BMRC-2012.06.30-10Q

 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 June 30, 2012
 
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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x                    No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T 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 July 31, 2012, there were 5,364,912 shares of common stock outstanding.



TABLE OF CONTENTS
 
 
 
 
PART I
 
 
 
ITEM 1.
 
 
 
 
 
 
 
 
 
 
 
ITEM 2.
 
 
 
ITEM 3.
 
 
 
ITEM 4.
 
 
 
PART II
 
 
 
ITEM 1.
 
 
 
ITEM 1A.
 
 
 
ITEM 2.
 
 
 
ITEM 3.
 
 
 
ITEM 4.
 
 
 
ITEM 5.
 
 
 
ITEM 6.
 
 
 




Page-2



PART I       FINANCIAL INFORMATION
 
ITEM 1.  Financial Statements
 
BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF CONDITION 
at June 30, 2012 and December 31, 2011
(in thousands, except share data; 2012 unaudited)
June 30, 2012
 
December 31, 2011
Assets
 

 
 
Cash and due from banks
$
98,321

 
$
127,732

Short-term investments

 
2,011

Cash and cash equivalents
98,321

 
129,743

Investment securities
 

 
 

Held to maturity, at amortized cost
83,134

 
59,738

Available for sale (at fair market value; amortized cost $159,024 and $132,348 at June 30, 2012 and December 31, 2011, respectively)
161,803

 
135,104

Total investment securities
244,937

 
194,842

Loans, net of allowance for loan losses of $13,435 and $14,639 at June 30, 2012 and December 31, 2011, respectively
1,011,759

 
1,016,515

Bank premises and equipment, net
9,074

 
9,498

Interest receivable and other assets
42,909

 
42,665

Total assets
$
1,407,000

 
$
1,393,263

 
 
 
 
Liabilities and Stockholders' Equity
 

 
 

Liabilities
 

 
 

Deposits
 

 
 

Non-interest bearing
$
399,835

 
$
359,591

Interest bearing
 

 
 

Transaction accounts
149,822

 
134,673

Savings accounts
86,590

 
75,617

Money market accounts
423,682

 
434,461

CDARS® time accounts
27,297

 
46,630

Other time accounts
143,491

 
152,000

Total deposits
1,230,717

 
1,202,972

Federal Home Loan Bank borrowings
15,000

 
35,000

Subordinated debenture
5,000

 
5,000

Interest payable and other liabilities
11,957

 
14,740

Total liabilities
1,262,674

 
1,257,712

 
 
 
 
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 - 5,362,222 and 5,336,927 shares at
June 30, 2012 and December 31, 2011, respectively
57,543

 
56,854

Retained earnings
85,171

 
77,098

Accumulated other comprehensive income, net
1,612

 
1,599

Total stockholders' equity
144,326

 
135,551

Total liabilities and stockholders' equity
$
1,407,000

 
$
1,393,263


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

Page-3



BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 
Three months ended
 
Six months ended
(in thousands, except per share amounts;  unaudited)
June 30, 2012
 
March 31, 2012
 
June 30, 2011
 
June 30, 2012
 
June 30, 2011
Interest income
 
 
 
 
 
 
 
 
 
Interest and fees on loans
$
15,324

 
$
15,328

 
$
16,862

 
$
30,652

 
$
32,762

Interest on investment securities


 


 
 

 
 

 
 

Securities of U.S. Government agencies
817

 
967

 
745

 
1,784

 
1,478

Obligations of state and political subdivisions
455

 
387

 
303

 
842

 
605

Corporate debt securities and other
285

 
201

 
171

 
486

 
282

Interest on Federal funds sold and short-term investments
56

 
50

 
56

 
106

 
96

Total interest income
16,937

 
16,933

 
18,137

 
33,870

 
35,223

Interest expense
 

 
 

 
 

 
 

 
 

Interest on interest bearing transaction accounts
45

 
44

 
48

 
89

 
86

Interest on savings accounts
24

 
22

 
25

 
46

 
54

Interest on money market accounts
180

 
183

 
341

 
363

 
678

Interest on CDARS® time accounts
21

 
32

 
48

 
53

 
142

Interest on other time accounts
269

 
304

 
315

 
573

 
673

Interest on borrowed funds
117

 
147

 
357

 
264

 
709

Total interest expense
656

 
732

 
1,134

 
1,388

 
2,342

Net interest income
16,281

 
16,201

 
17,003

 
32,482

 
32,881

Provision for loan losses
100

 

 
3,000

 
100

 
4,050

Net interest income after provision for loan losses
16,181

 
16,201

 
14,003

 
32,382

 
28,831

Non-interest income
 

 
 

 
 

 
 

 
 

Service charges on deposit accounts
549

 
524

 
468

 
1,073

 
911

Wealth Management and Trust Services
488

 
456

 
469

 
944

 
903

Debit card interchange fees
259

 
234

 
203

 
493

 
391

Merchant interchange fees
186

 
193

 
159

 
379

 
265

Earnings on Bank-owned life insurance
192

 
188

 
193

 
380

 
362

Other income
126

 
100

 
89

 
226

 
348

Total non-interest income
1,800

 
1,695

 
1,581

 
3,495

 
3,180

Non-interest expense
 

 
 

