BMRC-2014.06.30-10Q

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

FORM 10-Q


(Mark One)
 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2014
 
OR
 
 o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the transition period from __________________ to __________________
 
Commission File Number  001-33572

Bank of Marin Bancorp
(Exact name of Registrant as specified in its charter)
 
California  
 
20-8859754
(State or other jurisdiction of incorporation)  
 
(IRS Employer Identification No.)
 
 
 
504 Redwood Blvd., Suite 100, Novato, CA 
 
94947
(Address of principal executive office)
 
(Zip Code)
 
Registrant’s telephone number, including area code:  (415) 763-4520
 
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 (§232.405 of this chapter) 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, 2014, there were 5,925,980 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, 2014 and December 31, 2013
(dollars in thousands, except share data; 2014 unaudited)
June 30, 2014

 
December 31, 2013

Assets
 

 
 
Cash and due from banks
$
81,380

 
$
103,773

Investment securities
 

 
 
Held-to-maturity, at amortized cost
123,085

 
122,495

Available-for-sale, at fair value (amortized cost $214,627 and $245,158 at June 30, 2014 and December 31, 2013, respectively)
215,873

 
243,998

Total investment securities
338,958

 
366,493

Loans, net of allowance for loan losses of $14,900 and $14,224 at June 30, 2014 and December 31, 2013, respectively
1,323,611

 
1,255,098

Bank premises and equipment, net
9,296

 
9,110

Goodwill
6,436

 
6,436

Core deposit intangible
4,117

 
4,503

Interest receivable and other assets
60,103

 
59,781

Total assets
$
1,823,901

 
$
1,805,194

 
 
 
 
Liabilities and Stockholders' Equity
 

 
 

Liabilities
 

 
 

Deposits
 

 
 

Non-interest-bearing
$
724,975

 
$
648,191

Interest-bearing
 

 


Transaction accounts
95,052

 
137,748

Savings accounts
121,890

 
118,770

Money market accounts
500,720

 
520,525

CDARS® time accounts

 
400

Other time accounts
156,186

 
161,468

Total deposits
1,598,823

 
1,587,102

   Federal Home Loan Bank borrowings
15,000

 
15,000

 Subordinated debentures
5,077

 
4,969

 Interest payable and other liabilities
14,095

 
17,236

Total liabilities
1,632,995

 
1,624,307

 
 
 
 
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 - 5,912,774 and 5,877,524 at
    June 30, 2014 and December 31, 2013, respectively
81,219

 
80,095

Retained earnings
108,922

 
101,464

Accumulated other comprehensive income (loss), net
765

 
(672
)
Total stockholders' equity
190,906

 
180,887

Total liabilities and stockholders' equity
$
1,823,901

 
$
1,805,194


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
(dollars in thousands, except per share amounts; unaudited)
June 30, 2014
 
June 30, 2013
 
June 30, 2014
 
June 30, 2013
Interest income
 
 
 
 
 
 
 
Interest and fees on loans
$
16,363

 
$
13,366

 
$
32,682

 
$
27,001

Interest on investment securities


 


 
 

 
 

Securities of U.S. government agencies
1,193

 
585

 
2,425

 
1,210

Obligations of state and political subdivisions
607

 
437

 
1,241

 
1,075

Corporate debt securities and other
256

 
339

 
524

 
663

Interest due from banks and other
37

 
3

 
88

 
11

Total interest income
18,456

 
14,730

 
36,960

 
29,960

Interest expense
 

 
 

 
 

 
 

Interest on interest-bearing transaction accounts
26

 
12

 
49

 
23

Interest on savings accounts
11

 
8

 
22

 
16

Interest on money market accounts
131

 
95

 
289

 
194

Interest on CDARS® time accounts

 
2

 

 
7

Interest on other time accounts
231

 
224

 
466

 
456

Interest on FHLB and overnight borrowings
78

 
84

 
156

 
163

Interest on subordinated debentures
105

 

 
210

 

Total interest expense
582

 
425

 
1,192

 
859

Net interest income
17,874

 
14,305

 
35,768

 
29,101

Provision for loan losses
600

 
1,100

 
750

 
870

Net interest income after provision for loan losses
17,274

 
13,205

 
35,018

 
28,231

Non-interest income
 

 
 

 
 

 
 

Service charges on deposit accounts
528

 
515

 
1,084

 
1,036

Wealth Management and Trust Services
613

 
539

 
1,177

 
1,086

Debit card interchange fees
360

 
280

 
660

 
532

Merchant interchange fees
207

 
222

 
405

 
427

Earnings on Bank-owned life insurance
211

 
186

 
424

 
587

Gain on sale of securities
97

 

 
89

 

Other income
352

 
202

 
745

 
382

Total non-interest income
2,368

 
1,944

 
4,584

 
4,050

Non-interest expense
 

 
 

 
 

 
 

Salaries and related benefits
6,232

 
5,430

 
13,162

 
10,728

Occupancy and equipment
1,329

 
1,052

 
2,663

 
2,125

Depreciation and amortization
403

 
353

 
819

 
689

Federal Deposit Insurance Corporation insurance
269

 
223

 
519

 
437

Data processing
748

 
696

 
2,108

 
1,245

Professional services
412

 
814

 
1,040

 
1,341

Other expense
2,064

 
1,851

 
3,989

 
3,549

Total non-interest expense
11,457

 
10,419

 
24,300

 
20,114

Income before provision for income taxes
8,185

 
4,730

 
15,302

 
12,167

Provision for income taxes
3,017

 
1,675

 
5,601

 
4,246

Net income
$
5,168

 
$
3,055

 
$
9,701

 
$
7,921

Net income per common share:
 

 
 

 
 
 
 
