,004     $ 111,083  

At June 30, 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 June 30, 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 $762 thousand to provide collateral for trust deposits. In addition, at June 30, 2010, investment securities carried at $1.4 million were pledged to collateralize an internal Wealth Management Services checking account and $3.3 million were pledged to collateralize interest rate swap as discussed in Note 9.  At June 30, 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.

 
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BANK OF MARIN BANCORP

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.

Nine and thirty investment securities were in unrealized loss positions at June 30, 2010 and December 31, 2009, respectively.  They are summarized and classified according to the duration of the loss period as follows:

June 30, 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
  $ 1,737     $ (5 )   $ 1,861     $ (198 )   $ 3,598     $ (203 )
                                                 
Available-for-sale
                                               
Corporate CMOs
    3,741       (32 )     1,498       (19 )     5,239       (51 )
Total available for sale
    3,741       (32 )     1,498       (19 )     5,239       (51 )
Total temporarily impaired securities
  $ 5,478     $ (37 )   $ 3,359     $ (217 )   $ 8,837     $ (254 )

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 June 30, 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 or equivalent 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, 2010.
Securities Carried at Cost

 
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BANK OF MARIN BANCORP

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 $5.0 million and $4.7 million of FHLB stock recorded at cost in other assets at June 30, 2010 and December 31, 2009, respectively. On April 29, 2010, the FHLB declared a cash dividend for the first quarter of 2010 at an annualized dividend rate of 0.26%.  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.

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
   
Six months ended
 
(Dollars in thousands; unaudited)
 
June 30, 2010
   
March 31, 2010
   
June 30, 2009
   
June 30, 2010
   
June 30, 2009
 
Beginning balance
  $ 10,648     $ 10,618     $ 10,289     $ 10,618     $ 9,950  
Provision for loan loss charged to expense
    1,350       1,550       700       2,900       1,885  
Loans charged off
    (241 )     (1,547 )     (971 )     (1,788 )     (1,846 )
Loan loss recoveries
    16       27       117       43       146  
Ending balance
  $ 11,773     $ 10,648     $ 10,135     $ 11,773     $ 10,135  
                                         
Total loans outstanding at period end, before deducting allowance for loan losses
  $ 939,293     $ 920,356     $ 909,614     $ 939,293     $ 909,614  
                                         
Ratio of allowance for loan losses to total loans
    1.25 %     1.16 %     1.11 %     1.25 %     1.11 %
                                         
Non-accrual loans at period end:
                                       
Construction
  $ 5,654     $ 5,671     $ 3,182     $ 5,654     $ 3,182  
Commercial real estate
    3,455       3,711       1,243       3,455       1,243  
Commercial
    1,354       1,094       1,101       1,354       1,101  
Installment and other consumer
    310       838       383       310       383  
Home equity
    ---       100       ---       ---       ---  
Total non-accrual loans
    10,773       11,414       5,909       10,773       5,909  
Accruing restructured loans:
                                       
Installment and other consumer
    908       742       251       908       251  
Total accruing restructured loans
    908       742       251       908       251  
Total impaired loans
  $ 11,681     $ 12,156     $ 6,160     $ 11,681     $ 6,160  
                                         
Allowance for loan losses to non-accrual loans at period end
    109.28 %     93.29 %     171.52 %     109.28 %     171.52 %
                                         
Non-accrual loans to total loans
    1.15 %     1.24 %     0.65 %     1.15 %     0.65 %
                                         
Average recorded investment in impaired loans
  $ 12,093     $ 12,356     $ 7,916     $ 12,225     $ 7,855  

The gross interest income that would have been recorded, had non-accrual loans been current, totaled $243 thousand, $236 thousand and $199 thousand in the quarters ended June 30, 2010, March 31, 2010, and June 30, 2009, respectively, and totaled $479 thousand and $346 thousand for the first half of 2010 and 2009, respectively. We recognized interest income of $23 thousand, $1 thousand and $10 thousand for cash payments received in the quarters ended June 30, 2010, March 31, 2010, and June 30, 2009, respectively, and $24 thousand and $10 thousand for the first halves of 2010 and 2009, respectively. There were no accruing loans past due more than 90 days at June 30, 2010, March 31, 2010 or June 30, 2009.

