form10q.htm


 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
 
(Mark One)
 
xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2011
 
OR
 
oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________________ to __________________
 
 Commission File Number  001-33572

Bank of Marin Bancorp
(Exact name of Registrant as specified in its charter)
 
California     20-8859754
(State or other jurisdiction of incorporation)     (IRS Employer Identification No.)
     
 504 Redwood Blvd., Suite 100, Novato, CA    94947
(Address of principal executive office)   (Zip Code)
 
Registrant’s telephone number, including area code:  (415) 763-4520
 
Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, 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 x                   No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b(2) of the Exchange Act.
         
 Large accelerated filer   o  Accelerated filer   x  Non-accelerated filer   o  Smaller reporting company   o
 
Indicate by check mark if the registrant is a shell company, as defined in Rule 12b(2) of the Exchange Act.
Yes   o     No  x
 
As of October 31, 2011 there were 5,331,368 shares of common stock outstanding.
 


 
 

 
 
TABLE OF CONTENTS
 
       
PART I
3  
       
ITEM 1.
3  
       
  4  
  5  
  6  
  7  
  8  
       
ITEM 2.
31  
       
ITEM 3.
48  
       
ITEM 4.
49  
       
PART II
49  
       
ITEM 1.
49   
       
ITEM 1A.
49  
       
ITEM 2.
49   
       
ITEM 3.
49  
       
ITEM 4.
49   
       
ITEM 5.
49  
       
ITEM 6.
50   
       
51  
 
 
Page -2

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

 
 
BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF CONDITION 
at September 30, 2011 and December 31, 2010
 
 
 
 
(in thousands, except share data; 2011 unaudited)
 
September 30, 2011
   
December 31, 2010
 
             
Assets
           
Cash and due from banks
  $ 130,675     $ 65,724  
Short-term investments
    2,111       19,508  
Cash and cash equivalents
    132,786       85,232  
                 
Investment securities
               
Held to maturity, at amortized cost
    39,077       34,917  
                 
                 
Available for sale (at fair market value, amortized cost $156,531 and $109,070 at September 30, 2011 and December 31, 2010, respectively)
    159,478       111,736  
Total investment securities
    198,555       146,653  
                 
                 
Loans, net of allowance for loan losses of $13,224 and $12,392 at September 30, 2011 and December 31, 2010, respectively
    979,419       929,008  
Bank premises and equipment, net
    9,624       8,419  
Interest receivable and other assets
    42,333       38,838  
                 
Total assets
  $ 1,362,717     $ 1,208,150  
                 
Liabilities and Stockholders' Equity
               
                 
Liabilities
               
Deposits
               
Non-interest bearing
  $ 373,844     $ 282,195  
Interest bearing
               
Transaction accounts
    128,916       105,177  
Savings accounts
    74,392       56,760  
Money market accounts
    417,505       371,352  
CDARS® time accounts
    32,592       67,261  
Other time accounts
    149,276       132,994  
Total deposits
    1,176,525       1,015,739  
                 
Federal Home Loan Bank borrowings
    35,000       55,000  
Subordinated debenture
    5,000       5,000  
Interest payable and other liabilities
    13,191       10,491  
                 
Total liabilities
    1,229,716       1,086,230  
                 
Stockholders' Equity
               
                 
Preferred stock, no par value, Authorized - 5,000,000 shares; none issued
    ---       ---  
Common stock, no par value, Authorized - 15,000,000 shares Issued and outstanding - 5,331,368 and 5,290,082 at September 30, 2011 and December 31, 2010, respectively
    56,670       55,383  
Retained earnings
    74,622       64,991  
Accumulated other comprehensive income, net
    1,709       1,546  
                 
Total stockholders' equity
    133,001       121,920  
                 
Total liabilities and stockholders' equity
  $ 1,362,717     $ 1,208,150  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
Page -4

 
 
BANK OF MARIN BANCORP
 
CONSOLIDATED STATEMENTS OF INCOME
 
                               
   
Three months ended
   
Nine months ended
 
(in thousands, except per share amounts;  unaudited)
 
September 30, 2011
   
June 30, 2011
   
September 30, 2010
   
September 30, 2011
   
September 30, 2010
 
                               
Interest income
                             
Interest and fees on loans
  $ 15,567     $ 16,862     $ 14,296     $ 48,329     $ 42,146  
Interest on investment securities
                                       