 
 

 
 

 
 

Salaries and related benefits
5,314

 
5,604

 
5,220

 
10,918

 
10,149

Occupancy and equipment
1,056

 
987

 
1,093

 
2,043

 
2,000

Depreciation and amortization
341

 
341

 
314

 
682

 
622

Federal Deposit Insurance Corporation insurance
218

 
233

 
214

 
451

 
601

Data processing
660

 
606

 
909

 
1,266

 
1,491

Professional services
516

 
585

 
740

 
1,101

 
1,473

Other expense
1,580

 
1,479

 
1,508

 
3,059

 
2,792

Total non-interest expense
9,685

 
9,835

 
9,998

 
19,520

 
19,128

Income before provision for income taxes
8,296

 
8,061

 
5,586

 
16,357

 
12,883

Provision for income taxes
3,345

 
3,121

 
2,147

 
6,466

 
4,935

Net income
$
4,951

 
$
4,940

 
$
3,439

 
$
9,891

 
$
7,948

Net income per common share:
 

 
 

 
 

 
 
 
 
Basic
$
0.93

 
$
0.93

 
$
0.65

 
$
1.86

 
$
1.50

Diluted
$
0.91

 
$
0.91

 
$
0.64

 
$
1.82

 
$
1.48

Weighted-average shares used to compute net income per common share:


 
 

 
 

 
 
 
 
Basic
5,337

 
5,326

 
5,300

 
5,331

 
5,292

Diluted
5,419

 
5,425

 
5,385

 
5,422

 
5,376

Dividends declared per common share
$
0.17

 
$
0.17

 
$
0.16

 
$
0.34

 
$
0.32

Comprehensive income
 
 
 
 
 
 


 


Net income
$
4,951

 
$
4,940

 
$
3,439

 
$
9,891

 
$
7,948

Other comprehensive (loss) income


 


 


 


 


Change in net unrealized gain on available for sale securities
(39
)
 
28

 
1,068

 
(11
)
 
10

Reclassification adjustment for (gain) losses included in net income
(4
)
 
38

 

 
34

 

Net change in unrealized gain on available for sale securities, before tax
(43
)
 
66

 
1,068

 
23

 
10

Deferred tax (benefit) expense
(18
)
 
28

 
449

 
10

 
4

Other comprehensive (loss) income, net of tax
(25
)
 
38

 
619

 
13

 
6

Comprehensive income
$
4,926

 
$
4,978

 
$
4,058

 
$
9,904

 
$
7,954


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

Page-4



BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
for the year ended December 31, 2011 and the six months ended June 30, 2012

(dollars in thousands; 2012 unaudited )
 
Common Stock
 
Retained
Earnings

 
Accumulated Other
Comprehensive Income,
Net of Taxes

 
 Total

Shares

 
Amount

 
 
 
Balance at December 31, 2010
 
5,290,082

 
$
55,383

 
$
64,991

 
$
1,546

 
$
121,920

Net income
 

 

 
15,564

 

 
15,564

Other comprehensive income
 

 

 

 
53

 
53

Stock options exercised
 
34,913

 
741

 

 

 
741

Excess tax benefit - stock-based compensation
 

 
120

 

 

 
120

Stock issued under employee stock purchase plan
 
982

 
33

 

 

 
33

Restricted stock granted
 
5,675

 

 

 

 

Restricted stock forfeited / cancelled
 
(315
)
 

 

 

 

Stock-based compensation - stock options
 

 
234

 

 

 
234

Stock-based compensation - restricted stock
 

 
143

 

 

 
143

Cash dividends paid on common stock
 

 

 
(3,457
)
 

 
(3,457
)
Stock issued in payment of director fees
 
5,590

 
200

 

 

 
200

Balance at December 31, 2011
 
5,336,927

 
$
56,854

 
$
77,098

 
$
1,599

 
$
135,551

Net income
 

 

 
9,891

 

 
9,891

Other comprehensive income
 

 

 

 
13

 
13

Stock options exercised
 
13,580

 
324

 

 

 
324

Excess tax benefit - stock-based compensation
 

 
41

 

 

 
41

Stock issued under employee stock purchase plan
 
385

 
14

 

 

 
14

Restricted stock granted
 
9,030

 

 

 

 

Restricted stock forfeited
 
(380
)
 

 

 

 

Stock-based compensation - stock options
 

 
111

 

 

 
111

Stock-based compensation - restricted stock
 

 
95

 

 

 
95

Cash dividends paid on common stock
 

 

 
(1,818
)
 

 
(1,818
)
Stock purchased by directors under director stock plan
 
100

 
4

 

 

 
4

Stock issued in payment of director fees
 
2,580

 
100

 

 

 
100

Balance at June 30, 2012
 
5,362,222

 
$
57,543

 
$
85,171

 
$
1,612

 
$
144,326


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

Page-5



BANK OF MARIN BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the six months ended June 30, 2012 and 2011
(in thousands, unaudited)
June 30, 2012
 
June 30, 2011
Cash Flows from Operating Activities:
 
 
 
Net income
$
9,891

 
$
7,948

Adjustments to reconcile net income to net cash provided  by operating activities:
 