Specific valuation allowances on impaired loans totaled $501 thousand, $169 thousand and $32 thousand at June 30, 2010, March 31, 2010 and June 30, 2009, respectively.  The amount of the recorded investment in impaired loans for which there is no related specific valuation allowance for loan losses totaled $8.3 million, $9.5 million and $5.8 million at June 30, 2010, March 31, 2010 and June 30, 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 June 30, 2010 totaled approximately $4.9 million.  At June 30, 2010, there were no significant commitments to extend credit on impaired loans.

 
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BANK OF MARIN BANCORP

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 $1.1 million, $903 thousand and $251 thousand at June 30, 2010, March 31, 2010 and June 30, 2009, respectively, of which $908 thousand, $742 thousand and $251 thousand, respectively, were accruing interest. These restructured loan amounts have been included in the impaired loan totals noted above.

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, 2010 and December 31, 2009, we had no overnight borrowings outstanding under these credit facilities.

Federal Home Loan Bank Borrowings – As of June 30, 2010 and December 31, 2009, we had lines of credit with the FHLB totaling $216.6 million and $236.2 million, respectively.  At June 30, 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 August 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 June 30, 2010, $161.6 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 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 June 30, 2010 and December 31, 2009, we have borrowing capacity under this line totaling $41.7 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 June 30, 2010 was 3.02%. The debenture is subordinated to the claims of depositors and our other creditors.

 
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BANK OF MARIN BANCORP

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 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.

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
   
Six months ended
 
(in thousands except per share data, unaudited)
 
June 30, 2010
   
March 31, 2010
   
June 30, 2009
   
June 30, 2010
   
June 30, 2009
 
Cash dividends to common shareholders
  $ 787     $ 785     $ 724     $ 1,572     $ 1,446  
Cash dividends per common share
  $ 0.15     $ 0.15     $ 0.14     $ 0.30     $ 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 statement of income 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 $219.7 million at June 30, 2010 at rates ranging from 2.25% to 8.25%.  This amount included $122.9 million under commercial lines of credit (these commitments are contingent upon customers maintaining specific credit standards), $73.2 million under revolving home equity lines, $10.7 million under undisbursed construction loans, $4.2 million under standby letters of credit, and a remaining $8.7 million under personal and other lines of credit. We have set aside an allowance for losses in the amount of $439 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 $1.2 million, $2.2 million, $2.2 million, $2.2 million and $2.0 million for 2010 (July through December), 2011, 2012, 2013, and 2014 respectively, and $16.1 million for all years thereafter.

Capital Purchase Commitment

In 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 $750 thousand, of which $201 thousand has been paid as of June 30, 2010.

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 to a floating-rate interest stream, generally benchmarked to the one-month U.S. dollar LIBOR index, protects us against changes in the fair value of our loans 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 is no longer considered a derivative and has been amortized using the effective yield method over the life of the designated loan.

In May 2010, we made a second firm commitment to enter into a long-term fixed-rate loan with a borrower and simultaneously enter into a forward interest rate swap agreement with a correspondent bank to mitigate the change in fair value of the yield maintenance agreement.  The forward swap is considered a non-designated hedge prior to the loan’s expected funding in August 2010.  The forward starting interest rate swap and the yield maintenance agreement 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). The changes in the fair value of the forward swap and the yield maintenance agreement offset each other recorded in interest income.

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, if any) 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 June 30, 2010 is $2.9 million, for which we have posted collateral in the form of securities available for sale totaling $3.3 million.

As of June 30, 2010, we had five interest rate swap agreements, which are scheduled to mature in September 2018, April 2019, June 2020, August 2020 and June 2022.  Our interest rate swaps are settled monthly with counterparties. Accrued interest on the swaps totaled $57 thousand as of June 30, 2010. Information on our derivatives follows:

 
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BANK OF MARIN BANCORP

   
Asset derivatives
   
Liability derivatives
 
(in thousands; June 30, 2010 unaudited)
 
June 30, 2010
   
December 31, 2009
   
June 30, 2010
   
December 31, 2009
 
                         
Fair value hedges
                       
Interest rate contracts notional amount
    ---     $ 1,905     $ 18,512     $ 17,076  
Credit risk amount
    ---       35       ---       ---  
Interest rate contracts fair value (1)
    ---       35       2,717       1,624  
Balance sheet location
    ---    
Other assets
   
Other liabilities
   
Other liabilities
 
                                 
Non-designated hedges