Securities of U.S. Government agencies
    1,153       745       829       2,631       2,442  
Obligations of state and political subdivisions
    298       303       284       903       855  
Corporate debt securities and other
    151       171       144       433       452  
Interest on Federal funds sold and short-term investments
    56       56       48       152       98  
Total interest income
    17,225       18,137       15,601       52,448       45,993  
                                         
Interest expense
                                       
Interest on interest bearing transaction accounts
    35       48       32       121       81  
Interest on savings accounts
    21       25       27       75       79  
Interest on money market accounts
    326       341       602       1,004       2,128  
Interest on CDARS® time accounts
    50       48       221       192       663  
Interest on other time accounts
    305       315       391       978       1,122  
Interest on borrowed funds
    1,268       357       363       1,977       1,070  
Total interest expense
    2,005       1,134       1,636       4,347       5,143  
                                         
Net interest income
    15,220       17,003       13,965       48,101       40,850  
Provision for loan losses
    500       3,000       1,400       4,550       4,300  
Net interest income after provision for loan losses
    14,720       14,003       12,565       43,551       36,550  
                                         
Non-interest income
                                       
Service charges on deposit accounts
    478       468       446       1,389       1,355  
Wealth Management and Trust Services
    486       469       364       1,389       1,127  
Other income
    601       644       497       1,967       1,679  
Total non-interest income
    1,565       1,581       1,307       4,745       4,161  
                                         
Non-interest expense
                                       
Salaries and related benefits
    5,320       5,220       4,665       15,469       13,832  
Occupancy and equipment
    1,021       1,093       880       3,021       2,692  
Depreciation and amortization
    329       314       335       951       1,033  
Federal Deposit Insurance Corporation insurance
    189       214       388       790       1,125  
Data processing
    642       909       491       2,133       1,422  
Professional services
    465       740       550       1,938       1,436  
Other expense
    1,455       1,508       1,198       4,247       3,780  
Total non-interest expense
    9,421       9,998       8,507       28,549       25,320  
Income before provision for income taxes
    6,864       5,586       5,365       19,747       15,391  
                                         
Provision for income taxes
    2,631       2,147       2,006       7,566       5,747  
Net income
  $ 4,233     $ 3,439     $ 3,359     $ 12,181     $ 9,644  
                                         
Net income per common share:
                                       
Basic
  $ 0.80     $ 0.65     $ 0.64     $ 2.30     $ 1.84  
Diluted
  $ 0.79     $ 0.64     $ 0.63     $ 2.26     $ 1.82  
                                         
Weighted average shares used to compute net income per common share:
                                       
                                         
Basic
    5,310       5,300       5,241       5,298       5,231  
Diluted
    5,390       5,385       5,311       5,381       5,305  
                                         
Dividends declared per common share
  $ 0.16     $ 0.16     $ 0.15     $ 0.48     $ 0.45  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
Page -5

 
 
BANK OF MARIN BANCORP
 
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
 
for the year ended December 31, 2010 and the nine months ended September 30, 2011
 
                                     
                     
Accumulated Other
       
(dollars in thousands; 2011 unaudited )
 
Preferred Stock
   
Common Stock
   
Retained
   
Comprehensive
Income,
       
 
Shares
   
Amount
   
Earnings
   
Net of Taxes
   
Total
 
Balance at December 31, 2009
    ---       5,229,529     $ 53,789     $ 54,644     $ 618     $ 109,051  
Comprehensive income:
                                               
Net income
    ---       ---       ---       13,552       ---       13,552  
Other comprehensive income
                                               
                                                 
Net change in unrealized gain on available for sale securities (net of tax effect of $672)
    ---       ---       ---       ---       928       928  
Comprehensive income
    ---       ---       ---       13,552       928       14,480  
Stock options exercised
    ---       49,940       895       ---       ---       895  
Excess tax benefit - stock-based compensation
    ---       ---       132       ---       ---       132  
Stock issued under employee stock purchase plan
    ---       563       17       ---       ---       17  
Restricted stock granted
    ---       6,150       ---       ---       ---       ---  
Restricted stock forfeited / cancelled
    ---       (2,320 )     ---       ---       ---       ---  
Stock-based compensation - stock options
    ---       ---       241       ---       ---       241  
Stock-based compensation - restricted stock
    ---       ---       109       ---       ---       109  
Cash dividends paid on common stock
    ---       ---       ---       (3,205 )     ---       (3,205 )
Stock issued in payment of director fees
    ---       6,220       200       ---       ---       200  
Balance at December 31, 2010
    ---       5,290,082     $ 55,383     $ 64,991     $ 1,546     $ 121,920  
Comprehensive income:
                                               
