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BMRC > SEC Filings for BMRC > Form 10-Q on 12-Nov-2013All Recent SEC Filings

Show all filings for BANK OF MARIN BANCORP



Quarterly Report

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

In the following pages, Management discusses its analysis of the financial condition and results of operations for the third quarter of 2013 compared to the third quarter of 2012 and to the second quarter of 2013, as well as the nine months ended September 30, 2013 compared to the same period in 2012. 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 2012 Annual Report on Form 10-K. 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 economic uncertainty in the United States and abroad, changes in interest rates, deposit flows, real estate values, expected future cash flows on acquired loans, 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.

The events or factors that could cause results or performance to materially differ from those expressed in our prior forward-looking statements concerning the NorCal acquisition include:

lower than expected consolidated revenues for us;

higher than expected acquisition related costs;

losses of deposit and loan customers resulting from the acquisition;

greater than expected operating costs and/or loan losses;

significant increases in competition;

            the inability to achieve expected cost savings from the acquisition,
             or the inability to achieve those savings as soon as expected; and

            unexpected costs and difficulties in adapting to technological
             changes and integrating systems.

These and other important factors are detailed in the Risk Factors section of the Form 10-Q for the quarter ended June 30, 2013 and in the Risk Factors section of our 2012 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.



Highlights of the financial results are presented in the following table:
                                                For the three months ended                                   For the nine months ended
(dollars in thousands,
except per share                                                                                     September 30,
 data; unaudited)            September 30, 2013       June 30, 2013       September 30, 2012             2013            September 30, 2012
For the period:
Net income                 $              4,004     $         3,055     $              3,224       $        11,925     $             13,115
Net income per share
Basic                      $               0.74     $          0.56     $               0.60       $          2.20     $               2.46
Diluted                    $               0.72     $          0.55     $               0.59       $          2.16     $               2.41
Return on average equity                   9.91   %            7.72   %                 8.76   %             10.09   %                12.32   %
Return on average assets                   1.07   %            0.86   %                 0.89   %              1.10   %                 1.23   %
Common stock dividend
payout ratio                              24.52   %           32.06   %                29.95   %             24.59   %                21.23   %
Average shareholders'
equity to average total
assets                                    10.79   %           11.20   %                10.16   %             10.94   %                 9.97   %
Efficiency ratio                          63.19   %           64.12   %                57.38   %             61.49   %                55.25   %
 Tax equivalent net
interest margin                            3.99   %            4.30   %                 4.44   %              4.25   %                 4.78   %

At period end:
Book value per common
share                      $              29.61     $         29.10     $              27.45
Total assets               $          1,483,603     $     1,428,518     $          1,435,114
Total loans                $          1,092,851     $     1,091,482     $          1,013,710
Total deposits             $          1,292,476     $     1,224,437     $          1,258,873
Loan-to-deposit ratio                      84.6   %            89.1   %                 80.5   %
Total risk based capital
ratio - Bancorp                            14.1   %            14.0   %                 14.0   %

Executive Summary

On July 1, 2013, we entered into a definitive agreement to acquire NorCal Community Bancorp, parent company of Bank of Alameda. Bank of Alameda has four branch offices serving Alameda, Emeryville, and Oakland, and had assets of $271.5 million, total deposits of $237.2 million, and total loans of $177.3 million as of September 30, 2013. We have all the necessary regulatory approvals. NorCal shareholders gave their approval on October 17, 2013. The thirty day election process whereby NorCal shareholders will elect to receive cash, shares of Bancorp common stock or a combination in exchange for their NorCal shares began on October 22, 2013. The transaction is on schedule to close in the fourth quarter of 2013. For more information concerning the transaction, please see the S-4 filed with the Securities and Exchange Commission ("SEC") on August 23, 2013, and 8-K Reports filed with the SEC on July 1 and July 5, 2013. For other important factors regarding the NorCal acquisition, please see the Forward Looking Statements and Risk Factors sections of the Form 10-Q for the quarter ended June 30, 2013.

Earnings totaled $4.0 million for the third quarter of 2013, compared to $3.1 million in the second quarter of 2013 and $3.2 million in the third quarter of 2012. Diluted earnings per share totaled $0.72 in the third quarter of 2013, compared to $0.55 in the prior quarter and $0.59 in the same quarter last year. Earnings for the nine months ended September 30, 2013 totaled $11.9 million compared to $13.1 million in the same period a year ago. Diluted earnings per share for the nine-month period ended September 30, 2013 totaled $2.16 compared to $2.41 in the same period a year ago.

We recorded a reversal in the provision for loan losses totaling $480 thousand in the third quarter of 2013, compared to a provision for loan losses of $1.1 million in the prior quarter and $2.1 million in the same quarter a year ago. The reversal in the provision in the third quarter of 2013 primarily related to improved collateral values, a continued low level of net charge-offs and fewer newly identified non-performing loans.

