form10q.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 September 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
6(Exact name of Registrant as specified in its charter)


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


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

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

Not Applicable 

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

Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.  Yes  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 October 31, 2007 there were 5,174,147 shares of common stock outstanding.
 




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.  Bancorp assumed the ticker symbol BMRC, which was formerly used by Bank of Marin. 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 for periods subsequent to the reorganization relate to consolidated Bank of Marin Bancorp.  Periods prior to the reorganization relate to Bank of Marin only.  The information is comparable as the sole subsidiary of Bank of Marin Bancorp is the Bank of Marin.

This report refers to 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 Bancorp’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 Bancorp
 
TABLE OF CONTENTS


PART  I
FINANCIAL INFORMATION
 
     
Item 1
Financial Statements
 
 
4
 
5
 
7
 
8
 
9
   
 
Item 2
18
   
 
Item 3
32
   
 
Item 4
32
   
 
PART II
OTHER INFORMATION
 
   
 
Item 1
33
   
 
Item 1A
33
   
 
Item 2
33
   
 
Item 3
34
   
 
Item 4
34
   
 
Item 5
34
   
 
Item 6
34
   
 
35
   
 
36

 
Bank of Marin Bancorp
 
CONDENSED CONSOLIDATED STATEMENT OF CONDITION
 
at September 30, 2007 and December 31, 2006
 
             
(in thousands, except share data - 2007 unaudited)
 
September 30, 2007
   
December 31, 2006
 
             
Assets
           
Cash and due from banks
  $
25,245
    $
37,283
 
Fed funds sold
   
70,200
     
1,500
 
Other short-term investments
   
15,000
     
---
 
Cash and cash equivalents
   
110,445
     
38,783
 
                 
Investment securities
               
Held to maturity, at amortized cost
   
13,544
     
14,159
 
Available for sale (at fair market value, amortized cost $85,591 at 9/30/07 and $76,231 at 12/31/06)
   
85,076
     
75,214
 
Total investment securities
   
98,620
     
89,373
 
                 
Loans, net of allowance for loan losses of  $7,227 at 9/30/07   and $8,023 at 12/31/06
   
678,748
     
711,755
 
Bank premises and equipment, net
   
8,019
     
8,446
 
Interest receivable and other assets
   
28,212
     
28,221
 
                 
Total assets
  $
924,044
    $
876,578
 
                 
Liabilities and Stockholders' Equity
               
                 
Liabilities
               
Deposits
               
Non-interest bearing
  $
201,896
    $
206,201
 
Interest bearing
               
Transaction accounts
   
78,782
     
75,993
 
Savings and money market
   
446,865
     
365,850
 
Time
   
81,871
     
88,653
 
Total deposits
   
809,414
     
736,697
 
                 
Federal funds purchased and Federal Home Loan Bank borrowings
   
15,300
     
39,400
 
Subordinated debenture
   
5,000
     
5,000
 
Interest payable and other liabilities
   
7,755
     
5,956
 
                 
Total liabilities
   
837,469
     
787,053
 
                 
Stockholders' Equity
               
Common stock, no par value
               
Authorized - 15,000,000 shares
               
Issued and outstanding - 5,174,147 shares at 9/30/07 and 5,366,416 at 12/31/06
   
52,476
     
61,355
 
Retained earnings
   
34,397
     
28,760
 
Accumulated other comprehensive loss, net
    (298 )     (590 )
                 
Total stockholders' equity
   
86,575
     
89,525
 
                 
Total liabilities and stockholders' equity
  $
924,044
    $
876,578
 

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

 
Bank of Marin Bancorp
 
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
 
for the nine months ended September 30, 2007 and September 30, 2006
 
             
(in thousands, except per share data - unaudited)
 
September 30, 2007
   
September 30, 2006
 
             
Interest income
           
Interest and fees on loans held in portfolio
  $
39,006
    $
39,352
 
Interest on auto loans held for sale
   
2,062
     
---
 
Interest on investment securities
               
U.S. Treasury securities
   
8
     
60
 
Securities of U.S. Government agencies
   
2,714
     
2,741
 
Obligations of state and political subdivisions (tax exempt)
   