Net income
    ---       ---       ---       12,181       ---       12,181  
Other comprehensive income
                                               
Net change in unrealized gain on available for sale securities (net of tax effect of $118)
    ---       ---       ---       ---       163       163  
Comprehensive income
    ---       ---       ---       12,181       163       12,344  
Stock options exercised
    ---       29,504       651       ---       ---       651  
Excess tax benefit - stock-based compensation
    ---       ---       117       ---       ---       117  
Stock issued under employee stock purchase plan
    ---       832       27       ---       ---       27  
Restricted stock granted
    ---       5,675       ---       ---       ---       ---  
Restricted stock forfeited
    ---       (315 )     ---       ---       ---       ---  
Stock-based compensation - stock options
    ---       ---       186       ---       ---       186  
Stock-based compensation - restricted stock
    ---       ---       106       ---       ---       106  
Cash dividends paid on common stock
    ---       ---       ---       (2,550 )     ---       (2,550 )
Stock issued in payment of director fees
    ---       5,590       200       ---       ---       200  
Balance at September 30, 2011
    ---       5,331,368     $ 56,670     $ 74,622     $ 1,709     $ 133,001  
 
The accompanying notes are an integral part of these consolidated financial statements.
         
 
 
Page -6

 
 
BANK OF MARIN BANCORP
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
for the nine months ended September 30, 2011 and 2010
 
             
(in thousands, unaudited)
 
September 30, 2011
   
September 30, 2010
 
             
Cash Flows from Operating Activities:
           
Net income
  $ 12,181     $ 9,644  
Adjustments to reconcile net income to net cash provided  by operating activities:
               
Provision for loan losses
    4,550       4,300  
Compensation expense--common stock for director fees
    150       150  
Stock-based compensation expense
    292       332  
Excess tax benefits from exercised stock options
    (96 )     (70 )
Amortization of investment security premiums, net of accretion of discounts
    984       848  
Accretion of discount on acquired loans
    (3,395 )     ---  
Depreciation and amortization
    951       1,033  
Bargain purchase gain on acquisition, net of tax
    (85 )     ---  
Loss on sale of repossessed assets
    36       6  
Loss on disposal of premise and equipment
    ---       3  
Net change in operating assets and liabilities:
               
Interest receivable
    (67 )     147  
Interest payable
    (47 )     150  
Deferred rent and other rent-related expenses
    205       191  
Other assets
    1,306       (336 )
Other liabilities
    435       283  
Total adjustments
    5,219       7,037  
Net cash provided by operating activities
    17,400       16,681  
Cash Flows from Investing Activities:
               
Proceeds from sale of furniture and equipment
    18       ---  
Purchase of securities held-to-maturity
    (5,566 )     ---  
Purchase of securities available-for-sale
    (91,151 )     (36,370 )
Proceeds from paydowns/maturity of:
               
Securities held-to-maturity
    1,255       480  
Securities available-for-sale
    42,857       24,316  
Loans originated and principal collected, net
    11,710       (21,776 )
Purchase of bank owned life insurance policies
    (2,500 )     ---  
Purchase of premises and equipment
    (2,139 )     (1,577 )
Proceeds from sale of repossessed assets
    199       158  
Cash receipt from acquisition
    44,042       ---  
Net cash used in investing activities
    (1,275 )     (34,769 )
                 
Cash Flows from Financing Activities:
               
Net increase in deposits
    66,705       79,217  
Proceeds from stock options exercised
    651       244  
Repayment of Federal Home Loan Bank borrowings
    (33,500 )     ---  
Cash dividends paid on common stock
    (2,550 )     (2,361 )
Stock issued under employee stock purchase plan
    27       12  
Excess tax benefits from exercised stock options
    96       70  
Net cash provided by financing activities
    31,429       77,182  
                 
Net increase in cash and cash equivalents
    47,554       59,094  
Cash and cash equivalents at beginning of period
    85,232       38,660  
                 
Cash and cash equivalents at end of period
  $ 132,786     $ 97,754  
                 
Supplemental disclosure of non-cash investing and financing activities:
               
Loans transferred to repossessed assets
  $ 301     $ 210  
Stock issued in payment of director fees
  $ 200     $ 200  
Acquisition:
               
Fair value of assets acquired
  $ 107,763       ---  
Fair value of liabilities assumed
  $ 107,678       ---  
 
The accompanying notes are an integral part of these consolidated financial statements.
               