Gross loans totaled $1.1 billion at September 30, 2013, up $18.9 million or 1.8% when compared to December 31, 2012. The current competitive banking environment continues to be a challenge for community banks. Non-accrual loans totaled $17.3 million, or 1.58% of the total loan portfolio at September 30, 2013, compared to $17.7 million or


1.64% at December 31, 2012. The allowance for loan losses decreased slightly to 1.26% of loans at September 30, 2013, compared to 1.27% at December 31, 2012.

Deposits totaled $1.3 billion at both September 30, 2013 and December 31, 2012. Non-interest bearing deposits totaled 41.6% of total deposits at September 30, 2013, compared to 31.1% at December 31, 2012. The increase in non-interest bearing deposits is primarily due to a strategic product change which discontinued interest on one type of consumer account in early 2013. This resulted in a reclassification of the accounts from interest-bearing to non-interest bearing with the affected balances totaling $83.1 million at September 30, 2013.

The total risk-based capital ratio for Bancorp totaled 14.1% at September 30, 2013, up from 13.7% at December 31, 2012, due to accumulation of undistributed earnings and continues to be well above regulatory requirements for a well-capitalized institution. The total risk-based capital ratio is expected to decline when the pending NorCal acquisition is completed. However, we expect the Bank to remain well-capitalized under the current requirements for capital adequacy, as well as under the new Basel III rules.

Net interest income totaled $14.0 million in the third quarter of 2013 compared to $14.3 million in the prior quarter and $14.9 million in the same quarter a year ago. The tax-equivalent net interest margin was 3.99% in the third quarter of 2013 compared to 4.30% in the prior quarter and 4.44% in the same quarter a year ago. The net interest income decrease in the third quarter of 2013 compared to the prior quarter and the same quarter a year ago relates to downward repricing on existing loans, new loans yielding lower rates and a lower level of income recognition on loans from the Charter Oak Bank acquisition. Additionally, a higher concentration of lower yielding cash balances in interest-bearing due from banks compounded the decline of net interest margin from the prior quarter.

Non-interest income in the third quarter of 2013 totaled $2.0 million, essentially flat compared to the prior quarter and up from $1.8 million in the same quarter a year ago. The increase in the third quarter of 2013 compared to the same quarter a year ago primarily relates to higher dividend income from the Federal Home Loan Bank of San Francisco, gain on sale of repossessed personal property, debit card and merchant interchange fees, and Wealth Management fees.

Non-interest expense totaled $10.1 million in the third quarter of 2013, compared to $10.4 million in the prior quarter and $9.6 million in the same quarter a year ago. The increase compared to the same quarter a year ago primarily relates to higher acquisition-related professional fees and higher staffing costs as the Bank has filled some key vacant positions that will prepare us for integration and future growth. We are putting the infrastructure in place to support a larger bank, and the results from the acquired operations, as well as growth in our existing markets should absorb these expenses as we move into 2014.

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, Acquired Loans, Other-than-temporary Impairment of Investment Securities, 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 charge-offs, net of recoveries. 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 facts demonstrate heightened risk of default. Confirmation of the quality of our grading process is obtained by


independent reviews conducted by outside consultants specifically hired for this purpose and by periodic examination by various bank regulatory agencies. Management monitors delinquent loans continuously and identifies problem loans to be evaluated individually for impairment testing. For loans that are deemed 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 and 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, including consideration of our charge-off history. Allowances for changing environmental factors are Management's best estimate of the probable impact on the loan portfolio as a whole.

At September 30, 2013, we refined our methodology for calculating the general allowance for loan losses for categories of credits. The refinement did not result in significant changes in the amount of allowance as discussed in Note 6 to our Consolidated Financial Statements in this Form 10-Q.

For our methodology on estimating the allowance for loan losses on acquired loans, refer to the section Acquired Loans below.

Acquired Loans

From time to time, we acquire loans through business acquisitions. Acquired loans are recorded at their estimated fair values at acquisition date in accordance with ASC 805 Business Combinations, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded for acquired loans as of the acquisition date.

The process of estimating fair values of the acquired loans, including the estimate of losses that are expected to be incurred over the estimated remaining lives of the loans at acquisition date and the ongoing updates to Management's expectation of future cash flows, requires significant subjective judgments and assumptions, particularly considering the current economic environment. The economic environment and the lack of market liquidity and transparency are factors that have influenced, and may continue to affect, these assumptions and estimates.

We estimated the fair value of acquired loans at the acquisition date based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, risk classification, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and current discount rates. Loans were grouped together according to similar characteristics and were treated in the aggregate when applying various valuation techniques. The estimate of expected cash flows incorporates our best estimate of current key assumptions, such as property values, default rates, loss severity and prepayment speeds. The discount rates used for loans were based on current market rates for new originations of comparable loans, where available, and include adjustments for liquidity concerns.