Basic
$
0.88

 
$
0.56

 
$
1.65

 
$
1.47

Diluted
$
0.86

 
$
0.55

 
$
1.62

 
$
1.44

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


 
 

 
 
 
 
Basic
5,888

 
5,419

 
5,879

 
5,404

Diluted
5,993

 
5,509

 
5,987

 
5,498

Dividends declared per common share
$
0.19

 
$
0.18

 
$
0.38

 
$
0.36

Comprehensive income:
 
 
 
 


 


Net income
$
5,168

 
$
3,055

 
$
9,701

 
$
7,921

Other comprehensive income (loss)


 


 


 


Change in net unrealized gain (loss) on
   available-for-sale securities
976

 
(1,666
)
 
2,391

 
(1,969
)
     Reclassification adjustment for loss on
        sale of available-for-sale securities included in
        net income

 

 
15

 

             Net change in unrealized gain (loss) on
             available-for-sale securities, before tax
976

 
(1,666
)
 
2,406

 
(1,969
)
Deferred tax expense (benefit)
450

 
(700
)
 
969

 
(826
)
Other comprehensive income (loss), net of tax
526

 
(966
)
 
1,437

 
(1,143
)
Comprehensive income
$
5,694

 
$
2,089

 
$
11,138

 
$
6,778


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, 2013 and the six months ended June 30, 2014

(dollars in thousands; 2014 unaudited )
 
Common Stock
 
Retained
Earnings

 
Accumulated Other
Comprehensive Income,
Net of Taxes

 
 Total

Shares

 
Amount

 
 
 
Balance at December 31, 2012
 
5,389,210

 
$
58,573

 
$
91,164

 
$
2,055

 
$
151,792

Net income
 

 

 
14,270

 

 
14,270

Other comprehensive loss
 

 

 

 
(2,727
)
 
(2,727
)
Stock options exercised
 
71,237

 
2,218

 

 

 
2,218

Excess tax benefit - stock-based compensation
 

 
125

 

 

 
125

Stock issued under employee stock purchase plan
 
870

 
34

 

 

 
34

Restricted stock granted
 
11,850

 

 

 

 

Restricted stock forfeited / cancelled
 
(3,998
)
 

 

 

 

Stock-based compensation - stock options
 

 
175

 

 

 
175

Stock-based compensation - restricted stock
 

 
228

 

 

 
228

Cash dividends paid on common stock
 

 

 
(3,970
)
 

 
(3,970
)
Stock purchased by directors under director stock plan
 
160

 
6

 


 


 
6

Stock issued in payment of director fees
 
5,619

 
222

 

 

 
222

Stock issued to NorCal Community Bancorp shareholders
 
402,576

 
18,514

 

 

 
18,514

Balance at December 31, 2013
 
5,877,524

 
$
80,095

 
$
101,464

 
$
(672
)
 
$
180,887

Net income
 

 

 
9,701

 

 
9,701

Other comprehensive income
 

 

 

 
1,437

 
1,437

Stock options exercised
 
25,206

 
672

 

 

 
672

Excess tax benefit - stock-based compensation
 

 
106

 

 

 
106

Stock issued under employee stock purchase plan
 
329

 
14

 

 

 
14

Restricted stock granted
 
8,523

 

 

 

 

Restricted stock forfeited / cancelled
 
(1,191
)
 

 

 

 

Stock-based compensation - stock options
 

 
108

 

 

 
108

Stock-based compensation - restricted stock
 

 
121

 

 

 
121

Cash dividends paid on common stock
 

 

 
(2,243
)
 

 
(2,243
)
Stock issued in payment of director fees
 
2,383

 
103

 

 

 
103

Balance at June 30, 2014
 
5,912,774

 
$
81,219

 
$
108,922

 
$
765

 
$
190,906


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, 2014 and 2013
(dollars in thousands, unaudited)
June 30, 2014

 
June 30, 2013

Cash Flows from Operating Activities:
 
 
 
Net income
$
9,701

 
$
7,921

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

 
 

Provision for loan losses
750

 
870

Compensation expense--common stock for director fees
133

 
110

Stock-based compensation expense
229

 
211

Excess tax benefits from exercised stock options
(67
)
 
(66
)
Amortization of core deposit intangible
386

 

Amortization of investment security premiums, net of accretion of discounts
1,300

 
1,676

Accretion of discount on acquired loans
(2,410
)
 
(789
)
Accretion of discount on subordinated debentures
108

 

Net amortization of deferred loan origination costs/fees
(265
)

(674
)
(Gain) on sale of investment securities
(89
)


Depreciation and amortization
819

 
689

Gain on sale of repossessed assets

 
(5
)
Earnings on bank owned life insurance policies
(424
)
 
(587
)
Net change in operating assets and liabilities:
 

 
 

Interest receivable
139

 
86

Interest payable
(35
)
 
(20
)
Deferred rent and other rent-related expenses
69

 
44

Other assets
(670
)
 
(2,804
)
Other liabilities
(3,191
)
 
705

Total adjustments
(3,218
)
 
(554
)
Net cash provided by operating activities
6,483

 
7,367

Cash Flows from Investing Activities:
 

 
 

Purchase of available-for-sale securities
(9,872
)
 

Proceeds from sale of available-for-sale securities
2,023

 
1,082

Proceeds from sale of held-to-maturity securities
2,146

 

Proceeds from paydowns/maturity of held-to-maturity securities
10,891

 
6,550

Proceeds from paydowns/maturity of available-for-sale securities
23,584

 
20,736

Loans originated and principal collected, net
(66,666
)
 
(19,220
)
Purchase of premises and equipment
(1,005
)
 
(523
)
Proceeds from sale of repossessed assets

 
40

Cash paid for low income housing tax credit investment
(208
)
 

Net cash (used in) provided by investing activities
(39,107
)
 
