form10-q.htm


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

FORM 10-Q
 
(Mark One)

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

For the quarterly period ended     June 30, 2007

OR

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

For the transition period from __________________ to __________________

 Commission File Number ____001-33572 ___________________________________

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


California
 
20-8859754
(State or other jurisdiction of incorporation)
 
(IRS Employer Identification No.)

504 Redwood Blvd., Suite 100, Novato, CA
 
94947
(Address of principal executive office)
 
(Zip Code)

Registrant’s telephone number, including area code:  (415) 927-2265

Not Applicable

(Former name or former address, if changes since last report)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer.

Large accelerated filer  o
 
Accelerated filer  x
 
Non accelerated filer  o

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

As of July 31, 2007 there were 5,166,642 shares of common stock outstanding.




 
Bank of Marin
 
Explanatory Note
 
Bank of Marin Bancorp is the successor registrant to Bank of Marin pursuant to an 8-K filed with the SEC on June 29, 2007.

On July 1, 2007 (the “Effective Date”), a bank holding company reorganization was completed whereby Bank of Marin Bancorp became the parent holding company for Bank of Marin.  On the Effective Date, each outstanding share of Bank of Marin common stock was converted into one share of Bank of Marin Bancorp common stock and Bank of Marin became a wholly-owned subsidiary of the holding company.  Prior to the Effective Date, Bank of Marin filed reports and proxy statements with the Federal Deposit Insurance Corporation (“FDIC”) pursuant to Sections 12 of the Securities Exchange Act of 1934 (the “’34 Act”).

The financial statements and discussion thereof contained in this report relate to Bank of Marin only.  Prior to the Effective Date, Bank of Marin Bancorp conducted no operations and had no material assets or liabilities.

This report refers to several previous filings made by Bank of Marin with the FDIC pursuant to the ’34 Act.  Copies of these filing are available by requesting them in writing or by phone from:
 
Corporate Secretary
Bank of Marin
504 Redwood Blvd., Suite 100
Novato, CA 94947
415-763-4523

Copies of such filings are also available on Bank of Marin’s website at www.bankofmarin.com. This website address is for information only and is not intended to be an active link, or to incorporate any website information into this document.

page 2

 
Bank of Marin
 
TABLE OF CONTENTS


PART  I
 
FINANCIAL INFORMATION
   
         
Item 1
     
     
4
     
5
     
7
     
8
     
9
         
Item 2
   
18
         
Item 3
   
31
         
Item 4
   
31
         
PART II
 
OTHER INFORMATION
   
         
Item 1
   
31
         
Item 1A
   
31
         
Item 2
   
31
         
Item 3
   
32
         
Item 4
   
33
         
Item 5
   
33
         
Item 6
   
34
         
 
35
         
CERTIFICATIONS        
    Exhibit 31.01   36
    Exhibit 31.02   37
    Exhibit 32.01   38
 
page 3

 
Bank of Marin
 
CONDENSED STATEMENT OF CONDITION
 
at June 30, 2007 and December 31, 2006
 
             
(in thousands, except share data - 2007 unaudited)
 
     June 30, 2007
   
December 31, 2006
 
             
Assets
           
Cash and due from banks
  $
29,319
    $
37,283
 
Fed funds sold
   
76,500
     
1,500
 
Cash and cash equivalents
   
105,819
     
38,783
 
                 
Investment securities
               
Held to maturity, at amortized cost
   
15,161
     
14,159
 
Available for sale (at fair market value, amortized cost $88,054 at 6/30/07 and $76,231 at 12/31/06)
   
86,740
     
75,214
 
Total investment securities
   
101,901
     
89,373
 
                 
Loans, net of allowance for loan losses of $7,053 at 6/30/07 and $8,023 at 12/31/06)
   
646,871
     
711,755
 
Bank premises and equipment, net
   
8,216
     
8,446
 
Interest receivable and other assets
   
27,570
     
28,221
 
                 
Total assets
  $
890,377
    $
876,578
 
                 
Liabilities and Stockholders' Equity
               
                 
Liabilities
               
Deposits
               
Non-interest bearing
  $
204,335
    $
206,201
 
Interest bearing
               
Transaction accounts
   
74,387
     
75,993
 
Savings and money market
   
409,795
     
365,850
 
Time
   
87,960
     
88,653
 
Total deposits
   
776,477
     
736,697
 
Federal funds purchased and Federal Home Loan Bank borrowings
   
10,000
     
39,400
 
Subordinated debenture
   
5,000
     
5,000
 
Interest payable and other liabilities
   
14,750
     
5,956
 
                 
Total liabilities
   
806,227
     
787,053
 
                 
Stockholders' Equity
               
Common stock, no par value
               
Authorized - 15,000,000 shares
               
Issued and outstanding - 5,190,791 shares at 6/30/07 and 5,366,416 at 12/31/06
   
53,032
     
61,355
 
Retained earnings
   
31,880
     
28,760
 
Accumulated other comprehensive loss, net
    (762 )     (590 )
                 
Total stockholders' equity
   
84,150
     
89,525
 
                 
Total liabilities and stockholders' equity
  $
890,377
    $
876,578
 

The accompanying notes are an integral part of these condensed financial statements.
 
