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

FORM 10-Q
 
(Mark One)

T
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 

For the quarterly period ended September 30, 2009

OR

£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 

For the transition period from __________________ to __________________

Commission File Number  001-33572

Bank of Marin Bancorp
(Exact name of Registrant as specified in its charter)

California
20-8859754
(State or other jurisdiction of incorporation)
(IRS Employer Identification No.)
   
504 Redwood Blvd., Suite 100, Novato, CA
94947
(Address of principal executive office)
(Zip Code)

Registrant’s telephone number, including area code:  (415) 763-4520

Not Applicable
 
(Former name or former address, if changes since last report)

Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.
Yes  T     No  £

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  £     No  £

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 £
Accelerated filer T
Non-accelerated filer £
Smaller reporting company £

Indicate by check mark if the registrant is a shell company, as defined in Rule 12b(2) of the Exchange Act.
Yes  £     No  T

As of October 30, 2009 there were 5,227,493 shares of common stock outstanding.
 


 
 

 



PART  I
FINANCIAL INFORMATION
 
     
Item 1
Financial Statements
 
 
4
 
5
 
7
 
8
 
9
     
Item 2
22
     
Item 3
39
     
Item 4
40
     
PART II
OTHER INFORMATION
 
     
Item 1
40
     
Item 1A
41
     
Item 2
41
     
Item 3
41
     
Item 4
41
     
Item 5
41
     
Item 6
42
     
43
     
44


PART I FINANCIAL INFORMATION

Item 1.  Financial Statements

 
BANK OF MARIN BANCORP
CONSOLIDATED STATEMENT OF CONDITION
at September 30, 2009 and December 31, 2008

(in thousands, except share data; September 30, 2009 unaudited)
 
September 30,
2009
   
December 31,
2008
 
             
Assets
           
Cash and due from banks
  $ 63,589     $ 24,926  
                 
Investment securities
               
Held to maturity, at amortized cost
    30,163       23,558  
Available for sale (at fair market value, amortized cost $79,850 and $79,284 at September 30, 2009 and December 31, 2008, respectively)
    81,841       79,952  
Total investment securities
    112,004       103,510  
                 
Loans, net of allowance for loan losses of $11,118 and $9,950 at September 30, 2009 and December 31, 2008, respectively
    908,726       880,594  
Bank premises and equipment, net
    8,257       8,292  
Interest receivable and other assets
    33,953       32,235  
                 
Total assets
  $ 1,126,529     $ 1,049,557  
                 
Liabilities and Stockholders' Equity
               
                 
Liabilities
               
Deposits
               
Non-interest bearing
  $ 246,968     $ 201,363  
Interest bearing
               
Transaction accounts
    89,355       82,223  
Savings and money market
    454,759       440,496  
CDARS® reciprocal time
    55,535       42,892  
Other time
    102,674       85,316  
Total deposits
    949,291       852,290  
                 
Federal funds purchased and Federal Home Loan Bank borrowings
    55,000       56,800  
Subordinated debenture
    5,000       5,000  
Interest payable and other liabilities
    9,822       9,921  
                 
Total liabilities
    1,019,113       924,011  
                 
Stockholders' Equity
               
Preferred stock, no par value, $1,000 per share liquidation preference; Authorized - 5,000,000 shares; Issued and outstanding - none and 28,000 shares at September 30, 2009 and December 31, 2008, respectively
    ---       27,055  
Common stock, no par value Authorized - 15,000,000 shares Issued and outstanding - 5,226,993 and 5,146,798 at September 30, 2009 and December 31, 2008, respectively
    53,635       51,965  
Retained earnings
    52,626       46,138  
Accumulated other comprehensive income, net
    1,155       388  
                 
Total stockholders' equity
    107,416       125,546  
                 
Total liabilities and stockholders' equity
  $ 1,126,529     $ 1,049,557  

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

 
BANK OF MARIN BANCORP
CONSOLIDATED STATEMENT OF OPERATIONS
for the nine months ended September 30, 2009 and 2008

(in thousands, except per share amounts; unaudited)
 
September 30,
2009
   
September 30,
2008
 
             
Interest income
           
Interest and fees on loans
  $ 40,945     $ 40,545  
Interest on investment securities
               
Securities of U.S. Government agencies
    2,471       2,641  
Obligations of state and political subdivisions (tax exempt)
    818       531  
Corporate debt securities and other
    292       258  
Interest on Federal funds sold
    4       138  
Total interest income
    44,530       44,113  
                 
Interest expense
               
Interest on interest bearing transaction accounts
    86       277  
Interest on savings and money market deposits
    2,428       5,607  
Interest on CDARS® reciprocal time deposits
    550       55  
Interest on other time deposits
    1,188       1,962  
Interest on borrowed funds
    1,101       702  
Total interest expense
    5,353       8,603  
                 
Net interest income
    39,177       35,510  
Provision for loan losses
    2,985       2,810  
Net interest income after provision for loan losses
    36,192       32,700  
                 
