In the following pages, Management discusses its analysis of the financial condition and results of operations for the third quarter of 2009 compared to the third quarter of 2008 and to the prior quarter (second quarter of 2009) as well as the nine-month period ended September 30, 2009 compared to the same period in 2008. This discussion should be read in conjunction with the related consolidated financial statements in this Form 10-Q and with the audited consolidated financial statements and accompanying notes included in our 2008 Annual Report. Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances.

Forward-Looking Statements

This 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.

Our 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 our earnings in future periods. A number of factors-many of which are beyond Management's control-could cause future results to vary materially from current Management expectations. Such factors include, but are not limited to, general economic conditions; the current financial turmoil in the U.S. and abroad; 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 our operations, pricing, products and services. These and other important factors are detailed in the Risk Factors section of our 2008 Form 10-K as filed with the SEC, copies of which are available from us at no charge. Forward-looking statements speak only as of the date they are made. We do not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events.

Executive Summary

We produced healthy financial results in the first nine months of 2009 and continued to focus on our customer relationships which led to higher deposits, a core funding source for our steady loan growth. We have also expanded our franchise by opening a branch in Greenbrae, California in September 2009.

We reported third-quarter 2009 earnings of $3.6 million, up $906 thousand, or 33.6%, from the same period a year ago, and up $468 thousand, or 14.9% from the second quarter of 2009. Diluted earnings per common share in the third quarter of 2009 were $0.68, up sixteen cents, or 30.8% from the third quarter of 2008, and up eight cents, or 13.3% from the second quarter of 2009. Earnings for the nine-month period ended September 30, 2009 totaled $10.0 million, an increase of $606 thousand, or 6.5%, over the same period a year ago. Diluted earnings per share for the nine-month period ended September 30, 2009 totaled $1.66, compared to $1.79 for the same period a year ago. The earnings per common share for the nine-month period ended September 30, 2009 were reduced by $0.25 as a result of the non-recurring accelerated accretion of the redemption premium resulting from our early repurchase of the preferred stock, and dividends on the preferred stock. Further, earnings reflected a special assessment imposed by the Federal Deposit Insurance Corporation ("FDIC") on all banks in the second quarter of 2009, which resulted in $496 thousand in additional expense and reduced diluted earnings per share by $0.06 for the nine-month period ended September 30, 2009.

Gross loans increased $29.3 million, or 3.3%, over December 31, 2008 and totaled $919.8 million at September 30, 2009. The mix of loans reflects an increase in the percentage of home equity lines of credit to total loans, as well as a decrease in construction loans.

While the U.S. economy showed some signs of improvement during the second and third quarter of 2009, consumers continue to experience high levels of financial stress from an increased unemployment rate as well as continued declines in home prices. These factors have impacted the markets we serve. Our customers are also affected by further reductions in spending by consumers and businesses. In the quarters ended September 30, 2009, June 30, 2009 and September 30, 2008, our loan loss provision totaled $1.1 million, $700 thousand and $1.7 million, respectively, and net charge-offs totaled $117 thousand, $854 thousand, and $969 thousand in the same periods, respectively. The allowance for loan losses as a percentage of loans totaled 1.21% at September 30, 2009 compared to 1.12% at December 31, 2008. Non-accrual loans totaled $6.0 million, or 0.7%, of the Bank's loan portfolio at September 30, 2009, compared to $6.7 million, or 0.8%, at December 31, 2008.

We have been focusing on improving our core funding mix by generating low cost deposits though our dedicated team of bankers, and those efforts have produced growth of $97.0 million or 11.4% in deposits from 2008 year-end. Core deposit growth has provided valuable low-cost liquidity to support our asset growth.

Net interest income of $13.3 million in the quarter ended September 30, 2009 increased $1.0 million, or 8.3%, from the same period last year, and the year-to-date amount for 2009 increased $3.7 million, or 10.3% from the same period last year. The increases reflect growth in interest-earning assets and a reduced cost of funds, partially offset by decreased loan yields primarily due to a lower-rate environment. The tax-equivalent net interest margin was 5.18% in the third quarter of 2009 compared to 5.35% in the third quarter of 2008 and 5.16% in the first nine months of 2009 compared to 5.43% in the first nine months of 2008. Decreases in the tax-equivalent net interest margin were primarily due to the downward re-pricing of our loan portfolio in a declining rate environment and to a lesser extent, interest foregone on non-accrual loans (representing a nine-basis point and an eight-basis point impact on the net interest margin in the quarter and nine months ended September 30, 2009, respectively).