8,665

Cash Flows from Financing Activities:
 

 
 

Net increase (decrease) in deposits
11,721

 
(28,852
)
Proceeds from stock options exercised
672

 
1,304

Proceeds from stock issued - employee and director stock purchase
14

 
26

Advance on Federal Home Loan Bank borrowings

 
17,200

Cash dividends paid on common stock
(2,243
)
 
(1,950
)
Excess tax benefits from exercised stock options
67

 
66

Net cash provided by (used in) financing activities
10,231

 
(12,206
)
Net (decrease) increase in cash and cash equivalents
(22,393
)
 
3,826

Cash and cash equivalents at beginning of period
103,773

 
28,349

Cash and cash equivalents at end of period
$
81,380

 
$
32,175

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
1,126

 
$
879

Cash paid for income taxes
$
4,680

 
$
7,889

Supplemental disclosure of non-cash investing and financing activities:
 

 
 

Change in unrealized gain on available-for-sale securities
$
2,406


$
(1,969
)
Loans transferred to repossessed assets
$

 
$
192

Securities transferred from available-for-sale to held-to-maturity
$
14,297

 
$

Subscription in low income housing tax credit investment
$
1,000

 
$
1,000

Stock issued in payment of director fees
$
103

 
$
110


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 Bancorp 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.
 
On November 29, 2013, we completed the merger of NorCal Community Bancorp ("NorCal"), parent company of Bank of Alameda, to enhance our market presence (the “Acquisition”). On the date of acquisition, Bancorp assumed ownership of NorCal Community Bancorp Trusts I and II, respectively (the "Trusts"), which were formed for the sole purpose of issuing trust preferred securities. Bancorp is not considered the primary beneficiary of the Trusts (variable interest entities), therefore the Trusts are not consolidated in our consolidated financial statements, but rather the subordinated debentures are shown as a liability on our consolidated statements of condition. Bancorp's investment in the common stock of the Trusts is accounted for under the equity method and is included in interest receivable and other assets on the consolidated statements of condition.

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 2013 Annual Report on Form 10-K.  The results of operations for the three months and six months ended June 30, 2014 are not necessarily indicative of the operating results for the full year.
 
The following table shows: 1) weighted average basic shares, 2) potentially diluted 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 potentially diluted 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 potentially diluted common shares included in year-to-date diluted EPS is a year-to-date weighted average of potentially diluted common shares included in each quarterly diluted EPS computation. We have two forms of 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 shareholders and they both share equally in undistributed earnings.

Page-7



 
Three months ended
Six months ended
(shares and dollars in thousands; except per share data; unaudited)
June 30, 2014
June 30, 2013
June 30, 2014
June 30, 2013
Weighted average basic shares outstanding
5,888

5,419

5,879

5,404

Add: Potentially diluted common shares related to stock options
40

39

42

41

Potentially diluted common shares related to unvested restricted stock
2

2

4

4

Potentially diluted common shares related to the warrant
63

49

62

49

Weighted average diluted shares outstanding
5,993

5,509

5,987

5,498

 
 
 
 
 
Net income
$
5,168

$
3,055

$
9,701

$
7,921

Basic EPS
$
0.88

$
0.56

$
1.65

$
1.47

Diluted EPS
$
0.86

$
0.55

$
1.62

$
1.44

 








Weighted average anti-dilutive shares not included in the calculation of diluted EPS
54

60

44

54


Page-8




Note 2: Recently Issued Accounting Standards
 
In February 2013, the FASB issued ASU No. 2013-04, Liabilities (Topic 405) Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date. The ASU requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date. Entities are required to record the amount the entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors at the reporting date. Examples of obligations within the scope of this guidance include debt arrangements, other contractual obligations, settled litigation and judicial rulings. ASU 2013-04 is effective retrospectively to all periods presented for fiscal years and interim periods beginning after December 15, 2013 for public entities. We adopted this ASU in 2014 and the adoption did not have an impact on our financial condition or results of operations.

In July 2013, the FASB issued ASU No. 2013-10, Derivatives and Hedging (Topic 815) Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedging Accounting Purposes. The ASU provides for the inclusion of the Fed Funds Effective Swap Rate or also referred to as the Overnight Index Swap Rate ("OIS") as a U.S. benchmark interest rate for hedge accounting purposes, in addition to direct Treasury obligations of the U.S. government ("UST") and London Interbank Offered Rate ("LIBOR"). The ASU is a result of the financial crisis in 2008, as the exposure to and the demand for hedging the Fed Funds rate have increased significantly. ASU 2013-10 is effective prospectively for qualifying new or re-designated hedging relationships entered into on or after July 17, 2013. We do not expect this ASU to have a significant impact on our financial condition or results of operations.

In July 2013, the FASB issued ASU No. 2013-11, Income Taxes (Topic 740) Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. The ASU requires an entity to present an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss ("NOL") carryforward, or similar tax loss or tax credit carryforward, rather than as a liability, when (1) the uncertain tax position would reduce the NOL or other carryforward under the tax law of the applicable jurisdiction and (2) the entity intends to and is able to use the deferred tax asset for that purpose. Otherwise, the unrecognized tax benefit should be presented as a liability and should not be combined with deferred tax assets. ASU 2013-11 is effective prospectively for fiscal years, and interim periods beginning after December 15, 2013 for public entities. We adopted this ASU in the first quarter of 2014 and the adoption did not have an impact on our financial condition or results of operations.

In January 2014, the FASB issued ASU No. 2014-01, Investments - Equity Method and Joint Ventures (Topic 323) Accounting for Investments in Qualified Affordable Housing Projects. This ASU permits entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, the initial cost of the investment is amortized in proportion to the tax credits and other tax benefits received and the net investment performance is recognized in the income statement as part of income tax expense (benefit). We adopted this ASU in the first quarter of 2014 and elected to account for all low income housing investments using the proportional amortization method instead of cost method. The change in accounting policy did not have a significant impact on our financial condition or results of operations.

