Nancy Boatright - SVP and Corporate Secretary Russ Colombo - President and CEO Tani Girton - EVP and CFO.

Jeff Rulis - D.A. Davidson Jackie Bohlen - KBW Tim O'Brien - Sandler O'Neill Matthew Clark - Piper Jaffray Don Worthington - Raymond James.

Good morning and thank you for joining Bank of Marin Bancorp's Earnings Call for the Second Quarter ended June 30th, 2018. I am Nancy Boatright, Senior Vice President and Corporate Secretary. During the presentation, all participants will be in a listen-only mode. After the prepared remarks, we will conduct a question-and-answer session.

[Operator Instructions] As a reminder, this conference is being recorded. Joining us on the call today are Russ Colombo, President and CEO; and Tani Girton, Executive Vice President and Chief Financial Officer. Our earning press release, which we issued this morning, can be found on our website at bankofmarin.com where this call is also being webcast.

Before we get started, I want to emphasize that the discussion on this call is based on information we know as of today, July 23rd, 2018 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 our earnings press release as well as our SEC filings. Following our prepared remarks, Russ and Tani will be available to answer your questions. And now, I'd like to turn the call over to Russ Colombo..

Thank you, Nancy. Good morning and welcome to our call. We delivered excellent results in the second quarter of 2018 that I'm pleased to share with you now. Our net income was 7.9 million with diluted earnings per share of $1.12. Loan originations of 75.8 million were up $20 million over the second quarter of 2017.

Activity was well dispersed between commercial banking market and to a lesser extent, consumer banking, as we executed on our organic growth strategy, while staying true to our disciplined underwriting standards.

Higher yields on loans and investments contributed to an 8 basis point expansion of our net interest margin and $1 million increase in our net interest income versus last quarter. Net interest bearing deposits or non-interest bearing deposits represented 49.5% of deposits, which totaled 2.1 billion at the end of the quarter.

The cost in total deposits was 8 basis points for the quarter and is among the lowest in our peer group. Strong credit quality continues to be a hallmark for the bank, with no provision for loan losses or off balance sheet commitments recorded in the second quarter. Non-accrual loans again represented just 0.2% of the portfolio at quarter end.

We launched our share repurchase program, which was approved by our Board of Directors in April and we are once again raising the quarterly cash dividend by $0.01 to $0.32 per share. This represents the 53rd consecutive quarterly dividend paid to our shareholders. Now, let me turn it over to Tani for additional insight on our financial results..

Thank you, Russ and good morning. Our second quarter results clearly reflect the successful execution of our strategy and the strength of our balance sheet. Strong loan growth, low deposit cost, higher net interest income, and lower non-interest expenses all point to the potential earnings power of the bank.

Loan balances grew 45.9 million for the second quarter. Originations of 75.8 million exceeded payoffs of 37.3 million and first and second quarter originations exceeded those in the first two quarters of 2017. Likewise, payoffs in the first two quarters of 2018 were lower than what we saw in 2017.

Payoffs continue to be concentrated in the sale of assets underlying loans, including the successful completion of construction projects. Higher average balances of loans, investments, and non-interest bearing deposits all combined with higher yield across asset classes to produce net interest income of 22.8 million.

Reported net interest margin of 3.87% was up 8 basis points from the first quarter and the tax equivalent margin of 3.92% was up 7 basis points. Total deposits declined 48.9 million from March 31, primarily due to normal business related cash fluctuations on the part of several large deposit clients.

Additionally, some customers moved their excess liquidity into deposit network time account to obtain higher interest rates, while maintaining their relationship with the bank. A small number of account holders that were focused solely on obtaining the highest rates in the marketplace moved to other institutions.

Our efficiency ratio of 57.9% was down from 66.6% last quarter and 61.9% a year ago. These ratios reflect non-interest expenses of 14.5 million, 16.1 million, and 12.6 million for those respective periods. We completed our core processing contract renegotiations and expect to see savings over the life of the five year agreement.

Contract negotiation fees declined from 750,000 in Q1 to 300,000 in the second quarter, and we don't anticipate any further charges this year. Salary and benefits expense was down from the first quarter as employees’ net retirement eligibility requirements for stock-based compensation in the first quarter.