Non-interest income
               
Service charges on deposit accounts
    1,323       1,253  
Wealth Management Services
    1,017       976  
Net gain on redemption of shares in Visa, Inc.
    ---       457  
Other income
    1,501       1,489  
Total non-interest income
    3,841       4,175  
                 
Non-interest expense
               
Salaries and related benefits
    13,050       12,372  
Occupancy and equipment
    2,569       2,363  
Depreciation and amortization
    1,021       996  
FDIC insurance
    1,456       366  
Data processing
    1,173       1,355  
Professional services
    1,184       1,161  
Other expense
    3,480       2,970  
Total non-interest expense
    23,933       21,583  
Income before provision for income taxes
    16,100       15,292  
                 
Provision for income taxes
    6,137       5,935  
Net income
  $ 9,963     $ 9,357  
                 
Preferred stock dividends and accretion
  $ (1,299 )   $ ---  
Net income available to common stockholders
  $ 8,664     $ 9,357  
                 
Net income per common share:
               
Basic
  $ 1.68     $ 1.82  
Diluted
  $ 1.66     $ 1.79  
                 
Weighted average shares used to compute net income per common share:
               
Basic
    5,172       5,135  
Diluted
    5,224       5,224  
                 
Dividends declared per common share
  $ 0.42     $ 0.42  

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

 
BANK OF MARIN BANCORP
CONSOLIDATED STATEMENT OF OPERATIONS
for the three months ended September 30, 2009, June 30, 2009, and September 30, 2008

(in thousands, except per share amounts; unaudited)
 
September 30,
2009
   
June 30,
2009
   
September 30,
2008
 
                   
Interest income
                 
Interest and fees on loans
  $ 13,860     $ 13,623     $ 13,833  
Interest on investment securities
                       
Securities of U.S. Government agencies
    794       809       892  
Obligations of state and political subdivisions (tax exempt)
    285       287       187  
Corporate debt securities and other
    176       115       91  
Interest on Federal funds sold
    1       3       25  
Total interest income
    15,116       14,837       15,028  
                         
Interest expense
                       
Interest on interest bearing transaction accounts
    31       31       93  
Interest on savings and money market deposits
    821       817       1,833  
Interest on CDARS® reciprocal time deposits
    186       183       50  
Interest on other time deposits
    378       397       562  
Interest on borrowed funds
    364       376       179  
Total interest expense
    1,780       1,804       2,717  
                         
Net interest income
    13,336       13,033       12,311  
Provision for loan losses
    1,100       700       1,685  
Net interest income after provision for loan losses
    12,236       12,333       10,626  
                         
Non-interest income
                       
Service charges on deposit accounts
    456       432       417  
Wealth Management Services
    350       351       330  
Other income
    525       490       447  
Total non-interest income
    1,331       1,273       1,194  
                         
Non-interest expense
                       
Salaries and related benefits
    4,286       4,418       4,179  
Occupancy and equipment
    950       842       802  
Depreciation and amortization
    335       336       351  
FDIC insurance
    307       832       131  
Data processing
    400       392       480  
Professional services
    366       395       336  
Other expense
    1,132       1,385       1,163  
Total non-interest expense
    7,776       8,600       7,442  
Income before provision for income taxes
    5,791       5,006       4,378  
                         
Provision for income taxes
    2,190       1,873       1,683  
Net income
  $ 3,601     $ 3,133     $ 2,695  
                         
Net income available to common stockholders
  $ 3,601     $ 3,133     $ 2,695  
                         
Net income per common share:
                       
Basic
  $ 0.69     $ 0.61     $ 0.53  
Diluted
  $ 0.68     $ 0.60     $ 0.52  
                         
Weighted average shares used to compute net income per common share:
                       
Basic
    5,205       5,164       5,130  
Diluted
    5,274       5,214       5,209  
                         
Dividends declared per common share
  $ 0.14     $ 0.14     $ 0.14  

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

 
BANK OF MARIN BANCORP
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
for the year ended December 31, 2008 and the nine months ended September 30, 2009

(dollars in thousands; activities in 2009 unaudited )
 
Preferred
   
Common Stock
   
Retained
   
Accumulated Other Comprehensive Income (Loss),
       
 
Stock
   
Shares
   
Amount
   
Earnings
   
Net of Taxes
   
Total
 
Balance at December 31, 2007
    ---       5,122,971     $ 51,059     $ 36,983     $ (268 )   $ 87,774  
Comprehensive income:
                                               
Net income
    ---       ---       ---       12,150       ---       12,150  
Other comprehensive income
                                               