 
 

Provision for loan losses
100

 
4,050

Compensation expense--common stock for director fees
100

 
110

Stock-based compensation expense
206

 
204

Excess tax benefits from exercised stock options
(36
)
 
(73
)
Amortization of investment security premiums, net of accretion of discounts
931

 
776

Accretion of discount on acquired loans
(1,502
)
 
(2,211
)
Decrease in deferred loan origination fees, net1
(631
)

(914
)
Loss on sale of investment securities
34



Depreciation and amortization
682

 
622

Loss on disposal of premise and equipment
5

 

Bargain purchase gain on acquisition, net of tax

 
(85
)
Loss on sale of repossessed assets
3

 
36

Earnings on bank owned life insurance policies1
(380
)
 
(362
)
Net change in operating assets and liabilities:
 

 
 

Interest receivable
(188
)
 
(196
)
Interest payable
(123
)
 
25

Deferred rent and other rent-related expenses
87

 
162

Other assets1
718

 
1,724

Other liabilities
(2,346
)
 
(1,668
)
Total adjustments
(2,340
)
 
2,200

Net cash provided by operating activities
7,551

 
10,148

Cash Flows from Investing Activities:
 

 
 

Proceeds from sale of premises and equipment

 
18

Purchase of securities held to maturity
(25,661
)
 
(700
)
Purchase of securities available for sale
(52,710
)
 
(76,537
)
Proceeds from sale of securities available for sale
2,186

 

Proceeds from paydowns/maturity of securities held to maturity
1,843

 

Proceeds from paydowns/maturity of securities available for sale
23,305

 
20,203

Loans originated and principal collected, net1
6,364

 
17,070

Purchase of bank owned life insurance policies
(364
)
 
(2,500
)
Purchase of premises and equipment
(263
)
 
(1,466
)
Proceeds from sale of repossessed assets
22

 
199

Cash receipt from acquisition

 
44,042

Net cash (used in) provided by investing activities
(45,278
)
 
329

Cash Flows from Financing Activities:
 

 
 

Net increase in deposits
27,745

 
29,086

Proceeds from stock options exercised
324

 
472

Repayment of Federal Home Loan Bank borrowings
(20,000
)
 
(13,500
)
Cash dividends paid on common stock
(1,818
)
 
(1,698
)
Stock issued under employee and director stock purchase plans
18

 
17

Excess tax benefits from exercised stock options
36

 
73

Net cash provided by financing activities
6,305

 
14,450

Net (decrease) increase in cash and cash equivalents
(31,422
)
 
24,927

Cash and cash equivalents at beginning of period
129,743

 
85,232

Cash and cash equivalents at end of period
$
98,321

 
$
110,159

Supplemental disclosure of cash flow information:
 
 
 
Cash paid in interest
$
1,511

 
$
2,318

Cash paid in income taxes
$
7,936

 
$
6,049

Supplemental disclosure of non-cash investing and financing activities:
 

 
 

Change in unrealized gain on available-for- sale securities
$
23


$
10

Loans transferred to repossessed assets
$
65

 
$
100

Stock issued in payment of director fees
$
100

 
$
100

Acquisition:
 

 
 

Fair value of assets acquired
$

 
$
107,763

Fair value of liabilities assumed
$

 
$
107,678

1 Amounts for prior periods have been reclassified to conform to current financial statement presentation.
The accompanying notes are an integral part of these consolidated financial statements.

Page-6



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 except for discussion in Note 7, Note 8 and Note 9 herein.
 
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 2011 Annual Report on Form 10-K.  The results of operations for the three months and six months ended June 30, 2012 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, unvested restricted stock and stock warrant, and 3) weighted average diluted shares. Basic earnings per share (“EPS”) are calculated by dividing net income by the weighted average number of common shares outstanding during each period, excluding unvested restricted stock. 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 under the treasury stock method. The number of potential common shares included in year-to-date diluted EPS is a year-to-date weighted average of potential common shares included in each quarterly diluted EPS computation. We have two forms of our outstanding common stock: common stock and unvested restricted stock awards. Holders of 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
 
Six months ended
(in thousands, except per share data; unaudited)
June 30, 2012

March 31, 2012

June 30, 2011

 
June 30, 2012

June 30, 2011

Weighted average basic shares outstanding
5,337

5,326

5,300

 
5,331

5,292

Add: Potential common shares related to stock options
39

49

43

 
44

43

Potential common shares related to unvested restricted stock
2

5

3

 
4

4

Potential common shares related to warrants
41

45

39

 
43

37

Weighted average diluted shares outstanding
5,419

5,425

5,385

 
5,422

5,376

 
 
 
 
 
 
 
Net income
$
4,951

$
4,940

$
3,439

 
$
9,891

$
7,948

 
 
 
 
 
 
 
Basic EPS
$
0.93

$
0.93

$
0.65

 
$
1.86

$
1.50

Diluted EPS
$
0.91

$
0.91

$
0.64

 
$
1.82

$
1.48

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






 




Stock options
56

32

73

 
44

66

Unvested restricted stock
13


6

 

3

Total anti-dilutive shares
69

32

79

 
44

69


Page-7



Note 2: Recently Issued Accounting Standards
 
In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-11 Balance Sheet (Topic 210) Disclosures about Offsetting Assets and Liabilities. The ASU enhances disclosures in order to improve the comparability of offsetting (netting) assets and liabilities reported in accordance with U.S. generally accepted accounting principles (“GAAP”) and International Financial Reporting Standards (“IFRS”) by requiring entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the statements of condition and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. This ASU is effective for annual periods beginning on or after January 1, 2013, and interim periods within those annual periods. We do not expect that the adoption of this ASU will have a significant impact on our financial condition or results of operations as it affects presentation only.