 
Bank of Marin
 
CONDENSED STATEMENT OF OPERATIONS
 
for the six months ended June 30, 2007 and June 30, 2006
 
             
(in thousands, except per share amounts - unaudited)
 
June 30, 2007
   
June 30, 2006
 
             
Interest income
           
Interest and fees on loans held in portfolio
  $
25,723
    $
25,734
 
Interest on auto loans held for sale
   
2,062
     
---
 
Interest on investment securities
               
U.S. Treasury securities
   
8
     
43
 
Securities of U.S. Government agencies
   
1,651
     
1,820
 
Obligations of state and political subdivisions (tax exempt)
   
229
     
317
 
Corporate debt securities and other
   
221
     
140
 
Interest on Federal funds sold
   
417
     
92
 
Total interest income
   
30,311
     
28,146
 
                 
Interest expense
               
Interest on interest bearing transaction accounts
   
151
     
152
 
Interest on savings and money market deposits
   
7,170
     
4,499
 
Interest on time deposits
   
1,751
     
1,945
 
Interest on borrowed funds
   
764
     
800
 
Total interest expense
   
9,836
     
7,396
 
                 
Net interest income
   
20,475
     
20,750
 
Provision for loan losses
   
140
     
502
 
Net interest income after provision for loan losses
   
20,335
     
20,248
 
                 
Non-interest income
               
Service charges on deposit accounts
   
569
     
498
 
Wealth Management Services
   
573
     
523
 
Net gain on indirect auto portfolio
   
710
     
---
 
Other income
   
1,049
     
918
 
Total non-interest income
   
2,901
     
1,939
 
                 
Non-interest expense
               
Salaries and related benefits
   
8,126
     
8,024
 
Occupancy and equipment
   
1,439
     
1,171
 
Depreciation and amortization
   
611
     
443
 
Data processing
   
843
     
717
 
Other expense
   
2,700
     
2,480
 
Total non-interest expense
   
13,719
     
12,835
 
Income before provision for income taxes
   
9,517
     
9,352
 
                 
Provision for income taxes
   
3,640
     
3,801
 
Net income
  $
5,877
    $
5,551
 
                 
Net income per common share:
               
Basic
  $
1.13
    $
1.05
 
Diluted
  $
1.09
    $
0.99
 
 
               
Weighted average shares used to compute net income per common share:
               
Basic
   
5,209
     
5,285
 
Diluted
   
5,376
     
5,588
 
                 
Dividends declared per common share
  $
0.25
    $
0.22
 

The accompanying notes are an integral part of these condensed financial statements.
 
 
Bank of Marin
 
CONDENSED STATEMENT OF OPERATIONS
 
for the three months ended June 30, 2007, March 31, 2007 and June 30, 2006
 
                   
(in thousands, except per share amounts - unaudited)
 
June 30, 2007
   
March 31, 2007
   
June 30, 2006
 
                   
Interest income
                 
Interest and fees on loans held in portfolio
  $
13,027
    $
12,696
    $
13,061
 
Interest on auto loans held for sale
   
954
     
1,108
     
---
 
Interest on investment securities
                       
U.S. Treasury securities
   
---
     
8
     
20
 
Securities of U.S. Government agencies
   
809
     
842
     
914
 
Obligations of state and political subdivisions (tax exempt)
   
111
     
118
     
150
 
Corporate debt securities and other
   
123
     
98
     
69
 
Interest on Federal funds sold
   
415
     
2
     
88
 
Total interest income
   
15,439
     
14,872
     
14,302
 
                         
Interest expense
                       
Interest on interest bearing transaction accounts
   
74
     
77
     
80
 
Interest on savings and money market deposits
   
3,778
     
3,392
     
2,474
 
Interest on time deposits
   
882
     
869
     
963
 
Interest on borrowed funds
   
227
     
537
     
406
 
Total interest expense
   
4,961
     
4,875
     
3,923
 
                         
Net interest income
   
10,478
     
9,997
     
10,379
 
Provision for loan losses
   
75
     
65
     
242
 
Net interest income after provision for loan losses
   
10,403
     
9,932
     
10,137
 
                         
Non-interest income
                       
Service charges on deposit accounts
   
321
     
248
     
248
 
Wealth Management Services
   
298
     
275
     
267
 
Net gain on indirect auto portfolio
   
190
     
520
     
---
 
Other income
   
584
     
465
     
482
 
Total non-interest income
   
1,393
     
1,508
     
997
 
                         
Non-interest expense
                       
Salaries and related benefits
   
4,163
     
3,963
     
4,112
 
Occupancy and equipment
   
729
     
710
     
602
 
Depreciation and amortization
   
310
     
301
     
224
 
Data processing
   
425
     
418
     
361
 
Other expense
   
1,403
     
1,297
     
1,294
 
Total non-interest expense
   
7,030
     
6,689
     
6,593
 
Income before provision for income taxes
   
4,766
     
4,751
     
4,541
 
                         
Provision for income taxes
   
1,863
     
1,777
     
1,900
 
Net income
  $
2,903
    $
2,974
    $
2,641
 
                         
Net income per common share:
                       
Basic
  $
0.56
    $
0.57
    $
0.50
 
Diluted
  $
0.54
    $
0.55
    $
0.47
 
                         
Weighted average shares used to compute net income per common share:
                       
Basic
   
5,187
     
5,231
     
5,324
 
Diluted
   
5,329
     
5,417
     
5,597
 
                         
Dividends declared per common share
  $
0.13
    $
0.12
    $
0.12
 

The accompanying notes are an integral part of these condensed financial statements.
 
page 6

 
Bank of Marin
 
CONDENSED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
 
for the year ending December 31, 2006 and the six months ended June 30, 2007
 
               
Accumulated Other
       
                     
Comprehensive
       
   
Common Stock
   
Retained
   
Loss,
       
(dollar amounts in thousands - 2007 unaudited)
 
Shares
   
Amount
   
Earnings
   
Net of Taxes
   
Total
 
Balance at December 31, 2005
   
4,960,248
    $
50,957
    $
28,030
    $ (766 )   $
78,221
 
Comprehensive income:
                                       
Net income
   
---
     
---
     
11,883
     
---
     
11,883
 
Other comprehensive income
                                       
Net change in unrealized loss on available for sale securities (net of tax liability of $128)
   