Net change in unrealized gain (loss) on available for sale securities (net of tax effect of $475)
    ---       ---       ---       ---       656       656  
Comprehensive income
    ---       ---       ---       12,150       656       12,806  
Issuance of preferred stock
    27,039       ---       ---       ---       ---       27,039  
Issuance of common stock warrant
    ---       ---       961       ---       ---       961  
Stock options exercised
    ---       95,298       1,384       ---       ---       1,384  
Excess tax benefit - stock-based compensation
    ---       ---       380       ---       ---       380  
Common stock repurchased, including commission costs
    ---       (88,316 )     (2,526 )     ---       ---       (2,526 )
Stock issued under employee stock purchase plan
    ---       1,253       32       ---       ---       32  
Stock-based compensation - stock options
    ---       ---       404       ---       ---       404  
Restricted stock granted
    ---       6,700       ---       ---       ---       ---  
Stock-based compensation - restricted stock
    ---       ---       24       ---       ---       24  
Cash dividends paid on common stock
    ---       ---       ---       (2,882 )     ---       (2,882 )
Dividends on preferred stock
    ---       ---       ---       (97 )     ---       (97 )
Accretion of preferred stock
    16       ---       ---       (16 )     ---       ---  
Stock issued in payment of director fees
    ---       8,892       247       ---       ---       247  
Balance at December 31, 2008
    27,055       5,146,798       51,965       46,138       388       125,546  
Net income
    ---       ---       ---       9,963       ---       9,963  
Other comprehensive income
                                               
Net change in unrealized gain on available for sale securities (net of tax effect of $556)
    ---       ---       ---       ---       767       767  
Comprehensive income
    ---       ---       ---       9,963       767       10,730  
Accretion of preferred stock
    945       ---       ---       (945 )     ---       ---  
Repurchase of preferred stock
    (28,000 )     ---       ---       ---       ---       (28,000 )
Stock options exercised
    ---       58,824       845       ---       ---       845  
Excess tax benefit - stock-based compensation
    ---       ---       270       ---       ---       270  
Stock issued under employee stock purchase plan
    ---       709       18       ---       ---       18  
Restricted stock granted
    ---       11,575       ---       ---       ---       ---  
Stock-based compensation - stock options
    ---       ---       252       ---       ---       252  
Stock-based compensation - restricted stock
    ---       ---       52       ---       ---       52  
Cash dividends paid on common stock
    ---       ---       ---       (2,176 )     ---       (2,176 )
Dividends on preferred stock
    ---       ---       ---       (354 )     ---       (354 )
Stock issued in payment of director fees
    ---       9,087       233       ---       ---       233  
Balance at September 30, 2009
    ---       5,226,993     $ 53,635     $ 52,626     $ 1,155     $ 107,416  

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

 
BANK OF MARIN BANCORP
CONSOLIDATED STATEMENT OF CASH FLOWS
for the nine months ended September 30, 2009 and 2008

(in thousands, unaudited)
 
September 30,
2009
   
September 30,
2008
 
             
Cash Flows from Operating Activities:
           
Net income
  $ 9,963     $ 9,357  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
    2,985       2,810  
Compensation expense--common stock for director fees
    165       195  
Stock-based compensation expense
    304       331  
Excess tax benefits from exercised stock options
    (142 )     (128 )
Amortization and accretion of investment security premiums, net
    284       186  
Loss on sale of investment securities
    9       2  
Depreciation and amortization
    1,021       996  
Net gain on redemption of shares in Visa, Inc.
    ---       (457 )
Loss on disposal of premises and equipment
    ---       14  
Loss on sale of repossessed assets
    29       ---  
Net change in operating assets and liabilities:
               
Interest receivable
    (4 )     106  
Interest payable
    40       57  
Deferred rent and other rent-related expenses
    202       105  
Other assets
    (2,200 )     2,194  
Other liabilities
    1,393       988  
Total adjustments
    4,086       7,399  
Net cash provided by operating activities
    14,049       16,756  
                 
Cash Flows from Investing Activities:
               
Purchase of securities held-to-maturity
    (8,438 )     (9,584 )
Purchase of securities available-for-sale
    (30,662 )     (42,607 )
Proceeds from sale of securities
    1,410       21,489  
Proceeds from paydowns/maturity of:
               
Securities held-to-maturity
    320       1,125  
Securities available-for-sale
    29,906       36,531  
Loans originated and principal collected, net
    (32,557 )     (115,460 )
Purchase of bank owned life insurance policies
    ---       (2,219 )
Additions to premises and equipment
    (986 )     (1,747 )
Proceeds from sale of repossessed assets
    42       ---  
Net cash used in investing activities
    (40,965 )     (112,472 )
                 
Cash Flows from Financing Activities:
               
Net increase in deposits
    97,001       14,586  
Proceeds from stock options exercised
    845       1,262  
Net (decrease) increase  in Federal Funds purchased and Federal
               
Home Loan Bank borrowings
    (1,800 )     28,600  
Preferred stock repurchased
    (28,000 )     ---  
Common stock repurchased
    ---       (2,526 )
Cash dividends paid on common stock
    (2,176 )     (2,161 )
Cash dividends paid on preferred stock
    (451 )     ---  
Stock issued under employee stock purchase plan
    18       26  
Excess tax benefits from exercised stock options
    142       128  
Net cash provided by financing activities
    65,579       39,915  
                 
Net increase (decrease) in cash and cash equivalents
    38,663       (55,801 )
Cash and cash equivalents at beginning of period
    24,926       76,265  
                 
Cash and cash equivalents at end of period
  $ 63,589     $ 20,464  

Non-Cash Transactions: The nine months ended September 30, 2009 reflects non-cash financing items of $233 thousand for stock issued to pay director fees and $945 thousand for accretion of preferred stock.  The nine months ended September 30, 2009 also reflects non-cash investing items of $141 thousand of loans transferred to repossessed assets. The nine months ended September 30, 2008 reflects a non-cash financing item of $247 thousand for stock issued to pay director fees.