To the extent comparable market rates are not readily available, a discount rate was derived based on the assumptions of market participants' cost of funds, servicing costs and return requirements for comparable risk assets. In either case, the discount rate does not include a factor for credit losses, as that has been considered in estimating the cash flows. The initial estimate of cash flows to be collected was derived from assumptions such as default rates, loss severities and prepayment speeds.

We purchased certain loans from the Federal Deposit Insurance Corporation ("FDIC) in the Charter Oak Bank closure with evidence of credit quality deterioration subsequent to their origination and for which it was probable, at acquisition, that we would be unable to collect all contractually required payments. Management has applied significant subjective judgment in determining which loans are PCI loans. Evidence of credit quality deterioration as of the purchase date may include data such as past due and nonaccrual status, risk grades and recent loan-to-value percentages. Revolving credit agreements (e.g., home equity lines of credit and revolving commercial loans) where the borrower had revolving privileges at acquisition date are not considered PCI loans because the timing and amount of cash flows cannot be reasonably estimated.

The accounting guidance for PCI loans provides that the difference between the contractually required payments and the cash flows expected to be collected at acquisition, considering the impact of prepayments, is referred to as the nonaccretable difference and is not recorded. Furthermore, the difference between the expected cash flows and the


day one fair value should be accreted into interest income at a level rate of return over the remaining term of the loan, provided that the timing and amount of future cash flows is reasonably estimable.

The initial estimate of cash flows expected to be collected is updated each quarter and requires the continued usage of key assumptions and estimates similar to the initial estimate of fair value. Given the current economic environment, we apply judgment to develop our estimate of cash flows for PCI loans given the impact of real estate value changes, changing probability of default, loss severities and prepayment speeds.

For purposes of accounting for the PCI loans associated with the closure of Charter Oak Bank, we elected not to apply the pooling method but to account for these loans individually. Disposals of loans, which may include sales of loans to third parties, receipt of payments in full by the borrower, or foreclosure of the collateral, result in removal of the loan from the PCI loan portfolio at its carrying amount.

If we have probable and significant increases in cash flows expected to be collected on PCI loans, we first reverse any previously established allowance for loan loss and then increase interest income as a prospective yield adjustment over the remaining life of the loans. The impact of changes in variable interest rates is recognized prospectively as adjustments to interest income. All PCI loans that were classified as non-accrual loans prior to the acquisition were no longer classified as non-accrual because we believed that we would fully collect the new carrying value of these loans at acquisition. Subsequent to the acquisition, specific allowances are allocated to PCI loans that have experienced credit deterioration through an increase to the allowance for loan losses. The amount of cash flows expected to be collected and, accordingly, the adequacy of the allowance for loan losses are particularly sensitive to changes in loan credit quality. When there is doubt as to the timing and amount of future cash flows to be collected, PCI loans are classified as non-accrual loans. It is important to note that judgment is required to classify PCI loans as performing or non-accrual, and is dependent on having a reasonable expectation about the timing and amount of cash flows expected to be collected.

For acquired loans not considered PCI loans, we recognize the entire fair value discount accretion based on the acquired loan's contractual cash flows using an effective interest rate method for term loans, and on a straight line basis to interest income for revolving lines, as the timing and amount of cash flows under revolving lines are not predictable. Subsequent to Acquisition, if the probable and estimable losses for non-PCI loans exceed the amount of the remaining unaccreted discount, the excess is established as an allowance for loan losses.

For further information regarding our acquired loans, see Note 6 to our Consolidated Financial Statements in this Form 10-Q.

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.

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 we recognize deferred tax assets and liabilities related to expected future tax consequences. 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 and all available evidence, that the position will be sustained upon examination, including the resolution through protests, appeals or litigation processes. For tax positions that meet the more-likely-than-not threshold, we measure the largest amount of tax benefit that is greater than fifty percent likely of being realized upon ultimate settlement with the taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described previously is recognized as a liability for unrecognized tax benefits, along with any related interest and penalties. Interest and penalties related to unrecognized tax benefits are recognized as a component of tax expenses.

In deciding whether or not our tax positions taken meet the more-likely-than-not recognition threshold, we must make judgments and interpretations about the application of inherently complex state and federal tax laws. To the extent tax authorities disagree with tax positions taken by us, our effective tax rates could be materially affected in the period of settlement with the taxing authorities. Revision of our estimate of accrued income taxes also may result from our own income tax planning, which may affect our effective tax rates and our results of operations for any given quarter.

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 and derivatives are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record certain assets at fair value on a non-recurring basis, such as purchased loans recorded at acquisition date, 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 write-downs of individual assets due to application of lower-of-cost or market accounting.

We have established and documented a process for determining fair value. We maximize the use of observable inputs when developing fair value measurements. Whenever there is no readily available market data, Management uses its best . . .

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