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. In December 2011, the FASB issued ASU No. 2011-12 Comprehensive Income (Topic 220) Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards, which supersedes certain pending paragraphs in ASU No. 2011-05 that pertain to how, when, and where reclassification adjustments are presented. ASU 2011-05 is effective for fiscal years, and interim periods beginning on or after December 15, 2011. 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 is deferred until the FASB re-deliberates. We have adopted this ASU in the first quarter of 2012.

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. GAAP and IFRS. 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: 1) application of the highest and best use and valuation premises concepts; 2) measuring fair value of an instrument classified in a reporting entity's shareholders' equity; and 3) disclosure requirements regarding quantitative information about unobservable inputs categorized within Level 3 of the fair value hierarchy. In addition, for assets and liabilities not recognized at fair value but disclosure is required, entities need to disclose the level in which the fair value measurement would be categorized within the fair value hierarchy. For public entities, ASU 2011-04 is effective during interim and annual periods beginning after December 15, 2011. We have adopted this ASU in the first quarter of 2012 and provided the applicable disclosure in Note 4 herein.

Note 3:  Acquisition
 
On February 18, 2011, we entered into a modified whole-bank purchase and assumption agreement without loss share 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”). For further information related to the Charter Oak Bank Acquisition, see Note 2 to the Consolidated Financial Statements in the Company's 2011 Form 10-K.

Page-8




Note 4:  Fair Value of Assets and Liabilities
 
Fair Value Hierarchy and Fair Value Measurement
 
We group our assets and liabilities that are measured at fair value in three levels within the fair value hierarchy, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
 
Level 1: Valuations are based on 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.
 
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)

At June 30, 2012 (unaudited):
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
Mortgage-backed securities and collaterized mortgage obligations issued by U.S. government-sponsored agencies
$
126,444

 
$

 
$
126,444

 
$

Debentures of government-sponsored agencies
$
14,641

 
$

 
$
14,641

 
$

Privately-issued collateralized mortgage obligations
$
20,718

 
$

 
$
20,718

 
$

Derivative financial liabilities (interest rate contracts)
$
5,409

 
$

 
$
5,409

 
$

At December 31, 2011:
 

 
 
 
 

 
 

Securities available for sale:
 

 

 
 

 
 

Mortgage-backed securities and collaterized mortgage obligations issued by U.S. government-sponsored agencies
$
108,857

 
$

 
$
108,857

 
$

Debentures of government-sponsored agencies
$
8,050

 
$

 
$
8,050

 
$

Privately-issued collateralized mortgage obligations
$
18,197

 
$

 
$
18,197

 
$

Derivative financial liabilities (interest rate contracts)
$
5,052

 
$

 
$
5,052

 
$

 
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 2 securities include U.S. agencies’ or government sponsored agencies' debt securities, mortgage-backed securities, and privately-issued

Page-9



collateralized mortgage obligations. As of June 30, 2012 and December 31, 2011, there are no securities that are considered Level 1 or Level 3 securities.
 
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) 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 that were measured at fair value on a nonrecurring basis and that were still held in the balance sheet at each respective period end, by level within the fair value hierarchy as of June 30, 2012 and December 31, 2011.

 
(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) 1

 
At June 30, 2012 (unaudited):
 
 
 

 
 

 
 

 
Impaired loans carried at fair value 2
$
1,545

 
$

 
$

 
$
1,545

 
 
 
 
 
 
 
 
 
 
At December 31, 2011:
 

 
 

 
 

 
 

 
Impaired loans carried at fair value 2
$
5,269

 
$

 
$

 
$
5,269

 

1 Represents collateral-dependent loan principal balances that had been generally written down to the values of the underlying collateral, net of specific valuation allowance of $713 thousand and $1.4 million at June 30, 2012 and December 31, 2011, respectively. Significant unobservable inputs such as appraisals, recent comparable sales or offered prices are factored in when valuing these collaterals. The carrying value of loans fully charged-off, which includes unsecured lines of credit, overdrafts and all other loans, is zero.

2 Represents the portion of impaired loans that have been written down to their estimated fair value.

 

Page-10



Disclosures about Fair Value of Financial Instruments
 
The table below is a summary of fair value estimates for financial instruments as of June 30, 2012 and December 31, 2011, excluding financial instruments recorded at fair value on a recurring basis (summarized in the first table in Note 4). The carrying amounts in the following table are recorded in the consolidated statements of condition under the indicated captions. We have excluded non-financial assets and non-financial liabilities defined by the Codification (ASC 820-10-15-1A), such as Bank premises and equipment, deferred taxes and other liabilities.  In addition, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements of the Financial Instruments Topic of the Codification (ASC 825-10-50-8), such as Bank-owned life insurance policies.
 
