BANK OF MARIN
2003 ANNUAL REPORT
TABLE OF CONTENTS
Directors and Executive Officers ................................................ 17
Bank Officers and Staff .............................................................. 18
Message to Shareholders ........................................................... 19
Business of the Bank ................................................................. 20
Management's Discussion and Analysis ..................................... 21
Report of Independent Auditors ................................................. 33
Financial Statements ................................................................. 34
Notes to Financial Statements ................................................... 39
Selected Financial Data ............................................................. 48
Stock Price and Dividend Information ........................................ 48
DIRECTORS AND EXECUTIVE OFFICERS
Judith O’Connell Allen, Community volunteer, Chairman, Bank of Marin
James E. Deitz, President, Marin Business Services
W. Robert Griswold, Jr., President and CEO, Bank of Marin
Ray Hoffman, III, Proprietor, Hoffman Development Co.
* Nancy R. Boatright, Vice President & Corp.Sec., Bank of Marin
Norma J. Howard, Business consultant
J. Patrick Hunt, Partner, Hunt Investments
H. C. Jackson, Retired merchant
James D. Kirsner, Business consultant
* Larry Klaustermeier, Sr. Exec. Vice President & CCO, Bank of Marin
* M. Thomas LeMasters, Exec. Vice President & CFO, Bank of Marin
* Patrick J. London, Exec. Vice President & Director of Investment
Advisory & Trust Services, Bank of Marin
Stuart D. Lum, Partner, Veracast Communications
Joseph D. Martino, Retired banker
James L. Placak, Sales Representative, CIGNA
Joel Sklar, MD, Partner, Cardiology Assoc. of Marin & San Francisco
Brian M. Sobel, Partner, Sobel Communications
* Alexandra E. Souza, Exec.Vice President & CAO, Bank of Marin
J. Dietrich Stroeh, Partner, CSW/Stuber-Stroeh Engineering Group
* These executive officers are not also directors.
This annual report serves as the annual disclosure statement for the purposes of part 350 of the Federal Deposit
Insurance Corporation rules. It has not been reviewed or confirmed for accuracy or relevance by the FDIC.
17
BANK STAFF
Mary Adams
Diane Akers
Dino Alessio
Nova Alexander
Terry Aman
Michele Anderson
Natalie Andryushina
Brett Armstrong
Sabrina Arnaud-Randall
Cathy Atkinson
Tamara Austin
Boualay Bala
Kenneth Beagle
Susan Beaver
Robin Bentivegna
John Berens
Josiane Bougard
Arlene Brians
Vanessa Camacho
Scott Canaan
Brian Carlson
Megan Carter
David Cerejo
Nancy Chapin
Gaik Chen
Angela Colglazier
Kay Commins
Mitsch Croker
Anooshik Cronin
Monique de Brito
Amra Dizdarevic
Barbara Dougherty
Mary Jayne Elmore
Florette Eugene
Brandee Everett
Susan Farac
Coy Ferini
Richard Fisher
Craig Fox
Hung Fung
Karen Garbarino
Elizabeth Greene
Judy Grider
Vicki Gruber
Sal Gutierrez
Victoria Gutierrez
Dina Hadzikadunic
Leslie Harrell
Bryan Heagy
Leslie Heggli
Viviana Henao
Dean Higgins
Debbie Higgins
Helen Hoffmann
Josh Iversen
Sharika Jefferson
Tracy Jerves
Claudia Just Olsen
Catherine Karklyn
Laura Kerby
Mindy King
Lisa Kleinecke
Tori Kuciej
Christopher Li
Trini Lopez
Van Luu
Molly Manisay
Connie Marelich
Joan Marino
Scott Martini
Stephanie McLeod
Kenny Meligan
Mary Melville
Victor Mencarelli
Bob Meyer
Pia Mize
Marisol Negrete
Eric Nelson
Linda Nolt
Michael Nord
Jon O'Halloran
Anotinette Oroz
Jaime Ortiz
Teri Pearson
Connie Pedersen
BANK OFFICERS
John Pedone
Irene Pelmear
Nancy Reich
Linda Reid
Rachel Rempe
Penny Reynolds
Sarah Richards
Marie Reick
Jessica Ritchie
Mike Roney
Stephen Ross
Matthew Roybal
Saroj Sachdev
Holly Schmidt
Ellie Shattuck
Mari Soria
Renee Sullivan
Nancy Sutherland
Jamie Thigpen
Allison Thornton
Kim To
Barbara Tolin
Cindy Toscanini
Ray Vallerga
Patty Varela
Joe Villaluna
Danielle Wu
Vita Yumanova
Jacky Zingarelli
Kate Albaugh, Asst. Vice President
Sue Anderson, Vice President
Marshall Appleton, Asst. Vice President
Gisela Bigden-Fisher, Vice President
Bo Boero, Asst. Vice President
Michael Burke, Vice President
Fabia Butler, Asst. Vice President
Michael Callan, Vice President
Joan Capurro, Vice President
Jennifer Casper, Asst. Vice President
Sal Catinella, Vice President
Douglas Caulfield. Vice President
Judi Cole, Vice President
Chris Colliver, Asst. Vice President
Phyllis Cope, Vice President
Robert Davisson, Vice President
Emily DiLaura, Vice President
Pat Feingold, Vice President
Holly Ford, Vice President
Sharon Fox, Vice President
Faith Giosso, Asst. Vice President
Kevin Gish, Asst. Vice President
Robert Gotelli, Asst. Vice President
Jeff Graham, Asst. Vice President
Janet Hayward, Vice President
Karen Hegarty, Vice President
Wayne Hoffer, Vice President
Fran Hoke, Asst. Vice President
Martha Hollenbeck, Vice President
Joseph Iacocca, Vice President
Donald Jarvis, Vice President
18
Nancy Jones, Vice President
Steve Kambur, Vice President
James King, Vice President
Carol Kneis, Vice President
David Kough, Vice President
Mae Lacourse, Vice President
Carrie Lee, Asst. Vice President
Thomas Leong, Asst. Vice President
John Luce, Vice President
Marguerite Matthews, Vice President
Lynn McHale, Asst. Vice President
Bill Montgomery, Vice President
Frank Murray, Sr. Vice President
Patti O'Brien, Asst. Vice President
Elizabeth O'Farrell, Sr. Vice President
Peter Pelham, Vice President
Frank Perachiotti, Jr., Vice President
Carole Reif, Vice President
Elizabeth Reizman, Sr. Vice President
Lucy Rezendes, Vice President
Dan Rheiner, Vice President
Robert Rowen, Asst. Vice President
David Schmidt, Vice President
Dave Schrader, Asst. Vice President
Liza Silva, Vice President
Linda Steidle, Vice President
Rich Ugarte, Vice President
Sherry Wallace, Vice President
Jackie Williams, Vice President
Bonnie Wilson, Asst. Vice President
Nicole Young, Asst. Vice President
Keith Zimmerman, Sr. Vice President
MESSAGE TO OUR SHAREHOLDERS:
Bank of Marin was founded on the principals of providing outstanding service to our customers, a
competitive return to our shareholders, a satisfying work environment for our employees, and of being
a contributing member of the communities we serve. Consistency in all these areas has been a big part
of our success. Our ongoing challenge is to grow in a way that is consistent with these goals. We are
pleased to report another year of consistent growth in deposits, loans and earnings, as well as of
enhanced service to our customers and to our communities.
We were able to achieve strong financial results in 2003 even though our economy did not experience
the recovery many had expected earlier in the year. The decision of the Federal Reserve Open Market
Committee to cut overnight rates by a further 25 basis points in late June brought interest rates to levels
not seen in 40 years. Now eight months later most of us are still waiting for results, hoping for job growth
in California and nationally, and for a reduction in available office space locally. We did see some
increase in loan demand late in 2003, and we remain hopeful that 2004 will bring an improving economy
and a return to more normal interest rate levels.
In 2003 deposits grew faster than loans, reversing the trend of the previous year. As a result, our loan
to deposit ratio declined, hurting our net interest margin, because we invested excess deposits in short
term, lower earning investments. Despite that, our net interest income increased by $2.1 million or
8.4%. We were also able to grow our non-interest income by $0.6 million or 27.7% and importantly,
limit growth in non-interest expenses to $0.7 million or 4.0%, while growing our total assets by 19.2%.
The bottom line was an increase in net income of $1.2 million or 19.7% compared to 2002.
We experienced only modest charge-offs during the year (0.06%) and ended the year with no non-
performing loans or loans 90 days past due, evidence that the credit quality of our portfolio remains
high. Our strong earnings and the shift in our asset mix increased our total risk based capital ratio to
10.92%, indicating, when combined with our historical levels of current year earnings, that we have
the necessary capital to support our growth. These factors together with our growing reputation for
“legendary customer service” and a strong commitment to our communities, give us confidence that
the Bank’s future remains bright.
Strong leadership by boards of directors and senior management is important, especially at this time
when corporate boards are under particular scrutiny to ensure good corporate governance. Your board
of directors and the Bank’s senior management are committed to the highest standards of ethical
conduct, as outlined in our recently formalized Code of Ethical Conduct.
Again this year, we want to take this opportunity to express our appreciation to our talented team of
dedicated and committed community bankers. Our success would not be possible without them and
you, our loyal customers and shareholders.
/s/ Judith O'Connell Allen
/s/ W. Robert Griswold, Jr.
Judith O’Connell Allen
Chairman of the Board
W. Robert Griswold, Jr.
President & Chief Executive Officer
19
BUSINESS OF THE BANK
General
Bank of Marin (the ‘Bank’) was incorporated in August 1989, received its charter from the California
Superintendent of Banks (now the California Department of Financial Institutions) and commenced operations
in January 1990. The Bank is an insured bank under the Federal Deposit Insurance Act and, like most state
chartered banks of its size in California, is not a member of the Federal Reserve System.
Market Area and Customer Base
The Bank’s market area stretches from southern Sonoma County south to the Golden Gate Bridge and lies
between the Pacific Ocean on the west and San Pablo Bay to the east. Of this larger market area the Bank has
designated the communities of San Rafael, Corte Madera, Greenbrae, Larkspur, Kentfield, Ross, San Anselmo,
Tiburon, Belvedere, Mill Valley, Sausalito, Terra Linda, Bel Marin Keys, Novato and Petaluma as its primary
market areas. The Bank’s customer base is made up of business and personal banking relationships from the
communities near the nine branch office locations.
Loans
The Bank offers a broad range of commercial and retail lending programs including commercial loans,
construction financing, consumer loans, and home equity loans and lines of credit. The Bank also offers a
proprietary Visa credit card to its customers, including a Business Visa program for business and professional
customers. For reporting purposes these programs are consolidated into the general categories of commercial
loans, real estate loans and personal loans. At December 31, 2003, these broad categories totaled $450.9
million, and accounted for approximately 24%, 60% and 16%, respectively, of the loan portfolio.
The interest rates on most commercial loans are tied to the Wall Street Journal prevailing prime rate and change
as rate changes are reported. A majority of these loans have a term of one year or less.
Real estate loans include commercial real estate loans, consumer loans and lines of credit secured by real
property, and construction financing. Commercial real estate loans are generally written for ten years with
fixed rates for the first 5 years and then adjusting to an indexed spread for the remaining 5 years. Consumer
real estate secured loans include equity lines of credit and installment loans for various consumer purposes.
Generally, equity lines are for a term of ten years or less and are secured by first or second deeds of trust on
residential properties and bear interest at a floating rate tied to the Wall Street Journal prevailing prime rate.
Usually, home equity installment loans are for a term of 15 years or less and have a fixed rate of interest.
The Bank offers construction financing to developers of single family residences and commercial real estate
properties. Construction loans are typically repaid through permanent financing by the Bank or from other
financial institutions. Usually these loans have terms of twelve to eighteen months, have fixed rates of interest
or floating rates tied to the Wall Street Journal prevailing prime rate, and are secured by first deeds of trust.
Deposits
The Bank offers a variety of checking and savings accounts, and a number of time deposit alternatives,
including interest bearing and non-interest bearing personal and business checking accounts and time
certificates of deposit. We offer direct deposit of payroll, social security and pension checks. Our ATM system
is tied into both the STAR and PLUS networks, and we offer a proprietary Visa check card.