358
     
435
 
Corporate debt securities and other
   
329
     
215
 
Interest on Federal funds sold and other short-term investments
   
1,664
     
218
 
Total interest income
   
46,141
     
43,021
 
                 
Interest expense
               
Interest on interest bearing transaction accounts
   
225
     
222
 
Interest on savings and money market deposits
   
11,052
     
7,650
 
Interest on time deposits
   
2,628
     
2,921
 
Interest on borrowed funds
   
973
     
1,060
 
Total interest expense
   
14,878
     
11,853
 
                 
Net interest income
   
31,263
     
31,168
 
Provision for loan losses
   
340
     
789
 
Net interest income after provision for loan losses
   
30,923
     
30,379
 
                 
Non-interest income
               
Service charges on deposit accounts
   
894
     
757
 
Wealth Management Services
   
904
     
794
 
Net gain on indirect auto and Visa portfolios
   
1,097
     
---
 
Other income
   
1,592
     
1,384
 
Total non-interest income
   
4,487
     
2,935
 
                 
Non-interest expense
               
Salaries and related benefits
   
12,064
     
11,756
 
Occupancy and equipment
   
2,155
     
1,912
 
Depreciation and amortization
   
929
     
704
 
Data processing
   
1,254
     
1,139
 
Professional services
   
1,239
     
873
 
Other expense
   
3,004
     
3,036
 
Total non-interest expense
   
20,645
     
19,420
 
                 
Income before provision for income taxes
   
14,765
     
13,894
 
                 
Provision for income taxes
   
5,699
     
5,238
 
Net income
  $
9,066
    $
8,656
 
                 
Net income per common share:
               
Basic
  $
1.74
    $
1.62
 
Diluted
  $
1.70
    $
1.55
 
                 
Weighted average shares used to compute net income per common share:
               
Basic
   
5,197
     
5,335
 
Diluted
   
5,347
     
5,602
 
                 
Dividends declared per common share
  $
0.38
    $
0.34
 

The accompanying notes are an integral part of these condensed consolidated financial statements.
 
page 5

 
Bank of Marin Bancorp
 
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
 
for the three months ended September 30, 2007, June 30, 2007 and September 30, 2006
 
                   
(in thousands, except per share data - unaudited)
 
September 30, 2007
   
June 30, 2007
   
September 30, 2006
 
                   
Interest income
                 
Interest and fees on loans held in portfolio
  $
13,283
    $
13,027
    $
13,618
 
Interest on auto loans held for sale
   
---
     
954
     
---
 
Interest on investment securities
                       
U.S. Treasury securities
   
---
     
---
     
17
 
Securities of U.S. Government agencies
   
1,063
     
809
     
921
 
Obligations of state and political subdivisions (tax exempt)
   
129
     
111
     
118
 
Corporate debt securities and other
   
108
     
123
     
75
 
Interest on Federal funds sold and other short-term investments
   
1,247
     
415
     
126
 
Total interest income
   
15,830
     
15,439
     
14,875
 
                         
Interest expense
                       
Interest on interest bearing transaction accounts
   
74
     
74
     
70
 
Interest on savings and money market deposits
   
3,882
     
3,778
     
3,151
 
Interest on time deposits
   
877
     
882
     
976
 
Interest on borrowed funds
   
209
     
227
     
260
 
Total interest expense
   
5,042
     
4,961
     
4,457
 
                         
Net interest income
   
10,788
     
10,478
     
10,418
 
Provision for loan losses
   
200
     
75
     
287
 
Net interest income after provision for loan losses
   
10,588
     
10,403
     
10,131
 
                         
Non-interest income
                       
Service charges on deposit accounts
   
325
     
321
     
259
 
Wealth Management Services
   
331
     
298
     
271
 
Net gain on indirect auto and Visa portfolios
   
387
     
190
     
---
 
Other income
   
543
     
584
     
466
 
Total non-interest income
   
1,586
     
1,393
     
996
 
                         
Non-interest expense
                       
Salaries and related benefits
   
3,938
     
4,163
     
3,732
 
Occupancy and equipment
   
716
     
729
     
741
 
Depreciation and amortization
   
318
     
310
     
261
 
Data processing
   
411
     
425
     
422
 
Professional Services
   
536
     
384
     
343
 
Other expense
   
1,007
     
1,019
     
1,086
 
Total non-interest expense
   
6,926
     
7,030
     
6,585
 
                         
Income before provision for income taxes
   
5,248
     
4,766
     
4,542
 
                         
Provision for income taxes
   
2,059
     
1,863
     
1,437
 
Net income
  $
3,189
    $
2,903
    $
3,105
 
                         
Net income per common share:
                       