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


BANK OF MARIN BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Introductory Explanation

References in this report to “Bancorp” mean the Bank of Marin Bancorp as the parent holding company for Bank of Marin, the wholly-owned subsidiary (the “Bank”). References to “we,” “our,” “us” mean the holding company and the Bank that are consolidated for financial reporting purposes.

Note 1:  Basis of Presentation

The consolidated financial statements include the accounts of Bancorp and its only wholly-owned bank subsidiary, the Bank. All material intercompany transactions have been eliminated. In the opinion of Management, the unaudited interim consolidated financial statements contain all adjustments necessary to present fairly our financial position, results of operations, changes in stockholders' equity and cash flows. All adjustments are of a normal, recurring nature. Management has evaluated subsequent events for potential recognition and/or disclosure through the issuance date of this Form 10-Q, and has determined that there were no subsequent events that require recognition or disclosure.
 
Certain information and footnote disclosures presented in the annual financial statements are not included in the interim consolidated financial statements.  Accordingly, the accompanying unaudited interim consolidated financial statements should be read in conjunction with our 2008 Annual Report on Form 10-K.  The results of operations for the three and nine months ended September 30, 2009 are not necessarily indicative of the operating results for the full year.

The following table shows: 1) weighted average basic shares, 2) potential common shares related to stock options, non-vested restricted stock and stock warrant, and 3) weighted average diluted shares. Net income available to common stockholders is calculated as net income reduced by dividends accumulated on preferred stock and amortization of discounts on the preferred stock. Basic earnings per share (“EPS”) are calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during each period.  Diluted EPS are calculated using the weighted average diluted shares. The number of potential common shares included in quarterly diluted EPS is computed using the average market prices during the three months included in the reporting period. For year-to-date diluted EPS, the number of potential common shares included in the denominator is determined by computing a year-to-date weighted average of the number of potential common shares included in each quarterly diluted EPS computation. Our calculation of weighted average shares includes two classes of our outstanding common stock: common stock and unvested restricted stock awards. Holders of restricted stock awards receive non-forfeitable dividends at the same rate as common stockholders and they both share equally in undistributed earnings.


BANK OF MARIN BANCORP

   
Three months ended
   
Nine months ended
 
(in thousands, except per share data; unaudited)
 
September 30,
2009
   
June 30,
2009
   
September 30,
2008
   
September 30,
2009
   
September 30,
2008
 
Weighted average basic shares outstanding
    5,205       5,164       5,130       5,172       5,135  
Add:  Potential common shares related to stock options
    49       49       79       45       89  
Potential common shares related to non-vested restricted stock
    3       1       ---       1       ---  
Potential common shares related to warrant
    17       ---       ---       6       ---  
Weighted average diluted shares outstanding
    5,274       5,214       5,209       5,224       5,224  
                                         
Net income
  $ 3,601     $ 3,133     $ 2,695     $ 9,963     $ 9,357  
Preferred stock dividends and accretion
    ---       ---       ---       (1,299 )     ---  
Net income available to common stockholders
  $ 3,601     $ 3,133     $ 2,695     $ 8,664     $ 9,357  
                                         
Basic EPS
  $ 0.69     $ 0.61     $ 0.53     $ 1.68     $ 1.82  
Diluted EPS
  $ 0.68     $ 0.60     $ 0.52     $ 1.66     $ 1.79  
                                         
Weighted average anti-dilutive shares not included in the calculation of diluted EPS
                                       
Stock options
    210       299       201       288       201  
Non-vested restricted stock
    ---       5       ---       2       ---  
Warrant
    ---       154       ---       ---       ---  
Total anti-dilutive shares
    210       458       201       290       201  


Note 2: Recently Issued Accounting Standards

In August 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2009-05, Fair Value Measurements and Disclosures (Topic 820) - Measuring Liabilities at Fair Value. This update provides clarification for circumstances in which a quoted price in an active market for the identical liability is not available. In such circumstances a reporting entity is required to measure fair value using one or more of the following techniques: (1) A valuation technique that uses: (a) the quoted price of the identical liability when traded as an asset; or (b) quoted prices for similar liabilities or similar liabilities when traded as assets; or (2) another valuation technique that is consistent with the principles of Topic 820 such as an income approach or a market approach. The guidance in this update will be effective for the quarter beginning October 1, 2009 and we do not expect it will have a significant impact on our financial condition or results of operations.