 
 
Page -7

 
 
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, and has determined that there are no subsequent events that require recognition or disclosure.
 
Certain information and footnote disclosures presented in the annual consolidated 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 2010 Annual Report on Form 10-K.  The results of operations for the three months and nine months ended September 30, 2011 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. 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. We have two forms 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.
 
   
Three months ended
   
Nine months ended
 
(in thousands, except per share data; unaudited)
 
September 30, 2011
   
June 30, 2011
   
September 30, 2010
   
September 30, 2011
   
September 30, 2010
 
Weighted average basic shares outstanding
    5,310       5,300       5,241       5,298       5,231  
                                         
Add: Potential common shares related to stock options
    40       43       42       42       46  
                                         
Potential common shares related to non-vested restricted stock
    3       3       3       4       3  
                                         
Potential common shares related to warrant
    37       39       25       37       25  
Weighted average diluted shares outstanding
    5,390       5,385       5,311       5,381       5,305  
                                         
Net income available to common stockholders
  $ 4,233     $ 3,439     $ 3,359     $ 12,181     $ 9,644  
                                         
Basic EPS
  $ 0.80     $ 0.65     $ 0.64     $ 2.30     $ 1.84  
Diluted EPS
  $ 0.79     $ 0.64     $ 0.63     $ 2.26     $ 1.82  
                                         
                                         
Weighted average anti-dilutive shares not included in the calculation of diluted EPS
                                       
Stock options
    74       73       175       69       164  
Non-vested restricted stock
    ---       6       ---       4       ---  
Total anti-dilutive shares
    74       79       175       73       164  
 
 
Page -8

 
 
Note 2: Recently Issued Accounting Standards
 
In September 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-08 Intangibles – Goodwill and Other (Topic 350) Testing Goodwill for Impairment. The ASU simplifies how entities, both public and nonpublic, test goodwill for impairment. The amendments to Topic 350 permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carry amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. An entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. This ASU is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. We do not expect this ASU to have a significant impact on our financial condition or results of operations.
 
In June 2011, the FASB issued ASU No. 2011-05 Comprehensive Income (Topic 220) Presentation of Comprehensive Income. The ASU improves the comparability, consistency, and transparency of financial reporting and increases the prominence of items reported in other comprehensive income. The amendments to Topic 220, Comprehensive Income, require entities to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Entities are no longer permitted to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. Any adjustments for items that are reclassified from other comprehensive income to net income are to be presented on the face of the entities’ financial statement regardless of the method of presentation for comprehensive income.  The amendments do not change items to be reported in comprehensive income or when an item of other comprehensive income must be reclassified to net income, nor do the amendments change the option to present the components of other comprehensive income either net of related tax effects or before related tax effects. ASU 2011-05 is effective for fiscal years, and interim periods beginning on or after December 15, 2011. However, on October 21, 2011, the FASB met and discussed the operational concerns of stakeholders about the presentation requirements for reclassification adjustments in ASU No. 2011-05, and decided that the specific requirement to present items that are reclassified from other comprehensive income to net income alongside their respective components of net income and other comprehensive income will be deferred. We do not expect this ASU to have an impact on our financial condition or results of operations as it affects presentation only.
 
In May 2011, the FASB issued ASU No. 2011-04 Fair Value Measurement (Topic 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The ASU improves the comparability of fair value measurements presented and disclosed in accordance with U.S. generally accepted accounting principles (“GAAP”) and International Financial Reporting Standards (“IFRS”s) by changing the wording used to describe many of the requirements in U.S GAAP for measuring fair value and disclosure of information. The amendments to this ASU provide explanations on how to measure fair value but do not require any additional fair value measurements and do not establish valuation standards or affect valuation practices outside of financial reporting. The amendments clarify existing fair value measurements and disclosure requirements to include application of the highest and best use and valuation premises concepts; measuring fair value of an instrument classified in a reporting entity’s shareholders’ equity; and disclosure requirements regarding quantitative information about unobservable inputs categorized within Level 3 of the fair value hierarchy. In addition, clarification is provided for measuring the fair value of financial instruments that are managed in a portfolio and the application of premiums and discounts in a fair value measurement. For public entities, ASU 2011-04 is effective during interim and annual periods beginning after December 15, 2011. We do not expect this ASU to have a significant impact on our financial condition or results of operations.
 