---
     
---
     
---
     
176
     
176
 
Comprehensive income
   
---
     
---
     
11,883
     
176
     
12,059
 
Stock options exercised
   
258,207
     
3,307
     
---
     
---
     
3,307
 
Tax benefit from exercised stock options
   
---
     
1,394
     
---
     
---
     
1,394
 
Stock repurchased, including commission costs
    (115,625 )     (3,968 )    
---
     
---
      (3,968 )
Stock-based compensation
   
---
     
555
     
---
     
---
     
555
 
Stock issued on 5% dividend declared on April 13
   
250,658
     
8,678
      (8,705 )    
---
      (27 )
Cash dividends paid
   
---
     
---
      (2,448 )    
---
      (2,448 )
Stock issued in payment of director fees
   
12,928
     
432
     
---
     
---
     
432
 
Balance at December 31, 2006
   
5,366,416
    $
61,355
    $
28,760
    $ (590 )   $
89,525
 
Cummulative-effect adjustment of adoption of SFAS No.159
   
---
     
---
      (1,452 )    
---
      (1,452 )
Comprehensive income:
                                       
Net income
   
---
     
---
     
5,877
     
---
     
5,877
 
Other comprehensive income
                                       
Net change in unrealized loss on available for sale securities (net of tax benefit of $125)
   
---
     
---
     
---
      (172 )     (172 )
Comprehensive income
   
---
     
---
     
5,877
      (172 )    
5,705
 
Stock options exercised
   
108,516
     
1,559
     
---
     
---
     
1,559
 
Tax benefit from exercised stock options
   
---
     
724
     
---
     
---
     
724
 
Stock repurchased, including commission costs
    (289,692 )     (11,055 )    
---
     
---
      (11,055 )
Stock-based compensation
           
255
                     
255
 
Cash dividends paid
   
---
     
---
      (1,305 )             (1,305 )
Stock issued in payment of director fees
   
5,551
     
194
     
---
     
---
     
194
 
Balance at June 30, 2007
   
5,190,791
    $
53,032
    $
31,880
    $ (762 )   $
84,150
 

The accompanying notes are an integral part of these condensed financial statements.
 
page 7

 
Bank of Marin
 
CONDENSED STATEMENT OF CASH FLOWS
 
for six months ended June 30, 2007 and 2006
 
             
(in thousands - unaudited)
 
June 30, 2007
   
June 30, 2006
 
             
Cash Flows from Operating Activities:
           
Net income
  $
5,877
    $
5,551
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
   
140
     
502
 
Compensation payable in common stock
   
141
     
240
 
Stock-based compensation expense
   
255
     
283
 
Excess tax benefits from exercised stock options
    (621 )     (956 )
Amortization and accretion of investment security premiums, net
   
93
     
315
 
Depreciation and amortization
   
611
     
443
 
Net gain on indirect auto portfolio
    (710 )    
---
 
Net change in operating assets and liabilities:
               
Interest receivable
   
537
     
176
 
Interest payable
   
52
     
74
 
Deferred rent and other rent-related expenses
   
59
     
---
 
Other assets
   
1,286
      (1,802 )
Other liabilities
   
9,460
     
903
 
Total adjustments
   
11,303
     
178
 
Net cash provided by operating activities
   
17,180
     
5,729
 
                 
Cash Flows from Investing Activities:
               
Purchase of securities held-to-maturity
    (2,056 )    
---
 
Purchase of securities available-for-sale
    (19,454 )     (7,976 )
Proceeds from paydowns/maturity of:
               
Securities held-to-maturity
   
1,000
     
5,330
 
Securities available-for-sale
   
7,592
     
6,615
 
Proceeds from sale of indirect auto loans
   
76,681
     
---
 
Loans originated and principal collected, net
    (13,726 )     (18,894 )
Additions to premises and equipment
    (381 )     (1,737 )
Net cash provided by (used in) investing activities
   
49,656
      (16,662 )
                 
Cash Flows from Financing Activities:
               
Net increase in deposits
   
39,780
     
22,005
 
Proceeds from stock options exercised
   
1,559
     
1,669
 
Net decrease in Federal Funds purchased and Federal Home Loan Bank borrowings
    (29,400 )     (700 )
Common stock repurchased
    (11,055 )    
---
 
Dividends paid in cash
    (1,305 )     (1,141 )
Cash paid for fractional shares
   
---
      (27 )
Excess tax benefits from exercised stock options
   
621
     
956
 
Net cash provided by financing activities
   
200
     
22,762
 
                 
Net increase in cash and cash equivalents
   
67,036
     
11,829
 
                 
Cash and cash equivalents at beginning of period
   
38,783
     
22,262
 
                 
Cash and cash equivalents at end of period
  $
105,819
    $
34,091
 

Non-Cash Transactions: The six months ended June 30, 2007 reflected a cumulative-effect adjustment of the adoption of SFAS No. 159, which included non-cash decreases to net loans of $2.5 million and retained earnings of $1.5 million, and a non-cash increase to other assets of $1.0 million.
 
The accompanying notes are an integral part of these condensed financial statements.

page 8

 
Bank of Marin
 
NOTES TO CONDENSED FINANCIAL STATEMENTS

Note 1:  Basis of Presentation

On July 1, 2007 (the “Effective Date”), a bank holding company reorganization was completed whereby Bank of Marin Bancorp became the parent holding company for Bank of Marin ( the “Bank”).  On the Effective Date, each outstanding share of the Bank was converted into one share of Bank of Marin Bancorp and the Bank became a wholly-owned subsidiary of the holding company. The condensed financial statements and accompanying footnotes are those of Bank of Marin, since prior to the Effective Date, Bank of Marin Bancorp had no material assets or liabilities.

In the opinion of Management, the unaudited interim condensed financial statements contain all adjustments necessary to present fairly the financial position, results of operations, changes in stockholders' equity and cash flows for the Bank. All adjustments are of a normal, recurring nature.