Basic
  $
0.62
    $
0.56
    $
0.57
 
Diluted
  $
0.60
    $
0.54
    $
0.55
 
                         
Weighted average shares used to compute net income per common share:
                       
Basic
   
5,172
     
5,187
     
5,430
 
Diluted
   
5,301
     
5,329
     
5,630
 
                         
Dividends declared per common share
  $
0.13
    $
0.13
    $
0.12
 

The accompanying notes are an integral part of these condensed consolidated financial statements.
 
 
Bank of Marin Bancorp
 
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
 
for the year ended December 31, 2006 and the nine months ended September 30, 2007
 
   
Common Stock
   
Retained
   
Accumulated Other
Comprehensive
Gain (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
 
Cumulative-effect adjustment of adoption of SFAS No.159
   
---
     
---
      (1,452 )    
---
      (1,452 )
Comprehensive income:
                                       
Net income
   
---
     
---
     
9,066
     
---
     
9,066
 
Other comprehensive income
                                       
Net change in unrealized loss on available for sale securities (net of tax liability of $211)
   
---
     
---
     
---
     
292
     
292
 
Comprehensive income
   
---
     
---
     
9,066
     
292
     
9,358
 
Stock options exercised
   
112,128
     
1,614
     
---
     
---
     
1,614
 
Tax benefit from exercised stock options
   
---
     
728
     
---
     
---
     
728
 
Stock repurchased, including commission costs
    (314,091 )     (11,931 )    
---
     
---
      (11,931 )
Stock issued under employee stock purchase plan
   
104
     
3
     
---
     
---
     
3
 
Stock-based compensation
   
---
     
379
                     
379
 
Cash dividends paid
   
---
     
---
      (1,977 )    
---
      (1,977 )
Stock issued in payment of director fees
   
9,590
     
328
     
---
     
---
     
328
 
Balance at September 30, 2007
   
5,174,147
    $
52,476
    $
34,397
    $ (298 )   $
86,575
 

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

 
Bank of Marin Bancorp
 
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
 
for the nine months ended September 30, 2007 and 2006
 
             
(in thousands - unaudited)
 
September 30, 2007
   
September 30, 2006
 
             
Cash Flows from Operating Activities:
           
Net income
  $
9,066
    $
8,656
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
   
340
     
789
 
Compensation payable in common stock
   
193
     
353
 
Stock-based compensation expense
   
379
     
428
 
Excess tax benefits from exercised stock options
    (534 )     (1,137 )
Amortization and accretion of investment security premiums, net
   
142
     
448
 
Depreciation and amortization
   
929
     
704
 
Net gain on indirect auto and Visa portfolios
    (1,097 )    
---
 
Gain on sale of equipment
   
---
      (8 )
Net change in operating assets and liabilities:
               
Interest receivable
   
139
     
129
 
Interest payable
   
125
     
181
 
Deferred rent and other rent-related expenses
   
83
     
135
 
Other assets
   
707
      (2,408 )
Other liabilities
   
2,454
     
826
 
Total adjustments
   
3,860
     
440
 
Net cash provided by operating activities
   
12,926
     
9,096
 
                 
Cash Flows from Investing Activities:
               
Purchase of securities held-to-maturity
    (2,056 )     (1,087 )
Purchase of securities available-for-sale
    (24,445 )     (7,976 )
Proceeds from paydowns/maturity of:
               
Securities held-to-maturity
   
2,590
     
6,570
 
Securities available-for-sale
   
15,024
     
11,708
 
Proceeds from sale of indirect auto and Visa loans
   
78,599
     
---
 
Loans originated and principal collected, net
    (47,334 )     (26,364 )
Purchase of bank owned life insurance policies
   
---
      (1,159 )
Proceeds from disposition of assets
   
---
     
12
 
Additions to premises and equipment
    (502 )     (2,265 )
Net cash provided by (used in) investing activities
   
21,876
      (20,561 )
                 
Cash Flows from Financing Activities:
               
Net increase in deposits
   
72,717
     
21,046
 
Proceeds from stock options exercised
   
1,614
     
2,964
 
Net decrease in Federal Funds purchased and Federal Home Loan Bank borrowings
    (24,100 )     (800 )
Common stock repurchased
    (11,931 )    
---
 