In June 2009, the FASB issued guidance that establishes the FASB Accounting Standards CodificationTM (the “Codification” or “ASC”) as the source of authoritative U.S. generally accepted accounting principles (“U.S. GAAP”) recognized by the FASB for nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also included in the Codification as sources of authoritative U.S. GAAP for SEC registrants. SFAS No. 168 and the Codification are effective for financial statements issued for interim and annual periods ending after September 15, 2009.  The Codification supersedes all existing non-SEC accounting and reporting standards. Following Statement 168, instead of issuing new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts, the FASB issues Accounting Standards Updates, which serves only to: (a) update the Codification; (b) provide background information about the guidance; and (c) provide the bases for conclusions on the change(s) in the Codification. We started following the guidelines in the Codification on July 1, 2009.

In May 2009, the FASB issued guidance (ASC 855) that establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, it sets forth: a) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; b) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and c) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. We adopted the subsequent event guidance in the quarter ended June 30, 2009, which did not have a significant impact on our financial condition or results of operations.


BANK OF MARIN BANCORP

On April 9, 2009, FASB issued the following application guidance to enhance disclosures regarding fair value measurements and impairments of securities:

1. The first guidance relates to interim disclosures about fair value of financial instruments (ASC 825-10-50), which requires an entity to provide quantitative and qualitative disclosures about fair value of any financial instruments for interim reporting periods as well as in annual financial statements. Prior to issuing this guidance, fair values for these assets and liabilities were only disclosed annually. We adopted the interim fair value disclosure guidance in the quarter ended June 30, 2009 and the adoption did not have a significant impact on our financial condition or results of operations. See Note 3 below for further information.

2. The second guidance relates to recognition and presentation of other-than-temporary impairments (ASC 320-10-35), which is intended to bring greater consistency to the timing of impairment recognition, and provide greater clarity to investors about the credit and non-credit components of impaired debt securities that are not expected to be sold. Further, it replaces the existing requirement that the entity’s management assert it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert: (a) it does not have the intent to sell the security; and (b) it is more likely than not it will not have to sell the security before recovery of its cost basis. It also requires increased and more timely disclosures sought by investors regarding expected cash flows, credit losses, and an aging of securities with unrealized losses. We adopted ASC 320-10-35 for the quarter ended June 30, 2009 and the adoption did not have a significant impact on our financial condition or results of operations. See Note 4 for further information.

3. The third guidance relates to determining fair value when the volume and level of activity for the asset or liability have significantly decreased and identifying transactions that are not orderly (ASC 820-10-35-15A). It reaffirms the objective of fair value measurement— to reflect how much an asset would be sold for in an orderly transaction (as opposed to a distressed or forced transaction) at the date of the financial statements under current market conditions. Specifically, it reaffirms the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets have become inactive. It also requires an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence. Adoption of this guidance did not have a significant impact on our financial condition or results of operations.

Note 3:  Fair Value of Assets and Liabilities

Fair Value Hierarchy and Fair Value Measurement

We group our assets and liabilities that are recorded at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1: Valuations are based on quoted prices in active markets for identical assets or liabilities. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

Level 2: Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data.

Level 3: Valuations are based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Values are determined using pricing models and discounted cash flow models and include management judgment and estimation which may be significant.


BANK OF MARIN BANCORP

The following table summarizes our assets and liabilities that were required to be recorded at fair value on a recurring basis, all of which were valued using Level 2 inputs.

(in thousands)
Description of Financial Instruments
 
Carrying Value
   
Quoted Prices in Active Markets for Identical Assets (Level 1)
   
Significant Other Observable Inputs 
(Level 2)
   
Significant Unobservable Inputs (Level 3)
 
Balance at September 30, 2009 (unaudited):
                       
Securities available for sale
  $ 81,841     $ ---     $ 81,841     $ ---  
                                 
Derivative financial assets
  $ 9     $ ---     $ 9     $ ---  
                                 
Derivative financial liabilities
  $ 2,196     $ ---     $ 2,196     $ ---  
                                 
Balance at December 31, 2008:
                               
Securities available for sale
  $ 79,952     $ ---     $ 79,952     $ ---  
                                 
Derivative financial liabilities
  $ 3,456     $ ---     $ 3,456     $ ---  

Securities available for sale are recorded at fair value on a recurring basis. When available, quoted market prices (Level 1) are used to determine the fair value of securities available for sale. If quoted market prices are not available, we obtain pricing information from a reputable third-party service provider, who may utilize valuation techniques that use current market-based or independently sourced parameters, such as bid/ask prices, dealer-quoted prices, interest rates, benchmark yield curves, prepayment speeds, and credit spreads (Level 2).  Level 1 securities include those traded on active markets, including U.S. Treasury securities.  Level 2 securities include U.S. agencies’ debt securities, mortgage-backed securities and corporate collateralized mortgage obligations.