Effective January 1, 2007, the Bank elected early adoption of SFAS No.159, The Fair Value Option for Financial Assets and Financial Liabilities and SFAS No. 157, Fair Value Measurements. SFAS No. 159 generally permits the measurement of selected eligible financial instruments at fair value at specified election dates. Upon adoption of SFAS No. 159, the Bank selected the fair value option for its auto loan portfolio, which was subsequently sold on June 5, 2007. For further information on the financial effect of SFAS Nos. 159 and 157 see Note 2 below.

Certain information and footnote disclosures presented in the Bank's annual financial statements are not included in the interim condensed financial statements.  Accordingly, the accompanying unaudited interim condensed financial statements should be read in conjunction with the Bank's 2006 Annual Report to Stockholders, which is incorporated by reference in the Bank's 2006 Annual Report on Form 10-K.  The results of operations for the six months ended June 30, 2007 are not necessarily indicative of the operating results for the full year.

The following table shows weighted average basic shares, potential common shares related to stock options, and weighted average diluted shares used in calculating earnings per share.  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.

   
Three months ended
   
Six months ended
 
(in thousands)
 
June 30, 2007
   
March 31, 2007
   
June 30, 2006
   
June 30, 2007
   
June 30, 2006
 
Weighted average basic shares outstanding
   
5,187
     
5,231
     
5,324
     
5,209
     
5,285
 
Add: Potential common shares related to stock options
   
142
     
186
     
273
     
167
     
303
 
Weighted average diluted shares outstanding
   
5,329
     
5,417
     
5,597
     
5,376
     
5,588
 
Anti-dilutive shares not included in the calculation of diluted earnings per share
   
67
     
0
     
32
     
0
     
16
 
                                         
Net income
  $
2,903
    $
2,974
    $
2,641
    $
5,877
    $
5,551
 
Earnings per share (basic)
  $
0.56
    $
0.57
    $
0.50
    $
1.13
    $
1.05
 
Earnings per share (diluted)
  $
0.54
    $
0.55
    $
0.47
    $
1.09
    $
0.99
 

page 9

 
Bank of Marin

Note 2:  Fair Value Measurement

Effective January 1, 2007, the Bank adopted SFAS 157, Fair Value Measurements, concurrent with its early adoption of SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 157 clarifies the definition of fair value, describes methods used to appropriately measure fair value in accordance with generally accepted accounting principles and expands fair value disclosure requirements. This statement applies whenever other accounting pronouncements require or permit fair value measurements. SFAS No. 159 generally permits the measurement of selected eligible financial instruments at fair value at specified election dates.

The Bank performs fair-market valuations on certain assets as a result of the application of accounting guidelines that were in effect prior to the adoption of SFAS No. 157. In addition, in conjunction with the Bank’s decision to sell its auto portfolio, on January 1, 2007 the Bank elected the fair value measurement option for its indirect auto loan portfolio under the early adoption provisions of SFAS No. 159. The sale of the indirect auto portfolio was concluded on June 5, 2007. The following table summarizes the Bank’s financial instruments that were measured at fair value on a recurring basis at June 30, 2007.

(Dollars in thousands)
                       
Description of Financial Instruments
 
June 30, 2007
   
Quoted Prices in Active Markets for Identical Assets 
(Level 1)
   
Significant Other Observable Inputs 
(Level 2)
   
Significant Unobservable Inputs 
(Level 3)
 
                         
Securities available for sale
  $
86,740
    $
86,740
    $
---
    $
---
 
Derivative financial instruments
   
409
     
---
     
409
     
---
 
Total
  $
87,149
    $
86,740
    $
409
    $
---
 
 
 

Securities available for sale are valued based upon open-market quotes obtained from reputable third-party brokers. Market pricing is based upon specific CUSIP identification for each individual security. Changes in fair market value are recorded in other comprehensive income.

The fair value of derivative financial instruments is based on the present value of future expected cash flows from those instruments discounted at market forward rates. The fair value of derivative financial instruments is provided by a third party. Changes in fair market value are recorded in other non-interest income for fair value hedges using short-cut hedge accounting treatment and are recorded in interest income for fair value hedges not qualifying for short-cut hedge accounting treatment.

page 10

 
Bank of Marin
 
The following table presents a reconciliation of retained earnings at the initial adoption of SFAS No. 159 for the Bank’s auto loan portfolio.
 
 
 
January 1, 2007
   
Net Gain (Loss)
 
 
 
January 1, 2007
 
(Dollars in thousands)
 
Prior to Adoption
 
 
Upon Adoption
 
 
 
After Adoption
 
Assets
 
 
   
 
 
 
 
 
 
Auto loans, net
  $
83,327
    $ (2,499 )
(a)
  $
80,828
 
 
               
 
       
Pre-tax cummulative effect of adoption of the fair value option
            (2,499 )
 
       
 
               
 
       
Increase in deferred tax asset
           
1,047
 
 
       
 
               
 
       
Cummulative effect of adoption of the fair value option (charge to retained earnings)
          $ (1,452 )
 
       
 
(a)
The $2.5 million loss on loans that was recorded as part of the cumulative-effect adjustment to retained earnings upon initial adoption of SFAS No. 159 is net of $1.0 million that was removed from the allowance for loan losses.

Pre-tax non-recurring net gains of $190 thousand and $520 thousand were recorded in the second and first quarters of 2007, respectively. The gain on the indirect auto portfolio in the first quarter of 2007 represents the change in fair value of the portfolio during the period. The portion of this change attributable to changes in credit risk is not significant. The fair values at January 1, 2007 and at March 31, 2007 were calculated by a professional valuation firm using fair value hierarchy level two, “Significant Observable Inputs,” based on the weighted averages for the following criteria: original term of the underlying loans, remaining term, interest rate, FICO credit score and vehicle year. Also included was the vehicle mix (new/used). Cash flows for the remaining term of the loans were discounted using Treasury rates plus a spread above the Treasury rates that was applied based upon recent sales of similar assets. The gain in the second quarter of 2007 represents the pre-tax gain on sale based on actual proceeds net of selling expenses.