In January 2014, the FASB issued ASU No. 2014-04, Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40) Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. Current accounting literature on troubled debt restructurings include guidance on when a creditor obtains one or more collateral assets in satisfaction of all or part of the receivable. The accounting literature indicates that a creditor should reclassify a collateralized mortgage loan such that the loan should be de-recognized and the collateral asset recognized when it is determined that there has been in substance a repossession or foreclosure by the creditor. However, in substance repossession or foreclosure and physical possession are not currently defined and there is diversity about when a creditor should de-recognize the loan receivable and recognize the real estate property. This ASU clarifies when an in substance repossession or foreclosure occurs. ASU 2014-04 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2014 for public entities. We do not expect this ASU to have a significant impact on our financial condition or results of operations.

In June 2014, the FASB issued ASU No. 2014-12, Compensation - Stock Compensation (Topic 718) Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. This ASU provides guidance for entities that grant their employees share-based payment

Page-9



awards where a performance target that affects vesting could be achieved after the requisite service period. That is the case when an employee is eligible to retire or otherwise terminate employment before the end of the period in which a performance target could be achieved and still be eligible to vest in the award if and when the performance target is achieved. This ASU stipulates that compensation expense should be recognized in the period where the performance target becomes probable of being achieved as opposed to the date that the award was granted. ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. We do not expect this ASU to have a significant impact on our financial condition or results of operations, as we currently do not grant share-based payment awards where a performance target that affects vesting could be achieved after the requisite service period.



Page-10


Note 3: Acquisition

On November 29, 2013, we completed the merger of NorCal, parent company of Bank of Alameda, to enhance our market presence. The merger added $173.8 million in loans, $241.0 million in deposits and $53.7 million in investment securities to Bank of Marin as well as four branch offices serving Alameda, Emeryville, and Oakland. The assets acquired and liabilities assumed, both tangible and intangible, were recorded at their fair values as of the acquisition date in accordance with ASC 805, Business Combinations. We have up to a year from the acquisition date to obtain additional information that existed at the acquisition date and affected the identification and measurement of assets acquired and liabilities assumed. There have been no additional information nor significant changes in the acquisition-date fair value of assets acquired or liabilities assumed as of June 30, 2014. The acquisition was treated as a "reorganization" within the definition of section 368(a) of the Internal Revenue Code and is generally considered tax-free for U.S. federal income tax purposes.

As a result of the Acquisition, we recorded $6.4 million in goodwill, which represents the excess of the total purchase price paid over the fair value of the assets acquired, net of the fair values of liabilities assumed. Goodwill mainly reflects expected value created through the combined operations of Bank of Alameda and Bank of Marin and our expanded footprint in the East Bay. It is evaluated for impairment annually. We determined that the fair value of our traditional community banking activities (provided through our branch network) exceeded its carrying amount and no impairment on goodwill has been recorded. The goodwill is not expected to be deductible for tax purposes. The following is a description of the methods used to determine the fair values of significant assets and liabilities at acquisition date presented above.

The core deposit intangible represents estimated future benefits of acquired deposits and is booked separately from the related deposits in other assets. We recorded a core deposit intangible asset of $4.6 million on November 29, 2013, of which $69 thousand was amortized in 2013 and $386 thousand was amortized in the first six months of 2014. It is amortized on an accelerated basis over an estimated ten-year life. The core deposit intangible asset is evaluated periodically for impairment, and no impairment loss was recognized as of June 30, 2014.




Page-11



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 include management judgment and estimation which may be significant.

Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with our monthly and/or quarterly valuation process.

Page-12



 
The following table summarizes our assets and liabilities that were required to be recorded at fair value on a recurring basis.
(dollars 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, 2014 (unaudited):
 
 
 
 
 
 
 
Securities available-for-sale:
 
 
 
 
 
 
 
Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies
$
173,936

 
$

 
$
171,149

 
$
2,787

Debentures of government-sponsored agencies
$
14,581

 
$

 
$
14,581

 
$

Privately-issued collateralized mortgage obligations
$
8,255

 
$

 
$
8,255

 
$

Obligations of state and political subdivisions
$
14,104

 
$

 
$
14,104

 
$

Corporate bonds
$
4,997

 
$

 
4,997

 
$

Derivative financial assets (interest rate contracts)
$
400

 
$

 
$
400

 
$

Derivative financial liabilities (interest rate contracts)
$
1,645

 
$

 
$
1,645

 
$

At December 31, 2013:
 

 
 
 
 

 
 

Securities available-for-sale:
 

 
 
 
 

 
 

Mortgage-backed securities and collateralized mortgage obligations issued by U.S. government-sponsored agencies
$
190,604

 
$

 
$
190,604

 
$

Debentures of government-sponsored agencies
$
21,312

 
$

 
$
21,312

 
$

Privately-issued collateralized mortgage obligations
$
10,874

 
$

 
$
10,874

 
$

Obligations of state and political subdivisions
$
15,771

 
$

 
$
15,771

 
$

Corporate bonds
$
5,437

 
$

 
$
5,437

 
$

Derivative financial assets (interest rate contracts)
$
961

 
$

 
$
961

 
$

Derivative financial liabilities (interest rate contracts)
$
2,519

 
$

 
$
2,519

 
$

 
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, probability of default, loss severity and credit spreads (Level 2).   Level 2 securities include U.S. agencies or government sponsored agencies' debt securities, mortgage-backed securities, government agency-issued and privately-issued collateralized mortgage obligations. As of June 30, 2014 and December 31, 2013, there are no securities that are considered Level 1 securities. As of June 30, 2014, we have one available-for-sale security that is considered Level 3 security. The security is a U.S. government agency obligation collateralized by a small pool of business equipment loans guaranteed by the Small Business Administration program. This security is not actively traded and is owned by a few investors. The significant unobservable data that is reflected in the fair value measurement include dealer quotes, projected prepayment speeds/average life and credit information, among other things. It was transferred to Level 3 security during the second quarter of 2014 and the increase in unrealized gain during the second quarter is $18 thousand.
 