Dividends paid in cash
    (1,977 )     (1,796 )
Stock issued under employee stock purchase plan
   
3
     
---
 
Cash paid for fractional shares
   
---
      (27 )
Excess tax benefits from exercised stock options
   
534
     
1,137
 
Net cash provided by financing activities
   
36,860
     
22,524
 
                 
Net increase in cash and cash equivalents
   
71,662
     
11,059
 
                 
Cash and cash equivalents at beginning of period
   
38,783
     
22,262
 
                 
Cash and cash equivalents at end of period
  $
110,445
    $
33,321
 
   
Supplemental disclosure of cash flow information:
               
Cash paid for interest
  $
14,751
    $
12,477
 
Cash paid for income taxes
  $
2,418
    $
4,145
 
 
Non-Cash Transactions: The nine months ended September 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 nine months ended September 30, 2006 included non-cash increases to both fixed assets and other liabilities representing tenant improvements paid for by the landlord for the Bank's administrative facility totaling $617 thousand. This amount is amortized over the fifteen-year term of the lease.

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


Bank of Marin Bancorp


NOTES TO CONDENSED CONSOLIDATED 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 (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 information contained in the financial statements and accompanying footnotes for periods subsequent to the reorganization relate to consolidated Bank of Marin Bancorp. Periods prior to the reorganization relate to Bank of Marin only. The information is comparable for all periods as the sole subsidiary of Bancorp is the Bank.

The condensed consolidated financial statements include the accounts of Bancorp and its wholly-owned bank subsidiary. All material intercompany transactions have been eliminated. In the opinion of Management, the unaudited interim consolidated financial statements contain all adjustments necessary to present fairly the financial position, results of operations, changes in stockholders' equity and cash flows. 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 Notes 2 and 3 below.

Certain information and footnote disclosures presented in the annual financial statements are not included in the interim consolidated financial statements.  Accordingly, the accompanying unaudited interim condensed consolidated 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 nine months ended September 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
   
Nine months ended
 
(in thousands)
 
Sept. 30, 2007
   
June 30, 2007
   
Sept. 30, 2006
   
Sept. 30, 2007
   
Sept. 30, 2006
 
Weighted average basic shares outstanding
   
5,172
     
5,187
     
5,430
     
5,197
     
5,335
 
Add: Potential common shares related to stock options
   
129
     
142
     
200
     
150
     
267
 
Weighted average diluted shares outstanding
   
5,301
     
5,329
     
5,630
     
5,347
     
5,602
 
Anti-dilutive shares not included in the calculation of diluted earnings per share
   
187
     
67
     
150
     
60
     
75
 
                                         
Net income
  $
3,189
    $
2,903
    $
3,105
    $
9,066
    $
8,656
 
Earnings per share (basic)
  $
0.62
    $
0.56
    $
0.57
    $
1.74
    $
1.62
 
Earnings per share (diluted)
  $
0.60
    $
0.54
    $
0.55
    $
1.70
    $
1.55
 


Note 2: Recently Issued Accounting Standards

In September 2006, the FASB issued SFAS No. 157, which 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 and is effective for fiscal years beginning after November 15, 2007, with early adoption allowed effective January 1, 2007 in conjunction with the early adoption of SFAS No. 159. The adoption of SFAS No. 157 effective January 1, 2007 did not impact financial position or results of operations.

On February 15, 2007, the FASB released SFAS No. 159, which permits entities to choose to measure eligible financial instruments at fair value at specified election dates. Under SFAS No. 159 an entity records unrealized gains and losses in earnings on items for which the fair value option has been elected at each subsequent reporting date.  The objective is to mitigate volatility in reported earnings without having to apply complex hedge accounting provisions. The provisions of SFAS No. 159 are effective for fiscal years ending on or after November 15, 2007, with early adoption allowed effective January 1, 2007.


Bank of Marin Bancorp


Effective January 1, 2007, the Bank elected early adoption of SFAS No. 159. Upon adoption, 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 No. 159 see Note 3 below.