In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.  The ASU clarifies which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring (“TDR”), both for purposes of recording an impairment loss and for disclosure of a TDR. In evaluating whether a restructuring constitutes a TDR, a creditor must separately conclude that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. The amendments to ASU Topic 310, Receivables, clarify the guidance on a creditor’s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties. ASU No. 2011-02 is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. We have adopted this ASU in the third quarter of 2011 and provided the applicable disclosure in Note 6 herein.
 
 
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In December 2010, the FASB issued ASU No. 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations to address diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. This ASU is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning January 1, 2011. It requires a public entity to disclose pro forma revenue and earnings of the combined entity for the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma revenue and earnings of the combined entity for the comparable prior reporting period should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. We have provided the applicable disclosure in Note 3 herein.
 
Note 3:  Acquisition
 
On February 18, 2011, we entered into a modified whole-bank purchase and assumption agreement without loss share (the “P&A Agreement”) with the Federal Deposit Insurance Corporation (the “FDIC”), the receiver of Charter Oak Bank of Napa, California, to purchase certain assets and assume certain liabilities of the former Charter Oak Bank to enhance our market presence (the “Acquisition”). The purchase price reflected an asset discount of $19.8 million and no deposit premium.
 
The P&A Agreement only covers designated assets and liabilities of Charter Oak Bank. Common stock of Charter Oak Bank, certain assets and certain liabilities, such as claims against any officer, director, employee, accountant, attorney, or any other person employed by the former Charter Oak Bank, were not purchased or assumed by us. In addition, loans of the former Charter Oak Bank at their book values totaling approximately $24.4 million as of the acquisition date were retained by the FDIC. The excluded loans mainly represent loans delinquent more than sixty days or more as of the bid valuation date (October 18, 2010) and certain types of land and construction loans.
 
The assets acquired and liabilities assumed, both tangible and intangible, were recorded at their fair values as of acquisition date in accordance with ASC 805, Business Combinations.  These fair value estimates are subject to change for up to one year after the acquisition date as additional information relative to acquisition date fair values becomes available. In addition, the tax treatment of FDIC-assisted acquisitions is complex and subject to interpretations that may result in future adjustments of deferred taxes as of the acquisition date.
 
In FDIC-assisted transactions, only certain assets and liabilities are transferred to the acquirer and, depending on the nature and amount of the acquirer’s bid, the FDIC may be required to make a cash payment to the acquirer or the acquirer may be required to make payment to the FDIC.  We received cash totaling $32.6 million from the FDIC upon initial settlement of the transaction and recorded a receivable from the FDIC of $196 thousand, for consideration of the net liabilities assumed (i.e., the net difference between the liabilities assumed and the assets acquired). The $196 thousand receivable has been settled in August 2011.
 
 
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The following table presents the net liabilities assumed from Charter Oak and the estimated fair value adjustments, which resulted in a bargain purchase gain as of the acquisition date as the loans were purchased at a discount:
 
(Dollars in thousands, unaudited)
 
Acquisition Date
(February 18, 2011)
 
Book value of net liabilities assumed from Charter Oak Bank
  $ (15,750 )
Cash received from the FDIC upon initial settlement
    32,588  
Receivable from the FDIC
    196  
         
Fair value adjustments:
       
Loans
    (17,406 )
Core deposit intangible asset
    725  
Vehicles and equipment
    16  
Deferred tax liabilities
    (62 )
Deposits
    (220 )
Advances from the Federal Home Loan Bank
    (2 )
Total purchase accounting adjustments
    (16,949 )
         
Bargain purchase gain, net of tax
  $ 85  
 
The bargain purchase gain represents the excess of the estimated fair value of the assets acquired over the estimated fair value of the liabilities assumed.  We did not immediately acquire the banking facilities, including outstanding lease agreements, furniture, fixtures and equipment, as part of the P&A Agreement as of the acquisition date. We have since acquired all data processing equipment and the Napa branch fixed assets totaling $206 thousand, and renegotiated a new lease with the landlord. The smaller St. Helena branch acquired from Charter Oak Bank was closed effective April 29, 2011.
 