Note 3:  Allowance for Loan Losses and Non Accrual Loans

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

page 11

 
Bank of Marin
 
Activity in the allowance for loan losses follows:
 
   
Three months ended
   
Six months ended
 
(in thousands - unaudited)
 
June 30, 2007
   
March 31, 2007
   
June 30, 2006
   
June 30, 2007
   
June 30, 2006
 
Beginning balance
  $
7,042
    $
8,023
    $
7,340
    $
8,023
    $
7,115
 
Cumulative-effect adjustment of adoption of SFAS No. 159
   
---
      (1,048 )    
---
      (1,048 )    
---
 
Provision for loan loss charged to expense
   
75
     
65
     
242
     
140
     
502
 
Loans charged off
    (77 )     (1 )     (88 )     (78 )     (166 )
Loan loss recoveries
   
13
     
3
     
25
     
16
     
68
 
Ending balance
  $
7,053
    $
7,042
    $
7,519
    $
7,053
    $
7,519
 
                                         
Total loans held in portfolio at end of period, before deducting allowance for loan losses
  $
653,924
    $
656,116
    $
705,457
    $
653,924
    $
705,457
 
Ratio of allowance for loan losses to loans held in portfolio
    1.08 %     1.07 %     1.07 %     1.08 %     1.07 %
Nonaccrual loans at period end
  $
5
    $
117
    $
2,608
    $
5
    $
2,608
 

At December 31, 2006 nonaccrual loans totaled $49 thousand. The nonaccrual balance at June 30, 2006 primarily relates to one commercial loan that was sold in the fourth quarter of 2006.
 
Note 4:  Stockholders’ Equity

Upon the adoption of SFAS No. 159 for its indirect auto loan portfolio, the Bank recorded a cumulative-effect adjustment as a charge to retained earnings totaling $1.5 million. See Note 2.

In October 2006, the Bank received approval from the California Department of Financial Institutions (DFI) and the Federal Deposit Insurance Corporation (FDIC) to buy back up to 10%, or approximately 545,884 of the Bank’s 5,458,838 then-outstanding shares, not to exceed $15 million.  The repurchase program allowed the Bank to purchase common shares for a period of approximately twelve months from the approval date in the open market or in privately negotiated transactions. In 2006, the Bank purchased 115,625 shares at prices ranging from $32.43 to $36.25 for a total cost of $4.0 million.  In the first quarter of 2007, the Bank purchased an additional 289,692 shares at prices ranging from $36.05 to $39.10 for a total cost of $11.1 million, thereby completing the share repurchase under the approved program.  The Bank executed these transactions pursuant to the Securities and Exchange Commission’s Rule 10b-18.  All shares repurchased were made in open market transactions and were part of the publicly announced repurchase program.

page 12

 
Bank of Marin
 
A summary of the Bank’s cash dividends, which are recorded as a reduction of retained earnings, is presented below.
 
   
Three months ended
   
Six months ended
 
(in thousands except per share - unaudited)
 
June 30, 2007
   
March 31, 2007
   
June 30, 2006
   
June 30, 2007
   
June 30, 2006
 
Cash dividends
  $
680
    $
625
    $
641
    $
1,305
    $
1,141
 
Cash dividends per share
  $
0.13
    $
0.12
    $
0.12
    $
0.25
    $
0.22
 
 
Included in cash dividends during the second quarter of 2007 is $5 thousand paid to shareholders in connection with the redemption of all the preferred share purchase rights issued pursuant to the Bank’s Rights Agreement of August 11, 2003. The redemption, in anticipation of the formation of a bank holding company, was effective June 14, 2007 at a redemption price of $0.001 per right. On that same day, Bank of Marin Bancorp’s Board of Directors executed a Rights Agreement substantially similar to the Bank’s agreement and has issued replacement rights under the new Rights Agreement to shareholders of record as of July 23, 2007. The Bank of Marin Bancorp Rights Agreement is designed to discourage takeovers that involve abusive tactics or do not provide fair value to shareholders.

Under SFAS No. 123R which was implemented in January 2006, the fair value of stock options on the grant date is recorded as an expense on the income statement over the service period with a corresponding increase in common stock.  In addition, the Bank records tax benefits on exercised stock options which are accounted for as an addition to common stock with a corresponding decrease in accrued tax liability. See Note 5 for further information on accounting for stock options and share-based payments.

Stock-based compensation and tax benefits on exercised options are shown below.

   
Three months ended
   
Six months ended
 
(in thousands - unaudited)
 
June 30, 2007
   
March 31, 2007
   
June 30, 2006
   
June 30, 2007
   
June 30, 2006
 
Stock-based compensation
  $
133
    $
122
    $
121
    $
255
    $
283
 
Tax benefits on exercised options
  $
126
    $
598
    $
737
    $
724
    $
956
 
 
page 13

 
Bank of Marin
 
Note 5: Stock Options

On January 1, 2006 the Bank adopted the provisions of Statement of Financial Accounting Standard No. 123R (SFAS No. 123R), Share-Based Payment, which requires that all share-based payments to employees, including stock options, be recognized as an expense in the income statement based on the grant date fair value of the award with a corresponding increase in common stock.  The fair value, as defined in SFAS No. 123R, is amortized over the implied service period, which is generally the vesting period.