We attract deposits from individuals, merchants, small to medium sized businesses and professionals who live
and/or work in our market areas. More than 90% of our deposits come from Marin and Sonoma Counties.
Approximately half of the Bank’s deposits are from businesses and half are from individuals. The Bank as a
matter of policy does not accept brokered deposits.
Investment Advisory & Trust Services
In 1998, the Bank began to offer investment advisory and personal trust services. The services include
customized portfolio management of individual stocks, bonds and cash; professional management of all trust
assets including real estate and other specialty assets; tax reporting, safekeeping and accounting of assets;
estate settlement and administration of all areas of living, testamentary and charitable trusts.
20
MANAGEMENT’S DISCUSSION AND ANALYSIS
The following discussion of the Bank’s financial condition and results of operations for each of the three years
ended December 31, 2003 should be read in conjunction with the Bank’s financial statements and related notes
thereto, located on pages 34 to 47 of this Annual Report. Average balances, including balances used in
calculating certain financial ratios, are generally comprised of average daily balances. In April 2003, the Board
of Directors declared a 5% stock dividend, equal to the dividend declared in April of 2002. Per share information
with respect to earnings and book value has been restated to reflect the stock dividends.
Critical Accounting Policy
Management has considered the accounting principles upon which the Bank’s financial reporting depends and
has determined the allowance for loan losses to be the Bank’s most critical accounting policy. The allowance
for loan losses is discussed in further detail beginning on page 27 of this Annual Report. The Bank formally
assesses the adequacy of the allowance for loan losses on a quarterly basis. Determination of the adequacy is
based on ongoing assessments of the probable risk in the outstanding loan portfolio. These assessments
include the periodic re-grading of loans based on changes in their individual credit characteristics including
delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the
interest rate environment, and other factors as warranted. Loans are initially graded when originated. They
are re-graded as they are renewed, when there is a new loan to the same borrower, when identified facts
demonstrate heightened risk of nonpayment, or if they become delinquent. Re-grading of larger problem loans
occurs at least quarterly. Confirmation of the quality of the grading process is obtained by independent credit
reviews conducted by consultants specifically hired for this purpose and by various bank regulatory agencies.
The Bank’s method for assessing the appropriateness of the allowance includes specific allowances for
identified problem loans, an allowance factor for pools of credits, and allowances for changing environmental
factors (e.g. portfolio trends, concentration of credit, growth, economic factors, etc.). Allowances for identified
problem loans are based on specific analysis of individual credits. Loss estimation factors for loan pools are
based on analysis of local economic factors applicable to each loan pool. Due to our minimal historic losses,
loss estimation factors are based only in part on the previous historical loss experience for each pool. Allowances
for changing environmental factors are management’s best estimate of the probable impact these changes have
had on the loan portfolio as a whole.
RESULTS OF OPERATIONS
Overview
The 2003 financial performance for Bank of Marin produced record levels of deposits, loans, and net income.
Total deposits reached $584,116,000 in 2003, an increase of $98,087,000 or 20.2% from the prior year. Total
loans finished the year at $450,881,000 compared to $410,155,000 in 2002, representing an increase of
$40,726,000 or 9.9%. Net income for 2003 was $7,473,000 or $2.38 per share (diluted) compared with
$6,242,000 or $2.06 per share (diluted) in 2002. The year over year change in net income represents an
improvement of 19.7%.
The Bank’s return on average assets (ROA) and return on average equity (ROE) improved over the prior year.
In 2003 the Bank’s ROA and ROE were, respectively, 1.28% and 14.46% compared to 1.26% and 14.12% in
2002. Management continues to balance the desire to increase the return ratios to those of its peers with the
desire to increase the Bank’s deposit penetration in Marin and Sonoma Counties. For the twelve month period
from June 2002 to June 2003 (the latest date for which the information is available), the Bank’s market share
of total Marin County deposits increased from 7.36% to 8.11%.
Net interest income was a principal source of the earnings improvement for the year, as it reached $27,656,000,
an increase of $2,134,000 or 8.4% over 2002. The interest income component of net interest income was up
3.4% to $32,825,000, and is the result of the increase in the size of the Bank’s loan portfolio. Total interest
expense of $5,169,000 was down from 2002 by $1,059,000 or 17.0%. While the Bank’s deposit portfolio showed
strong growth, total interest expense was down significantly, as market interest rates and the Bank’s rates
declined throughout the year.
21
The Bank provided $686,000 to the allowance for loan losses in 2003, and net charge-offs were $263,000. This
compares to a provision of $577,000 and net charge-offs of $122,000 in 2002. At year-end 2003 and 2002, the
allowance for loan losses as a percentage of total loans was 1.21% and 1.23%, respectively.
Non-interest income is comprised of service charges on deposit accounts, Investment Advisory & Trust Services
(IA&TS) revenue, and other income. In 2003, total non-interest income was $2,960,000, which is an
improvement of $642,000 or 27.7% over 2002. Service charges on deposit accounts increased to $1,021,000
versus $840,000 one year ago. IA&TS revenue grew to $815,000, an increase of $145,000, and other income
finished the year at $1,125,000 compared to $809,000 in the prior year.
Non-interest expenses increased from $17,125,000 in 2002 to $17,817,000 in 2003, a $693,000 or 4.0%
increase and were largely due to the growth in the operations of the Bank. From 2001 to 2002, non-interest
expenses increased by over 18.0%. The significant year over year increase in 2002 was due to the costs
associated with branch expansion that occurred in the second half of 2001.
Assets of the Bank totaled $642,607,000 at December 31, 2003, an increase of $103,582,000 or 19.2% from
2002 ending balances. The Bank ended 2003 with a total capital to risk weighted asset ratio of 10.92%, well
above the regulatory minimum of 8.0%.
Summary of Quarterly Results of Operations
Table 1 sets forth the results of operations for the four quarters of 2002 and 2003.
Table 1 Summarized Statement of Operations
(Dollars in thousands)
2002 Quarters Ended
Mar. 31 June 30 Sept. 30 Dec. 31
2003 Quarters Ended
Mar. 31 June 30 Sept. 30 Dec. 31
Interest income ............................................. $7,425
1,526
Interet expense .............................................
5,899
Net interest income ....................................
150
Provision for loan losses .........................
Net interest income after provision
for loan losses ....................................
Non-interest income ......................................
Non-interest expense ....................................
Income before provision for income taxes ..
Provision for income taxes ......................
5,749
508
4,213
2,044
766
Net income ................................................ $1,278
Net income per common share
$7,817
1,540
6,277
175
6,102
557
4,203
2,456
939
$1,517
$8,111
1,624
6,487
150
6,337
608
4,287
2,658
1,027
$1,631
$8,397
1,538
6,859
102
6,757
645
4,421
2,981
1,165
$1,816
$8,115
1,405
6,710
167
6,543
668
4,580
2,631
1,020
$1,611
$8,340
1,285
7,055
205
6,850
679
4,492
3,037
1,179
$1,858
$8,213
1,239
6,974
174
6,800
796
4,482
3,114
1,194
$1,920
$8,156
1,239
6,917
139
6,778
816
4,263
3,331
1,247
$2,084
Basic ......................................................
Diluted ...................................................
$ 0.45
$ 0.43
$ 0.53
$ 0.50
$ 0.56
$ 0.53
$ 0.63
$ 0.59
$ 0.55
$ 0.52
$ 0.64
$ 0.59
$ 0.65
$ 0.61
$ 0.71
$ 0.65
Net Interest Income
Net interest income is the difference between the interest earned on earning assets, such as loans and
investments, and the interest expense on interest bearing liabilities used to fund those assets, primarily
deposits. Net interest income is the Bank’s largest (90.3%) source of income.
Net interest income is impacted by changes in general market interest rates and by changes in the amounts
and composition of interest earning assets and interest bearing liabilities. Comparisons of net interest income
are frequently made using net interest margin and net interest rate spread. Net interest margin is expressed
as net interest income divided by average earning assets. Net interest rate spread is the difference between the
average rate earned on total interest earning assets and the average rate incurred on total interest bearing
liabilities. Both of these measures are reported on a taxable equivalent basis. Net interest margin is the higher
of the two because it reflects interest income earned on assets funded with non-interest bearing liabilities,
which includes demand deposits and stockholders’ equity.
Table 2, Distribution of Average Statements of Condition and Analysis of Net Interest Income, compares interest
income and interest earning assets with interest expense and interest bearing liabilities for the three years 2001
through 2003. The table also indicates net interest income, net interest margin and net interest rate spread
for each year.
22
Table 2 Distribution of Average Statements of Condition and Analysis of Net Interest Income
(Dollars in thousands)
Assets
2001
Interest
Average
Income/ Yield/
Balance Expense(1) Rate(1)
2002
Interest
Average
Income/ Yield/
Balance Expense(1) Rate(1)
2003
Interest
Average
Income/ Yield/
Balance Expense(1)Rate(1)
Federal funds sold .............................. $ 19,627
--
Interest-earning deposits .............
731
--
3.72% $ 13,237
--
--
204
--
1.54% $ 23,312
--
--
243
--
1.04%
--
Investment securities
22,471
17,647
12,208
22,802
1,403
1,556
701
1,030
291,717 25,020
386,472 30,441
6.25
8.82
5.74
6.24
8.58
7.98
17,522
21,769
15,201
24,281
1,101
1,009
848
1,027
366,408 27,561
458,418 31,750
6.28
4.64
5.58
6.02
7.52
7.02
11,459
32,672
12,303
23,991
518
1,018
791
954
434,908 29,301
538,645 32,825
4.52
3.11
6.43
5.72
6.74
6.17
U. S. Treasury securities ..............
U. S. government agencies ...........
Other ...........................................
Municipal bonds ..........................
Loans and bankers’ acceptances.(2) ....
Total interest-earning assets ........
Cash and due from banks ...................
Bank premises and equipment ............
Interest receivable and other assets ....
22,358
2,887
2,043
Total Assets ................................. $413,760
Liabilities and Stockholders' Equity
Interest-bearing transaction accounts . $ 35,638
140,092
Savings accounts ................................
98,512
Time accounts .....................................
16
Funds purchased ................................
274,258
Total interest-bearing liabilities ....
98,599
Demand accounts ...............................
3,030
Interest payable ..................................
37,873
Stockholders’ equity ............................
Total Liabilities and
Stockholders' Equity ................ $413,760
270
4,149
4,565
1
8,985
0.76
2.96
4.63
6.78
3.28
29,877
4,196
2,090
$494,581
$ 43,188
182,532
105,409
333
331,462
115,983
2,922
44,214
$494,581
309
2,953
2,960
6
6,228
0.72
1.62
2.81
1.86
1.88
33,056
4,361
5,513
$581,575
$ 51,664
226,288
110,740
91
388,783
138,214
2,890
51,688
$581,575
207
2,426
2,534
2
5,169
0.40
1.07
2.29
1.71
1.33
Net Interest Income ....................................
Net Interest Margin ....................................
Net Interest Spread ....................................
$21,456
$25,522
$27,656
5.65%
4.70%
5.66%
5.14%
5.21%
4.84%
(1) Yields and interest income are presented on a taxable equivalent basis using the Federal statutory rate of 34 percent.
(2) Average balances on loans outstanding include all non-performing loans. The amortized portion of net loan origination fees
(costs) is included in interest income on loans, representing an adjustment to the yield.
In 2003, the Bank’s net interest income increased by $2,134,000 or 8.4% over 2002, and by $4,066,000 or
19.0% in 2002 over 2001. These increases are attributable to growth in average earning assets of $80,227,000
in 2003 and $71,946,000 in 2002. The Bank’s 2003 year-end loan to deposit ratio was 77.2%. The Bank’s yield
on interest earning assets declined in 2003 by 85 basis points to 6.17%, and the yield on its loan portfolio
declined from 7.52% in 2002 to 6.74% in 2003. The yield on the Bank’s Federal funds sold dropped from 1.54%
in 2002 to 1.04% in 2003. These decreases in yield are the result of interest rate reductions implemented by
the Federal Reserve Board by reducing the Federal funds interest rate (the interest rate banks charge each other
for short term borrowings), and the time required for these rate changes to impact market rates of interest. In
the last two years there was a fifty basis point reduction in the Federal funds rate in 2002, and a twenty-five
basis point reduction in 2003.