 
June 30, 2012
 
December 31, 2011
(in thousands; 2012 unaudited)
Carrying Amounts

Fair Value

Fair Value Hierarchy
 
Carrying Amounts

Fair Value

Fair Value Hierarchy
Financial assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
98,321

$
98,321

Level 1
 
$
129,743

$
129,743

Level 1
Investment securities held to maturity
83,134

85,784

Level 2
 
59,738

62,185

Level 2
Loans, net
1,011,759

1,039,756

Level 3
 
1,016,515

1,053,762

Level 3
Interest receivable
4,826

4,826

Level 2
 
4,638

4,638

Level 2
Financial liabilities
 

 

 
 
 

 

 
Deposits
1,230,717

1,231,942

Level 2
 
1,202,972

1,203,974

Level 2
Federal Home Loan Bank borrowings
15,000

16,368

Level 2
 
35,000

36,256

Level 2
Subordinated debenture
5,000

4,796

Level 2
 
5,000

4,759

Level 2
Interest payable
258

258

Level 2
 
381

381

Level 2

Following is a description of methods and assumptions used to estimate the fair value of each class of financial instrument not recorded at fair value but required for disclosure purposes:
 
Cash and Cash Equivalents - The carrying amounts of cash and cash equivalents approximate their fair value because of the short-term nature of these instruments.
 
Held-to-maturity Securities - Held-to-maturity securities, which generally consist of obligations of state & political subdivisions and corporate bonds, 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, 2012 and December 31, 2011, 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. 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.

Page-11



 
Federal Home Loan Bank Borrowings - The fair value is estimated by discounting the future cash flows using current rates offered by the Federal Home Loan Bank of San Francisco ("FHLB") for similar credit advances corresponding to the remaining 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 seven-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, corporate bonds, debentures issued by government-sponsored agencies such as FNMA and FHLMC, as well as privately issued CMOs, as reflected in the table below:
 
 
 
 
 
 
 
 
 
 
 
June 30, 2012
 
December 31, 2011
 
Amortized

Fair

Gross Unrealized
 
Amortized

Fair

Gross Unrealized
(in thousands; 2012 unaudited)
Cost

Value

Gains

(Losses)

 
Cost

Value

Gains

(Losses)

Held to maturity
 
 
 
 
 
 
 
 
 
  Obligations of state and
  political subdivisions
$
60,750

$
63,515

$
2,790

$
(25
)
 
$
54,738

$
57,226

$
2,688

$
(200
)
  Corporate bonds
22,384

22,269

7

(122)

 
5,000
4,959

(41)
Total held to maturity
83,134
85,784
2,797
(147)
 
59,738
62,185
2,688
(241)
 
 
 
 
 
 
 
 
 
 
Available for sale
 
 
 
 
 
 
 
 
 
  Securities of U. S. government agencies:
 
 
 
 
 
 
 
 
 
    MBS pass-through securities issued by FNMA and FHLMC
48,709

49,981

1,304

(32
)
 
26,360
27,486
1,126

    CMOs issued by FNMA
9,540

9,699

159


 
10,775
11,099
324

    CMOs issued by FHLMC
17,608

17,948

341

(1
)

18,853
19,386
533

    CMOs issued by GNMA
47,882

48,816

988

(54
)

49,940
50,886
946

Debentures of government- sponsored agencies
14,527

14,641

114


 
8,000
8,050
50

  Privately issued CMOs
20,758

20,718

222

(262)

 
18,420
18,197
116
(339)
Total available for sale
159,024
161,803
3,128
(349
)
 
132,348
135,104
3,095
(339)
 
 
 
 
 
 
 
 
 
 
Total investment securities
$
242,158

$
247,587

$
5,925

$
(496
)
 
$
192,086

$
197,289

$
5,783

$
(580
)
 
 
 
 
 
 
 
 
 
 

Page-12



The amortized cost and fair value of investment debt securities by contractual maturity at June 30, 2012 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.
 
 
June 30, 2012
 
Held to Maturity
 
Available for Sale
(in thousands; unaudited)
Amortized Cost

 
Fair Value

 
Amortized Cost

 
Fair Value

Within one year
$
3,897

 
$
3,910

 
$

 
$

After one but within five years
44,613

 
45,182

 
20,212

 
20,523

After five years through ten years
24,000

 
25,834

 
24,751

 
24,857

After ten years
10,624

 
10,858

 
114,061

 
116,423

Total
$
83,134

 
$
85,784

 
$
159,024

 
$
161,803

 
One available-for-sale security was sold in February 2012 with proceeds of $2.2 million and loss of $34 thousand. There were no other sales of security in the first half of 2012.
        
Investment securities carried at $51.5 million and $53.6 million at June 30, 2012 and December 31, 2011, respectively, were pledged with the State of California: $50.8 million and $52.9 million to secure public deposits in compliance with the Local Agency Security Program at June 30, 2012 and December 31, 2011, respectively, and $713 thousand and $707 thousand to provide collateral for trust deposits at June 30, 2012 and December 31, 2011, respectively. In addition, investment securities carried at $1.1 million were pledged to collateralize an internal Wealth Management and Trust Services (“WMTS”) checking account at both June 30, 2012 and December 31, 2011.