As of May 8, 2007, the 2007 Equity Plan was approved by shareholders. The 2007 Equity Plan was subsequently adopted by Bank of Marin Bancorp as part of the holding company formation described in Note 1.  Awards under the 2007 Equity Plan will now relate to shares of common stock of Bank of Marin Bancorp. All new stock-based compensation awards from the approval date are granted through the 2007 Equity Plan.

The 2007 Equity plan provides financial incentives for selected employees, advisors and non-employee directors. Terms of the plan provide for the issuance of up to 500,000 shares of common stock for these employees, advisors and non-employee directors. The Compensation Committee of the Board of Directors has the authority, in its discretion to determine those employees, advisors and non-employee directors who will receive an award, the timing of awards, the vesting schedule for each award, the type of award to be granted, the number of shares of Bancorp stock to be subject to each option and restricted stock award, and all other terms and conditions of any award.

The Bank has two additional stock option plans, the 1999 Stock Option Plan and the 1989 Stock Option Plan for full-time, salaried officers and employees who have substantial responsibility for the successful operation of the Bank.  Upon approval of the 1999 Stock Option Plan, no new awards were granted under the 1989 Stock Option Plan. Upon approval of the 2007 Equity Plan, no new awards were granted under the 1999 Stock Option Plan.

Terms of the 1999 Stock Option Plan and the 1989 Stock Option Plan provided for the issuance of up to 1,115,629 and 975,189 shares, respectively, of common stock for these officers and employees. Options representing common shares totaling 398,754 and 30,782 have been awarded but not exercised under the 1999 Stock Option Plan and the 1989 Stock Option Plan, respectively, as of June 30, 2007. Terms of the 1999 Stock Option and the 1989 Stock Option plans also provided for the issuance of up to 190,965 and 192,113 shares, respectively, for non-employee directors. Options representing 48,828 common shares have been awarded but not exercised by directors under the 1999 Stock Option Plan and zero under the 1989 Stock Option Plan.

Stock options granted pursuant to the 1989 and 1999 Stock Option Plans were subsequently adopted by Bank of Marin Bancorp as part of the holding company formation described in Note 1.  Stock options under these plans will now relate to shares of common stock of Bank of Marin Bancorp.

Options are issued at the fair market value of the stock at the date of grant.  Options to officers and employees granted prior to January 1, 2006 vested 20% immediately and 20% on each anniversary of the grant for four years. Options granted subsequent to January 1, 2006 vested 20% on each anniversary of the grant for five years.  All officer and employee options expire ten years from the grant date. Options granted to non-employee directors vest 20% immediately and 20% on each anniversary of the grant for four years. Director options expire seven years from the grant date.

page 14

 
Bank of Marin
 
A summary of activity for the Bank’s options for the first two quarters of 2007 is presented below.
 
 
 
Number of Shares
   
Weighted Average
Exercise Price
   
Aggregate Intrinsic Value
(in thousands)
   
Weighted Average Remaining Contractual Term
(in years)
 
For the quarter ending March 31, 2007:
                   
                         
Options outstanding at December 31, 2006
   
546,265
    $
20.69
     
---
     
---
 
Granted
   
---
     
---
     
---
     
---
 
Cancelled/forfeited
    (2,443 )    
28.60
     
---
     
---
 
Exercised
    (83,582 )    
14.88
    $
1,895
     
---
 
Options outstanding at March 31, 2007
   
460,240
     
21.70
    $
6,379
     
5.5
 
Exercisable (vested) at March 31, 2007
   
308,035
    $
16.93
    $
5,739
     
4.2
 
                                 
For the quarter ending June 30, 2007:
                               
                                 
Options outstanding at March 31, 2007
   
460,240
    $
21.70
     
---
     
---
 
Granted
   
54,551
     
34.87
     
---
     
---
 
Cancelled/forfeited
    (1,442 )    
30.31
     
---
     
---
 
Exercised
    (24,934 )    
12.65
    $
572
     
---
 
Options outstanding at June 30, 2007
   
488,415
     
23.61
    $
4,415
     
6.0
 
Exercisable (vested) at June 30, 2007
   
312,494
    $
18.38
    $
4,459
     
4.6
 
 
As of June 30, 2007 there was $1.2 million of total unrecognized compensation related to non-vested stock options.  This cost is expected to be recognized over a weighted average period of approximately 15.8 months.

The Bank determines fair value at grant date using the Black-Scholes pricing model that takes into account the stock price at the grant date, the exercise price, the expected dividend yield and the risk-free interest rate over the expected life of the option. The Black-Scholes model requires the input of highly subjective assumptions including the expected life of the stock-based award and stock price volatility.  The estimates used in the model involve inherent uncertainties and the application of management judgment.  As a result, if other assumptions had been used, the Bank’s recorded stock-based compensation expense could have been materially different from that reflected in these financial statements.  In addition, the Bank is required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest.  If the Bank’s actual forfeiture rate is materially different from the estimate, the share-based compensation expense could be materially different.

page 15

 
Bank of Marin
 
Assumptions used in the Bank’s pricing model are shown below.

 
June 30, 2007
December 31, 2006
Risk-free interest rate
4.64%
5.06%
Expected dividend yield
1.38%
1.37%
Expected life in years
7
7
Expected price volatility
12.30%
12.53%

Note 6: 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.  These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. 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 contract amount of the commitment in the event of non-performance by the borrower. 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 $213.4 million at June 30, 2007.  This amount included $104.3 million under commercial lines of credit (these commitments are contingent upon customers maintaining specific credit standards), $58.3 million under revolving home equity lines and $36.2 million under undisbursed construction loans.  The Bank has set aside an allowance for losses in the amount of $427 thousand for these commitments, which is recorded in "interest payable and other liabilities."

The contract amount of loan commitments not reflected on the statement of condition was $218.8 million at December 31, 2006.  This amount included $106.4 million under commercial lines of credit, $58.9 million under revolving home equity lines and $38.0 million under undisbursed construction loans.  As of December 31, 2006 the Bank had set aside an allowance for loan losses of $438 thousand for these commitments.