Additionally, higher loan originations in the second quarter led to higher deferred loan origination costs. Bank of Napa acquisition related expenses declined from 615,000 in the first quarter to 250,000 in the second quarter and we expect minimal expenses for the remainder of the year.

As noted in our earnings release, 2018’s second quarter non-interest expense was up 1.9 million from 2017 due to the Bank of Napa acquisition, the opening of our Healdsburg branch, core processor contract renegotiation fees and a reversal of provisions for off balance sheet commitments in 2017.

The effective tax rate for the first half of 2018 was 23.3%. Reduction in the federal statutory income tax rate to 21% contributed $0.25 or just over half of our $0.45 improvement in diluted earnings per share versus the first half of 2017. Bank of Marin is in an excellent position for the future.

Our liquidity and capital positions are robust and our 1.28% return on assets and 10.54% return on equity for the quarter reflect the power of our core values and business model. Now, I will turn the call back over to Russ for some closing comments..

Thank you, Tani. We are a consistently high performing bank because of our commitment to both community and commercial banking. Our strong financial results for the second quarter are a testament to the continued execution of our proven strategic plan and reflect the significant investments we made in our organic growth platform last year.

As the 45.9 million increase in loans in the second quarter reflects, we're delivering on our promise of loan growth in the East Bay and Napa as well as business banking in Marin and Petaluma. We are in very attractive market and have maintained our discipline underwriting standards.

We have built our deposit franchise on legendary service and deep relationships and we remain dedicated to that mission. In the current rising interest rate environment, our low cost deposit franchise and high quality asset portfolio have paved the way for net interest margin expansion and we have a healthy 80.3% loan to deposit ratio.

By closely managing expenses and maintaining our historically outstanding loan quality, we've been able to achieve strong organic growth, while also investing in staff and infrastructure. Our experience and committed team of bankers is delivering great results and we continue to attract successful and qualified people to enhance our staff.

Looking ahead, we are ready to expand and grow our franchise. And as always, the best interest of our customers, shareholders and employees remain our primary focus. Thank you for your time this morning and now, we'll open it up to answer your questions.

Mannie?.

[Operator Instructions] The first question comes from the line of Jeff Rulis from D.A. Davidson..

Just to follow-up on the loan payoff discussion.

I guess are you reading into the lower payoffs? Anecdotally, has anything changed on that customer base that your -- that is somewhat different than it has been in the recent past?.

Not really. I mean I think we continue to get good loan volume and most of the payoff -- as we said, most of the payoffs have been because of sale of properties or construction projects that have been completed. So you have normal paydowns in that respect.

Throughout this, even when we had higher payoffs, not a big – there wasn’t a big percentage, which were refinances elsewhere. There's always a little bit of that, but there hasn't.

This quarter was the same and we just had really good volume and just bringing the payoff number down a little bit has translated into really good volume, I mean, loan growth..

Have you had significant seasonality by quarter on the payoffs? I mean is it -- if it is tied to construction, are there certain quarters that you say, look, we've been seeing heavier payoffs in such and such quarter?.

Not really. The construction projects, just when they get completed, they get loans and they get paid off. And there is really –there's no seasonality. I suppose the wintertime, when you're doing some construction, you're going to have lower construction process just because of the weather, but the Bay Area’s weather is pretty predictable.

So it hasn't really had that much impact. And so I -- we really haven't seen -- we haven't seen much seasonality at all with payoffs..

Got it. And then maybe one for Tani, just on the expenses. I guess, a few moving pieces with the merger costs and the conversion costs.

I suppose, any sort of color on going forward, I think, you alluded to maybe some cost saves, strictly through, if you can talk about the expense base and kind of what's artificial and what do you think is core?.

Yeah. So, as I said on Napa and the core processor contract renegotiations, those were pretty much done with. We will see a decline in data processing costs going forward. We can't quantify that right now, but that will start to become more apparent in the next quarter as we’ll have a full quarter of the new contract in effect at that time.

Additionally, we do have some vacancies out there.

We were running kind of our standard vacancy rates, but to the extent that we feel some of those vacancies in employee’s positions that could put some pressure, but I think the guidance that we gave you last quarter and where we are standing today are pretty good indicators, if you keep those two things in mind..

Our next question comes from the line of Jackie Bohlen from KBW..

Russ, you had some good growth in other residential this quarter.