The third quarter efficiency ratio improved to 53.02%, down from 55.11% in the same quarter last year and 60.11% in the preceding quarter, reflecting the expansion of net interest income mentioned above. The decrease in the efficiency ratio from the prior quarter also benefited from the decrease in non-interest expenses, mainly due to the absence of the FDIC special assessment and ACH operational losses included in the second quarter of 2009.

Non-interest income totaled $1.3 million in the third quarter of 2009, an increase of $137 thousand or 11.5% from the same period last year. Excluding a pre-tax non-recurring gain of $457 thousand recorded in the first quarter of 2008 related to the mandatory redemption of a portion of our shares in Visa Inc., non-interest income of $3.8 million for the first nine months of 2009 increased modestly by 3.3% from the same period last year.

Non-interest expense totaled $7.8 million in the third quarter of 2009 and $23.9 million in the first nine months of 2009. Non-interest expense for the first nine months of 2008 included a reversal of a pre-tax charge of $242 thousand that was originally recorded in the fourth quarter of 2007, for the potential obligation to Visa Inc. in connection with certain litigation indemnifications provided to Visa Inc. by Visa member banks. Excluding this reversal of the $242 thousand litigation liability, non-interest expense in the first nine months of 2009 increased $2.1 million, or 9.7%, from the same period a year ago. The increase reflected $1.1 million more in FDIC premiums related to a significantly higher FDIC premium assessment rate (including a special assessment of five basis points on total assets minus Tier 1 capital as of June 30, 2009) and increased deposits levels. The increase also reflects higher personnel and occupancy costs associated with branch expansion, ACH operational losses, increased legal fees in connection with our participation and termination in the TCPP program, as well as costs associated with delinquent loans, partially offset by lower data processing and other professional costs.

Critical Accounting Policies

Critical accounting policies are those that are both most important to the portrayal of our financial condition and results of operations and require Management's most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Management has determined the following five accounting policies to be critical:
Allowance for Loan Losses, Other-than-temporary Impairment of Investment Securities, Share-Based Payment, Accounting for Income Taxes and Fair Value Measurements.

Allowance for Loan Losses

Allowance for loan losses is based upon estimates of loan losses and is maintained at a level considered adequate to provide for probable losses inherent in the outstanding loan portfolio. The allowance is increased by provisions charged to expense and reduced by net charge-offs. In periodic evaluations of the adequacy of the allowance balance, Management considers our past loan loss experience by type of credit, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, current economic conditions and other factors. We formally assess the adequacy of the allowance for loan losses on a quarterly basis. These assessments include the periodic re-grading of loans based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment, and other factors as warranted. Loans are initially graded when originated. They are reviewed as they are renewed, when there is a new loan to the same borrower and/or when identified facts demonstrate heightened risk of default. Management monitors delinquent loans continuously and identifies problem loans to be evaluated individually for impairment testing. For loans that are determined impaired, formal impairment measurement is performed at least quarterly on a loan-by-loan basis.

Our method for assessing the appropriateness of the allowance includes specific allowances for identified problem loans, an allowance factor for categories of credits, and allowances for changing environmental factors (e.g., portfolio trends, concentration of credit, growth, economic factors). Allowances for identified problem loans are based on specific analysis of individual credits. Loss estimation factors for loan categories are based on analysis of local economic factors applicable to each loan category. Allowances for changing environmental factors are Management's best estimate of the probable impact these changes have had on the loan portfolio as a whole.