Other-Than-Temporarily Impaired Debt Securities
 
We do not have the intent to sell the securities that are temporarily impaired, and it is more likely than not that we will not have to sell those securities before recovery of the cost basis. Additionally, we have evaluated the credit ratings of our investment securities and their issuers and/or insurers, if applicable. Based on our evaluation, Management has determined that no investment security in our investment portfolio is other-than-temporarily impaired.
 
Twenty-seven and seventeen investment securities were in unrealized loss positions at June 30, 2012 and December 31, 2011, respectively. They are summarized and classified according to the duration of the loss period as follows:
 
June 30, 2012
 
< 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
 
$
9,547

 
$
(25
)
 
$

 
$

 
$
9,547

 
$
(25
)
Corporate bonds
 
17,262

 
(122
)
 

 

 
17,262

 
(122
)
Total held to maturity
 
26,809

 
(147
)
 

 

 
26,809

 
(147
)
Available-for-sale
 
 
 
 
 
 
 
 
 
 
 
 
MBS pass-through securities
 
7,322

 
(32
)
 

 

 
7,322

 
(32
)
CMOs issued by FHLMC
 
778

 
(1
)
 

 

 
778

 
(1
)
CMOs issued by GNMA
 
5,072

 
(54
)
 

 

 
5,072

 
(54
)
Privately issued CMOs
 
5,111

 
(175
)
 
5,557

 
(87
)
 
10,668

 
(262
)
Total available for sale
 
18,283

 
(262
)
 
5,557

 
(87
)
 
23,840

 
(349
)
Total temporarily impaired securities
 
$
45,092

 
$
(409
)
 
$
5,557

 
$
(87
)
 
$
50,649

 
$
(496
)

Page-13



 
December 31, 2011
 
< 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
 
$
17,607

 
$
(174
)
 
$
1,775

 
$
(26
)
 
$
19,382

 
$
(200
)
Corporate bonds
 
4,959

 
(41
)
 

 

 
4,959

 
(41
)
Total held to maturity
 
22,566

 
(215
)
 
1,775

 
(26
)
 
24,341

 
(241
)
Available-for-sale
 
 
 
 
 
 
 
 
 
 
 
 
Privately issued CMOs
 
8,173

 
(205)

 
3,757

 
(134)

 
11,930

 
(339)

Total available for sale
 
8,173

 
(205)

 
3,757

 
(134)

 
11,930

 
(339)

Total temporarily impaired securities
 
$
30,739

 
$
(420
)
 
$
5,532

 
$
(160
)
 
$
36,271

 
$
(580
)
 
Seven obligations of U.S. states and political subdivisions, six corporate bonds, one CMO issued by FHLMC, one CMO issued by GNMA, two MBS pass through securities, and three privately issued CMOs in our portfolio were in a temporary loss position for less than twelve months. These securities are deemed credit worthy without delinquency history and are all rated above A by at least one of the major credit agencies. As a result, we concluded that these securities were not other-than-temporarily impaired at June 30, 2012.

As of June 30, 2012, there were seven privately issued CMOs in our portfolio in a continuous loss position for more than twelve months. The unrealized losses associated with privately issued CMOs is primarily driven by changes in interest rates and not due to the credit quality of the securities. These securities are privately issued by financial institutions with no guarantee from government sponsored agencies. They are collateralized by residential mortgages or home equity loans and may be prepaid at par prior to maturity. Most of these securities were AAA rated by at least one major rating agency. We estimate loss projections for each security by assessing loans collateralizing the security and determining expected default rates and loss severities. Based upon our assessment of expected credit losses of each security given the performance of the underlying collateral and credit enhancements where applicable, we concluded that these securities were not other-than-temporarily impaired at June 30, 2012.

Securities Carried at Cost
 
As a member of the FHLB, we are required to maintain a minimum investment in the FHLB capital stock determined by the Board of Directors of the FHLB. The minimum investment requirements can also increase in the event we need to increase our borrowing capacity with the FHLB. Shares cannot be purchased or sold except between the FHLB and its members at its $100 per share par value. We held $6.0 million and $5.4 million of FHLB stock recorded at cost in other assets at June 30, 2012, and December 31, 2011, respectively. On July 26, 2012, FHLB declared a cash dividend for the second quarter of 2012 at an annualized dividend rate of 0.47%. Management does not believe that the FHLB stock is other-than-temporarily-impaired, as we expect to be able to redeem this stock at cost.

As a member bank of Visa U.S.A., we hold 16,939 shares of Visa Inc. Class B common stock with a carrying value of zero, which is equal to our cost basis. These shares are restricted from resale until their conversion into Class A (voting) shares upon the termination of Visa Inc.'s covered litigation escrow account. The fair value of the Class B common stock we own was $890 thousand and $732 thousand at June 30, 2012 and December 31, 2011, respectively, based on the Class A as-converted rate of 0.4254, which is subject to further reduction upon the final settlement of the covered litigation against Visa Inc. and its member banks. See Note 9 herein.