Maybe if you could just speak to, what kind of competition as much at all you’re seeing in that portfolio and then how it’s impacting the overall yield?.

That’s the TIC portfolio, primarily San Francisco. And it's an interesting market, because there is not many competitors, but there is a couple.

But it’s – as we’ve adjusted our pricing a little bit and adjusted our models a little bit in terms of what we offered and we thought, we’re seeing tremendous volume pickup and it’s really driven by where you want to be in terms of rate, and we made a few adjustments in the last couple of quarters and we've seen really good volume there.

So that's really where that growth is coming from..

So still not a lot of competition, because you're one of the few banks that specializes on this?.

There's not many banks that are in that business. And I will tell you that in the, I think it’s around 14 years we've been doing, we’ve been making loans and TIC loans. We had one default in the 14 years and that was resolved in restructuring and that’s it, not another problem.

And so, while it’s a unique project, not that many banks are in it, we’ve had good success with it..

Would you say that with the adjustments and the growth that you saw in the quarter, are we nearing a ramp period where you could continue to see growth each quarter? Because I know it’s typically, with the exception of 2Q17 relatively flattish last year..

Probably. I think we continue to get volume. San Francisco, it’s a limited market. So there's only so much you can do, because the TIC, it's really, it’s primarily – not primarily, almost all of it is in San Francisco and it’s such a limited market of housing in a city. There is not that much turnover in these units.

So when they do turn over, we get an opportunity and sometimes, we will refinance opportunities, but that really has kind of gone now too. So, I’m not highly confident it’s going to grow dramatically as we go, but it’s a nice, steady income producer..

Okay. Thanks. That’s a really helpful update. I know we don’t talk about that portfolio that much. And just one last one for me, Tani, I know you touched on expenses a bit, but just another different type of question.

In terms of the cost savings from the Bank of Napa, were most of those realized in the quarter or do you still have a few more to come out?.

On the cost savings, I think we pretty much have all of those embedded now and this quarter, I think, this quarter, it’s pretty clean, because most of the conversion costs were in the first quarter, but we did do the final conversion in April. So next quarter is going to be a better indicator.

So sorry about that, not that clear, but what I will say is I say, on the Napa deal, when we look at our transaction costs, so one-time costs, those were slightly – all-in, those ended up being slightly below what we projected, but pretty much on target and the cost savings look like we’re pretty much on target there as well.

So, I think the accretion is looking very, very good compared to what we model..

Jackie, I will just add one thing on the people side, we achieved the number of reductions that we have planned, but the good news there was that, we also were able to take some of the people who have frankly weren’t in the model and placed them in position, open positions in Novato, in our headquarters, in our operations area.

And so we actually kept more people that we have projected, but we kept the number we projected in our original plan, but we still had open positions with some of the other people. It’s worked out exceptionally well, and very, very happy with the staffing that we received in this acquisition. The Napa people have been great..

Our next question comes from the line of Tim O'Brien with Sandler O'Neill..

You might have already given this color, but do you happen to have the commercial line utilization number at quarter end, relative -- and also the first quarter end of quarter number?.

Hang on a second. We can find it. Do you have another question? I will come back to that one..

Sure. You bet. And then the other question that I had was, you gave some color on this.

So, looking at the P&L, professional costs were down, professional service costs were down pretty considerably this quarter and you said that that included, did that include 300,000 for the contract negotiation?.

So the professional service costs were down and does that include the 300,000 contracts?.

Yes. That is included in that line item. Sorry..

I was going to say 41.98% was the utilization..

And how did that compare to last quarter?.

42.41% last quarter. So slightly down..

Inconsequential? Still decent utilization? As far as utilization is concerned, Russ, just kind of overarching qualitatively, do you envision that the market can bear or that your clients would, in a good environment, increase their utilization.

I mean, obviously, it would be nice to see, but above 40%, are you happy with that, I guess relatively speaking?.

Yeah. Above 40, good. There's so many different elements in that number that go up and down. There's construction and construction starts low and then if we put a new construction loan on, it’s zero initially, and then as they build project, it grows and utilization goes higher.

Lines of credit, fluctuate all over the place, because it's kind of the working and there's some seasonality to that as customers utilize -- use the line of credit, like the line business, that certainly has a lot of seasonality. And then you have the home equity line, which are in that number and same thing, it kind of is all over the park.