The yield on the Bank’s portfolio of Treasury Securities, and Agency Securities declined from prior year levels
to 4.52% and 3.11%, respectively. The Bank’s Treasury and Agency Securities generally have an average life
of less than three years and will mature or be called more quickly than other securities in the Bank’s portfolio.
Therefore, their yield is significantly impacted by market rates of interest. The yield on Municipal Securities
decreased from 6.02% in 2002 to 5.72% in 2003, while the yield on other securities increased during the same
period. Other Securities is largely comprised of corporate bonds, and the yield on these instruments improved
during the year from 5.58% to 6.43%.
While the yield the Bank realized on interest earning assets decreased, deposit rates also declined in 2003. The
rate paid on interest bearing liabilities declined from 1.88% in 2002 to 1.33% in 2003. This is primarily the
result of the aforementioned changes in market interest rates originating from actions taken by the Federal
Reserve in 2002 and 2003. In 2003, the Bank achieved a net interest margin (NIM) of 5.21%, down from the
NIM of 5.66% experienced in 2002. The combination of a lower loan to deposit ratio in 2003, and the decline
in market rates of interest contributed to this change.
23
In 2002 the Bank’s net interest margin increased by one basis point when compared to 2001. While market
rates of interest changed substantially in 2001 and 2002, the increase in the Bank’s loan to deposit ratio from
79.2% in 2001 to 84.4% in 2002 aided in maintaining the Bank’s NIM.
Table 3, Analysis of Changes in Net Interest Income, separates the change in the Bank’s net interest income
into two components: (1) volume - change caused by increases or decreases in the average asset and liability
balances outstanding, and (2) yield/rate - changes in average yields on earning assets and average rates for
interest bearing liabilities. Table 3 shows the impact on income of balance sheet changes and the changes in
market interest rate levels which occurred during 2002 and 2003. The increase in net interest income during
both years is primarily the result of growth in average earning assets, a change in the mix of average earning
assets, and the decline in the rate paid on interest bearing liabilities.
Table 3 Analysis of Changes in Net Interest Income
(Dollars in thousands)
Assets
Year ended December 31,
2002 compared to 2001
Yield/
Volume Rate*
Total
Year ended December 31,
2003 compared to 2002
Yield/
Volume Rate*
Total
Federal funds sold .......................... $ (238) $ (289) $ (527)
Interest-earning deposits ................
--
Investment securities
--
--
U. S. Treasury securities .............
U. S. government agencies ..........
Other ..........................................
Municipal bonds .........................
(309)
363
172
--
Loans and bankers’ acceptances .... 6,406
Total interest-earning assets ....... 6,394
7
(910)
(25)
(3)
(3,865)
(5,085)
(302)
(547)
147
(3)
2,541
1,309
$ 156 $ (117)
--
--
$ 39
--
(381)
506
(162)
(17)
5,153
5,255
(202)
(497)
105
(56)
(3,413)
(4,180)
(583)
9
(57)
(73)
1,740
1,075
Liabilities
Interest-bearing transaction acct. ...
57
Savings accounts ............................ 1,257
320
Time accounts ................................
21
Funds purchased ...........................
Total interest-bearing liabilities ... 1,655
(17)
(2,453)
(1,924)
(16)
(4,410)
40
(1,196)
(1,604)
5
(2,755)
61
708
150
(4)
915
(163)
(1,235)
(576)
0
(1,974)
(102)
(527)
(426)
(4)
(1,059)
Net Interest Income ............................ $4,739 $ (675) $4,064
$4,340 $ (2,206) $2,134
*
Variances due to changes in both yield/rate and volume (mix) are allocated to yield/rate.
Provision for Loan Losses
The Bank provides as an expense an amount to bring the allowance for loan losses to a level to provide adequate
coverage for probable loan losses. The adequacy of the allowance for loan losses is evaluated based on several
factors, including growth of the loan portfolio, analysis of probable losses in the portfolio and recent loss
experience. Actual losses on loans are charged against the allowance and the allowance is increased through
the provision charged to expense. The Bank’s provision for loan losses in 2003 was $686,000 versus $577,000
for 2002 and $619,000 in 2001. Net charge-offs for 2003 totaled $263,000 compared with $122,000 in 2002
and $43,000 in 2001. Table 4, Non-performing Loans at December 31, shows the total non-performing assets
at December 31 for the last five years.
Table 4 Non-performing Loans at December 31
Non accrual loans ...................................................
Accruing loans past due 90 days or more ................
Other real estate owned ..........................................
$ 90,000
--
--
Total non-performing assets .............................
$ 90,000
1999
2000
$ --
--
--
$ --
2001
$ --
--
--
$ --
2002
$ --
--
--
$ --
2003
$ --
--
--
$ --
Loans are placed on nonaccrual when management believes that there is serious doubt as to the collection of principal or interest,
or when they become contractually past-due by 90 days or more with respect to principal or interest, except for loans that are both
well secured and in the process of collection. When loans are placed on nonaccrual status, any accrued but uncollected interest is
reversed from current income, and additional income is recorded only as payments are received.
24
Non-interest Income
Most of the growth in non-interest income to $2,960,000, up from $2,318,000 in 2002 and $1,873,000 in 2001,
is attributable to the growth in the operations of the Bank.
Service charges on deposits in 2003 and in 2002 increased by $180,000 and $133,000 respectively. These
increases are generally due to growth in the number of accounts in the Bank. The Bank’s IA&TS has shown
similar results. IA&TS revenue in 2003 was $815,000, an increase over the prior year of $145,000. This increase
is primarily the result of growth in assets under management. IA&TS revenue showed a $144,000 increase over
2001. The increase in “other” income is primarily from growth in other services associated with an expanding
customer base.
Non-interest Expense
Table 5, Significant Components of Non-Interest Expense, summarizes the amounts and changes in dollars
and percentages. As with non-interest income, much of the increase in non-interest expense is attributable
to the growth in the operations of the Bank. In 2003 non-interest expense increased 4.0% while average loans
and deposits increased 18.7% and 17.8%, respectively. In 2002 non-interest expense increased 19.4%, while
average loans and deposits increased 25.6% and 20.0%, respectively.
Table 5 Significant Components of Non-Interest Expense
(Dollars in Thousands)
Year ended
December 31,
2002
2003
2001
2002 compared to 2001
Amount
Increase
Percent
Increase
2003 compared to 2002
Percent
Increase
Amount
Increase
(Decrease) (Decrease)
Salaries and related benefits .........
Occupancy and equipment ...........
Legal fees ......................................
Other professional fees ..................
Data processing fees .....................
Other ............................................
$8,835 $10,446 $10,767
2,668
2,483
54
93
468
437
1,039
952
2,821
2,714
2,041
78
365
796
2,313
$1,611
442
15
72
156
401
Total ...................................... $14,428 $17,125 $17,817
$2,697
18.2%
21.7
19.2
19.7
19.6
17.3
18.7%
$321
185
(39)
31
87
107
$692
3.1%
7.5
(41.9)
7.1
9.1
3.9
4.0%
In 2003 salaries and benefits costs increased by $321,000 or 3.1% primarily due to annual merit pay increases.
The number of full-time equivalent (FTE) employees increased slightly to 161, up from 2002’s level of 159. In
2003 there were expenses of $917,000 for the Bank’s Employee Stock Ownership and Savings Plan (ESOP),
and $885,000 for staff and officer incentive bonus plans. The increase in ESOP expense for 2003 was $38,000
or 4.3%. The increase in salary and ESOP costs were offset by a decrease in incentive bonus plan expense which
decreased by $293,000 or 24.9% from 2002.
In comparing 2002 with 2001, salaries and benefits costs increased by 18.2%. The number of full-time
equivalent (FTE) employees increased by seven from December 31, 2001 to 159 at December 31, 2002. In 2002
there were expenses of $879,000 for the Bank’s Employee Stock Ownership and Savings Plan and $1,178,000
for staff and officer incentive bonus plans. The year over year increase in salaries and benefits was due to branch
expansion in 2001. The larger expenses for incentive compensation were due to the Bank’s strong loan and
deposit growth, and improved profitability.
The 2003 increase of $185,000 in occupancy and equipment costs is largely due to annual increases in branch
operating leases. This year over year increase represents a decline when compared to the increase experienced
in the prior year. In 2002, the Bank incurred an increase of $442,000, which was largely due to increases in
branch operating leases and the amortization of improvements associated with two new branch offices.
Additionally, the Bank incurred costs associated with the remodel of a branch office, and software
improvements in the Bank’s central operations department.
In 2003, data processing costs were $1,039,000, an increase over 2002 of $87,000 or 9.1%. This increase is
largely attributable to the growth in the operations of the Bank. In 2002, data processing expense increased
by $156,000, and like 2003, is attributable to the increase in the growth in the operations of the Bank.
25
Other non-interest expenses of $2,821,000 represent a $107,000 or 3.9% increase over 2002. Generally, this
increase is due to the growth in activity of the Bank. In 2002, other non-interest expenses increased by
$481,000 or 21.5%. These increases were due to the growth in activity of the Bank, and the expansion of the
Bank’s branch offices that took place in the second half of 2001.
The Bank’s efficiency ratio (non-interest expense divided by the sum of non-interest income and net interest
income) improved over the prior year and finished at 58.1% in 2003. Last year, the Bank’s efficiency ratio was
61.5%.
FINANCIAL CONDITION
Investment Securities
The Bank maintains an investment securities portfolio to provide liquidity and earnings on funds that have
not been loaned. Management determines the maturities and the types of securities to be purchased based on
the need for liquidity to fund loans and the desire to attain a high investment yield. Table 6 shows the makeup
of the securities portfolio at December 31, 2002 and 2003.
Table 6 Securities Investments
Type and Maturity Grouping
December 31, 2002
(Dollars in thousands)
Held to maturity
U.S. Treasury
Principal
Amount
Book
Value*
Market Average
Yield
Value
Principal
Value
December 31, 2003
Market
Value
Book
Value*
Average
Yield
Total ........................................
$ --
$ --
$ --
--%
$ --
$ --
$ --
--%
Other U.S. Government
Total ........................................
--
--
--
--
--
--
--
--
State and municipal
Due within 1 year ...........................
Due after 1 but within 5 years .........
Due after 5 but within 10 years .......
Due after 10 years ..........................
Total ........................................
Corporate Bonds
Due within 1 year ...........................
Due after 1 but within 5 years .........
Due after 5 but within 10 years .......
Due after 10 years ..........................
Total ........................................
Total held to maturity .............................
Available for sale
U.S. Treasury
Due within 1 year ...........................
Due after 1 but within 5 years .........
Due after 5 but within 10 years .......
Due after 10 years ....................
Total ........................................
Other U. S. Goverment
1,075
17,570
1,575
1,890
22,110
2,000
10,500
--
--
12,500
34,610
9,000
3,000
--
--
12,000
Due within 1 year ...........................
Due after 1 but within 5 years .........
Due after 5 but within 10 years .......
Due after 10 years ...........................
Total ........................................
--
13,500
2,258
--
15,758
Total available for sale ............................
27,758
1,078
17,998
1,583
1,939
22,598
2,034
10,580
--
--
12,614
35,212
9,080
3,027
--
--
12,107
--
13,601
2,268
--
15,869
27,976
1,101
18,994
1,716
2,033
23,844
2,052
11,461
--
--
13,513
37,357
9,280
3,296
--
--
12,576
--
14,012
2,337
--
16,349
4.57
4.05
4.75
4.69
4.18
3.54
6.71
--
--
6.20
4.90
6.03
6.71
--
--
6.20
--
4.34
6.11
--
4.57
28,925
5.28
7,320
13,795
6,705
1,890
29,710
--
11,500
--
--
11,500
41,210
5,500
7,500
--
--
13,000
26,794
28,407
10,000
716
65,917
78,917
7,367
14,028
7,205
1,899
30,499
--
11,691
--
--
11,691
42,190
5,514
7,802
--
--
13,316
27,258
28,798
10,012
713
66,781
80,097
7,359
14,797
7,244
1,960
31,360
--
12,380
--
--
12,380
43,740
5,572
7,879
--
--
13,451
27,572
28,919
9,852
742
67,085
80,536
2.94
4.13
3.39
4.69
3.71
--
6.05
--
--
6.05
4.36
3.09
2.43
--
--
2.71
4.69
3.04
4.15
6.13
3.92
3.72
Total ......................................................