On a recurring basis, derivative financial instruments are recorded at fair value, which is based on the income approach using observable Level 2 market inputs, reflecting market expectations of future interest rates as of the measurement date.  Standard valuation techniques are used to calculate the present value of the future expected cash flows assuming an orderly transaction.  Valuation adjustments may be made to reflect both our own credit risk and the counterparties’ credit quality in determining the fair value of the derivatives. Level 2 inputs for the valuations are limited to observable market prices for London Interbank Offered Rate (“LIBOR”) cash rates (for the very short term), quoted prices for LIBOR futures contracts, observable market prices for LIBOR swap rates, and one-month and three-month LIBOR basis spreads at commonly quoted intervals.  Mid-market pricing of the inputs is used as a practical expedient in the fair value measurements.  Key inputs for interest rate valuations are used to project spot rates at resets specified by each swap, as well as to discount those future cash flows to present value at the measurement date.  When the value of any collateral placed with counterparties is less than the interest rate derivative liability, the interest rate liability position is further discounted to reflect our potential credit risk to counterparties.  We have used the spread over LIBOR on the BBB rated U.S. Bank Composite rate with maturity term corresponding to the duration of the swaps to calculate this credit-risk-related discount of future cash flows.

Certain financial assets may be measured at fair value on a non-recurring basis. These assets are subject to fair value adjustments that result from the application of the lower of cost or fair value accounting or write-downs of individual assets. For example, when a loan is identified as impaired, it is reported at the lower of cost or fair value, measured based on the loan's observable market price (Level 1), the present value of expected future cash flows discounted at the loan’s original effective interest rate (Level 2), or the current appraised value of the underlying collateral securing the loan if the loan is collateral dependent (Level 3).  Securities held to maturity may be written down to fair value (determined using the same techniques discussed above for securities available for sale) as a result of an other-than-temporary impairment, if any.


BANK OF MARIN BANCORP

The following table presents the carrying value of financial instruments by level within the fair value hierarchy as of September 30, 2009, for which a non-recurring change in fair value has been recorded.

(in thousands; unaudited)
Description of Financial Instruments
 
At September 30, 2009
             
 
Carrying Value
   
Quoted Prices in Active Markets for Identical Assets (Level 1)
   
Significant Other Observable Inputs (Level 2) (a)
   
Significant Unobservable Inputs (Level 3) (b)
   
Losses for the three months ended September 30, 2009 (c)
   
Losses for the nine months ended September 30, 2009 (c)
 
Loans carried at fair value
  $ 2,258     $ ---     $ 770     $ 1,488     $ 584     $ 2,539  

(a) Represents impaired loan principal balances net of specific valuation allowance of $41 thousand, determined using the discounted cash flow method.

(b) Represents collateral-dependent loan principal balances that had been written down to the appraised value of the underlying collateral, net of specific valuation allowance of $183 thousand. The carrying value of loans fully charged-off, which includes unsecured lines of credit, overdrafts and all other loans, is zero.

(c) Represents charge-offs during the period presented and the specific valuation allowance established on loans during the period.

Disclosures about Fair Value of Financial Instruments

The table below is a summary of fair value estimates for financial instruments as of September 30, 2009 and December 31, 2008, excluding financial instruments recorded at fair value on a recurring basis (summarized in a separate table). The carrying amounts in the following table are recorded in the statement of condition under the indicated captions. We have excluded nonfinanical assets and nonfinancial liabilities defined by the Codification (ASC 820-10-15-1A), such as Bank premises and equipment, deferred taxes and other liabilities.  In addition, we have not disclosed the fair value of financial instruments specifically excluded from disclosure requirements of the Financial Instruments Topic of the Codification (ASC 825-10-50-8), such as Bank-owned life insurance policies.

   
September 30, 2009
   
December 31, 2008
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
(in thousands; 2009 amounts unaudited)
 
Amounts
   
Value
   
Amounts
   
Value
 
Financial assets
                       
Cash and cash equivalents
  $ 63,589     $ 63,589     $ 24,926     $ 24,926  
Investment securities held to maturity
    30,163       31,593       23,558       23,135  
Loans, net
    908,726       896,825       880,594       896,628  
Interest receivable
    4,085       4,085       4,081       4,081  
Financial liabilities
                               
Deposits
    949,291       949,871       852,290       853,187  
Federal funds purchased overnight and Federal Home Loan Bank short-term borrowings
    ---       ---       21,800       21,800  
Federal Home Loan Bank long-term borrowings
    55,000       54,067       35,000       34,137  
Subordinated debenture
    5,000       3,795       5,000       5,000  
Interest payable
    958       958       918       918  

Following is a description of methods and assumptions used to estimate the fair value of each class of financial instrument not recorded at fair value but required for disclosure purposes:

Cash and Cash Equivalents – The carrying amounts of cash and cash equivalents approximate their fair value because of the short-term nature of these instruments.

Held-to-maturity Securities - Held-to-maturity securities, which generally consist of obligations of state & political subdivisions, are recorded at their amortized cost. Their fair value for disclosure purposes is determined using methodologies similar to those described above for available-for-sale securities using Level 2 inputs. If Level 2 inputs are not available, we may utilize pricing models that incorporate unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities (Level 3).  As of September 30, 2009, we did not hold any securities whose fair value was measured using significant unobservable inputs.


