Jarrod Gerhardt - SVP, Director of Marketing Russ Colombo - President and CEO Tani Girton - CFO.

Jeff Rulis - D.A. Davidson Alex Morris - Sandler O'Neill & Partners Tim Coffey - FIG Partners Don Worthington - Raymond James.

Operator:.

Good morning, and thank you for joining us for Bank of Marin Bancorp's Earnings Call for the Second Quarter ended June 30, 2017. My name is Jarrod Gerhardt. I'm the Senior Vice President and Director of Marketing for Bank of Marin. During the presentation, all participants will be listen-only mode.

After the call, we will conduct a question-and-answer session. [Operator Instruction] As a reminder, this conference is being recorded on July 24, 2017. Presenting this morning will be Russ Colombo, President and CEO, and Tani Girton, Chief Financial Officer.

You may access the information discussed from the press release which went over the wire at 5:00 A.M. Pacific Time this morning and on our website at bankofmarin.com, where this call is also being webcast.

Before we get started, I want to emphasize that the discussion you hear on this call is based on information we know as of today, July 24, 2017, and may contain forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those set forth in such statements.

For a discussion of these risks and uncertainties, please review the forward-looking statements disclosure in the earnings press release we issued earlier this morning as well as Bank of Marin Bancorp's SEC filing. Following the prepared remarks, our team will be available for questions. And now, I'd like to turn the call over to Russ Colombo..

Thank you, Jarrod. I'll apologize in advance for my hoarse voice. I have a cold. I'll do the best I can. We're pleased to review our results with you for the second quarter of 2017. In general, we had a solid quarter for earnings growth and saw significant progress on both our hiring and strategic initiatives. Let's start with some highlights.

Second quarter loan originations totaled $56 million versus $24 million in the first quarter and $45 million in the second quarter of 2016. Our year-to-date originations were $80 million and at the same period last year, which were $74 million.

Gross loans increased by $14 million over the prior quarter and totaled approximately $1.5 billion at the end of the second quarter. We continue to have substantial commercial lending opportunities in the San Francisco Bay area and our pipeline remains robust. Our credit quality continues to be outstanding.

There was no provision for loan losses taken in the first quarter. We monitor the portfolio carefully to identify any potential borrower issues and address them proactively. Loan payoffs for the quarter were $48 million up from $33 million in the first quarter and $40 million in the second quarter last year.

The largest portion of payoffs came from the successful completion of construction projects and the sale of assets underlying other loans. Total deposits grew by $61 million to $1.8 billion in the quarter. Non-interest-bearing deposits continue to be a strength of the bank, making up 48.5% of total deposits.

The total cost of deposits dropped one basis point from the prior quarter to 0.06% down two basis points from the quarter ended June 30, 2016. In the second quarter, we made considerable advancements on our strategic initiative.

In a matter of weeks, we'll be opening our 21st branch in Healdsburg, an important strategic market for us as we sharpen our focus on wine industry businesses. We continued to expand our commercial banking team with five hires in the second quarter. We're also on track to open an East Bay commercial loan office by the end of the year.

Diluted earnings per share increased to $0.84 in the second quarter of 2017 and our Board of Directors has increased the quarterly cash dividend to $0.29, an increase of $0.02 per share. This is the 49th consecutive dividend paid by the bank. Now, let me turn it over to Tani for additional insights on our financial results..

Thank you, Russ and good morning to everyone on the call. We had an excellent second quarter with net income of $5.2 million up from $4.5 million last quarter and $4.8 million a year ago. The tax equivalent net interest margin was 3.85% in the quarter compared to 3.79% in the prior quarter and 3.77% in the same quarter a year ago.

The increase over the first quarter 2017 came from hiring yields on earning asset and increased acquired loan income, while the improvement over last year came primarily from asset growth and early repayment of FHLB borrowings in June of 2016.

The positive impact of federal funds rate increases on investment securities, interest-bearing cash and variable rate loan yields is manifestly improving trend in our margin. As a result, net interest income of $18.3 million this quarter was 683,000 hires in last quarter and $1.1 million more than second quarter 2016.