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’

Page-13



credit quality in determining the fair value of the derivatives. Level 2 inputs for the valuations are limited to observable market prices for 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 & Poor's BBB rated U.S. Bank Composite rate and LIBOR with the maturity term corresponding to the duration of the swaps to calculate this credit-risk-related discount of future cash flows.
 
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 statements of condition at each respective period end, by level within the fair value hierarchy as of June 30, 2014 and December 31, 2013.
(dollars in thousands)
Description of Financial Instruments
Carrying Value1

 
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, 2014 (unaudited):
 
 
 

 
 

 
 

 
Impaired loans carried at fair value:


 


 


 


 
Construction
2,654

 

 

 
2,654

 
Installment and other consumer
32

 

 

 
32

 
Total
$
2,686

 
$

 
$

 
$
2,686

 
 
 
 
 
 
 
 
 
 
At December 31, 2013:
 

 
 

 
 

 
 

 
Impaired loans carried at fair value:
 
 
 
 
 
 


 
Construction
3,037

 

 

 
3,037

 
Installment and other consumer
35

 

 

 
35

 
Total
$
3,072

 
$

 
$

 
$
3,072

 

1 Represents collateral-dependent loan principal balances that had been generally written down to the values of the underlying collateral, net of specific valuation allowances of $250 thousand and $363 thousand at June 30, 2014 and December 31, 2013, respectively. The carrying value of loans fully charged-off, which includes unsecured lines of credit, overdrafts and all other loans, is zero.

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 impaired loans and other real estate owned ("OREO").

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 net realizable value of the underlying collateral securing the loan, if the loan is collateral dependent (Level 3).  Net realizable value of the underlying collateral is the fair value of the collateral less estimated selling costs and any prior liens. Appraisals, recent comparable sales, offers and listing prices are factored in when valuing the collateral. We review and verify the qualifications and licenses of  the certified general appraisers used for appraising commercial properties or certified residential appraisers for residential properties. Real estate appraisals may utilize a combination of approaches including replacement cost, sales comparison and the income approach. Comparable sales and income data are analyzed by the appraisers and adjusted to reflect differences between them and the subject property such as type, leasing status and physical condition. When the appraisals are received, Management reviews the assumptions and methodology utilized in the appraisal, as well as the overall resulting value in conjunction with independent data sources such as recent market data and industry-wide statistics. We generally use a 6% discount for selling costs which is applied to all properties, regardless of size. Appraised values may be adjusted to reflect changes in market conditions that have occurred subsequent to the appraisal date, or for revised estimates regarding the timing or cost of the property sale. These adjustments are based on qualitative judgments made by management on a case-by-case basis. There have been no significant changes in the valuation techniques during the quarter and six-month period ended June 30, 2014.


Page-14



OREO represents collateral acquired through foreclosure and is initially recorded at fair value as established by a current appraisal, adjusted for disposition costs. Subsequently, OREO is measured at lower of cost or fair value. OREO values are reviewed on an ongoing basis and any subsequent decline in fair value is recorded as a foreclosed asset expense in the current period. The value of OREO is determined based on independent appraisals, similar to the process used for impaired loans, discussed above, and is generally classified as Level 3. At June 30, 2014 and December 31, 2013, we had $461 thousand of OREO acquired from Bank of Alameda as part of the Acquisition. There was no change in the estimated fair value of the OREO from the date of the Acquisition through June 30, 2014.

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.
 
 Disclosures about Fair Value of Financial Instruments
 
The table below is a summary of fair value estimates for financial instruments as of June 30, 2014 and December 31, 2013, excluding financial instruments recorded at fair value on a recurring basis (summarized in the first table in this note). 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, 2014
 
December 31, 2013
(dollars in thousands; 2013 unaudited)
Carrying Amounts

Fair Value

Fair Value Hierarchy
 
Carrying Amounts

Fair Value

Fair Value Hierarchy
Financial assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
81,380

$
81,380

Level 1
 
$
103,773

$
103,773

Level 1
Investment securities held-to-maturity
123,085

125,298

Level 2
 
122,495

123,858

Level 2
Loans, net
1,323,611

1,326,184

Level 3
 
1,255,098

1,245,475

Level 3
Interest receivable
5,628

5,628

Level 2
 
5,767

5,767

Level 2
Financial liabilities
 

 

 
 
 

 

 
Deposits
1,598,823

1,599,827

Level 2
 
1,587,102

1,588,278

Level 2
Federal Home Loan Bank borrowings
15,000

15,566

Level 2
 
15,000

15,665

Level 2
Subordinated debentures
5,077

5,250

Level 3
 
4,969

4,950

Level 3
Interest payable
218

218

Level 2
 
253

253

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 mortgage-backed securities, obligations of state and 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, 2014 and December 31, 2013, we did not hold any held-to-maturity securities whose fair value was measured using significant unobservable inputs.
 
Loans - The fair value of loans with variable interest rates approximates current carrying value, because loan 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 the portion of loan discount attributable to credit risks.