Note 7: Derivative Financial Instruments and Hedging Activities

The Bank has entered into interest-rate swaps, primarily as an asset/liability management strategy, in order to hedge the change in the fair value of both long-term fixed-rate loans and firm commitments to enter into long-term fixed-rate loans due to changes in interest rates.  Such hedges allow the Bank to offer long-term fixed rate loans to customers without assuming the interest rate risk of a long-term asset by swapping the Bank's fixed-rate interest stream for a floating-rate interest stream tied to one-month LIBOR.  Such modification of the interest characteristics of the loan protects the Bank against an adverse effect on earnings and the net interest margin due to fluctuating interest rates.

During the second quarter of 2007, the Bank’s forward swap was designated to offset the change in fair value of a loan originated during the period.  The fair value of the related yield maintenance agreement totaling $69 thousand at the date of designation is being amortized to interest income using the effective yield method over the life of the loan.

page 16

 
Bank of Marin
 
The two interest rate swaps held by the Bank are scheduled to mature in June of 2020 and June of 2022.  Information on the Bank’s hedges follows:

(in thousands)
 
Fair Value Swap
(Shortcut Accounting Treatment)
   
Fair Value Swap
(Non-shortcut Accounting Treatment)
   
Yield 
Maintenance
Agreement
             
At June 30, 2007:
                             
Notional or contractual amount
  $
7,344
    $
8,300
     
---
             
Credit risk amount (1)
   
403
     
6
     
---
             
Estimated net fair value
   
403
     
6
     
69
             
                                     
At December 31, 2006:
                                   
Notional or contractual amount
  $
7,513
    $
8,300
    $
8,300
             
Credit risk amount (1)
   
220
     
---
     
295
             
Estimated net fair value
   
220
      (295 )    
295
             
                                     
 
 
Three months ended
   
Six months ended
 
 
 
June 30, 2007
 
 
March 31, 2007
   
June 30, 2006
   
June 30, 2007
   
June 30, 2006
 
Fair Value Swap
(Shortcut Accounting Treatment):
                                   
Weighted average pay rate
    4.59 %     4.59 %     4.59 %     4.59 %     4.59 %
Weighted average receive rate
    5.32 %     5.32 %     5.02 %     5.32 %     4.79 %
                                         
Fair Value Swap
(Non-Shortcut Accounting Treatment):
                                       
Weighted average pay rate
    5.54 %     5.54 %     5.54 %     5.54 %     5.54 %
Weighted average receive rate
    5.32 %     5.32 %     5.02 %     5.32 %     4.79 %
                                         
Yield maintenance agreement
                                       
Weighted average receive rate (2)
    5.15 %     5.15 %     5.15 %     5.15 %     5.15 %
                                         
Gain (loss) on designated and undesignated interest rate contracts
   
482
     
2
     
357
     
484
     
429
 
(Decrease) increase in value of designated loans and yield maintenance agreement qualifying as derivatives
    (483 )     (2 )     (357 )     (485 )     (429 )
Net gain (loss) on derivatives used to hedge loans recorded in income
  $ (1 )   $
0
    $
0
    $ (1 )   $
0
 
 
1
Credit risk represents the amount of unrealized gain included in derivative assets which is subject to counterparty credit risk. It reflects the effect of master netting agreements and includes credit risk on  virtual derivatives.
2
Tax equivalent yield equals 8.26%.
 
An insignificant amount of ineffectiveness was recorded in interest income during the three months ended June 30, 2007.  The full change in value of swaps was included in the assessment of hedge effectiveness.

Note 8: Subsequent Events

On July 1, 2007 (the “Effective Date”), a bank holding company reorganization was completed whereby Bank of Marin Bancorp (“Bancorp”) became the parent holding company for Bank.  On the Effective Date, each outstanding share of the Bank was converted into one share of Bancorp and the Bank became a wholly-owned subsidiary of the holding company.  Bancorp assumed the ticker symbol BMRC which was formerly used by Bank of Marin.

As discussed in Note 4, pursuant to Bancorp’s Rights Agreement of June 14, 2007, Bancorp declared a dividend of one preferred share purchase right for each outstanding share of common stock, no par value, of Bancorp. The dividend was paid July 23, 2007 to shareholders of record on that date. Each right entitles the registered holder to purchase from Bancorp one one-hundredth of a share of Series A Junior Participating Preferred Stock, no par value of Bancorp at a price of $125 per one one-hundredth of a Preferred share, subject to adjustment. The Rights Agreement is designed to discourage takeovers that involve abusive tactics or do not provide fair value to shareholders. The Rights Agreement replaces a similar Rights Agreement that existed at the Bank level prior to the holding company formation.
 
page 17

 
Bank of Marin
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 

In the following pages, Management discusses its analysis of the Bank's financial condition and results of operations for the second quarter of 2007 compared to the second quarter of 2006 and to the prior quarter (first quarter of 2007), as well as the first six months of 2007 compared to the same period in 2006. This discussion should be read in conjunction with the related financial statements and with the audited financial statements and accompanying notes included in the Bank's 2006 Annual Report to Stockholders.  Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances.

Holding Company

On May 8, 2007 the Bank’s shareholders approved the formation of a bank holding company.  On July 1, 2007, the holding company, Bank of Marin Bancorp, was formed with Bank of Marin as its wholly owned subsidiary. The holding company is expected to provide flexibility in meeting the financing needs of the Bank and in responding to evolving changes in the banking and financial services industries. See Notes 1 and 8.

Forward-looking Statements

The discussion of financial results includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, (the "1933 Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the "1934 Act").  Those sections of the 1933 Act and 1934 Act provide a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about their financial performance so long as they provide meaningful, cautionary statements identifying important factors that could cause actual results to differ significantly from projected results.