Page-14




Note 6:  Loans and Allowance for Loan Losses
 
Credit Quality of Loans
 
Outstanding loans by class and payment aging as of June 30, 2012 and December 31, 2011 are as follows:
 
Loan Aging Analysis by Class as of June 30, 2012 and December 31, 2011
(dollars in thousands; 2012 unaudited)
Commercial

 
Commercial real estate, owner-occupied

 
Commercial real estate, investor

 
Construction

 
Home equity

 
Other residential 1

 
Installment and other consumer

 
Total

June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
30-59 days past due
$
5,540

 
$

 
$

 
$

 
$
352

 
$

 
$
14

 
$
5,906

60-89 days past due

 

 

 
3,823

 

 

 
108

 
3,931

Greater than 90 days past due (non-accrual) 2
1,751

 
1,403

 
5,961

 
2,821

 
981

 
740

 
690

 
14,347

Total past due
7,291

 
1,403

 
5,961

 
6,644

 
1,333

 
740

 
812

 
24,184

Current
168,711

 
171,354

 
447,495

 
41,304

 
97,232

 
54,576

 
20,338

 
1,001,010

Total loans 3
$
176,002

 
$
172,757

 
$
453,456

 
$
47,948

 
$
98,565

 
$
55,316

 
$
21,150

 
$
1,025,194

Non-accrual loans to total loans
1.0
%
 
0.8
%
 
1.3
%
 
5.9
%
 
1.0
%
 
1.3
%
 
3.3
%
 
1.4
%
December 31, 2011
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

30-59 days past due
$
371

 
$
576

 
$
6,060

 
$

 
$
195

 
$

 
$
7

 
$
7,209

60-89 days past due
139

 

 

 

 

 

 
34

 
173

Greater than 90 days past due (non-accrual) 2
2,955

 
2,033

 
741

 
3,014

 
766

 
1,942

 
519

 
11,970

Total past due
3,465

 
2,609

 
6,801

 
3,014

 
961

 
1,942

 
560

 
19,352

Current
172,325

 
172,096

 
439,624

 
48,943

 
97,082

 
59,560

 
22,172

 
1,011,802

Total loans 3
$
175,790

 
$
174,705

 
$
446,425

 
$
51,957

 
$
98,043

 
$
61,502

 
$
22,732

 
$
1,031,154

Non-accrual loans to total loans
1.7
%
 
1.2
%
 
0.2
%
 
5.8
%
 
0.8
%
 
3.2
%
 
2.3
%
 
1.2
%
1 Our residential loan portfolio includes no sub-prime loans, nor is it our normal practice to underwrite loans commonly referred to as "Alt-A mortgages", the characteristics of which are loans lacking full documentation, borrowers having low FICO scores or higher loan-to-value ratios.

2 Amounts include $1.6 million and $2.5 million of Purchased Credit Impaired ("PCI") loans that have stopped accreting interest at June 30, 2012 and December 31, 2011, respectively, and exclude accreting PCI loans of $3.1 million and $3.4 million at June 30, 2012 and December 31, 2011, respectively, as their accretable yield interest recognition is independent from the underlying contractual loan delinquency status. There were no accruing loans past due more than 90 days at June 30, 2012 or December 31, 2011.

3 Amounts were net of deferred loan fees of $969 thousand and $1.6 million at June 30, 2012 and December 31, 2011, respectively. Amounts were also net of unaccreted purchase discounts on non-PCI loans of $2.4 million and $2.9 million at June 30, 2012 and December 31, 2011, respectively.

Our commercial loans are generally made to established small to mid-sized businesses to provide financing for their working capital needs or acquisition of fixed assets.  Management examines historical, current, and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral. The cash flows of borrowers, however, may not occur as expected, and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed, such as accounts receivable or inventory, and incorporate a personal guarantee. Some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. We target stable local businesses with strong guarantors that have proven to be more resilient in periods of economic stress.  Typically, the strong guarantors provide an additional source of repayment for most of our credit extensions.
 
Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans discussed above. We underwrite these loans to be repaid from cash flow and to be supported by real property collateral. Repayment of commercial real estate loans is largely dependent on the successful operation of the property securing the loan, or the business conducted on the property securing the loan. Substantially all of these loans underwritten by us meet a minimum debt coverage ratio of 120%, and we also generally require a conservative loan-to-value of 65% or less. Furthermore, substantially all of our loans are guaranteed by the owners of the properties.  Commercial real estate loans may be adversely affected by conditions in the real estate markets or in the general economy. In the event of a vacancy, strong guarantors have historically carried the loans until a replacement tenant can be found.  The owner’s substantial equity investment provides a strong economic incentive to continue to support the commercial real estate

Page-15



projects. As such, we experience nominal loss and delinquencies on a percentage basis in this portfolio.

Construction loans are generally made to developers and builders to finance land acquisition as well as the subsequent construction. These loans are underwritten after evaluation of the borrower's financial strength, reputation, prior track record and obtaining independent appraisal reviews. The construction industry can be severely impacted by several major factors, including: 1) the inherent volatility of real estate markets; 2) vulnerability to delays due to weather or change orders, labor or material shortages and price hikes; and 3) generally thin margins and tight cash flow. Estimates of construction costs and value associated with the complete project may be inaccurate. Repayment of construction loans is largely dependent on the success of the ultimate project.
 