Page-15



 
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 Borrowing - 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 Debentures - As part of the Acquisition, we assumed two tranches of subordinated debentures from NorCal. See Note 7 for further information. The fair values of the subordinated debentures were estimated by discounting the future cash flows (interest payment at a rate of three-month LIBOR plus 3.05% and 1.40%, respectively) to their present values using current market rates at which similar bonds would be issued with similar credit ratings as ours and similar remaining maturities. Each future quarterly interest payment was discounted at the spot rate for the corresponding term based on comparable trust preferred securities, plus an illiquidity premium of 3.00%. In July 2010, the Dodd-Frank Act was signed into law and limits the ability of certain bank holding companies to treat trust preferred security debt issuances as Tier 1 capital. This law effectively closed the trust-preferred securities markets for new issuance and led to the absence of observable or comparable transactions in the market place. Due to the use of unobservable inputs in the valuation of trust preferred securities, we consider the fair value to be a Level 3 measurement.

Commitments - Loan commitments and standby letters of credit generate ongoing fees, which are recognized over the term of the commitment period. Given the uncertainty in the likelihood and timing of a commitment being drawn upon, the carrying value of the related unamortized commitment fees and the reserve for these off-balance sheet commitments are determined to approximate fair value, which is not material.
 

Page-16



Note 5:  Investment Securities
 
Our investment securities portfolio consists of obligations of state and political subdivisions, corporate bonds, U.S. government agency securities, including mortgage-backed securities (“MBS”) and collateralized mortgage obligations (“CMOs”) issued or guaranteed by Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC"), or Government National Mortgage Association ("GNMA"), 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, 2014
 
December 31, 2013
 
Amortized
Fair
Gross Unrealized
 
Amortized
Fair
Gross Unrealized
(dollars in thousands; 2014 unaudited)
Cost
Value
Gains
(Losses)
 
Cost
Value
Gains
(Losses)
Held-to-maturity
 
 
 
 
 
 
 
 
 
  Obligations of state and
  political subdivisions
$
69,136

$
70,799

$
1,848

$
(185
)
 
$
80,381

$
81,429

$
1,764

$
(716
)
  Corporate bonds
40,469

40,872

412

(9
)
 
42,114

42,429

375

(60
)
MBS pass-through securities issued by FHLMC and FNMA
13,480

13,627

427

(280
)
 




Total held-to-maturity
123,085
125,298
2,687
(474
)
 
122,495
123,858
2,139
(776
)
 
 
 
 
 
 
 
 
 
 
Available-for-sale
 
 
 
 
 
 
 
 
 
Securities of U.S. government agencies:
 
 
 
 
 
 
 
 
MBS pass-through securities issued by FHLMC and FNMA
104,272

104,981

775

(66
)
 
124,063

123,033

616

(1,646
)
CMOs issued by FNMA
16,887

16,872

85

(100
)
 
18,573

18,438

60

(195
)
CMOs issued by FHLMC
30,372

30,344

111

(139
)

23,710

23,679

144

(175
)
CMOs issued by GNMA
21,329

21,739

437

(27
)

24,944

25,454

609

(99
)
Debentures of government- sponsored agencies
14,760

14,581

133

(312
)
 
21,845

21,312

108

(641
)
Privately issued CMOs
8,045

8,255

228

(18
)
 
10,649

10,874

257

(32
)
  Obligations of state and
  political subdivisions
14,032

14,104

101

(29
)
 
15,948

15,771

14

(191
)
  Corporate bonds
4,930

4,997

71

(4
)
 
5,426

5,437

25

(14
)
Total available-for-sale
214,627
215,873
1,941
(695
)
 
245,158

243,998

1,833

(2,993
)
 
 
 
 
 
 
 
 
 
 
Total investment securities
$
337,712

$
341,171

$
4,628

$
(1,169
)
 
$
367,653

$
367,856

$
3,972

$
(3,769
)
 
 
 
 
 
 
 
 
 
 

As part of our ongoing review of our investment securities portfolio, we reassessed the classification of certain MBS pass-through securities issued by FHLMC and FNMA that are qualified for Community Reinvestment Act ("CRA") credit. Effective January 31, 2014, we transferred $14.2 million of these CRA qualified MBS, which we intend and have the ability to hold to maturity, from available-for-sale securities to held-to-maturity at fair value. The unrealized pre-tax holding gain of $84 thousand at the date of transfer remained in accumulated other comprehensive income and is amortized over the remaining lives of the securities as an adjustment to yield.


Page-17



The amortized cost and fair value of investment debt securities by contractual maturity at June 30, 2014 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, 2014
 
December 31, 2013
 
Held-to-Maturity
 
Available-for-Sale
 
Held-to-Maturity
 
Available-for-Sale
(dollars in thousands; 2014 unaudited)
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Within one year
$
21,157

 
$
21,366

 
$
2,459

 
$
2,467

 
$
8,731

 
$
8,784

 
$
5,522

 
$
5,521

After one year but within five years
67,640

 
68,736

 
41,026

 
41,356

 
88,255

 
89,095

 
42,229

 
42,338

After five years through ten years
19,554

 
20,351

 
19,701

 
19,476

 
24,244

 
24,786

 
26,232

 
25,478

After ten years
14,734

 
14,845

 
151,441

 
152,574

 
1,265

 
1,193

 
171,175

 
170,661

Total
$
123,085

 
$
125,298

 
$
214,627

 
$
215,873

 
$
122,495

 
$
123,858

 
$
245,158

 
$
243,998

 
We sold one available-for-sale and six held-to-maturity securities in the first six months of 2014 with total proceeds of $2.0 million and $2.1 million, respectively, and incurred a loss of $15 thousand and net gain of $104 thousand, respectively. The sales of the held-to-maturity securities were due to evidence of significant deterioration of creditworthiness of the issuers since purchase. Two available-for-sale securities were sold in January 2013 with proceeds of $1.1 million and a small net gain of $339.