Noninterest income of $2.1 million was virtually unchanged from the first quarter. Quarter and year-to-date declines from last year relate to gains on security sales booking in 2016.

Noninterest expense of $12.6 million was down from $13 million in the prior quarter mostly due to the 208,000 reversal of reserves for our off-balance sheet commitment, while salary and benefits were also down from the first quarter due to seasonal factors, year-to-date salaries and benefits were up $1.3 million over 2016 as open positions related to our organic growth initiatives have been filled.

Nonaccrual loans remain at 0.08% of Bank of Marin's loan portfolio, down from 0.19% a year ago. Classified loans fell slightly to $29.3 million and accruing pass due loans fell to $393,000. The loan loss reserve is over 1% of total loans and almost 13 times nonaccrual loans.

The efficiency ratio improved to 61.9% from 65.9% last quarter and our return on average equity was 8.74% for the quarter, up from both the prior quarter and the same quarter a year ago. We have a very strong capital position and a low-cost deposit base, which position us well for future growth. Now back to Russ for some closing comments..

Thank you, Tani. Before taking your questions, I want to provide an update on the San Francisco Bay Area market and the impact of the Fed's recent [fee] increases. The economy in the San Francisco Bay Area remained strong in large part due to continued strong growth in the technology sector.

We have almost no direct exposure to the technology industry and focus on industries where we have expertise and while the market remains very competitive, we continue to succeed in taking market share and expanding our relationship with existing customers by leveraging our relationship banking model.

Turning to the interest rate, we're finally starting to get some relief. Thanks to the Fed's recent rate increases, which should help stabilize and likely expand our net interest margin. This is a welcome change from the razor thin margins banks have had for years. However, increasing rate environment also bring pressure to raise deposit rate.

At Bank of Marin we're well-positioned to manage that pressure. We are asset sensitive and continue to have a solid low-cost deposit base of only six basis point. In fact, this is a great time to be a relationship bank that drives value based on service and community involvement rather than rate.

In the second quarter, we made considerable progress on our strategic growth initiatives. In a matter of weeks, we'll be opening our -- we're also on track to open an East Bay commercial banking office by the end of the year. We're very pleased with our results this year and the opportunities ahead with Bank of Marin.

We're investing in our people and our client relationships to capture market share while remaining true to our underwriting discipline. We're also successfully executing on our organic growth initiatives, returning capital to shareholders and looking for M&A opportunities.

Above all, as we grow, we'll will stay true to the strategy that have made us successful over the last 28 years, our relationship banking model, industry expertise and underwriting discipline. Thank you all for your time this morning and now we'll open it up to answer your question..

Thank you, sir. [Operator instructions] Our first question over the phone comes from Jeff Rulis with D.A. Davidson and Company. Please proceed with your question..

Thanks. Good morning, Russ and Tony..

Good morning..

Good morning..

I have a question on the, maybe a follow-up to Russ, just a temperature on M&A discussions in your market, you mentioned that still on the lookout and I guess is it maybe with the dividend hikes in the indication that options are somewhat limited out there per capita use or maybe just a touch on that M&A landscape?.

Well I think there is a couple questions there. I think that first of all from our perspective if you look at where we are, we're in markets we're in and the contiguous markets, it's a fairly limited group of banks that have potential M&A opportunity. So, we continue to have conversations with every one of them.

I wish there was something imminent I could tell you, but there's nothing at this point, but we continue to have conversations with banks that would enhance our franchise. On the capital side, we have a lot of capital and despite M&A activity and most M&A these days is likely to be done with stock as opposed to cash.

So frankly wouldn't use capital in that respect anyway. So, we think it's important to return capital to our shareholders and still our ratio was in the 30s. So, we think that's appropriate level..

Okay. Thanks. And then maybe Tani your thoughts on the expense outlook with these five hires and some of the branch openings going on.

Would you anticipate any pick up on the operating expense line?.

Yes, you can see that the staffing, salaries and benefits has bumped up a little that is indicative of where we'll be.

We still have couple more hires that we're looking for and additionally with the addition of a new branch, you'll see some occupancy and expense increases as well as we did have lease in New Orleans, San Francisco and the price of that lease has gone up. So that's in this quarter's numbers and that will continue going forward at least for a year..