$62,368
$63,188
$66,282
5.07% $120,127 $122,287 $124,276
3.94%
*
Book value reflects cost, adjusted for accumulated amortization and accretion. No securities are less than investment grade.
26
The Bank’s investment securities portfolio, consisting primarily of U.S. Treasuries, other U.S. government
agencies, state and municipal securities, and corporate bonds, increased $58,588,000 or (91.3%) in 2003. U.S.
Treasuries, representing 11.0% of the portfolio increased by $875,000. U.S. government agency securities
made up 54.6% of the portfolio and increased by $50,735,000. State and municipal securities increased by
$7,901,000 and represent 24.9% of the portfolio, and corporate bonds totaling $11,691,000 or 9.5% of the
portfolio, decreased by $923,000 in 2003. The weighted average maturity of the portfolio at December 31, 2003
was approximately 24 months.
Loans
The Bank seeks to maintain a loan portfolio that is well balanced in terms of borrowers, collateral and
maturities. Of the Bank’s outstanding loans at December 31, 2003, 24% are commercial loans, 60% are secured
by real estate and 16% are to consumers. For the most part, this mix is not significantly changed from prior
years. The Bank’s commercial real estate loan portfolio is composed primarily of term loans for which the
primary source of repayment is cash flow from net operating income. Table 7 shows an analysis of loans by
type.
Table 7 Loans Outstanding by Type at December 31
(Dollars in thousands)
1999
2000
2001
2002
2003
Commercial loans ...................................................
Real estate
Commercial .........................................................
Construction .......................................................
Residential ..........................................................
Installment .............................................................
Total loans ...........................................................
Allowance for loan losses .....................................
$ 46,706
$ 54,030
$ 68,517
$ 85,192 $ 105,847
123,434
12,459
17,717
17,649
217,965
3,376
146,695
17,284
24,114
22,825
264,948
4,213
161,136
27,305
28,363
40,928
326,249
4,580
187,384
41,736
29,824
66,019
410,155
5,035
196,703
44,471
28,052
75,808
450,881
5,458
Net loans .............................................................
$214,589
$260,735
$321,669
$405,120
$445,423
Table 8 shows that both the fixed and variable rate portion of the portfolio in 2003 remained relatively
unchanged when compared to 2002. In 2003, the Bank’s fixed rate loans were 41.1% of the portfolio, and the
variable portion was 58.9%. The large majority of the variable rate loans are tied to independent indices (such
as the Wall Street Journal prime rate or the Treasury Constant Maturities) and the remainder adjusts with
changes in the Bank’s reference rate. Many of the fixed rate loans with an original term of more than five years
have provisions for the fixed rates to reset, or convert to a variable rate, after five years.
Table 8 Loan Portfolio Maturity Distribution and Interest Rate Sensitivity
(Dollars in thousands)
December 31, 2002
December 31, 2003
Fixed
Rate
Variable
Rate
Total
Percent
Fixed
Rate
Variable
Rate
Total Percent
Due within 1 year ...................................
Due after 1 but within 5 years ................
Due after 5 years ...................................
$34,938
69,123
56,719
$65,669 $100,607
116,530
193,018
47,407
136,299
24.5%
28.4
47.1
$28,498
89,142
67,620
$96,309 $124,807
134,814
191,260
45,672
123,640
27.7%
29.9
42.4
Total ............................................... $160,780 $249,375 $410,155 100.0% $185,260 $265,621 $450,881 100.0%
Percentage ......................................
39.2%
60.8%
100.0%
41.1%
58.9%
100.0%
Note: The "Due within 1 year" data includes demand loans, overdrafts and past due loans.
Allowance for Loan Losses
Credit risk is inherent in the business of lending. As a result, the Bank maintains an allowance for loan losses
to absorb losses inherent in the Bank’s loan portfolio. This is maintained through periodic charges to earnings.
These charges are shown in the Statement of Operations as provision for loan losses. All specifically identifiable
and quantifiable losses are immediately charged off against the allowance. The balance of the Bank’s allowance
for loan losses is an estimate of the remaining losses inherent in the portfolio.
27
The allowance for loan losses to total loans at December 31, 2003 was 1.21% versus 1.23% at the end of 2002.
At December 31, 2001, the allowance for loan losses to total loans was 1.40%. Based on the current conditions
of the loan portfolio, management believes that the $5,457,635 allowance for loan losses at December 31, 2003
is adequate to absorb losses inherent in the Bank’s loan portfolio. No assurance can be given, however, that
adverse economic conditions or other circumstances will not result in increased losses in the portfolio. Table
9 shows the activity in the allowance for loan losses for each of the years ended December 31. At December
31, 2003 and 2002 the Bank had no loans that were past due 90 days or otherwise nonperforming.
Table 9 Allowance for Loan Losses at December 31
1999
2000
2001
2002
2003
Beginning balance ................................................
Provision charged to expense ...............................
Loans charged off .................................................
Loan loss recoveries .............................................
$3,024,158 $3,179,195 $4,003,275 $4,579,744 $5,034,653
685,485
(376,544)
114,041
577,157
(194,562)
72,314
986,156
(214,990)
52,914
770,187
(691,678)
76,528
619,178
(52,596)
9,887
Ending balance ....................................................
$3,179,195 $4,003,275 $4,579,744 $5,034,653 $5,457,635
Total loans outstanding at end of year, before
deducting allowance for loan losses .................. $217,964,245 $264,948,338 $326,249,033 $410,154,831 $450,880,626
Average total loans outstanding during year ......... $200,268,739 $232,760,803 $291,716,706 $366,407,696 $434,908,002
Ratio of allowance for loan losses to total loans
at end of year ....................................................
1.46%
1.51%
1.40%
1.23%
1.21%
The Components of the Allowance for Loan Losses
As stated previously in “Critical Accounting Policy,” the overall allowance consists of a specific allowance, an
allowance factor, and an allowance for changing environmental factors. The first component, the specific
allowance, results from the analysis of identified problem credits and the evaluation of sources of repayment
including collateral, as applicable. Through management’s ongoing loan grading process, individual loans are
identified that have conditions that indicate the borrower may be unable to pay all amounts due under the
contractual terms. These loans are evaluated individually by management and specified allowances for loan
losses established where applicable.
The second component, the allowance factor, is an estimate of the probable losses that have occurred across
the major loan categories in the Bank’s loan portfolio. This analysis is based on loan grades by pool and current
general economic and business conditions. This analysis covers the Bank’s entire loan portfolio but excludes
any loans that were analyzed individually for specific allowances as discussed above. The total amount
allocated for this component is determined by applying loss estimation factors to outstanding loans.
The third component of the allowance for credit losses is an economic component that is not allocated to specific
loans or groups of loans, but rather is intended to absorb losses caused by portfolio trends, concentration of
credit, growth, economic trends, etc.
There are limitations to any credit risk grading process. The volume of loans makes it impractical to re-grade
every loan every quarter. Therefore, it is possible that some currently performing loans not recently graded will
not be as strong as their last grading and an insufficient portion of the allowance will have been allocated to
them. Grading and loan review often must be done without knowing whether all relevant facts are at hand.
Troubled borrowers may deliberately or inadvertently omit important information from reports or conversations
with lending officers regarding their financial condition and the diminished strength of repayment sources.
At December 31, 2003 the allowance for loan losses was $5,458,000 consisting of a specific allowance of
$1,110,000, an allowance factor of $3,643,000, and an economic allowance of $705,000. At December 31, 2002
the allowance for loan losses was $5,035,000 consisting of a specific allowance of $1,093,000, an allowance
factor of $3,325,000, and an economic allowance of $617,000.
28
Table 10 shows the allocation of the allowance by loan type as well as showing the percentage of total loans
in each of the same loan types.
Table 10 Allocation of Allowance for Loan Losses
December 31, 2002
December 31, 2003
Allocation
of allowance
balance
Loans as
percent of
total loans
Allocation
of allowance
balance
Loans as
percent of
total loans
Commercial ..................................... $1,584,000
872,000
Construction ...................................
1,577,000
Real estate ......................................
1,002,000
Installment .....................................
20.9%
10.2
45.9
23.0
Total allowance for loan losses ..... $5,035,000
Total percent ...............................
100.0%
$2,288,000
734,000
1,319,000
1,117,000
$5,458,000
23.4%
9.8
44.2
22.6
100.0%
Deposits
Deposits are used to fund the Bank’s interest earning assets. The Bank does not accept brokered deposits and
has only a nominal amount of public funds. Tables 11 and 12 show the relative composition of the Bank’s
average deposits for the years 2001, 2002 and 2003, and the maturity groupings for the Bank’s time deposits
of $100,000 or more.
Table 11 Distribution of Average Deposits
(Dollars in thousands)
2001
Amount Percent
Year ended December 31,
2002
Amount
Percent
2003
Amount Percent
Demand ......................................... $98,599
Interest checking ............................ 35,638
Savings ......................................... 47,791
Money market ................................. 92,300
Time deposits
26.4%
9.6
12.8
24.8
$115,983
43,188
70,502
112,030
25.9%
9.7
15.7
25.1
$138,214
51,664
84,161
142,128
26.2%
9.8
16.0
27.0
Less than $100,000 ................. 42,116
$100,000 or more .................... 56,396
Total time deposits ............... 98,512
11.3
15.1
26.4
40,762
64,647
105,409
9.1
14.5
23.6
39,756
70,984
110,740
7.5
13.5
21.0
Total Deposits ............................... $372,840
100.0%
$447,112
100.0%
$526,907
100.0%
Note:
Refer to Table 2 for the average amount of and the average rate paid on each deposit category.
Table 12 Maturities of Time Deposits of $100,000 or more at December 31
(Dollars in thousands)
December 31,
2001
2002
2003
Three months or less ................................................... $36,425
8,141
Over three months through six months .......................
8,707
Over six months through twelve months .....................
5,795
Over twelve months .....................................................
$31,542
8,840
11,330
27,371
$39,276
6,470
8,535
17,239
Total ................................................................. $59,068
$79,083
$71,520
Commitments
The following is a summary of the Bank’s contractual commitments associated with operating lease obligations
as of December 31, 2003.
Table 13 Contractual Obligations at December 31
(Dollars in thousands)
< 1 year
Payments due by period
3-5 years
1-3 years
>5 years
Total
Operating leases .....................................................
$1,342
$2,241
$1,793
$1,982
$7,358
The contract amount of loan commitments not reflected on the statement of condition was $153,695,000 at
December 31, 2003 and $135,558,000 at December 31, 2002.
29
Capital Adequacy
As discussed in Note 13 of the Notes to Financial Statements, the Bank’s capital ratios are above regulatory
guidelines to be considered “well capitalized.” In 2003, the Bank’s risk based capital ratio improved from
10.61% to 10.92%. This is due to a change in mix of risk weighted assets. Management expects the ratios to
increase modestly in 2004.
Liquidity
The goal of liquidity management is to provide adequate funds to meet both loan demand and unexpected
deposit withdrawals. This goal is accomplished by maintaining an appropriate level of liquid assets, consistent
with core deposit growth, and informal lines of credit to purchase funds from correspondent banks.
At year-end 2003, the Bank had approximately $105.1 million in cash, Federal funds sold and securities
maturing within one year. The remainder of the securities portfolio provides additional liquidity. Taken
together, these liquid assets equaled 19.1% of total assets at December 31, 2003, compared to 22.8% of total
assets at December 31, 2002.
The combination of 20.2% deposit growth and 9.9% loan growth during the year, resulted in a year-end loan
to deposit ratio of 77.2% compared to 84.4% at December 31, 2002.