It currently is running about 40%, despite the rest in total. But if you're above 40 these days, it’s pretty solid I think..

The other thing is just when you have a let alone growth, sometimes, it takes a little time for those borrowers to actually utilize their lines, because we have significant growth this time, there's probably some lag in the utilization..

And that raises an interesting point.

Did you provide unfunded commitments -- growth in unfunded commitments this quarter for C&I I guess or overall or do you track that number?.

We didn't provide it..

You want to in this public forum?.

Well, they have no problem. The unfunded line of commitment was about $8 million. That was the growth quarter to quarter. .

Fantastic..

And utilization, pretty solid, a little bit up in the line of credit, around – little over 40%.

The only one that really is completely different is construction and the utilization area is in the 60% range, because they build up a project, but our lines of credit have pretty much hung around 40%, both from lines of credit, home equity lines, volume, personal lines of credit, those kinds of things, they’re all kind of hanging around 40%..

And then one last question, Russ, you talk about -- it seems like it's a recurring theme too that when you see the key driver to prepayments or payoffs of loans is client transactions, sales -- business sales sometimes, but also property sales.

Are you seeing any -- can you give any color on what's going on in the market as far as that's concerned? Are transaction volumes steady here? Or with pricing, is it starting to get a little -- slow down a little bit or what’s your perspective there that we might be able to take away and look at long term? What's going to happen?.

It’s an interesting question, Tim. We just actually made a presentation to our board about real estate pricing in the Bay Area. And if you look at the way they have gone historically, they are -- they are at a kind of an all-time high.

That being said, there is these fluctuations that happen, depending upon the market and technology, which drives it so much. There's a very interesting correlation between prices in the Bay Area, particularly in San Francisco, with this added example.

The funding of DC and lease rates and then ultimately real estate sale prices and we are continuing to grow to very high level in all of those, all three of those and they correlate almost perfectly. And if you look back in time, back to 2002 and through recession, well, DC funding has come way down, prices come way down.

In San Francisco, lease rates are right around $80 a foot these days. And if you go back into the recession, it was about 35.

So it brings to the point that this is a really good time to say, well, it is a really good time, because you're at high levels, so it also brings up the point of, from the standpoint of a lender, of lenders that we want to be very careful of our lending into these very, very high prices because you don't want to have a very high loan to value against the property today -- today's rate.

You see a recession coming, because sure enough, that'll have a great impact on the prices of real estate in the Bay Area, particularly San Francisco, but certainly Peninsula East Bay, even Marin. So it’s an interesting thing to follow and we are watching it very closely all the time..

So I guess the takeaway is that, nothing has changed as far as, with pricing where it is, your clients are probably -- some of them are going to continue to look at selling and it makes for a tougher environment to lend into, given where prices are?.

It’s tough from the standpoint that you have to be careful. I don't think it’s necessarily tough if you understand that you can't think that everything that goes up won't come down eventually. You're going to get some, you bet, that market's going to restrict it.

So you don't just have to be very careful and our lenders have been really good about that and that's why we require guarantees. That’s why we require liquidity from our borrowers.

It's just -- we just have to stay cautious in terms of our loan to value and make sure our borrowers have the capacity to step in if there's a problem and that's certainly served us exceptionally well during the recession when we didn't have any problems.

I’ll remind you that over our loans that we've underwritten, total net losses in the commercial real estate are around $220,000 to $240,000..

I guess just one last quick question.

All the loan production you booked this quarter was all or loan growth you booked was all in-house production, correct?.

Yes.

We don’t buy -- you're talking about whether we bought?.

No loans bought?.

We don’t do that..

Didn’t think so. Thanks, Russ. Thanks for answering my questions, you guys..

Our next question comes from the line of Matthew Clark from Piper Jaffray..

Wanted to hone in on deposit pricing. You guys have among the best in the cost of deposit, transaction accounts though were down this quarter. Wanted to get a sense for whether or not you might start to feel a little pressure on the deposit pricing front here or not? I know you guys have an 80% loan to deposit ratio.

So may not?.

So, yeah, the ending balance is down, but I think it’s important to know that the average balance was still higher than the last quarter and so that is very indicative of the idea that we've got large customers with businesses that have significant cash fluctuations in and out of their account. So, that’s really what drives our deposit base.