Okay. So, I guess a question on -- oh go ahead..

I was going to add to that these hires and the opening of branches and things like that are investments in the future and while they may be an impact on short-term, and our short-term results, from a negative standpoint I think as they're adding expense of course, we firmly believe it's important to make these investments to grow the organization long-term and to continue to grow the values of this franchise..

Okay. Thank you.

And I guess I was just trying to get a sense for what may be is already incurred in Q2 run rate or you would effectively see a little bump as we get to the back half of the year, is that what you're applying?.

So, I think it's going to appear as a gradual increase. I would say we got some new hires in over the course of the quarters and several of them were early in the quarter and then again, the increase in San Francisco was probably mid to late quarters. So, I would say expect a gradual trend but again we're most of what we need to do is in there.

We got a few more new hires to go..

And I will say that the competition for quality loan officers is very intense and so the cost of good people is high, but I would say that good people regardless of how they achieve because they return their earnings as their cost pretty quickly.

Not as good people are expensive because they don't and so we're really looking for the best of the best and try to build the team and you definitely will be some run-up in the numbers over the next couple quarters..

Okay. Understood. Thanks..

Our next question comes from Tim O'Brien with Sandler O'Neill and Partners. Please proceed with your question..

Hi. Good morning Russ and Tani. It's actually Alex Morris on..

Hi Alex..

Hi Alex..

Maybe just a follow-up question, Russ you gave some good color in your prepared remarks about the margin and the asset sensitive position of Bank of Marin's balance sheet.

So, given that position and the benefit you guys showed this quarter, following the June rate hike, should we expect maybe a similar level of benefit here in the third quarter? I am not sure you can predict everything exactly, but is that your outlook?.

Yeah, I think, so while the variable rate loans, we're able to benefit from rate increases immediately. We do have a fair amount of adjustable-rate loans that adjust over time. So, we should some of that repricing come through the portfolio as those loans reprice..

Okay.

And Tani, the adjustable loans, would some of those be benefiting from the December rate hike as well as kind of the repricing timeframe on those or would that all be March and June rate hike benefit?.

Yeah it could be all three-rate hike because some of these have repricing periods of anywhere from a year to five years..

Obviously, we get the benefit of the rate hikes when we have on the variable rate loans like primary and so in our construction activity, which is primarily prime loans type activity, you're going to get benefits right away. The longer term longer-term market despite the short-term rate increases, haven’t seen a lot of movement in the long-term rate.

So, it's kind of certainly the yield curve is flattening and we're not as we did for things where they're requiring some kind of fixed rate for a period of time it's still very competitive, extremely competitive. And so, the benefits really come from not from that activity, but more from the prime clothing type of activity..

That's great color. Thank you. And then just, related on the construction portfolio, Russ you just mentioned same balance trend down over the last couple of quarters.

Has that been kind of an intentional run-up given what you're seeing in the market or just draws on commitments or any color you can provide there?.

Sure, it's actually not an intentional decline we have. We have a lot of good activity. We booked a number of big loans recently, but we had one in particular large construction project that was completed and sold and we got repaid. It was in the mid-teens payoff.

So that had a big impact, but that being said, we have a number of new projects that take time to run up. So, you're going to see those numbers start to go the other -- back up again. We're very happy about the portfolio. They're doing really well and we're excited about two or three new projects that we've got in that portfolio..

That's great. Glad to hear. Those are all my questions. Thanks a lot..

Our next question comes from Tim Coffey with FIG Partners. Please proceed with your question..

Great. Thank you. Good morning, everybody..

Good morning, Tim.

Good morning, Tim.

Russ, looking at kind of the higher interest rate environment and the potential pace for payoff, would you expect that payoff level to become a lot more predictable versus when rates were lower and the payoffs would come on big refinancing?.

Yeah. That would be the case of the last five years, but you think as rates rise, we would be more predictable because although we still have very high valuations on real estate and so we have a lot of activity where owners of projects, owners of properties decide to sell at a very high valuations, we get paid off. That's not predictable.