The following table reflects the estimated fair values of the assets acquired and liabilities assumed related to the Acquisition, including cash received and receivable from the FDIC on the acquisition date:
 
(Dollars in thousands, unaudited)
 
Acquisition Date
(February 18, 2011)
 
Assets:
     
Cash and due from banks
  $ 34,144  
Interest bearing deposits in banks
    5,663  
Federal funds sold
    4,235  
Total cash and cash equivalents
    44,042  
Loans
    61,765  
Core deposit intangible
    725  
Other assets (including the receivable from the FDIC)
    1,231  
Total assets acquired
    107,763  
Liabilities:
       
Deposits:
       
Noninterest bearing
    27,874  
Interest bearing
    65,987  
Total deposits
    93,861  
Advances from the Federal Home Loan Bank
    13,502  
Deferred tax liabilities
    62  
Other liabilities
    253  
Total liabilities assumed
    107,678  
         
Bargain purchase gain, net of tax (included in other non-interest income)
  $ 85  
 
 
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The following is a description of the methods used to determine the fair values of significant assets and liabilities at acquisition date presented above.
 
Loans
 
The fair values for acquired loans were developed based upon the present values of the expected cash flows utilizing market-derived discount rates. Expected cash flows for each acquired loan were projected based on contractual cash flows adjusted for expected prepayment, expected default (i.e. probability of default and loss severity), and principal recovery.
 
For purchased non-credit-impaired loans, prepayment rates were applied to the principal outstanding based on the following assumptions depending on type of loan:
 
 
For commercial and agriculture loans, a ten percent constant prepayment rate (“CPR”) was assumed based on current research associated with these loan types;
 
A one percent CPR was assumed for commercial real estate, construction and land loans as research data indicate limited prepayment activity over the life of these loans;
 
For single family residential loans, a twenty percent CPR was used, based on current research associated with these loan types;
 
For home equity lines of credit, a CPR of fifteen percent was assumed based on the refinance likelihood and other research; and,
 
For other consumer loans, a CPR of one and a half percent was used based on current capital markets research data for consumer unsecured credit.
 
Prepayment assumptions were not factored into the calculation of expected cash flows on purchased credit-impaired loans. For purchased non-credit impaired loans, the total gross contractual amounts receivable were $69.7 million as of the acquisition date.
 
Loans with similar characteristics were grouped together and were treated in the aggregate when applying the discount rate on the expected cash flows. Aggregation factors considered include the type of loan and related collateral, risk classification, fixed or variable interest rate, term of loan and whether or not the loan was amortizing. The discount rates used for the similar groups of loans are based on current market rates for new originations of comparable loans, where available, and include adjustments for credit and liquidity factors. To the extent comparable market rates are not readily available, a discount rate was derived based on the assumptions of a market participant's cost of funds, servicing costs, and return requirements for comparable risk assets.
 
Deposits
 
The fair values used for the transaction, savings and money market deposits are equal to the amount payable on demand at the reporting date. The fair values for time deposits are estimated using a discounted cash flow calculation that applies interest rates offered by market participants as of the acquisition date on time deposits with similar maturity terms as the discount rates.  The core deposit intangible assets recognized as a result of the acquisition of core deposits are deductible for income tax purposes over fifteen years.
 
Advances from the Federal Home Loan Bank
 
The advances from the Federal Home Loan Bank San Francisco (“FHLB”) were recorded at their estimated fair value, which was based on quoted prices supplied by the FHLB. Subsequent to the acquisition dates, all of these advances were repaid in full.
 
Pro Forma Results of Operations
 
The contribution of the acquired operations of the former Charter Oak Bank to our results of operations for the period February 18 to September 30, 2011 is as follows: revenue of $7.5 million, expenses of $3.5 million (including a provision for loan losses of $1.0 million), resulting in income after income taxes of $2.5 million. These amounts include the bargain purchase gain, Acquisition-related third-party costs, accretion of the discount on the acquired loans, gains on payoff of Purchased Credit Impaired (“PCI”) loans and amortization of the fair value mark on time deposits and the core deposit intangible amortization. Charter Oak Bank’s results of operations prior to the acquisition date are not included in our operating results for 2011. The contribution discussed above excludes allocated overhead and allocated cost of funds.
 
 
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We acquired only certain assets and assumed certain liabilities from the former Charter Oak Bank.  A significant portion of the former Charter Oak Bank’s operations, including certain delinquent loans, its St. Helena facilities and its central operations and administrative functions were not retained by us. Therefore, disclosure of supplemental pro forma financial information, especially prior period comparison is deemed neither practical nor meaningful given the troubled nature of Charter Oak Bank prior to the date of Acquisition.
 