Management monitors the Bank’s liquidity position daily, balancing loan fundings/payments with changes in
deposit activity and overnight investments. The Bank’s emphasis on local deposits at competitive rates,
combined with its 8.6% average equity capital base, provides a very stable funding base. The Bank also has
an informal line of credit of over $20 million to purchase Federal funds. The Bank is a member of the Federal
Home Loan Bank of San Francisco (FHLB), and has an available line of credit at an interest rate that is
determined daily. Borrowings under the line are limited to eligible collateral.
The Bank had undisbursed loan commitments of $153.7 million, including $78.3 million under lines of credit
(these commitments are contingent upon customers maintaining specific credit standards), $40.7 million
under revolving home equity lines, and $22.6 million under undisbursed construction loans. These commitments,
to the extent used, are expected to be funded through repayment of existing loans and normal deposit growth.
Market Risk Management
The objective for managing the assets and the liabilities of the Bank is to maximize net income while at the same
time, maintaining a high quality portfolio of loans and investments and assuming only limited interest rate risk.
The Loan and Investment Committee of the Board has overall responsibility for interest rate risk management
policies. The Committee establishes and monitors guidelines to control the sensitivity of net interest income
(NII) and regulatory Tier 1 capital (Capital) to changes in interest rates.
Activities in asset and liability management include, but are not limited to, lending, accepting deposits and
investing in securities. Interest rate risk is the primary market risk associated with asset and liability
management. Sensitivity of NII and Capital to interest rate changes arises when yields on loans and
investments change in a different time frame or amount from that of rates on deposits. To mitigate interest rate
risk, the structure of the statement of condition is managed with the objective of correlating the movements
of interest rates on loans and investments with those of deposits. The asset and liability policy sets limits on
the acceptable amount of change to NII and Capital in changing interest rate environments. The Bank uses
simulation models to forecast NII and Capital.
Simulation of NII and Capital under various scenarios of increasing or decreasing interest rates is the primary
tool used to measure interest rate risk. Using licensed software developed for this purpose, management is able
to estimate the potential impact of changing rates. A simplified statement of condition is prepared as a starting
point, using as inputs, actual loans, investments and deposits.
In the simulation of NII and Capital under various interest rate scenarios, the simplified statement of condition
is processed against at least six interest rate change scenarios. In addition to a flat rate scenario, which
30
assumes interest rates are unchanged, the six scenarios include three 100 basis point increases and three 100
basis point decreases. Each of these scenarios assumes that the change in interest rates is immediate and
remains at the new levels.
Table 14 summarizes the effect on NII and Capital due to changing interest rates as measured against the flat
rate scenario.
Table 14 Effect of Interest Rate Change on Net Interest Income and Capital
Changes in Interest
Rates (in basis points)
up 300 ..............................
up 200 ..............................
up 100 ..............................
unchanged ........................
down 100 ..........................
down 200 ..........................
down 300 ..........................
Estimated change in NII
(as percent of flat NII)
at December 31,
Estimated change in capital
(as percent of flat capital)
at December 31,
2002
6.5%
4.4%
2.2%
0.0%
(2.7%)
--
--
2003
5.4%
3.6%
1.8%
0.0%
(2.5%)
--
--
2002
3.9%
2.6%
1.3%
0.0%
(1.6%)
--
--
2003
3.3%
2.2%
1.1%
0.0%
(1.4%)
--
--
The results in the table indicate that the Bank was modestly asset sensitive since NII increased under the
increasing interest rate scenarios. The results are also well within the policy guidelines established by the
Committee. Further, the results do not assume nor incorporate any action(s) which management might take
to minimize any negative consequences of interest rate changes. Therefore, they are not intended to portray
likely results but rather estimates of the impact of interest rate risk.
As with any simulation model or other method of measuring interest rate risk, certain limitations are inherent
in the process. For example, although certain of the Bank’s assets and liabilities may have similar maturities
or repricing time frames, they may react differently to changes in market interest rates. In addition, the changes
in interest rates on certain categories of either the Bank’s assets or liabilities may precede or lag changes in
market interest rates.
Also, the actual rates and timing of prepayments on loans and investment securities could vary significantly
from the assumptions used in the various scenarios. Further, changes in US Treasury rates accompanied by
a change in the shape of the yield curve could produce different results from those presented in the table.
Accordingly, the results presented should not be relied upon as indicative of actual results in the event of
changing market interest rates.
Interest rate sensitivity is a function of the repricing characteristics of the Bank’s assets and liabilities. One
aspect is the time frame within which the interest earning assets and interest bearing liabilities are subject
to change in interest rates at repricing or maturity. An analysis of the repricing time frames is called a “gap”
analysis because it shows the gap between the amounts of assets and liabilities repricing in each of several
periods of time. Another aspect is the relative magnitude of the repricing for each category of interest earning
asset and interest bearing liability given various changes in market rates. Gap analysis gives no indication of
the relative magnitude of repricing. Interest rate sensitivity management focuses on the maturity of assets and
liabilities and their repricing during periods of change in market rates. Interest rate sensitivity gaps are
calculated as the difference between the amounts of assets and liabilities that are subject to repricing during
various time periods.
Table 15 shows the Bank’s repricing gaps as of December 31, 2003. Interest bearing transaction and savings
accounts, which may be repriced at will, have been excluded from the table. Historically, the magnitude of the
their repricing has been minimal and their inclusion would cause the Bank to appear to be liability sensitive.
Due to the limitations of gap analysis, as described above, the Bank does not generally use it in managing
interest rate risk. Instead the Bank relies on the more sophisticated simulation model described above as its
primary tool in measuring and managing interest rate risk.
31
Table 15 Interest Rate Sensitivity
(Dollars in thousands)
At December 31, 2003
Interest Bearing Liabilities
1-30
Days
31-90
Days
Maturing or Repricing
181-365
91-180
Days
Days
Over
one year
Total
Money market ................................ $319,615
--
Time deposits less than $100,000 --
--
Time deposits $100,000 or more ....
319,615
Total ...........................................
$ --
13,075
39,176
52,251
$ --
6,246
12,320
18,566
$ --
6,246
3,080
9,326
Interest Earning Assets
$16,900
Funds sold ....................................
--
Investment securities .....................
133,498
Loans ............................................
150,398
Total ...........................................
Sensitivity for period ..........................
(169,217)
Sensitivity - cumulative ..................... $(169,217)
$ 5
2,875
20,234
23,114
(29,137)
$(198,354)
$ --
4,412
9,026
13,438
(5,128)
$(203,482)
$ --
8,823
16,763
25,586
16,260
$(187,222)
$ --
7,293
16,945
24,238
$ --
106,616
265,902
$372,518
$ 319,615
32,860
71,521
423,996
$ 16,900
122,726
445,423
$585,054
CODE OF ETHICS
The Bank has adopted a Code of Ethics for the Chief Executive Officer, the Chief Financial Officer and all senior
financial officers as referred to in the Sarbanes-Oxley Act of 2002. A copy of the Code of Ethics may be obtained
by written request to Corporate Secretary, Bank of Marin, P. O. Box 2039, Novato, CA 94948.
FORWARD-LOOKING STATEMENTS
This discussion of financial results contains certain forward-looking statements about the Bank, including
descriptions of plans or objectives of management for future operations, products or services, and forecasts
of its revenues, earnings or other measures of economic performance. Forward-looking statements can be
identified by the fact that they do not relate strictly to historical or current facts. They often include the words
“believe,” “expect,” “intend,” “estimate” or words of similar meaning, or future or conditional verbs such as
“will,” “would,” “should,” “could” or “may.”
Forward-looking statements are based on management’s current expectations regarding economic, legislative,
and regulatory issues that may impact the Bank’s earnings in future periods. A number of factors - many of
which are beyond the Bank’s control - could cause future results to vary materially from current management
expectations. Such factors include, but are not limited to, general economic conditions, changes in interest
rates, deposit flows, real estate values and competition; changes in accounting principles, policies or
guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory and
technological factors affecting the Bank’s operations, pricing, products and services. These and other
important factors are detailed in various Federal Deposit Insurance Corporation filings made periodically by
the Bank, copies of which are available from the Bank at no charge. Forward-looking statements speak only
as of the date they are made. The Bank does not undertake to update forward-looking statements to reflect
circumstances or events that occur after the date the forward-looking statements are made or to reflect the
occurrence of unanticipated events.
32
INDEPENDENT AUDITORS’ REPORT
To the Board of Directors and Stockholders of
Bank of Marin
Corte Madera, California
We have audited the accompanying statement of condition of Bank of Marin (the Bank) as of December 31,
2002 and 2003, and the related statements of operations, stockholders’ equity, cash flows and comprehensive
income for the years then ended. These financial statements are the responsibility of the Bank’s management.
Our responsibility is to express an opinion on these financial statements based on our audits. The financial
statements of Bank of Marin for the year ended December 31, 2001 were audited by other auditors who have
ceased operations. Those auditors expressed an unqualified opinion on those financial statements in their
report dated January 11, 2002.
We conducted our audits in accordance with auditing standards generally accepted in the United States of
America. Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the 2002 and 2003 financial statements present fairly, in all material respects, the financial
position of the Bank as of December 31, 2002 and 2003, and the results of its operations and its cash flows
for the years then ended in conformity with accounting principles generally accepted in the United States of
America.
As discussed above, the financial statements of Bank of Marin for the year ended December 31, 2001 were
audited by other auditors who have ceased operations. As described in Notes 1 and 12, those financial
statements have been restated to reflect a stock dividend declared in 2002. We audited the adjustments
described in Notes 1 and 12 that were applied to restate the 2001 financial statements. Our audit procedures
with respect to the restatement for the stock dividend included i) reading the minutes of the Board of Directors
approving the stock dividend and ii) testing the mathematical accuracy of the recalculations made to reflect
the stock dividend. In our opinion, such adjustments have been properly applied. However, we were not
engaged to audit, review, or apply any procedures to the 2001 financial statements of the Bank of Marin other
than with respect to such adjustments and, accordingly, we do not express an opinion or any form of
assurance on the 2001 financial statements taken as a whole.
San Francisco, California
January 21, 2004
/s/ Deloitte & Touche LLP
33
STATEMENT OF CONDITION
Assets
Cash and due from banks
Federal funds sold
Cash and cash equivalents
December 31,
2002
2003
$ 29,168,902
29,500,000
58,668,902
$ 36,025,596
16,900,000
52,925,596
Investment securities
Held to maturity
Available for sale (at fair market value, cost
$27,976,102 in 2002 and $80,097,198 in 2003)
Total investment securities
35,211,907
42,189,876
28,925,824
64,137,731
80,535,801
122,725,677
Loans, net of allowance for loan losses of
$5,034,653 in 2002 and $5,457,635 in 2003
Bank premises and equipment, net
Interest receivable and other assets
Total assets
405,120,178
4,550,638
6,547,658
$ 539,025,107
445,422,991
4,508,222
17,024,125
$ 642,606,611
Liabilities and Stockholders’ Equity
Liabilities
Deposits
Non-interest bearing
Interest bearing
Transaction accounts
Savings
Time
Total deposits
$ 130,175,862
$ 160,121,639
48,009,450
193,174,691
114,669,148
486,029,151
63,800,859
255,813,637
104,379,545
584,115,680
Interest payable and other liabilities
Total liabilities
5,879,345
491,908,496
2,914,390
587,030,070
Commitments and contingencies
---
---
Stockholders' Equity
Common stock
Authorized - 5,000,000 shares
Issued and outstanding - 2,757,393 shares in 2002
and 2,954,054 shares in 2003
Retained earnings
Accumulated other comprehensive income
Unearned ESOP shares
Total stockholders’ equity
31,968,501
14,661,771
550,839
(64,500)
47,116,611
37,366,841
17,955,310
254,390
0
55,576,541
Total liabilities and stockholders’ equity
$ 539,025,107
$ 642,606,611
The accompanying notes are an integral part of these financial statements.