The Bank's forward-looking statements include 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:

Corporate Secretary
Bank of Marin
504 Redwood Blvd., Suite 100
Novato, CA 94947
415-763-4523
 
page 18

 
Bank of Marin
 
Copies of such filings are also available on Bank of Marin’s website at www.bankofmarin.com.  This website address is for information only and is not intended to be an active link, or to incorporate any website information into this document. Forward-looking statements speak only as of the date they are made.  The Bank does not undertake to update forward-looking statements to reflect circumstance or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events.

Critical Accounting Policies

Management considers three accounting policies to be critical: the Allowance for Loan Losses, Share-Based Payment and Fair Value Option for Financial Assets and Liabilities. Refer to the Bank’s 2006 Annual Report to Shareholders on Form 10-K pages 8 and 9 for a discussion of Allowance for Loan Losses and Share-Based Payment.

Effective January 1, 2007, the Bank elected early adoption of SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities and SFAS No. 157, Fair Value Measurements. SFAS No. 159 generally permits measurement of selected eligible financial instruments at fair value at specified election dates. Upon adoption of SFAS No. 159, the Bank selected the fair value option for its indirect auto loan portfolio. The changes in fair value of the selected financial instruments after the initial adoption at each balance sheet date were recorded through earnings prior to the sale of the portfolio on June 5, 2007. The Bank determined fair value at January 1, 2007 and March 31, 2007 based on certain criteria including weighted average interest rate, remaining term and FICO credit score. The expected cash flows were discounted using Treasury rates and a spread above the Treasury rate was applied based on recent sales of similar assets. (See Note 2.) The assumptions represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if other assumptions had been used, the Bank’s recorded unrealized gain in the first quarter of 2007 could have been materially different from that reflected in these financial statements.

As a result of the Bank’s fair value measurement election for the auto loan portfolio, the Bank recorded a cumulative-effect adjustment of $1.5 million, net of tax, as a reduction of retained earnings as of January 1, 2007. In addition, $190 thousand and $520 thousand of pre-tax net gains were recorded in the Bank’s second and first quarter earnings, respectively (2 cents and 6 cents per diluted share, respectively,  on an after-tax basis), representing the change in fair value of such instruments during those periods after giving effect to the cumulative-effect adjustment.

Executive Summary

The majority of the Bank’s assets and liabilities are monetary.  As a result, movement of interest rates plays a large part in the risk to its earnings.  In 2006, the Bank’s earnings were impacted by interest rate compression in which its deposit rates rose rapidly while loan rates remained flat.  The rise in deposit rates stemmed primarily from local market competition while loan rates reflected general economic conditions in which the interest yield curve was flat.  A more normal yield curve slopes upward giving a premium to longer term assets, such as term loans.  In 2007 local market competition for deposits eased in part due to softening loan demand. Members of the Bank’s Asset/Liability Management Committee monitor economic trends but cannot predict with certainty the movement of interest rates. The Committee is charged with developing interest rate strategies for various scenarios.

As part of the strategy for maintaining an adequate interest rate spread, the Bank sold its indirect auto loan portfolio in June 2007.  Management believes the sale of the indirect auto portfolio will improve the Bank’s net interest margin and provide a source of funding for higher-yielding relationship loans.  Management continually reviews the asset composition of the Bank in order to maximize earnings.

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Bank of Marin
 
Bank management is constantly alert for opportunities to offset the risk of interest compression including offering new fee income services and expansion of the Bank franchise. The recent decision to create a bank holding company was made in order to provide additional flexibility in meeting financing needs of the Bank and to make it easier to acquire other banks and move into other financial services.

Banking is a highly regulated industry.  Bank management continually monitors its compliance with regulatory requirements including capital adequacy and liquidity.

RESULTS OF OPERATIONS
Overview

Highlights of the Bank's results are presented in the following table.

   
As of and for the
   
As of and for the
 
(dollars in thousands
 
three months ended
   
six months ended
 
except per share data)
 
June 30, 2007
   
March 31, 2007
   
June 30, 2006
   
June 30, 2007
   
June 30, 2006
 
For the period:
                             
Net income
  $
2,903
    $
2,974
    $
2,641
    $
5,877
    $
5,551
 
Net income per share
                                       
Basic
  $
0.56
    $
0.57
    $
0.50
    $
1.13
    $
1.05
 
Diluted
  $
0.54
    $
0.55
    $
0.47
    $
1.09
    $
0.99
 
Return on average equity
    13.90 %     14.36 %     12.62 %     14.13 %     13.61 %
Return on average assets
    1.32 %     1.39 %     1.24 %     1.36 %     1.32 %
Cash dividend payout ratio
    23.21 %     21.05 %     24.00 %     22.12 %     20.95 %
Efficiency ratio
    59.22 %     58.14 %     57.96 %     58.69 %     56.57 %
At period end:
                                       
Book value per share
  $
16.21
    $
15.81
    $
15.86
    $
16.21
    $
15.86
 
Total assets
  $
890,377
    $
881,550
    $
868,182
    $
890,377
    $
868,182
 
Total loans
  $
653,924
    $
736,115
    $
705,457
    $
653,924
    $
705,457
 
Total deposits
  $
776,477
    $
774,029
    $
743,177
    $
776,477
    $
743,177
 
Loan-to-deposit ratio
    84.2 %     95.1 %     94.9 %     84.2 %     94.9 %

Net Interest Income

Net interest income is the difference between the interest earned on loans, investments and other interest-earning assets and the interest expense on deposits and other interest-bearing liabilities. The table below indicates net interest income, net interest margin, and net interest rate spread for each period presented. 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 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 sources of funds, which include demand deposits and stockholders’ equity.

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