BANK OF MARIN BANCORP

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 ratings and similar remaining maturities.

Interest Receivable and Payable - The accrued 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 Funds Purchased Overnight and Federal Home Loan Bank Short-term Borrowings - The balance represents its fair value as these borrowings settle overnight.

Federal Home Loan Bank Long-term Borrowings - The fair value is estimated by discounting the future cash flows using current rates offered by the Federal Home Loan Bank San Francisco (“FHLB”) for similar credit advances corresponding to the remaining duration of our fixed-rate credit advances.

Subordinated Debenture - The fair value of the subordinated debenture is estimated by discounting the future cash flows (interest payment at a rate of three-month LIBOR plus 2.48%) using current market rates at which similar bonds would be issued with similar credit ratings as ours and similar remaining maturities. We have used the spread of the ten-year BBB rated U.S. Bank Composite over LIBOR to calculate this credit-risk-related discount of future cash flows.

Commitments - Loan commitments and standby letters of credit generate ongoing fees, which are recognized over the term of the commitment period. In situations where the borrower's credit quality has declined, we record a reserve for these off-balance sheet commitments. Given the uncertainty in the likelihood and timing of a commitment being drawn upon, a reasonable estimate of the fair value of these commitments is the carrying value of the related unamortized loan fees plus the reserve, which is not material.

Note 4:  Investment Securities

Our investment securities portfolio at September 30, 2009 consists primarily of U.S. government agency securities, including mortgage-backed securities (“MBS”) and collateralized mortgage obligations (“CMOs”) issued or guaranteed by Federal National Mortgage Association (“FNMA”), Federal Home Loan Mortgage Corporation (“FHLMC”), or Government National Mortgage Association (“GNMA”). Our portfolio also includes obligations of state and political subdivisions, debentures issued by government-sponsored agencies including FHLB, Federal Farm Credit Bank and FNMA, as well as corporate CMOs, as reflected in the table below.


BANK OF MARIN BANCORP

(in thousands; September 30, 2009 unaudited)
 
September 30, 2009
   
December 31, 2008
 
 
Amortized
   
Fair
   
Gross Unrealized
   
Amortized
   
Fair
   
Gross Unrealized
 
 
Cost
   
Value
   
Gains
   
(Losses)
   
Cost
   
Value
   
Gains
   
(Losses)
 
Held to maturity
                                               
Obligations of state and political subdivisions
  $ 30,163     $ 31,593     $ 1,619     $ (189 )   $ 23,558     $ 23,135     $ 373     $ (796 )
                                                                 
Available for sale
                                                               
Securities of U. S. government agencies:
                                                               
MBS pass-through securities issued by FNMA and FHLMC
    10,924       11,228       304       ---       8,135       8,249       114       ---  
CMOs issued by FNMA
    15,604       16,178       574       ---       15,289       15,468       183       (4 )
CMOs issued by FHLMC
    20,331       20,934       603       ---       24,308       24,452       165       (21 )
CMOs issued by GNMA
    14,290       14,816       526       ---       13,160       13,341       219       (38 )
Debentures of government sponsored agencies
    5,000       5,065       65       ---       17,000       17,072       116       (44 )
Corporate CMOs
    13,701       13,620       1       (82 )     1,392       1,370       ---       (22 )
Total available for sale
    79,850       81,841       2,073       (82 )     79,284       79,952       797       (129 )
                                                                 
Total investment securities
  $ 110,013     $ 113,434     $ 3,692     $ (271 )   $ 102,842     $ 103,087     $ 1,170     $ (925 )

The amortized cost and fair value of investment securities at September 30, 2009 by contractual maturity are shown below.  Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.

   
September 30, 2009
 
   
Held to Maturity
   
Available for Sale
 
(in thousands; unaudited)
 
Amortized Cost
   
Fair Value
   
Amortized Cost
   
Fair Value
 
Within one year
  $ 360     $ 368     $ ---     $ ---  
After one but within five years
    3,683       3,839       2,000       2,065  
After five years through ten years
    11,886       12,660       19,776       20,002  
After ten years
    14,234       14,726       58,074       59,774  
Total
  $ 30,163     $ 31,593     $ 79,850     $ 81,841  

Investment securities carried at $26.9 million and $28.4 million were pledged at September 30, 2009 and December 31, 2008, respectively. During 2009, four held-to-maturity securities issued by the same issuer with a combined carrying value of $1.1 million, and another held-to-maturity security with a carrying value of $335 thousand were sold due to evidence of significant deterioration of creditworthiness.  The proceeds from the sales totaled $1.4 million and the transactions resulted in net losses of $9 thousand recorded in earnings.
 
Other-Than-Temporarily Impaired Debt Securities

For each security in an unrealized loss position, we assess whether we intend to sell the security, or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, we separate the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is calculated as the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is deemed to be due to factors that are not credit related and is recognized in other comprehensive income.