34
STATEMENT OF OPERATIONS
Interest income
Interest and fees on loans
Interest on investment securities
U. S. Treasury securities
Securities of U. S. government agencies
Obligations of state and political
subdivisions (tax exempt)
Corporate debt securities and other
Interest on Federal funds sold
Years ended December 31,
2001
2002
2003
$25,020,149 $27,561,435 $29,301,148
1,403,337
1,555,743
1,101,094
1,009,325
518,211
1,017,279
1,029,382
701,129
731,018
1,026,651
847,787
204,413
954,015
791,392
242,845
Total interest income
30,440,758
31,750,705 32,824,890
Interest expense
Interest on interest bearing transaction accounts
Interest on savings deposits
Interest on time deposits
Interest on borrowed funds
269,520
4,149,443
4,564,430
1,115
309,178
2,953,352
2,959,503
6,179
206,962
2,425,951
2,534,383
1,556
Total interest expense
8,984,508
6,228,212
5,168,852
Net interest income
Provision for loan losses
Net interest income after provision
for loan losses
21,456,250
619,178
25,522,493
27,656,001
577,157 685,485
20,837,072
24,945,336 26,970,516
Non-interest income
Service charges on deposit accounts
Investment advisory and trust services
Other
706,962
525,815
639,729
840,274
669,571
808,523
1,020,514
814,619
1,124,834
Total non-interest income
1,872,506
2,318,368 2,959,967
Non-interest expense
Salaries and related benefits
Occupancy
Depreciation and amortization
Data processing
Other
8,834,722
1,330,995
710,007
795,574
2,757,132
10,446,216
1,600,647
882,155
952,424
3,243,237
10,766,645
1,676,038
992,438
1,038,898
3,343,346
Total non-interest expense
14,428,430
17,124,679 17,817,365
Income before provision
for income taxes
8,281,148
10,139,025
12,113,155
Provision for income taxes
Net income
3,133,000
$ 5,148,148
3,897,000
4,640,000
$ 6,242,025 $ 7,473,155
Net income per common share
Basic
Diluted
$ 1.81
$ 1.76
$ 2.17
$ 2.06
$ 2.55
$ 2.38
The accompanying notes are an integral part of these financial statements.
35
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock
Shares
Amount
Retained
Earnings
Accumulated
other
Comprehensive
Income (Loss)
Unearned
ESOP
shares
Total
Balance at Dec. 31, 2000
2,434,698
$24,925,554
$9,238,885
$336,236 $(148,538) $34,352,137
Stock options exercised
Stock issued on 5% stock
dividend declared Apr. 12
Stock issued in payment of
director fees
Change in unearned ESOP
shares
Other comprehensive income
Net income
26,240
361,590
---
121,497
2,535,642
(2,549,380)
8,314
180,574
---
---
---
---
---
---
---
361,590
(13,738)
180,574
---
---
---
---
---
---
---
---
5,148,148
---
473,641
---
98,538
---
---
98,538
473,641
5,148,148
Balance at Dec. 31, 2001
2,590,749
$28,003,360 $11,837,653
$809,877 $(50,000) $40,600,890
Stock options exercised
Stock issued on 5% stock
dividend declared Apr. 11
Stock issued in payment of
director fees
Change in unearned ESOP
shares
Other comprehensive income
Net income
27,160
316,856
---
129,956
3,404,847
(3,417,907)
9,528
243,438
---
---
---
---
---
---
---
316,856
(13,060)
243,438
---
---
---
---
---
---
---
---
6,242,025
---
(259,038)
---
(14,500)
---
---
(14,500)
(259,038)
6,242,025
Balance at Dec. 31, 2002
2,757,393
$31,968,501 $14,661,771
$550,839 $(64,500) $47,116,611
Stock options exercised
Stock issued on 5% stock
dividend declared Apr. 10
Stock issued in payment of
director fees
Change in unearned ESOP
shares
Other comprehensive income
Net income
48,958
954,517
---
138,461
4,162,349
(4,179,616)
9,242
281,474
---
---
---
---
---
---
---
954,517
(17,267)
281,474
---
---
---
---
---
---
---
---
7,473,155
---
(296,449)
---
64,500
---
---
64,500
(296,449)
7,473,155
Balance at Dec. 31, 2003
2,954,054
$37,366,841 $17,955,310
$254,390
$0
$55,576,541
The accompanying notes are an integral part of these financial statements.
36
STATEMENT OF CASH FLOWS
Cash Flows from Operating Activities:
Net income
Adjustments to reconcile income to net cash
provided by operating activities:
Provision for loan losses
Compensation payable in common stock
Amortization and accretion of investments
Depreciation and amortization
Net change in operating assets and liabilities:
Interest receivable
Interest payable
Other assets
Other liabilities
Total adjustments
Years ended December 31,
2001
2002
2003
$ 5,148,148
$ 6,242,025 $ 7,473,155
619,178
180,574
185,887
710,007
577,157
243,438
750,590
882,155
685,485
281,474
1,106,840
992,438
143,061
(148,972)
(699,940)
265,026
1,254,821
19,153
(131,217)
(81,501)
(19,483)
(495,640)
(336,718)
2,609,514
(2,604,284)
4,575,436 (96,035)
Net cash provided by operating activities
6,402,969
10,817,461
7,377,120
Cash Flows from Investing Activities:
Purchase of securities held-to-maturity
Purchase of securities available-for-sale
Proceeds from maturity of:
Securities held-to-maturity
Securities available-for-sale
Purchase of bank owned life insurance policies
Loans originated and principal collected
Additions to premises and equipment
(11,805,458)
(8,351,180)
---
(17,128,299)
(14,277,237)
(87,478,963)
3,535,000
21,167,123
---
(61,300,695)
(2,397,121
2,694,000
31,672,803
---
(83,905,798)
(1,320,249)
6,972,300
34,577,995
(10,000,000)
(40,988,742)
(949,558)
Net cash used in investing activities
(59,152,331)
(67,987,543) (112,144,205)
Cash Flows from Financing Activities:
Net increase in deposits
Issuance of common stock
Other
70,106,716
361,590
(13,738)
74,211,686
316,856
(13,060)
98,086,529
954,517
(17,267)
Net cash provided by financing activities
70,454,568
74,515,482 99,023,779
Net increase (decrease) in cash and cash equivalents
17,705,206
17,345,400
(5,743,306)
Cash and cash equivalents at beginning of year
23,618,296
41,323,502
58,668,902
Cash and cash equivalents at end of year
$41,323,502 $58,668,902 $52,925,596
Cash paid for interest for the years ended December 31, 2001, 2002 and 2003 was
$9,133,480, $6,247,695 and $5,250,353, respectively. Cash paid for income taxes for the
years ended December 31, 2001, 2002 and 2003 was $3,280,000, $3,762,000 and $4,822,000,
respectively.
The accompanying notes are an integral part of these financial statements.
37
STATEMENT OF COMPREHENSIVE INCOME
Years ended December 31,
2001
2002
2003
Net income
$5,148,148
$6,242,025
$7,473,155
Cumulative effect of change in accounting
principle (net of taxes of $269,000)
Net change in unrealized gain (loss) on
available for sale securities (net of taxes
of $78,000, ($188,000) and ($215,000) in
the years 2001, 2002 and 2003)
385,109
---
---
88,532
(259,038)
(296,449)
Other comprehensive income (loss)
473,641
(259,038)
(296,449)
Comprehensive income
$5,621,789
$5,982,987
$7,176,706
The accompanying notes are an integral part of these financial statements.
38
NOTES TO FINANCIAL STATEMENTS
December 31, 2003
Note 1: Summary of Significant Accounting Policies
Nature of Operations: The Bank of Marin (the Bank) is a California state chartered bank. The Bank
operates eight branches in Marin County and one in southern Sonoma County, California. The
Bank's primary source of revenue is interest from providing loans to customers, who are
predominately professionals, small and middle-market businesses, and middle and high-income
individuals who work and/or reside in Marin and southern Sonoma counties. The accounting and
reporting policies of the Bank conform with generally accepted accounting principles and general
practice within the banking industry. A summary of the more significant policies follows.
Investment Securities are classified as "held to maturity," "trading securities" or "available for sale."
Held to maturity securities are those that the Bank has the ability and intent to hold to maturity.
Investments classified as held to maturity are reported at amortized cost; investments classified as
trading securities are reported at fair value, with unrealized gains and losses included in earnings;
and investments classified as available for sale are reported at fair value, with unrealized gains and
losses, net of related tax, if any, reported as a separate component of comprehensive income.
Loans are stated at the principal amount outstanding net of deferred fees and the allowance for loan
losses. Interest income is accrued daily using the simple interest method. Loans are placed on
nonaccrual status when management believes that there is serious doubt as to the collection of
principal or interest, or when they become contractually past-due by 90 days or more with respect
to principal or interest, except for loans that are both well secured and in the process of collection.
When loans are placed on nonaccrual status, any accrued but uncollected interest is reversed from
current income, and additional income is recorded only as payments are received. Loan origination
and commitment fees, offset by certain direct loan origination costs, are deferred and amortized as
yield adjustments over the contractual lives of the related loans.
Allowance for Loan Losses is based upon estimates of loan losses and is maintained at a level
considered adequate to provide for probable losses inherent in the loan portfolio. The allowance is
increased by provisions charged to expense and reduced by net charge-offs. The Bank considers
the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations
that may affect the borrower's ability to repay, the estimated value of any underlying collateral,
current economic conditions and other factors in periodic evaluations of the adequacy of the
allowance balance. The allowance for loan losses is based on estimates, and ultimate losses may
vary from current estimates.
The Bank’s method for assessing the appropriateness of the allowance includes specific allowances
for identified problem loans, an allowance factor for pools of credits, and allowances for changing
environmental factors (e.g., portfolio trends, concentration of credit, growth, economic factors, etc.)
Allowances for identified problem loans are based on specific analysis of individual credits. Loss
estimation factors for loan pools are based on analysis of local economic factors applicable to each
loan pool. Due to our minimal historic losses, loss estimation factors are based only in part on the
previous historical loss experience for each pool. Allowances for changing environmental factors
are management’s best estimate of the probable impact these changes have had on the loan portfolio
as a whole.
The Bank considers a loan as impaired when it is probable the Bank will be unable to collect all
amounts due according to the contractual terms of the loan agreement. For loans determined to
be impaired, the extent of the impairment is measured based on the present value of expected future
cash flows discounted at the loan's original effective interest rate. As a practical expedient,
impairment may be measured based on the loan's observable market price or the fair value of the
39
collateral if the loan is collateral dependent. When the measure of the impaired loan is less than
the recorded investment in the loan, the impairment is recorded through an allocation of the
allowance for loan losses.
Bank Premises and Equipment consist of leasehold improvements, and furniture and equipment
and are stated at cost, less accumulated depreciation and amortization. Depreciation is computed
on a straight-line basis over the estimated useful lives of furniture and equipment, generally from
three to ten years. Leasehold improvements are amortized over the terms of the leases or their
estimated useful lives, whichever is shorter.
Income Taxes reported in the financial statements are computed based on an asset and liability
approach. The Bank recognizes the amount of taxes payable or refundable for the current year, and
deferred tax assets and liabilities for the future tax consequences that have been recognized in the
financial statement or tax returns. The measurement of tax assets and liabilities is based on the
provisions of enacted tax laws.
Statements of Cash Flows are prepared assuming that cash and cash equivalents includes cash and
due from banks and federal funds sold, which have an original maturity of 90 days or less at the
time of purchase.
Earnings per share are based upon the weighted average number of common shares outstanding
during each year. The following table shows weighted average basic shares, potential common
shares related to stock options, and weighted average diluted shares. Basic earnings per share are
based upon the weighted average number of common shares outstanding during each period.
Diluted earnings per share are based upon the weighted average number of common shares and
potential common shares outstanding during each period.
December 31, 2001
December 31, 2002
December 31, 2003
Weighted average basic shares outstanding
Add: Potential common shares related to
stock options
2,838,875
2,882,801
2,928,641
80,120
151,626
210,394
Weighted average diluted shares outstanding
2,918,995
3,034,427
3,139,035
The number of antidilutive shares not included in the calculation of diluted earnings per shares
were 72,343, 24,076 and 11,577 at December 31, 2001, 2002 and 2003, respectively.
On April 10, 2003 the Board of Directors declared a 5% stock dividend payable May 5 to stockholders
of record April 21, 2003. Earnings per share have been restated for all periods to reflect the stock
dividend.