In July 2006, the FASB issued Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109,” which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 establishes a “more-likely-than-not” recognition threshold that must be met before a tax benefit can be recognized in the financial statements. For tax positions that meet the more-likely-than-not threshold, an enterprise may recognize only the largest amount of tax benefit that is greater than fifty percent likely of being realized upon ultimate settlement with the taxing authority. The cumulative effect of applying the provisions of FIN 48 would be recognized as an adjustment to the beginning balance of retained earnings. FIN 48 was adopted January 1, 2007 and has not had a material impact on financial condition or results of operations.

In September 2006, the Emerging Issues Task Force (EITF) reached a final consensus on Issue No. 064-4 (EITF 06-4), “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.” EITF 06-4 requires employers to recognize a liability for future benefits provided through endorsement split-dollar life insurance arrangements that extend into postretirement periods in accordance with SFAS No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions or APB Opinion No. 12, Omnibus Opinion-1967.  The provisions of EITF 06-4 become effective on January 1, 2008 and are to be applied as a change in accounting principle either through a cumulative-effect adjustment to retained earnings or other components of equity or net assets in the statement of financial position as of the beginning of the year of adoption, or through retrospective application to all prior periods. The Bank’s split-dollar life insurance benefits are limited to the employee’s active service period.  Therefore it is expected that EITF 06-4 will have no impact on financial condition or results of operations.

In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and OtherPostretirement Plans, an amendment of FASB Statements Nos. 87, 88, 106 and 132(R). SFAS No. 158 requires employers to recognize the underfunded or overfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through accumulated other comprehensive income.  Additionally, SFAS No. 158 requires employers to measure the funded status of a plan as of the date of its year-end statement of financial position.  The new reporting requirements and related new footnote disclosure rules of SFAS No. 158 are effective for fiscal years ending after December 15, 2006.  The new measurement date requirement applies for fiscal years ending after December 15, 2008. As the Bank has no pension or other post-retirement benefit plans, it is expected that SFAS No. 158 will have no impact on financial condition or results of operations.

Note 3:  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 on specified election dates.


Bank of Marin Bancorp


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 September 30, 2007.

(Dollars in thousands)
                       
Description of Financial Instruments
 
Sept. 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
  $
85,076
    $
85,076
    $
---
    $
---
 
Derivative financial instruments (assets)
   
174
     
---
     
174
     
---
 
Total assets
  $
85,250
    $
85,076
    $
174
    $
---
 
                                 
Derivative financial instruments (liabilities)
  $
265
    $
---
    $
265
    $
---
 

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.  The variable rates and discount rates are derived from LIBOR cash and swap rates.  LIBOR, rather than risk free rates, are used to adjust for the inherent credit risk associated with high quality counterparties. 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.

The following table presents a computation of the net change to 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 cumulative effect of adoption of the fair value option
            (2,499 )          
Increase in deferred tax asset
           
1,047
           
Cumulative effect of adoption of the fair value option (charged 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.


Bank of Marin Bancorp


Note 4:  Allowance for Loan Losses and Non Accrual Loans

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

Activity in the allowance for loan losses follows:

   
Three months ended
   
Nine months ended
 
(in thousands - unaudited)
 
Sept. 30, 2007
   
June 30, 2007
   
Sept. 30, 2006
   
Sept. 30, 2007
   
Sept. 30, 2006
 
Beginning balance
  $
7,053
    $
7,042
    $
7,519
    $
8,023
    $
7,115
 
Cumulative-effect adjustment of adoption of SFAS No. 159
   
---
     
---
     
---
      (1,048 )    
---
 
Provision for loan loss charged to expense
   
200
     
75
     
287
     
340
     
789
 
Loans charged off
    (33 )     (77 )     (150 )     (111 )     (316 )
Loan loss recoveries
   
7
     
13
     
74
     
23
     
142
 
Ending balance
  $
7,227
    $
7,053
    $
7,730
    $
7,227
    $
7,730
 
                                         
Total loans held in portfolio at end of period, before deducting allowance for loan losses
  $
685,975
    $
653,924
    $
712,851
    $
685,975
    $
712,851
 
Ratio of allowance for loan losses to loans held in portfolio
    1.05 %     1.08 %     1.08 %     1.05 %     1.08 %
Nonaccrual loans at period end
  $
150
    $
5
    $
4,374
    $
150
    $
4,374
 


At December 31, 2006, non-accrual loans totaled $49 thousand.  At September 30, 2006, non-accrual loans totaled $4.4 million, including one commercial loan for $2.3 million which was sold in the fourth quarter of 2006, and one commercial real estate loan for $2.0 million for which the principal and related interest were fully paid in the fourth quarter of 2006.