Consumer loans primarily consist of home equity lines of credit, other residential (tenancy-in-common, or “TIC”) loans, and other personal loans. We originate consumer loans utilizing credit score information, debt-to-income ratio and loan-to-value ratio analysis. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend reports are reviewed by Management on a regular basis. Underwriting standards for home equity loans include, but are not limited to, a maximum loan-to-value percentage of 75% of loans that are $1,250,000 or less (and even more conservatively for homes with values in excess of this amount), the number of such loans a borrower can have at one time, and documentation requirements. Our underwriting of the other residential loans, mostly secured by TIC units in San Francisco, was cautious compared to traditional residential mortgages due to the unique ownership structure and the interest-only feature of some of these loans.  However, these borrowers tend to have more equity in their properties, which mitigates risk. Personal loans are nearly evenly split between mobile home loans and floating home loans along with a small number of installment loans.
 
We use a risk rating system to evaluate asset quality, and to identify and monitor credit risk in individual loans, and ultimately in the portfolio. Definitions of loans that are risk graded “Special Mention” or worse loans are consistent with those used by the banking regulators.  Our internally assigned grades are as follows:
 
Pass – Loans to borrowers of acceptable or better credit quality. Borrowers in this category demonstrate fundamentally sound financial positions, repayment capacity, credit history and management expertise.  Loans in this category must have an identifiable and stable source of repayment and meet the Bank’s policy regarding debt service coverage ratios.  These borrowers are capable of sustaining normal economic, market or operational setbacks without significant financial impacts.  Financial ratios and trends are acceptable.  Negative external industry factors are generally not present.  The loan may be secured, unsecured or supported by non-real estate collateral for which the value is more difficult to determine and/or marketability is more uncertain. This category also includes “Watch” loans, where the primary source of repayment has been delayed. “Watch” is intended to be a transitional grade, with either an upgrade or downgrade within a reasonable period.
 
Special Mention - Potential weaknesses that deserve close attention. If left uncorrected, those potential weaknesses may result in deterioration of the payment prospects for the asset. Special Mention assets do not present sufficient risk to warrant adverse classification.
 
Substandard - Inadequately protected by either the current sound worth and paying capacity of the obligor or the collateral pledged, if any. A Substandard asset has a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Substandard assets are characterized by the distinct possibility that we will sustain some loss if such weaknesses or deficiencies are not corrected. Loss potential, while inherent in the aggregate substandard amount, does not necessarily exist in the individual assets classified Substandard. Well-defined weaknesses include adverse trends or developments of the borrower’s financial condition, managerial weaknesses and/or significant collateral deficiencies.
 
Doubtful - Critical weaknesses that make collection or liquidation in full improbable. There may be specific pending events that work to strengthen the asset, however, the amount or timing of the loss may not be determinable. Pending events generally occur within one year of the asset being classified as Doubtful. Examples include: merger, acquisition, or liquidation; capital injection; guarantee; perfecting liens on additional collateral; and refinancing. Such loans are placed on non-accrual status and usually are collateral-dependent.
 
We regularly review our credits for accuracy of risk grades whenever new information is received. Borrowers are required to submit financial information at regular intervals:

Generally, commercial borrowers with lines of credit are required to submit financial information with reporting

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intervals ranging from monthly to annually depending on credit size, risk and complexity.
Investor commercial real estate borrowers with loans greater than $750 thousand are required to submit rent rolls or property income statements at least annually.
Construction loans are monitored monthly, and assessed on an ongoing basis.
Home equity and other consumer loans are assessed based on delinquency.
Loans graded “Watch” or more severe, regardless of loan type, are assessed no less than quarterly.

The following table represents our analysis of loans by internally assigned grades, including the PCI loans, at June 30, 2012 and December 31, 2011:
 
(in thousands; 2012 unaudited)
Commercial

 
Commercial real estate, owner-occupied

 
Commercial real estate, investor

 
Construction

 
Home equity

 
Other residential

 
Installment and other consumer

 
Purchased credit-impaired

 
Total

Credit Risk Profile by Internally Assigned Grade:
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
145,403

 
$
146,443

 
$
428,537

 
$
28,604

 
$
92,522

 
$
50,735

 
$
20,130

 
$
2,050

 
$
914,424

Special Mention
17,414

 
20,797

 
12,568

 

 
2,119

 
1,758

 

 
620

 
55,276

Substandard
12,576

 
3,023

 
10,772

 
19,344

 
3,924

 
2,823

 
1,020

 
2,012

 
55,494

Doubtful

 

 

 

 

 

 

 

 

Total loans
$
175,393

 
$
170,263

 
$
451,877

 
$
47,948

 
$
98,565

 
$
55,316

 
$
21,150

 
$
4,682

 
$
1,025,194

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2011
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Pass
$
148,805

 
$
146,449

 
$
433,307

 
$
32,272

 
$
93,189

 
$
54,711

 
$
21,648

 
$
1,541

 
$
931,922

Special Mention
7,874

 
18,434

 
4,877

 

 
838

 
2,010

 

 
529

 
34,562