Acquisition-related expenses are recognized as incurred and continue until all systems have been converted and operational functions become fully integrated. We incurred third-party acquisition-related expenses in the following line items in the consolidated statements of income for the three-month and nine-month periods ended September 30, 2011 as follows:
 
Acquisiton-related Expenses
 
Three months ended
   
Three months ended
   
Nine months ended
 
(in thousands)
 
September 30, 2011
   
June 30, 2011
   
September 30, 2011
 
Professional services
  $ -     $ 153     $ 457  
Data processing
    47       378       455  
Other1
    (37 )     111       88  
Total
  $ 10     $ 642     $ 1,000  
                         
1Third-quarter 2011 expenses are offset by a $37 thousand final FDIC settlement reimbursement.
 
 
Note 4:  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 involve 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 includes management judgment and estimation which may be significant.
 
 
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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 September 30, 2011 (unaudited):
                       
Securities available for sale:
                       
                         
Mortgage-backed securities and collaterized mortgage obligations issued by U.S. government agencies
  $ 116,602     $ ---     $ 116,602     $ ---  
Debentures of government sponsored agencies
  $ 25,092     $ ---     $ 25,092     $ ---  
Corporate collateralized mortgage obligations
  $ 17,784     $ ---     $ 17,784     $ ---  
                                 
Derivative financial liabilities (interest rate contracts)
  $ 4,415     $ ---     $ 4,415     $ ---  
                                 
                                 
Balance at December 31, 2010:
                               
Securities available for sale:
                               
                                 
Mortgage-backed securities and collaterized mortgage obligations issued by U.S. government agencies
  $ 95,258     $ ---     $ 95,258     $ ---  
Corporate collateralized mortgage obligations
  $ 15,870     $ ---     $ 15,870     $ ---  
Equity securities
  $ 608     $ 608     $ -     $ ---  
                                 
Derivative financial liabilities (interest rate contracts)
  $ 2,470     $ ---     $ 2,470     $ ---  
 
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.  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, such as other real estate owned. 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 a market-based interest rate for similar loans (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.
 
 
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The following table presents the carrying value of financial instruments by level within the fair value hierarchy as of September 30, 2011 and December 31, 2010, for which a non-recurring change in fair value has been recorded.
 
(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) (a)
   
Losses for the three months ended September 30, 2011 (b)
   
Losses for the nine months ended September 30, 2011 (b)
   
Losses for the three months ended September 30, 2010 (b)
   
Losses for the nine months ended September 30, 2010 (b)
 
At September 30, 2011 (unaudited):                                                          
Impaired loans carried at fair value (c)
  $ 4,354     $ ---     $ ---     $ 4,354     $ 674     $ 4,757     $ 1,502     $ 3,702  
Other real estate owned
  $ 151     $ ---     $ ---     $ 151     $ ---     $ ---     $ ---     $ ---  
                                                                 
At December 31, 2010:                                                                
Impaired loans carried at fair value (c)
  $ 8,635     $ ---     $ ---     $ 8,635                                  
 
(a) Represents collateral-dependent loan principal balances that had been generally written down to the appraised value or estimated market value of the underlying collateral, net of specific valuation allowance of $925 thousand and $936 thousand at September 30, 2011 and December 31, 2010, respectively. The carrying value of loans fully charged-off, which includes unsecured lines of credit, overdrafts and all other loans, is zero.
(b) Represents net charge-offs during the period presented and the specific valuation allowance established on loans during the period.
(c) Represents the portion of impaired loans that have been written down to their estimated fair value.
 
Disclosures about Fair Value of Financial Instruments
 
The table below is a summary of fair value estimates for financial instruments as of September 30, 2011 and December 31, 2010, 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 statements of condition under the indicated captions. We have excluded non-financial assets and non-financial liabilities defined by the Codification (ASC 820-10-15-1A), such as Bank premises and equipment, deferred taxes and other liabilities.  In addition, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements of the Financial Instruments Topic of the Codification (ASC 825-10-50-8), such as Bank-owned life insurance policies.
 
   
September 30, 2011
   
December 31, 2010
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
(in thousands; 2011 amounts unaudited)
 
Amounts
   
Value
   
Amounts
   
Value
 
Financial assets
                       
Cash and cash equivalents
  $ 132,786     $ 132,786     $ 85,232     $ 85,232  
Investment securities held to maturity
    39,077       41,236       34,917       35,090  
Loans, net
    979,419       1,003,999       929,008       952,763  
Interest receivable
    4,274       4,274       4,207       4,207  
Financial liabilities
                               
Deposits
    1,176,525       1,177,434       1,015,739       1,016,401  
Federal Home Loan Bank borrowings
    35,000       36,371       55,000       57,090  
Subordinated debenture
    5,000       4,885       5,000       4,994  
Interest payable
    367       367       414       414  

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 September 30, 2011, we did not hold any securities whose fair value was measured using significant unobservable inputs.
 