The gross interest income that would have been recorded, had non-accrual loans been current, totaled $3 thousand for the third quarter of 2007. The amount was less than $1 thousand for the second quarter of 2007, and totaled $116 thousand for the third quarter of 2006. The uncollected interest income was $8 thousand for the nine months ended September 30, 2007 and $261 thousand for the nine months ended September 30, 2006.

Note 5:  Stockholders’ Equity

On the Effective Date, the bank holding company reorganization was completed and the Bank repurchased a total of 24,399 common shares of the Bank for $876 thousand from six shareholders who dissented to the exchange of these shares for Bancorp common stock.

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 effective January 1, 2007. See Note3.

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 up to 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 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.


Bank of Marin Bancorp

A summary of cash dividends paid to shareholders, which are recorded as a reduction of retained earnings, is presented below.

 
 
Three months ended
   
Nine months ended
 
(in thousands except per share data - unaudited)
 
Sept. 30, 2007
   
June 30, 2007
   
Sept. 30, 2006
   
Sept. 30, 2007
   
Sept. 30, 2006
 
Cash dividends
  $
672
    $
680
    $
655
    $
1,977
    $
1,796
 
Cash dividends per share
  $
0.13
    $
0.13
    $
0.12
    $
0.38
    $
0.34
 
 
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. Each right entitled the registered holder to purchase from Bank one one-hundredth of a share of Series A Junior Participating Preferred stock, no par value of Bank at a price of $125 per one one-hundredth of a preferred share, subject to adjustments. 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 to purchase shares of Bancorp 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 the exercise of non-qualified stock options and on the disqualifying disposition of incentive stock options, which are accounted for as an addition to common stock with a corresponding decrease in accrued taxes payable. See Note 6 for further information on accounting for stock options and share-based payments.

Stock-based compensation also includes compensation expense related to the Employee Stock Purchase Plan, which was implemented in the third quarter of 2007, whereby employees may purchase common shares of Bancorp at a five percent discount.  The discount amount is recorded as an expense at the time of the purchase, with a corresponding increase in common stock.

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

   
Three months ended
   
Nine months ended
 
(in thousands - unaudited)
 
Sept. 30, 2007
   
June 30, 2007
   
Sept. 30, 2006
   
Sept. 30, 2007
   
Sept. 30, 2006
 
Stock-based compensation
  $
124
    $
133
    $
145
    $
379
    $
428
 
Tax benefits on exercised options
  $
4
    $
126
    $
181
    $
728
    $
1,137
 
 
Note 6: Stock Option and Repurchase Plans

Effective July 1, 2007, Bank of Marin Bancorp adopted an Employee Stock Purchase Plan whereby employees of Bancorp and its subsidiary may purchase Bancorp common shares through payroll deductions of between one percent and fifteen percent of pay in each pay period.  Shares are purchased quarterly at a five percent discount from the closing market price on the last day of the quarter.  The plan calls for 200,000 common shares to be set aside for employee purchases.

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 now relate to shares of common stock of Bank of Marin Bancorp. All new stock-based compensation awards from the approval date forward 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.


Bank of Marin Bancorp


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. 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.

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 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.

A summary of activity for the Bank’s options for the first three quarters of 2007 is presented below.

                     
Weighted
 
                     
Average
 
               
Aggregate
   
Remaining
 
         
Weighted
   
Intrinsic
   
Contractual
 
   
Number of
   
Average
   
Value
   
Term
 
   
Shares
   
Exercise Price
   
(in thousands)
   
(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
 
                                 
For the quarter ending September 30, 2007:
                               
                                 
Options outstanding at June 30, 2007
   
488,415
   
$
23.61
     
---
     
---
 
Granted
   
---
     
---
     
---
     
---
 
Cancelled/forfeited
    (2,460 )    
31.66
     
---
     
---
 
Exercised
    (3,612 )    
15.19
   
$
60
     
---
 
Options outstanding at September 30, 2007
   
482,343
           
$
4,429
     
5.7
 
Exercisable (vested) at  September 30, 2007
   
321,740
   
$
18.86
   
$
4,346
     
4.4
 
 

Bank of Marin Bancorp


As of September 30, 2007 there was $1.1 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 15.1 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.