Other-than-temporary Impairment of Investment Securities

At each financial statement date, we assess whether declines in the fair value of held-to-maturity and available-for-sale securities below their costs are deemed to be other than temporary. We consider, among other things, (i) the length of time and the extent to which the fair value has been less than cost,
(ii) the financial condition and near-term prospects of the issuer, and (iii) our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value. Evidence evaluated includes, but is not limited to, the remaining payment terms of the instrument and economic factors that are relevant to the collectability of the instrument, such as: current prepayment speeds, the current financial condition of the issuer(s), industry analyst reports, credit ratings, credit default rates, interest rate trends and the value of any underlying collateral. Credit-related other-than-temporary-impairment results in a charge to earnings and the corresponding establishment of a new cost basis for the security. Non-credit-related other-than-temporary impairment results in a charge to other comprehensive income, net of applicable taxes, and the corresponding establishment of a new cost basis for the security. The other-than-temporary impairment recognized in other comprehensive income for debt securities classified as held-to-maturity is accreted from other comprehensive income to the amortized cost of the debt security over the remaining life of the debt security in a prospective manner on the basis of the amount and timing of future estimated cash flows.

Share-Based Payment

We recognize all share-based payments, including stock options and non-vested restricted common shares, as an expense in the income statement based on the grant-date fair value of the award with a corresponding increase to common stock.

We determine the fair value of stock options at the 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, stock price volatility 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 (derived from historical data on employee exercise and post-vesting employment termination behavior) and stock price volatility (based on the historical volatility of the common stock). The estimates used in the model involve inherent uncertainties and the application of Management's judgment. As a result, if other assumptions had been used, our recorded stock-based compensation expense could have been materially different from that reflected in these financial statements. The fair value of non-vested restricted common shares generally equals the stock price at grant date. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those share-based awards expected to vest. If our actual forfeiture rate is materially different from the estimate, the share-based compensation expense could be materially different.

Accounting for Income Taxes

Income taxes reported in the financial statements are computed based on an asset and liability approach. We recognize the amount of taxes payable or refundable for the current year, and deferred tax assets and liabilities for the expected future tax consequences that have been recognized in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We record net deferred tax assets to the extent it is more likely than not that they will be realized. In evaluating our ability to recover the deferred tax assets, Management considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. In projecting future taxable income, Management develops assumptions including the amount of future state and federal pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates being used to manage the underlying business. Bancorp files consolidated federal and combined state income tax returns.

We recognize the financial statement effect of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. For tax positions that meet the more-likely-than-not threshold, we 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. Management believes that all of our tax positions taken meet the more-likely-than-not recognition threshold. To the extent tax authorities disagree with these tax positions, our effective tax rates could be materially affected in the period of settlement with the taxing authorities.

Fair Value Measurements

We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. We base our fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Securities available for sale, derivatives, and loans held for sale, if any, are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets on a non-recurring basis, such as certain impaired loans held for investment and securities held to maturity that are other-than-temporarily impaired. These non-recurring fair value adjustments typically involve application of lower-of-cost or market accounting or write-downs of individual assets.

We have established and documented a process for determining fair value. We maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. Whenever there is no readily available market data, Management uses its best estimate and assumptions in determining fair value, but these estimates involve inherent uncertainties and the application of Management's judgment. As a result, if other assumptions had been used, our recorded earnings or disclosures could have been materially different from those reflected in these financial statements. For detailed information on our use of fair value measurements and our related valuation methodologies, see Note 3 of the Notes to Consolidated Financial Statements in this Form 10-Q.

                             BANK OF MARIN BANCORP

RESULTS OF OPERATIONS

Overview

Highlights of the financial results are presented in the following table:


(dollars in thousands, except per
share data;                                    As of and for the three months ended                As of and for the nine months ended
                                         September 30,         June 30,       September 30,           September 30,          September 30,
unaudited)                                        2009             2009                2008                    2009                   2008
For the period:
Net income                             $         3,601      $     3,133     $         2,695     $             9,963       $          9,357
Net income per share
Basic                                  $          0.69      $      0.61     $          0.53     $              1.68       $           1.82
Diluted                                $          0.68      $      0.60     $          0.52     $              1.66       $           1.79
Return on average assets                          1.29 %           1.16 %              1.10 %                  1.23 %                 1.35 %
Return on average equity                         13.46 %          12.25 %             11.37 %                 11.89 %                13.55 %
Common stock dividend payout ratio               20.29 %          22.95 %             26.42 %                 25.00 %                23.08 %
Average equity to average asset
ratio                                             9.57 %           9.51 %              9.70 %                 10.34 %                 9.94 %
Efficiency ratio                                 53.02 %          60.11 %             55.11 %                 55.63 %                54.39 %
At period end:
Book value per common share            $         20.55      $     19.90     $         18.43     $             20.55       $          18.43
Total assets                           $     1,126,529      $ 1,094,359     $       984,739     $         1,126,529       $        984,739
Total loans                            $       919,844      $   909,614     $       839,007     $           919,844       $        839,007
Total deposits                         $       949,291      $   922,605     $       849,228     $           949,291       $        849,228
Loan-to-deposit ratio                             96.9 %           98.6 %              98.8 %                  96.9 %                 98.8 %