It's just really -- it's hard. You have to generate a significant volume of loans to show growth and you saw the numbers and you've seen the number and it's a little better than it was, but it's not -- I wouldn't put it substantially better.

But the good news is you got a lot of volume, our lenders all around the Bay are doing a great job of generating new opportunities..

I agree. I think one of the pleasant surprises this quarter was the origination activity.

And then in the press release you discussed fluctuations in deposits, are you anticipating a the big increase in deposit the next couple of quarters that you normally wouldn't see?.

No nothing, we just have -- we have a number of depositors large deposit relationships that their business is deposit activity quite volatile and the reason for that is as an example, we have a number of contractors who do a lot of municipal work.

So, they’ll bid of project and the projects that will get funded and it will sit with the contractor and then it will decline over time as they do the work. That's hard to predict those deposits and we have ad agencies and things like that, which have large inflows of cash and the cash distribution. It's all great businesses.

We haven't lost customers in any case. It's all about just the deposits come and go and it's hard to predict where they end up each year, but the good news is our depositor base continues to grow. If you looked at it over the period of years you would see a very nice progression of growth in our deposit base..

Okay. So that one of the just the general flow of the deposit in the -- at the company and not a -- here we've got a client who has given a sizable legal benefit coming to him..

Right. So, another thing that happens is if customers experience states that need to be settled sometimes those accounts will get bumped up while the estate is being taking care of and that takes some time. So, I think that might be what you're referring to Tim..

Right. Yes. All right, well, great. Thank you. Those are my questions..

Thanks Tim..

[Operator instructions] Our next question comes from [indiscernible] with KBW. Please proceed with your question..

Hi. Good morning. It's [indiscernible] on for Jackie..

Good morning..

Most of my questions have already been asked. I just have a couple questions. You guys were able to lower your deposit cost again.

Are you seeing any pressure from customers or from competitors in your marketplace in order to raise your deposit pricing or your relationship already enough that you're not seeing any pressure at this point?.

We haven’t really been too much -- there has been a couple of random situations where depositors are offered higher rates, but we had really no real pressure from our customer base to raise rates. And the other thing about our deposit portfolio is its relationship-based and so it's not customers seeking higher deposit rate for the most part.

It's more because they're operating accounts and they bank with us because of the relationship, not because we pay higher rate. That being said of course, everybody is going to look for a little bit higher rate as rates rise, but so far, we haven’t had a lot of pressure from any of our customers to raise rate substantially..

Even I might add that, that decline is not so much from raising rates as it is a change in composition of the portfolio. So, when you have such a high percentage of non-costing deposits, the larger that gets, it's more impulsive rates, the average rate down..

And just what was the driver of the growth in the other residential bucket? Was it in common loans or was it something else?.

There is very few competitors in that market and we've done really well with our TIC portfolio and we've been in the business now 12 or 13 years and we've had zero default and so we continue to actively pursue TIC loans in San Francisco..

Okay. Great. Those are my questions. Everything else has been answered. Thank you, guys..

Thank you..

Thank you..

And our next question comes from Don Worthington with Raymond James. Please proceed with your question..

Good morning..

Good morning, Don..

In terms of the tax rate, where do you see that going the back half of the year?.

So, it did come down a little bit because we have more tax-exempt assets that we put on the books, the composition, it's really hard to tell where it's going to go, but that decline is related to a pretty substantial increase in tax exempt, long term securities..

Okay. All right. And then I think previously you've mentioned that you would like to get the loan-to-deposit ratio more up towards 90%.

Is that still in the plan as you go forward?.

Well, the loan-to-deposit ratio is 90%, I think is the perfect position to be in because you still have plenty of liquidity, but I am not pushing that too far and you're getting the best out of your assets, your earning asset. So, it's where you want to be. We're not there.

Loan growth is always a challenge because of the payoffs which are primarily from good reason and deposit growth has been strong. We obviously want to continue the deposit growth, but the loan growth is always a challenge and I think the story you even look at the nationwide loan growth is just not as pretty anemic from banks across the country..

Okay. Thank you..

You're welcome..

We have no further phone questions at this time..

Again, thank you all for joining us this morning and we look forward to talking to you again next quarter. Thank you very much..