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

   
Nine months ended
   
Year ended
 
 
 
September 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 7: 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 $225.8 million at September 30, 2007.  This amount included $129.2 million under commercial lines of credit (these commitments are contingent upon customers maintaining specific credit standards), $59.4 million under revolving home equity lines and $29.8 million under undisbursed construction loans.  The Bank has set aside an allowance for losses in the amount of $452 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 8: 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.


Bank of Marin Bancorp


During the third 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.

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:

   
Fair Value
   
Fair Value
       
   
Swap
   
Swap
       
(in thousands)
 
(Shortcut Accounting Treatment)
   
(Non-shortcut Accounting Treatment)
   
Yield Maintenance Agreement
 
At September 30, 2007:
                 
Notional or contractual amount
  $
7,289
    $
8,300
    $
---
 
Credit risk amount (1)
   
174
     
---
     
---
 
Estimated net fair value
   
174
      (265 )    
66
 
                         
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
   
Nine months ended
 
   
Sept. 30, 2007
   
June 30, 2007
   
Sept. 30, 2006
   
Sept. 30, 2007
   
Sept. 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
    5.47 %     5.32 %     5.35 %     5.37 %     4.97 %
                                         
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
    5.44 %     5.32 %     5.35 %     5.41 %     4.97 %
                                         
Yield maintenance agreement
                                       
Weighted average receive rate (2)
    5.15 %     5.15 %     5.15 %     5.15 %     5.15 %
                                         
(Loss) gain on designated and undesignated interest rate contracts
  $ (500 )   $
482
    $ (630 )   $ (16 )   $ (201 )
Increase (decrease) in value of designated loans and yield maintenance agreement qualifying as derivatives
   
491
      (483 )    
630
     
6
     
201
 
Net (loss) gain on derivatives used to hedge loans recorded in income
  $ (9 )   $ (1 )   $
---
    $ (10 )   $
---
 

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%.
 
Ineffectiveness of ($9) thousand and ($10) thousand was recorded in interest income during the three and nine months ended September 30, 2007.  The full change in value of swaps was included in the assessment of hedge effectiveness.


Bank of Marin Bancorp


Note 9: Condensed Bank of Marin Bancorp Unconsolidated Financial Statements

Presented below is financial information for Bank of Marin Bancorp, holding company only, subsequent to its formation on July 1, 2007. See Note 1.

CONDENSED UNCONSOLIDATED STATEMENT OF CONDITION
 
at September 30, 2007
 
       
(in thousands - unaudited)
 
September 30, 2007
 
       
Assets
     
Cash and due from Bank of Marin
  $
1,091
 
Investment in subsidiary
   
85,380
 
Other assets
   
125
 
Total assets
  $
86,596
 
         
Liabilities and Stockholders' Equity
       
Accrued expenses payable
  $
20
 
Intercompany payable
   
1
 
Total liabilities
   
21
 
Stockholders' equity
   
86,575
 
Total liabilities and stockholders' equity
  $
86,596
 


CONDENSED UNCONSOLIDATED STATEMENT OF OPERATIONS
 
for the three months ended September 30, 2007
 
       
(in thousands - unaudited)
 
September 30, 2007
 
       
Income
     
Dividends from bank subsidiary
  $
2,000
 
Total income
   
2,000
 
         
Expense
       
Non-interest expense
   
228
 
Total expense
   
228
 
         
Income before income taxes and equity in undistributed net income of subsidiary
   
1,772
 
Income tax benefit
   
95
 
Income before equity in undistributed net income of subsidiary
   
1,867
 
Equity in undistributed net income of subsidiary
   
1,322
 
         
Net income
  $
3,189
 
 

Bank of Marin Bancorp

CONDENSED UNCONSOLIDATED STATEMENT OF CASH FLOWS
 
for three months ended September 30, 2007
 
       
(in thousands - unaudited)
 
September 30, 2007
 
       
Cash Flows from Operating Activities:
     
Net income
  $
3,189
 
Adjustments to reconcile net income to net cash provided by operating activities:
       
Equity in undistrubuted net income of subsidiary
    (1,322 )
Net change in operating assets and liabilities
       
Other assets
    (125 )
Other liabilities
   
20
 
Intercompany payable
   
1
 
Net cash provided by operating activities