And if you look at the percentage of non-interest bearing accounts in our book, it's actually up. So that is our customer deposit base. So we have gotten selective calls. We're not getting inundated by any means with calls about rates, because our customer base is really relationship oriented and business oriented.

So, as we said in the comments, we did have some consumers that have some excess liquidity and so those funds may have been redeployed into deposit network time account. So out of liquid account and into some time deposits.

And then just a handful of customers who really, all they had with the bank was a deposit balance that was focused on getting the highest rate and we don't typically chase pricing on those types of accounts. We will let them go. So, there were a handful of those every quarter..

Okay.

And then what was your weighted average rate on new production, trying to get a sense for incremental spreads and where the margin could go?.

We don't publish those rates. The market remains competitive. We're still seeing -- even though short term rates have risen, there is such a flat yield curve that we’re seeing longer term, 5 to 7 year loans that are – there hasn’t been a huge growth in the spread in that number..

What we can say though is that across all categories, the rate that the new loans are coming in at are higher than the portfolio rate. So that may go without saying, but that is what pushing the margin up, at the same time, maintaining the low cost of deposits..

And then can you remind how much of your loan portfolio is truly variable and how much might reprice within the next year?.

Yeah. So about 45% of the portfolio is adjustable and 55% is fixed. And if you look at how much is repricing in the next 12 months, it's about 25% of the portfolio..

And then any guidance on the tax rate going forward? I think we talked about 22% last quarter.

I’m not sure if that's still a good rate going forward?.

Yes. So there are a couple of items that that can cause the tax rate to move around, primarily last quarter, we saw that, couple of employee net eligibility criterion, stock-based compensation and so those expenses went up, but also the tax reductions associated with those expenses went up. So that's why the rate was lower last quarter.

We had less activity in that realm this quarter. So in general, I think where we’re sitting is pretty indicative of the future, each time we run the taxes, we look at our best understanding of what the rate is going to be for the full year. And that’s what we knew. So some of those discrete items will cause it to fluctuate..

[Operator Instructions] Our next question comes from line of Don Worthington with Raymond James..

In terms of provisioning, would you expect to -- have to resume provisions if loan growth continues..

Good question. Of course, as we get more loan volume, we will have to provision at some point.

Our credit quality has been so good and we have so few, even special mention credits now that, it’s almost against the challenge in terms of what is acceptable from the standpoint of our -- the auditors or external auditors that, it’s the challenge, the provisioning, you have to justify.

And any provisioning that’s done and we haven't had any credit problems to speak of. So as we grow the portfolio, then of course, we will have to provision to support that portfolio. But it’s so clean right now. It’s pretty tough we have excess provisioning that we have to utilize before we can provision..

Yeah. And Don, we did have, the growth from this quarter did point to the need for an increased provision, but at the same time, we had a couple of loans that were upgraded that had a significant impact in the opposite direction. So, those two things sort of were the two main drivers, resulting in the note revision..

And then in terms of just your loan growth, strongest markets, Russ, if I remember your comment, it sounds like it's East Bay and Napa, is that the case?.

Correct. In also what we call business banking, which is -- wherein Petaluma kind of smaller credits have done exceptionally well. Napa and I'll make a couple of – first of all, I’ll talk about East Bay. East Bay has been terrific and has generated some significant opportunities and growing quite nicely.

On Napa, Napa has grown not just because of adding the Napa portfolio, but the combination of that plus people that we’ve added and we're getting some really nice opportunities to see and you talk about when you buy a smaller bank that there's opportunity potentially to up-tier relationships and sometimes that happens, sometimes it doesn't.

It seems to be happening in this environment and our team up in Napa is doing a great job with that. So pretty excited about what's going on in Napa as well as East Bay. In Napa, we have this combination of people from the Napa team, but also our existing ones.

We added not too long ago, a fellow by the name of Scott McAdams, who has a lot of commercial banking experience for many years in the Mechanics Bank and this team is gelling very nicely. So pretty happy with what’s going on up there..

[Operator Instructions] And there is no further questions on the phone line..

Okay. Well with that, I want to thank everyone for joining us this morning and we will look forward to talking to you again next quarter. Thank you..

Thank you..