Investment securities carried at $70.1 million and $61.8 million at June 30, 2014 and December 31, 2013, respectively, were pledged with the State of California: $69.4 million and $61.1 million to secure public deposits in compliance with the Local Agency Security Program at June 30, 2014 and December 31, 2013, respectively, and $739 thousand and $732 thousand to provide collateral for trust deposits at June 30, 2014 and December 31, 2013, 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, 2014 and December 31, 2013.


Page-18



Other-Than-Temporarily Impaired Debt Securities
 
We have evaluated the credit ratings of our investment securities and their issuer and/or insurers. Based on our evaluation, Management has determined that no investment security in our investment portfolio is other-than-temporarily impaired. We do not have the intent, and it is more likely than not that we will not have to sell the remaining securities temporarily impaired at June 30, 2014 before recovery of the cost basis.
 
Forty-one and ninety-five investment securities were in unrealized loss positions at June 30, 2014 and December 31, 2013, respectively. The table below shows investment securities that were in unrealized loss positions at June 30, 2014 and December 31, 2013, respectively. They are summarized and classified according to the duration of the loss period as follows:
 
June 30, 2014
 
< 12 continuous months
 
 
> 12 continuous months
 
 
Total securities
 in a loss position
(dollars in thousands; unaudited)
 
Fair value
 
Unrealized loss
 
Fair value
 
Unrealized loss
 
Fair value
 
Unrealized loss
Held-to-maturity
 
 
 
 
 
 
 
 
 
 
 
 
Obligations of state & political subdivisions
 
$
5,687

 
$
(22
)
 
7,509

 
(163
)
 
$
13,196

 
$
(185
)
Corporate bonds
 

 

 
3,558

 
(9
)
 
3,558

 
(9
)
MBS pass-through securities issued by FNMA and FHLMC
 

 

 
6,917

 
(280
)
 
6,917

 
(280
)
Total held-to-maturity
 
5,687

 
(22
)
 
17,984

 
(452
)
 
23,671

 
(474
)
Available-for-sale
 
 
 
 
 
 
 
 
 
 
 
 
MBS pass-through securities issued by FNMA and FHLMC
 
16,747

 
(66
)
 

 

 
16,747

 
(66
)
CMOs issued by FNMA
 
7,904

 
(100
)
 

 

 
7,904

 
(100
)
CMOs issued by FHLMC
 
25,620

 
(139
)
 

 

 
25,620

 
(139
)
CMOs issued by GNMA
 

 

 
3,689

 
(27
)
 
3,689

 
(27
)
Debentures of government- sponsored agencies
 
492

 
(3
)
 
9,691

 
(309
)
 
10,183

 
(312
)
Privately issued CMOs
 
327

 
(5
)
 
2,295

 
(13
)
 
2,622

 
(18
)
Obligations of state & political subdivisions
 
4,634

 
(29
)
 

 

 
4,634

 
(29
)
Corporate bonds
 
988

 
(4
)
 

 

 
988

 
(4
)
Total available-for-sale
 
56,712

 
(346
)
 
15,675

 
(349
)
 
72,387

 
(695
)
Total temporarily impaired securities
 
$
62,399

 
$
(368
)
 
$
33,659

 
$
(801
)
 
$
96,058

 
$
(1,169
)
 

Page-19



December 31, 2013
 
< 12 continuous months
 
 
> 12 continuous months
 
 
Total securities
 in a loss position
 
(dollars in thousands)
 
Fair value
 
Unrealized loss
 
Fair value
 
Unrealized loss
 
Fair value
 
Unrealized loss
Held-to-maturity
 
 
 
 
 
 
 
 
 
 
 
 
Obligations of state & political subdivisions
 
$
13,933

 
$
(419
)
 
$
9,033

 
$
(297
)
 
$
22,966

 
$
(716
)
Corporate bonds
 
3,017

 
(11
)
 
4,963

 
(49
)
 
7,980

 
(60
)
Total held-to-maturity
 
16,950

 
(430
)
 
13,996

 
(346
)
 
30,946

 
(776
)
Available-for-sale
 
 
 
 
 
 
 
 
 
 
 
 
MBS pass-through securities issued by FHLMC and FNMA
 
90,914

 
(1,297
)
 
3,172

 
(349
)
 
94,086

 
(1,646
)
CMOs issued by FNMA
 
17,535

 
(195
)
 

 

 
17,535

 
(195
)
CMOs issued by FHLMC
 
17,899

 
(175
)
 

 

 
17,899

 
(175
)
CMOs issued by GNMA
 
3,966

 
(99
)
 

 

 
3,966

 
(99
)
Debentures of government- sponsored agencies
 
16,872

 
(641
)
 

 

 
16,872

 
(641
)
Privately issued CMOs
 
4,634

 
(31
)
 
159

 
(1
)
 
4,793

 
(32
)
Obligations of state & political subdivisions
 
11,516

 
(191
)
 

 

 
11,516

 
(191
)
Corporate bonds
 
1,479

 
(14
)
 

 

 
1,479

 
(14
)
Total available-for-sale
 
164,815

 
(2,643
)
 
3,331

 
(350
)
 
168,146

 
(2,993
)
Total temporarily impaired securities
 
$
181,765

 
$
(3,073
)
 
$
17,327

 
$
(696
)
 
$
199,092

 
$
(3,769
)

As of June 30, 2014, there were thirteen investment positions that had been in a continuous loss position for more than 12 months. These securities consisted of debentures of government-sponsored agencies, obligations of U.S. state and political subdivisions, MBS, privately issued CMOs, CMOs issued by GNMA and a corporate bond. We have evaluated each of the bonds and believe that the decline in fair value is primarily driven by factors other than credit. It is probable that we will be able to collect all amounts due according to the contractual terms and no other-than-temporary impairment exists. MBS are supported by the U.S. Federal government to protect us from credit losses. Additionally, the obligations of state and political subdivisions and corporate bonds were deemed creditworthy based on our review of the issuers' recent financial information and their insurers, if any. The principal of the CMO issued by GNMA is fully guaranteed by the U.S. government. The private-labeled CMOs are collateralized by residential mortgages with low loan-to-value ratios and high credit support percentages and are rated AA+ by Standard & Poor's. Based upon our assessment of expected credit losses given the performance of the underlying collateral and the credit enhancements, we concluded that the security was not other-than-temporarily impaired at June 30, 2014.