Stock-Based Compensation In December 2002 the Bank adopted the disclosure provisions of
Statement of Financial Accounting Standards (SFAS) No. 148 - Accounting for Stock-Based
Compensation - Transition and Disclosure, which amends SFAS No. 123 - Accounting for Stock-
Based Compensation. This Statement provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee compensation. It
also amends the disclosure requirements to require prominent disclosure about the method of
accounting for stock-based employee compensation and the effect of the method used on reported
results.
The Bank accounts for stock-based awards for its plans under APB Opinion No. 25, under which
no compensation cost has been recognized. Had compensation cost for these plans been determined
in accordance with SFAS 123, the Bank's net income and earnings per share would have been
reduced to the pro forma amounts shown in the following table. The fair value of each option grant
is estimated on the date of grant using the Black-Scholes option pricing model. The weighted
40
average fair value of options granted was $10.67, $11.87, and $12.85 for 2001, 2002 and 2003,
respectively. The following weighted-average assumptions were used for grants in 2001, 2002 and
2003, respectively: risk-free interest rates of 5.00%, 4.00% and 4.00%, expected dividend yields
of 0%, 0% and 0%, expected lives of 7, 8 and 8 years, expected volatility of 37.84%, 30.88% and
28.83%.
Net income as reported
Stock-based compensation expense net of taxes
Pro forma net income
Earnings per share
As reported (basic)
As reported (diluted)
Pro forma (basic)
Pro forma (diluted)
2001
$5,148,148
(751,029)
$4,397,119
2002
$6,242,025
(909,812)
$5,332,213
2003
$7,473,155
(959,337)
$6,513,818
$1.81
1.76
1.55
1.51
$2.17
2.06
1.85
1.76
$2.55
2.38
2.22
2.08
Comprehensive Income for the Bank includes net income reported on the statement of operations
and changes in the fair value of its available for sale investments reported as a component of
stockholders’ equity.
Segment Information The Bank’s two operating segments include the traditional community
banking activities provided through its nine branches and its investment advisory and trust
services. The activities of these two segments are monitored and reported by Bank management
as separate operating segments. The accounting policies of the segments are the same as those
described in this note. The Bank evaluates segment performance based on total segment revenue
and does not allocate expenses between the segments. The investment advisory and trust services
revenues were $525,815 in 2001, $669,571 in 2002, and $814,619 in 2003, which are included in
non-interest income in the statement of operations. The revenues of the community banking
segment are reflected in all other income lines in the statement of operations.
New Accounting Principle On January 1, 2001, the Bank adopted the provisions of SFAS No. 133-
Accounting for Derivative Instruments and Hedging Activities (SFAS 133), as amended by SFAS No.
138. The Statement establishes accounting and reporting standards requiring that every derivative
instrument (including certain derivative instruments embedded in other contracts) be recorded in
the balance sheet as either an asset or liability measured at its fair value. The Bank does not engage
in hedging activities and owns no freestanding derivatives.
As permitted by the Statement, in connection with the adoption of SFAS 133, the Bank elected to
reclassify certain of its investment securities from held-to-maturity to available for sale. On
January 1, 2001, the Bank transferred $35,082,000 from held-to-maturity to available for sale. As
a result of this transfer, an unrealized gain of $385,109, net of tax, was recognized in the first quarter
of 2001 in other comprehensive income as a cumulative effect of change in accounting principle.
There was no other impact to the Bank's financial statement of adopting this Statement.
Reclassifications Certain amounts in prior years' financial statements have been reclassified to
conform with the current presentation. These reclassifications have no effect on previously reported
net income.
Use of Estimates The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent amounts of revenues and
expenses during the reporting period. Actual results could differ from those estimates.
41
Note 2: Investment Securities
An analysis of the investment security portfolio at December 31 follows:
2002 Held to maturity
Oblig. of state & political subdivisions
Corporate debt securities and other
2002 Available for sale
U. S. Treasury Securities
Securities of U.S. Government Agencies
Amortized Cost
Gains
Losses Market Value
Gross Unrealized
Fair
$22,598,260
12,613,647
35,211,907
$1,245,480
899,484
2,144,964
$ --
---
---
$23,843,740
13,513,131
37,356,871
12,107,213
15,868,889
27,976,102
469,037
480,685
949,722
---
---
---
12,576,250
16,349,574
28,925,824
Total
$63,188,009
$3,094,686
$ ---
$66,282,695
2003 Held to maturity
Oblig. of state & political subdivisions
Corporate debt securities and other
2003 Available for sale
U. S. Treasury Securities
Securities of U.S. Government Agencies
$30,499,319
11,690,557
42,189,876
$ 983,091
689,726
1,672,817
$ (122,327)
---
---
$31,360,083
12,380,283
43,740,366
13,316,120
66,781,078
80,097,198
134,948
509,507
644,455
( 21)
(205,831)
(205,852)
13,451,047
67,084,754
80,535,801
Total
$122,287,074
$2,317,272
$(328,179) $124,276,167
The maturities of the investment security portfolio at December 31, 2003 follows:
Held to maturity
Fair
Market Value
Amortized
Cost
Available for sale
Fair
Market Value
Amortized
Cost
Within one year
After one but within five years
After five years through ten years
After ten years
$ 10,496,306
23,213,725
7,428,191
1,051,654
$10,525,916
24,590,272
7,517,518
1,106,660
$ 42,459,125
29,403,578
8,234,495
0
$ 42,871,377
29,470,387
8,194,037
0
Total
$42,189,876
$43,740,366
$80,097,198
$ 80,535,801
For the years ended December 31, 2001, 2002, and 2003 the Bank did not sell any of its available
for sale securities, and accordingly, did not recognize any gains or losses. At December 31, 2003,
investment securities carried at $12,550,000 were pledged with the Federal Reserve Bank:
$4,174,000 to secure the Bank's Treasury, Tax and Loan account and trust deposits, $4,123,000
to provide collateral for potential future borrowings to meet unusual short term liquidity needs, and
$4,253,000 to secure the Bank's public fund deposits.
Securities catagorized as temporarily impaired at December 31, 2003 follows:
Fair Value Unrealized loss
Oblig. of state & political subdivisions
U. S. Treasury Securities
Securities of U.S. Government Agencies
$ 3,857,219
1,998,859
20,052,630
$(122,327)
(21)
(205,831)
Total temporarily imparied securities
$ 25,908,708
$(328,179)
At December 31, 2003, the book value or amortized cost of the Bank’s investment portfolio totaled
$122,287,074, and the fair market value was $124,276,167. The difference between these values
represents a gross unrealized gain of $1,989,093 on the Bank’s portfolio. Included, are nine
securities with a fair value of $25,908,708 that, as of December 31, 2003, had an unrealized loss
of $328,179. This temporary impairment is attributable to general changes in short term interest
rates as measured by the U.S. Treasury yield curve. The duration of this impairment was for a period
of less than twelve months and is believed to be temporary.
42
Note 3: Loans
Outstanding loans by type at December 31 follows:
Commercial loans
Real estate
Commercial
Construction
Residential
Installment
Total loans
Less - Allowance for loan losses
Net Loans
2002
$85,191,566
2003
$105,846,577
187,384,100
41,736,463
29,823,644
66,019,058
410,154,831
(5,034,653)
$405,120,178
196,702,770
44,471,036
28,051,819
75,808,424
450,880,626
(5,457,635)
$445,422,991
At December 31, 2003 the Bank had no loans that were past due greater than 90 days.
The Bank has, and expects to have in the future, banking transactions in the ordinary course of
its business with directors, officers, principal stockholders and their associates. These transac-
tions, including loans and deposits, are granted on substantially the same terms, including interest
rates and collateral on loans, as those prevailing at the same time for comparable transactions with
others and do not involve more than the normal risk of collectibility or present other unfavorable
features. Such loans, including loans guaranteed, amounted to $2,227,000 and $1,730,000 at
December 31, 2002 and 2003, respectively. During 2003, new loans to such parties amounted to
$546,000 and repayments were $1,043,000.
At December 31, 2002 the Bank had $2,379,974 of participated loans sold to third parties. The
terms under the participation agreements have precluded the Bank from recording these loans as
sales. As such, the gross amounts of the participated loans are recorded as both a loan and as a
liability within interest payable and other liabilities as of December 31, 2002.
Note 4: Allowance for Loan Losses
Activity in the allowance for loan losses for the three years in the period ended December 31 follows:
Beginning balance
Provision for loan loss charged to expense
Loans charged off
Loan loss recoveries
Ending balance
Total loans outstanding at end of year,
2001
$ 4,003,275
619,178
(52,596)
9,887
$ 4,579,744
2002
$ 4,579,744
577,157
(194,562)
72,314
$ 5,034,653
2003
$ 5,034,653
685,485
(376,544)
114,041
$ 5,457,635
before deducting allowance for loan losses
$ 326,249,033 $ 410,154,831 $ 450,880,626
Average total loans outstanding during the year
Ratio of allowance for loan losses
to total loans at end of year
$ 291,716,706 $ 366,407,696 $ 434,908,002
1.40%
1.23%
1.21%
Loans classified as nonaccrual amounted to $0 at December 31, 2002 and 2003.
At December 31, 2002 and 2003 the Bank had no impaired loans. The average recorded invest-
ment in impaired loans was $0 for the years ended December 31, 2002 and 2003.
Note 5: Bank Premises and Equipment
A summary of Bank premises and equipment at December 31 follows:
Leasehold improvements
Furniture and equipment
Accumulated depreciation and amortization
Bank premises and equipment, net
2002
$ 4,709,089
5,320,709
10,029,798
(5,479,160)
$ 4,550,638
2003
$ 5,213,825
5,748,404
10,962,229
(6,454,007)
$ 4,508,222
The amount of depreciation and amortization was $710,007, $882,155 and $992,438 for the three
years in the period ended December 31, 2003.
43
Note 6: Bank Owned Life Insurance
The Bank has purchased life insurance policies on the lives of certain officers in the Bank and
intends to use the policies ($10,202,986 cash surrender value as of December 31, 2003) to finance
employee benefit programs. The investment in the Bank owned life insurance (BOLI) policies are
reported in “interest receivable and other assets” at the cash surrender value of the policies. The
carrying value includes both the Bank’s original premiums invested in the life insurance policies
and the accumulated accretion of policy income since inception of the policies. In 2003 income of
$202,985 was recognized on the life insurance policies and is reported in “other non-interest
income.”
Note 7: Time Deposits
Time deposits in denominations of $100,000 or more were $79,083,000 and $71,520,000 at
December 31, 2002 and 2003, respectively. At December 31, 2003 the scheduled maturities of time
deposits were $54,280,000 in 2004, $8,733,000 in 2005, $2,876,000 in 2006, $2,537,000 in 2007,
and $3,094,000 in 2008.
Note 8: Benefit Plans
In 2003 the Bank established an Officer Deferred Compensation Plan, which allows key executive
officers designated by the Board of Directors of the Bank to defer up to 80% of their salary and 100%
of their annual bonus. Amounts deferred earn interest at a rate set annually by the Board of
Directors. The interest rate was set at 6% for the period from September 1, 2003 to December 31,
2003. The Bank’s deferred compensation obligation of $113,440 at December 31, 2003 is included
in “interest payable and other liabilities”.
The Bank also established a Split Dollar Plan and a Survivor Income Plan in 2003 for officers
designated by the Board of Directors. Death benefits are provided under the specific terms of these
plans. The Bank has purchased life insurance policies on the designated officers in connection
with these plans.
Note 9: Income Taxes
The current and deferred components of the income tax provision for the three years ended
December 31, 2003 are as follows:
Current tax provision
Federal
State
Total current
Deferred tax( benefit)/liability
Federal
State
Total deferred
Total income tax provision
2001
2002
2003
$ 2,406,000
950,000
3,356,000
$ 2,866,000
1,137,000
4,003,000
$ 3,175,000
1,235,000
4,410,000
(193,000)
(30,000)
(223,000)
$ 3,133,000
(96,000)
(10,000)
(106,000)
$ 3,897,000
145,000
85,000
230,000
$ 4,640,000
Income taxes recorded directly to comprehensive income are not included above. These income
taxes relating to changes in the unrealized gains and losses on available for sale investment
securities amounted to $347,000, ($188,000) and ($215,000), in 2001, 2002 and 2003, respectively.