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 incurred on deposits and other interest-bearing liabilities. Net interest income is impacted by changes in general market interest rates and by changes in the amounts and composition of interest-earning assets and interest-bearing liabilities. Interest rate changes can create fluctuations in the net interest margin due to an imbalance in the timing of repricing or maturity of assets or liabilities. We manage interest rate risk exposure with the goal of minimizing the impact of interest rate volatility on net interest margin.

Net interest margin is expressed as net interest income divided by average interest-earning assets. Net interest rate spread is the difference between the average rate earned on total interest-earning assets and the average rate incurred on total interest-bearing liabilities. Both of these measures are reported on a taxable-equivalent basis. Net interest margin is the higher of the two because it reflects interest income earned on assets funded with non-interest-bearing sources of funds, which include demand deposits and stockholders' equity.

The following table, Distribution of Average Statements of Condition and Analysis of Net Interest Income, compares interest income and interest-earning assets with interest expense and interest-bearing liabilities for the periods presented. The table also indicates net interest income, net interest margin and net interest rate spread for each period presented.

      Average Statements of Condition and Analysis of Net Interest Income

                                          Three months ended                         Three months ended                        Three months ended
                                          September 30, 2009                           June 30, 2009                           September 30, 2008
                                                 Interest                                   Interest                                 Interest
(Dollars in thousands;              Average       Income/       Yield/         Average       Income/       Yield/       Average       Income/       Yield/
unaudited)                          Balance       Expense         Rate         Balance       Expense         Rate       Balance       Expense         Rate
Assets
Federal funds sold and other
short-term investments          $       223     $       1         0.23 %   $     6,604     $       3         0.18 %   $   5,065     $      25         1.93 %
Investment securities
U.S. Government agencies (1)         67,514           794         4.70 %        68,915           809         4.70 %      71,726           892         4.95 %
Other (1)                             9,403           176         7.49 %         5,644           115         8.15 %       5,697            91         6.35 %
Obligations of state and
political subdivisions (2)           30,558           433         5.67 %        30,389           436         5.74 %      20,184           282         5.56 %
Loans and banker's
acceptances (2) (3)                 916,177        13,924         5.95 %       909,298        13,687         5.95 %     819,886        13,833         6.71 %
Total interest-earning assets     1,023,875        15,328         5.86 %     1,020,850        15,050         5.83 %     922,558        15,123         6.52 %
Cash and due from banks              51,316                                     23,960                                   23,248
Bank premises and equipment,
net                                   8,193                                      7,959                                    8,699
Interest receivable and other
assets, net                          25,550                                     26,150                                   17,530
Total assets                    $ 1,108,934                                $ 1,078,919                                $ 972,035
Liabilities and Stockholders'
Equity
Interest-bearing transaction
accounts                        $    90,448     $      31         0.14 %   $    93,706     $      31         0.13 %   $  78,650     $      93         0.47 %
Savings and money market
accounts                            444,423           821         0.73 %       420,629           817         0.78 %     459,633         1,833         1.59 %
Time accounts                       100,157           378         1.50 %        97,530           397         1.63 %      82,992           562         2.69 %
CDARS® reciprocal deposits           54,923           186         1.34 %        52,534           183         1.40 %       7,640            50         2.60 %
Purchased funds                      55,000           323         2.33 %        68,363           328         1.92 %      22,484           110         1.95 %
Subordinated debenture                5,000            41         3.21 %         5,000            48         3.80 %       5,000            69         5.40 %
Total interest-bearing
liabilities                         749,951         1,780         0.94 %       737,762         1,804         0.98 %     656,399         2,717         1.65 %
Demand accounts                     243,950                                    228,861                                  213,618
Interest payable and other
liabilities                           8,899                                      9,686                                    7,730
Stockholders' equity                106,134                                    102,610                                   94,288
. . .