Twenty-eight investment securities in our portfolio were in a temporary loss position for less than twelve months as of June 30, 2014. They consisted of obligations of U.S. state and political subdivisions, a corporate bond, MBS, CMOs, debentures issued by government agencies and privately issued CMOs. We determine that the strengths of GNMA and FNMA through guarantee or support from the U.S. Federal Government are sufficient to protect us from credit losses. The other temporarily impaired securities are deemed creditworthy after our internal analysis. Additionally, all are rated as investment grade by at least one major rating agency. As a result of this impairment analysis, we concluded that these securities were not other-than-temporarily impaired at June 30, 2014.

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 borrowings 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 $8.2 million and $7.8 million of FHLB stock recorded at cost in other assets on the consolidated statements of condition at June 30, 2014 and December 31, 2013, respectively. On July 29, 2014, the FHLB announced a cash dividend for the second quarter of 2014 at an annualized dividend rate of

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7.4% to be distributed in mid-August. 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. As a result of the restriction, these shares are not considered available-for-sale and are not carried at fair value. Converting this Class B common stock to Class A common stock at a conversion rate of 0.4206, the value would be $1.5 million and $1.6 million at June 30, 2014 and December 31, 2013, respectively. The conversion rate is subject to further reduction upon the final settlement of the covered litigation against Visa Inc. and its member banks. See Note 9 herein.


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Note 6:  Loans and Allowance for Loan Losses

Credit Quality of Loans
 
Outstanding loans by class and payment aging as of June 30, 2014 and December 31, 2013 are as follows:
Loan Aging Analysis by Class as of June 30, 2014 and December 31, 2013
(dollars in thousands; 2014 unaudited)
Commercial and industrial

 
Commercial real estate, owner-occupied

 
Commercial real estate, investor

 
Construction

 
Home equity

 
Other residential 1

 
Installment and other consumer

 
Total

June 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 30-59 days past due
$
634

 
$

 
$

 
$

 
$
253

 
$

 
$
109

 
$
996

 60-89 days past due
475

 

 

 

 

 

 

 
475

Greater than 90 days past due (non-accrual) 2
335

 
1,403

 
2,618

 
5,197

 
444

 

 
152

 
10,149

Total past due
1,444

 
1,403

 
2,618

 
5,197

 
697

 

 
261

 
11,620

Current
192,958

 
231,864

 
666,607

 
35,000

 
105,504

 
80,399

 
14,559

 
1,326,891

Total loans 3
$
194,402

 
$
233,267

 
$
669,225

 
$
40,197

 
$
106,201

 
$
80,399

 
$
14,820

 
$
1,338,511

Non-accrual loans to total loans
0.2
%
 
0.6
%
 
0.4
%
 
12.9
%
 
0.4
%
 
%
 
1.0
%
 
0.8
%
December 31, 2013
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 30-59 days past due
$
18

 
$

 
$

 
$

 
$
240

 
$
717

 
$
17

 
$
992

 60-89 days past due

 

 

 

 

 

 
3

 
3

Greater than 90 days past due (non-accrual) 2
1,187

 
1,403

 
2,807

 
5,218

 
234

 
660

 
169

 
11,678

Total past due
1,205

 
1,403

 
2,807

 
5,218

 
474

 
1,377

 
189

 
12,673

Current
182,086

 
239,710

 
622,212

 
26,359

 
97,995

 
71,257

 
17,030

 
1,256,649

Total loans 3
$
183,291

 
$
241,113

 
$
625,019

 
$
31,577

 
$
98,469

 
$
72,634

 
$
17,219

 
$
1,269,322

Non-accrual loans to total loans
0.6
%
 
0.6
%
 
0.4
%
 
16.5
%
 
0.2
%
 
0.9
%
 
1.0
%
 
0.9
%
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 $1.4 million of Purchased Credit Impaired ("PCI") loans that had stopped accreting interest at both June 30, 2014 and December 31, 2013, and exclude accreting PCI loans of $3.8 million and $5.7 million at June 30, 2014 and December 31, 2013, 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 ninety days at June 30, 2014 or December 31, 2013.

3 Amounts include net deferred loan costs of $288 thousand and $24 thousand at June 30, 2014 and December 31, 2013, respectively. Amounts are also net of unaccreted purchase discounts on non-PCI loans of $5.6 million and $7.6 million at June 30, 2014 and December 31, 2013, respectively.

Our commercial loans are generally made to established small and mid-sized businesses to provide financing for their working capital needs, equipment purchases, acquisitions, or refinancings.  Management examines historical, current, and projected cash flows to determine the ability of the borrower to repay 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 include a personal guarantee. Some short-term loans may be made on an unsecured basis. We target stable local businesses with guarantors that have proven to be more resilient in periods of economic stress.  Typically, the 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 of the business conducted on the property securing the loan. Underwriting standards for commercial real estate loans include, but are not limited to, conservative debt coverage and loan-to-value ratios. 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. When a vacancy has occurred, strong guarantors have historically carried the loans until a replacement tenant could be found.  The owner's substantial equity investment provides a strong economic incentive to continue to support the commercial real estate projects. As a result, we have generally experienced a relatively low level of loss and delinquencies 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

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