 
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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. The allowance for loan losses (“ALLL”) is considered to be a reasonable estimate of loan discount due to credit risks.
 
Interest Receivable and Payable - The interest receivable and payable balances approximate their fair value due to the short-term nature of their settlement dates.
 
Deposits - The fair value of 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 Borrowings - The fair value is estimated by discounting the future cash flows using current rates offered by the FHLB for similar credit advances corresponding to the remaining duration of our fixed-rate credit advances.
 
Subordinated Debenture - The 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 5:  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.
 
(in thousands; September 30, 2011 unaudited)
 
September 30, 2011
   
December 31, 2010
 
 
Amortized
   
Fair
   
Gross Unrealized
   
Amortized
   
Fair
   
Gross Unrealized
 
 
Cost
   
Value
   
Gains
   
(Losses)
   
Cost
   
Value
   
Gains
   
(Losses)
 
Held-to-maturity
                                               
Obligations of state and political subdivisions
  $ 39,077     $ 41,236     $ 2,203     $ (44 )   $ 34,917     $ 35,090     $ 666     $ (493 )
                                                                 
Available-for-sale
                                                               
Securities of U. S. government agencies:
                                                               
MBS pass-through securities issued by FNMA and FHLMC
    27,645       28,749       1,104       ---       16,119       16,424       419       (114 )
CMOs issued by FNMA
    11,294       11,740       446       ---       12,770       13,236       466       ---  
CMOs issued by FHLMC
    21,248       21,892       644       ---       19,725       20,177       452       ---  
CMOs issued by GNMA
    53,080       54,221       1,141       ---       44,607       45,421       884       (70 )
Debentures of government sponsored agencies
    25,001       25,092       91       ---       ---       ---       ---       ---  
Corporate CMOs
    18,263       17,784       135       (614 )     15,849       15,870       185       (164 )
Equity security
    ---       ---       ---       ---       ---       608       608       ---  
Total available for sale
    156,531       159,478       3,561       (614 )     109,070       111,736       3,014       (348 )
                                                                 
Total investment securities
  $ 195,608     $ 200,714     $ 5,764     $ (658 )   $ 143,987     $ 146,826     $ 3,680     $ (841 )
 
 
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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 upon 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 2010 Form 10-K.  The stock was re-classified from available-for-sale securities to cost-basis accounting in March 2011 as the stock is still currently restricted from resale based on new information received from Visa Inc. Hence, the unrealized gain on the stock, net of tax, at December 31, 2010 was reversed from other comprehensive income. The fair value of the Class B common stock we own was $709 thousand and $608 thousand at September 30, 2011 and December 31, 2010, respectively, based on the Class A as-converted rate of 0.4881 and 0.5102, respectively.
 
The amortized cost and fair value of investment securities by contractual maturity at September 30, 2011 are shown below.  Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.
 
   
September 30, 2011
 
   
Held to Maturity
   
Available for Sale
 
(in thousands; unaudited)
 
Amortized Cost
   
Fair Value
   
Amortized Cost
   
Fair Value
 
Within one year
  $ 3,028     $ 3,029     $ ---     $ ---  
After one but within five years
    7,666       7,950       23,442       23,637  
After five years through ten years
    20,923       22,483       17,255       17,512  
After ten years
    7,460       7,774       115,834       118,329  
Total
  $ 39,077     $ 41,236     $ 156,531     $ 159,478  
 
At September 30, 2011, investment securities carried at $39.8 million were pledged with the State of California:  $39.1 million to secure public deposits in compliance with the Local Agency Security Program and $704 thousand to provide collateral for trust deposits. In addition, at September 30, 2011, investment securities carried at $1.1 million were pledged to collateralize an internal Wealth Management Services checking account and $5.9 million were pledged to collateralize interest rate swaps as discussed in Note 11.
 
 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.
 
 
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Fifteen and twenty-nine investment securities were in unrealized loss positions at September 30, 2011 and December 31, 2010, respectively. They are summarized and classified according to the duration of the loss period as follows:
 
September 30, 2011
 
< 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