The effective tax rate of the Bank for 2001, 2002 and 2003 differs from the current Federal statutory
income tax rate as follows:
Federal statutory income tax rate
Increase (decrease) due to:
California franchise tax, net of federal tax benefit
Tax exempt interest on municipal securities
Other
2001
34.0%
7.3
(3.8)
0.3
37.8%
2002
34.0%
7.3
(3.3)
0.4
38.4%
2003
34.0%
7.2
(2.8)
(0.1)
38.3%
44
The following table shows the tax effect of the Bank's cumulative temporary differences as of
December 31:
Deferred tax asset:
Allowance for loan losses
Depreciation
State franchise tax
Deferred compensation
Deferred tax liabilities:
Net unrealized gain on securities available for sale
Depreciation
Net deferred tax asset
2002
2003
$2,084,000
1,000
316,000
124,000
2,525,000
$2,310,000
0
481,000
148,000
2,939,000
(399,000)
0
(399,000)
(180,000)
(184,000)
(364,000)
$2,126,000
$2,575,000
Note 10: Commitments and Contingencies
At December 31, 2003 the approximate minimum future rentals payable under noncancelable
operating leases for Bank premises totaled $7,358,000 as follows (in thousands): $1,342, $1,396,
$845, $879, $914 for the years 2004 through 2008, and $1,982 thereafter. Rent expense was
$964,000, $1,134,000 and $1,178,000 in 2001, 2002 and 2003, respectively.
The Bank is party to legal actions which arise from time to time as part of the normal course of its
business. The Bank believes, after consultation with legal counsel, that it has meritorious defenses
in these actions, and that the liability, if any, will not have a material adverse effect on the financial
position, results of operations, or cash flows of the Bank.
Note 11: Fair Value of Financial Instruments
The carrying amounts and fair values of the Bank's financial instruments at December 31,
2002 and 2003 follows:
2002
2003
Carrying
Amounts
Fair Value
Carrying
Amounts
Fair Value
Financial assets
Cash and cash equivalents
Investment securities
Loans, net
Accrued interest receivable
Financial liabilities
Deposits
Accrued interest payable
$ 58,668,026 $ 58,668,026
66,282,695
$ 52,925,596 $ 52,925,596
63,188,009
122,287,074 124,276,167
405,120,178 414,972,937 445,422,991 452,489,741
2,960,182
2,960,182
2,975,835
2,975,835
486,029,151 487,322,816 584,115,680
322,342
403,843
403,843
584,969,946
322,342
The following methods and assumptions were used to estimate the fair value of each class of
financial instruments:
Cash and Cash Equivalents - Cash and cash equivalents are valued at their carrying
amounts because of the short-term nature of these instruments.
Investment Securities - Investment securities are valued at the quoted market prices.
See Note 2 for further analysis.
Loans - Loans with variable interest rates are valued at the current carrying value,
because these loans are regularly adjusted to market rates. The fair value of fixed rate
loans with remaining maturities in excess of one year is estimated by discounting the
future cash flows using current rates at which similar loans would be made to
borrowers with similar credit ratings for the same remaining maturities.
Accrued Interest Receivable - The accrued interest receivable balance approximates
its fair value.
Deposits - The fair value of non-interest bearing deposits, interest bearing transaction
accounts and savings 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.
Commitments - The fair value of commitments is not material.
45
Note 12: Stockholders’ Equity
On April 12, 2001, April 11, 2002, and April 10, 2003, the Board of Directors declared 5% stock
dividends. Cash was paid in lieu of issuing fractional shares. Earnings per share amounts and
information with respect to stock options have been restated for all years presented to reflect the
stock dividends.
The Bank has stock option plans for full-time, salaried officers and employees who have substantial
responsibility for the successful operation of the Bank. Terms of the plans provide for the issuance
of up to 674,606 shares of common stock for these officers and employees. Options are issued at
the fair market value of the stock at the date of grant. Options expire ten years from the grant date,
and vest over a four year period. Terms of the plans also provide for the issuance of up to 115,473
shares for non-employee directors. These options expire seven years from the grant date, and vest
over a four year period. A summary of the status of the Bank's stock option plans at December 31,
2001, 2002 and 2003 and changes for the year then ended is presented in the following table.
Outstanding at beg. of year
Granted
Exercised
Forfeited
Expired
Outstanding at end of year
Exercisable at end of year
Shares
445,001
114,907
(29,204)
(12,629)
---
518,075
276,727
2001
Weighted Avg.
Exercise Price
$16.02
19.95
11.81
18.35
2002 2003
Weighted Avg.
Shares Exercise Price
518,075
83,057
(29,236)
(5,300)
---
566,596
347,432
Shares
566,596
52,259
(49,892)
(11,742)
---
557,221
395,654
$17.08
24.80
9.72
21.21
18.55
17.26
17.08
15.54
Weighted Avg.
Exercise Price
$18.55
30.09
15.17
21.85
19.86
18.42
A summary of the options outstanding and exercisable by price range as of December 31, 2003 is
presented in the following table.
Range of
Exercise Prices
$5.00 - $10.00
$10.01 - $15.00
$15.01 - $20.00
$20.01 - $25.00
$25.01 - $30.00
$30.01 - $35.00
Options Outstanding
OptionsExercisable
Outstanding
27,614
20,876
307,815
127,893
53,946
19,077
557,221
Weighted Avg.
Remaining
Contractual Life
1.5
2.5
5.0
7.1
8.1
8.5
5.6
Weighted Avg.
Exercise Price
$6.96
$10.43
$18.57
$21.93
$27.93
$33.04
$19.86
Weighted Avg.
Exercisable Exercise Price
$6.96
$10.43
$18.65
$21.61
$27.68
$33.04
$18.42
27,614
20,876
256,381
71,587
15,381
3,815
395,654
For the years ended December 2001, 2002 and 2003 the Bank recorded benefits expense related
to the Bank of Marin Employee Stock Ownership and Savings Plan and Trust of $565,700, $652,000
and $653,000 respectively. In December 2003 the Plan's trustees arranged for a $1,000,000 26-
month revolving line of credit at prime plus 1/4% from an unaffiliated community bank. At
December 31, 2003 there had been no borrowings on the line.
Under California state banking laws, payment of dividends is restricted to the lesser of retained
earnings or the amount of undistributed net profits from the three most recent fiscal years. Under
this restriction, the balance of retained earnings equalling approximately $17,955,000 was
available for payment of dividends as of December 31, 2003.
Note 13: Regulatory Matters
The Bank is subject to various regulatory capital requirements administered by the federal and
California banking agencies. The Federal Deposit Insurance Corporation (FDIC) has adopted risk-
based capital regulations, which assign risk weightings to bank assets and “off-balance sheet” items
(such as loan commitments). Failure to meet minimum capital requirements can initiate certain
mandatory, and possibly additional discretionary actions by the FDIC that, if undertaken, could
46
have a material effect on the Bank’s financial statements. The regulations require the Bank to
maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital
(as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined)
to average assets (as defined). Management believes, as of December 31, 2002 and 2003, that the
Bank met all capital adequacy requirements to which it is subject.
As of December 31, 2003, the most recent notification from the FDIC categorized the Bank as well
capitalized under the regulatory framework for prompt corrective action. There are no conditions
or events since the notification that management believes have changed the Bank’s category. The
Bank’s actual capital amounts and ratios as of December 31, 2002 and 2003 are presented in the
table.
As of December 31, 2002
Total Capital (to risk-weighted assets)
Tier 1 Capital (to risk-weighted assets)
Tier 1 Capital (to average assets)
As of December 31, 2003
Total Capital (to risk-weighted assets)
Tier 1 Capital (to risk-weighted assets)
Tier 1 Capital (to average assets)
Actual
Amount Ratio
For Capital
Adequacy Purposes
Amount Ratio
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
Amount
Ratio
$51,600,426 10.61% >$38,910,053 >8.0% >$48,637,566 >10.0%
$46,565,773 9.57% >$19,455,026 >4.0% >$29,182,540 > 6.0%
$46,565,773 8.69% >$19,783,245 >4.0% >$24,729,056 > 5.0%
$61,164,024 10.92% >$44,795,015 >8.0% >$55,993,769 >10.0%
$55,322,151 9.88% >$22,397,507 >4.0% >$33,596,261 > 6.0%
$55,322,151 8.80% >$23,263,018 >4.0% >$29,078,773 > 5.0%
Note 14: Financial Instruments with Off-Balance Sheet Risk
The Bank makes commitments to extend credit in the normal course of business to meet the
financing needs of its customers. Commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may require payment of a
fee. Since many of the commitments are expected to expire without being drawn upon, the total
commitment amount does not necessarily represent future cash requirements.
The Bank is exposed to credit loss, in the event of nonperformance by the borrower, in the contract
amount of the commitment. The Bank uses the same credit policies in making commitments as
it does for on-balance-sheet instruments and evaluates each customer’s creditworthiness on a case-
by-case basis. The amount of collateral obtained if deemed necessary by the Bank is based on
management’s credit evaluation of the borrower. Collateral held varies but may include accounts
receivable, inventory, property, plant and equipment, and real property. The contract amount of
loan commitments not reflected on the statement of condition was $153,695,000 at
December 31, 2003, for which the Bank has set aside an allowance in the amount of $384,000,
which is recorded in interest payable and other liabilities.
47
SELECTED FINANCIAL DATA (in thousands except per share) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
At December 31
Total assets
Total loans
Total deposits
Total stockholders’ equity
Equity to assets ratio
For year ended December 31
Net interest income
Provision for possible loan losses
Non-interest income
Non-interest expense
Net income
Net income per share
Dividend payout ratio
1999
$ 346,681
217,964
315,866
28,691
8.3%
1999
$ 15,906
800
1,239
10,474
3,650
1.31
0%
2000
$ 379,096
264,948
341,711
34,352
9.1%
2000
$ 19,271
986
1,638
12,675
4,523
1.58
0%
2001
$ 455,417
326,249
411,818
40,601
8.9%
2001
$ 21,456
619
1,873
14,428
5,148
1.76
0%
2002
$ 539,025
410,155
486,029
47,117
8.7%
2002
$ 25,522
577
2,318
17,125
6,242
2.06
0%
2003
$ 642,607
450,881
584,116
55,577
8.6%
2003
$ 27,656
685
2,960
17,817
7,473
2.38
0%
02/03
% change
19.2%
9.9%
20.2%
18.0%
02/03
% change
8.4%
18.7%
27.7%
4.0%
19.7%
15.5%
.
6
2
4
6
$
.
0
9
3
5
$
.
4
5
5
4
$
.
1
9
7
3
$
.
7
6
4
3
$
%
2
2
1
.
%
2
2
1
.
%
4
2
1
.
%
6
2
1
.
%
8
2
1
.
%
8
6
3
1
.
%
4
2
4
1
.
%
9
5
3
1
.
%
2
1
4
1
.
%
6
4
4
1
.
99
00
01
02
03
99
00
01
02
03
99
00
01
02
03
Total Assets (in millions)
Return on Assets
Return on Equity
8
3
2
$
.
6
0
2
$
.
.
6
7
1
$
8
5
1
$
.
.
1
3
1
$
.
1
8
8
1
$
.
8
2
6
1
$
.
2
2
4
1
$
.
9
1
2
1
$
.
5
4
0
1
$
99
00
01
02
03
99
00
01
02
03
Total Assets (in millions)
Earnings Per Share
Book Value Per Share
DIVIDEND INFORMATION, STOCK PRICE
AND MARKETPLACE DESIGNATION
On April 10, 2003 the Board of Directors
declared a 5% stock dividend payable May 5,
2003 to stockholders of record on April 21,
2003. The Bank paid cash for fractional shares.
During 2003 there were 863 trades at prices
ranging from a high of $41.89 to a low of
$28.00. In 2002 there were 685 trades at
prices ranging from a high of $31.00 to a
low of $23.00.
Bank of Marin common stock trades on the
Nasdaq SmallCap Market under the symbol
BMRC. There were 805 holders of record of the
Bank's common stock as of March 1, 2004.
48