We do not have the intent to sell the securities that are temporarily impaired, and it is more likely than not that we will not have to sell those securities before recovery of the cost basis. Additionally, we have evaluated the credit ratings of our investment securities and their issuers and/or insurers, if applicable. Based on our evaluation, Management has determined that no investment security in our investment portfolio is other-than-temporarily impaired.


BANK OF MARIN BANCORP

Six and thirty-seven investment securities were in unrealized loss positions at September 30, 2009 and December 31, 2008, respectively. They are summarized and classified according to the duration of the loss period as follows:
                   
September 30, 2009
 
< 12 continuous months
   
> 12 continuous months
   
Total Securities in a loss position
 
(In thousands; unaudited)
 
Fair value
   
Unrealized loss
   
Fair value
   
Unrealized loss
   
Fair value
   
Unrealized loss
 
Held-to-maturity
                                   
Obligations of state & political subdivisions
  $ ---     $ ---     $ 1,871     $ (189 )   $ 1,871     $ (189 )
                                                 
Available for sale
                                               
Corporate CMOs
    13,381       (82 )     ---       ---       13,381       (82 )
Total available for sale
    13,381       (82 )     ---       ---       13,381       (82 )
Total temporarily impaired securities
  $ 13,381     $ (82 )   $ 1,871     $ (189 )   $ 15,252     $ (271 )
                                                 
                                                 
December 31, 2008
 
< 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
  $ 10,449     $ (430 )   $ 1,819     $ (366 )   $ 12,268     $ (796 )
                                                 
Available for sale
                                               
Securities of U. S. Government Agencies
    23,369       (107 )     ---       ---       23,369       (107 )
Corporate CMOs
    643       (15 )     727       (7 )     1,370       (22 )
Total available for sale
    24,012       (122 )     727       (7 )     24,739       (129 )
Total temporarily impaired securities
  $ 34,461     $ (552 )   $ 2,546     $ (373 )   $ 37,007     $ (925 )


The unrealized losses associated with debt securities of U.S. government agencies are primarily driven by changes in interest rates and not due to the credit quality of the securities. Further, securities backed by GNMA, FNMA, or FHLMC have the guarantee of the full faith and credit of the U.S. Federal Government. Obligations of U.S. states and political subdivisions in our portfolio are all investment grade without delinquency history. The unrealized loss amount of the obligations of state and political subdivisions relates to one debenture with payments collected through property tax assessments in an affluent community.  These securities will continue to be monitored as part of our ongoing impairment analysis, but are expected to perform. As a result, we concluded that these securities were not other-than-temporarily impaired at September 30, 2009.

The unrealized losses associated with corporate CMO’s are primarily related to securities backed by residential mortgages. A majority 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 September 30, 2009.

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. We held $4.7 million and $3.9 million of FHLB stock recorded at cost in other assets at September 30, 2009 and December 31, 2008, respectively. In January 2009, the FHLB notified us that they temporarily suspended dividend payments on stock in order to build up higher retained earnings and to preserve their capital. On July 30, 2009, the FHLB declared a cash dividend for the second quarter of 2009 at an annualized dividend rate of 0.84%.  Management does not believe that the temporary suspension and/or reduction of dividends on FHLB stock resulted in other-than-temporary-impairment on our investment in FHLB stock, as we expect to be able to redeem this stock at cost.

In addition, as a member bank of Visa Inc., we hold 16,939 shares of Visa Inc. Class B common stock at a zero cost basis.  These shares are restricted from resale until their conversion into Class A (voting) shares on March 25, 2011.


BANK OF MARIN BANCORP

Note 5:  Allowance for Loan Losses and Non-accrual Loans

The allowance for loan losses is maintained at levels considered adequate by Management to provide for probable loan losses inherent in the portfolio. The allowance is based on Management's assessment of various factors affecting the loan portfolio, including problem loans, economic conditions and loan loss experience, and an overall evaluation of the quality of the underlying collateral.

Activity in the allowance for loan losses follows:

   
Three months ended
   
Nine months ended
 
                               
                               
(in thousands; unaudited)
 
September 30,
2009
   
June 30,
2009
   
September 30,
2008
   
September 30,
2009
   
September 30,
2008
 
Beginning balance
  $ 10,135     $ 10,289     $ 8,555     $ 9,950     $ 7,575  
Provision for loan loss charged to expense
    1,100       700       1,685       2,985       2,810  
Loans charged off
    (392 )     (971 )     (970 )     (2,238 )     (1,128 )
Loan loss recoveries
    275       117       1       421       14  
Ending balance
  $ 11,118     $ 10,135     $ 9,271     $ 11,118     $ 9,271  
                                         
Total loans held in portfolio at end of period, before deducting allowance for loan losses
  $ 919,844     $ 909,614     $ 839,007       919,844     $ 839,007  
                                         
                                         
Ratio of allowance for loan losses to loans
    1.21 %     1.11 %     1.11 %     1.21 %     1.11 %
Non-accrual loans at period end
  $ 6,049     $ 5,909     $ 823     $ 6,049     $ 823  
Average recorded investment in impaired loans
  $