Banc of California, Inc. (NYSE:BANC) Q3 2023 Earnings Call Transcript

Banc of California, Inc. (NYSE:BANC) Q3 2023 Earnings Call Transcript October 24, 2023

Banc of California, Inc. misses on earnings expectations. Reported EPS is $0.3 EPS, expectations were $0.31.

Operator: Hello and welcome to Bank of California’s Third Quarter Earnings Conference Call. [Operator Instructions] This call is being recorded and copy of the recording will be available later today on the company’s investor relations website. Today’s presentation will also include non- GAAP measures. The reconciliation for these and additional required information is available in the earnings press release, which is available on the company’s investor relations website. The reference presentation is also available on the company’s investor relations website. Before we begin, we would like to direct everyone to the company’s safe harbor statement on forward-looking statements included in both the earnings release and the earnings presentation. I would like now to turn the conference call over to Mr. Jared Wolff, Bank of California’s, Chairman, President, and Chief Executive Officer. Please go ahead.

Jared Wolff: Good morning and welcome to Bank of California’s third quarter earnings call. Joining me on today’s call is Joe Kauder, our Chief Financial Officer, who will talk in more detail about our quarterly results, as well as Bill Back, Head of Strategy for PacWest, who will be joining bank of California in a similar capacity upon the closing of our merger with PacWest. I’d like to start off by congratulating the teams at Bank of California and PacWest on a terrific job obtaining regulatory approval. It is worth noting that we obtained regulatory approval for the merger and also obtained approval for the combined bank to become a member of the Federal Reserve, which really is its own process altogether. These approvals didn’t just happen, and they required significant coordination.

A customer smiling as he signs a consumer loan agreement in a regional bank branch. Editorial photo for a financial news article. 8k. –ar 16:9

The results reflect the dedication and hard work of our colleagues and advisors. We also appreciate the dedication and equally hard work of our federal and state regulators, who had an important job to do. With regulatory approvals in hand and our shareholder meetings set for late November, we anticipate closing on or around November 30. We look forward to delivering a franchise poised to provide significant benefits to our shareholders, clients, communities and colleagues. Our two companies have made significant progress on integration planning, which is proceeding smoothly along with the preparation for the balance sheet repositioning actions that will occur in connection with the closing of the merger. I want to thank the bank of California and PacWest team members for their tremendous efforts, planning and dedication towards the successful close.

Turning to our third quarter performance, our results reflect many of our strategic decisions to position our balance sheet ahead of our merger with PacWest, which include limiting certain long term fixed rate deposits, resolving certain acquired credits, and hedging the interest rate risk associated with various assets we anticipate selling in connection with the closing of the merger. As a result of these initiatives. We generated net income of $42.6 million during the quarter, had increases in all of our capital ratios, and grew tangible book value per share by 5%. Joe is going to provide some of details, but our trends were positive and set us up well ahead of closing, expansion of our net interest margin, disciplined expense control, and continued growth in new commercial relationships.

As I’ve discussed in the past, against a backdrop of economic contraction and overall decline in deposit levels across the banking industry, we are focused on bringing new core deposit relationships to the bank. Through the first nine months of the year, we have generated over $200 million in new non-share [ph] deposits from new commercial relationships. These new relationships offset deposit outflows today and will continue to benefit our company in the future. Given the highly liquid balance sheet we expect to have following the merger, including a loan to deposit ratio at closing that is expected to be in the low 80s, we intentionally refrained from adding higher cost deposits to offset any deposit outflows. We continue to see healthy loan yields and have note in this quarter an increase in loan yields outpaced the increase in cost of funds.

Key asset quality ratios improved quarter over quarter and asset quality remained strong. We recorded a $5 million provision for credit losses, which was primarily related to loans from the PMB acquisition that we felt it was prudent to resolve ahead of the merger closing. At the beginning of the year, we indicated that one of our priorities was ramping up our new payments processing business, which we launched during the third quarter on track with our projected timeline. As we have said all along, we are being very prudent in the development of this business and we have steadily built our process and risk management systems as we have added clients. We continue to expect this business to begin making meaningful contributions during 2024, which will be accelerated with the PacWest merger and the larger client base to whom we can offer this highly differentiated payment solution.

In particular, we believe that there will be a high usage rate among clients in PacWest venture and HOA businesses. Now let me hand it over to Joe who will provide some more color on the performance and then I’ll have some closing remarks before opening up the line for questions.

Joseph Kauder: Thank you, Jared. Please feel free to refer to our investor deck, which can be found on our investor relations website as I review our third quarter performance, I will start with some of the highlights of our income statement and then we’ll move on to our balance sheet trends. Unless otherwise indicated, all prior period comparisons are with the second quarter of 2023. Our earnings release and investor presentation provide a great deal of information, so I will limit my comments to some areas where additional discussion is warranted. Net income for the third quarter was $42.6 million, or $0.74 per diluted share. On an adjusted basis net income totaled $17.1 million for the third quarter, or $0.30 per diluted common share, when we exclude impacts from certain credit, certain merger related items, including a pretax gain of $46.2 million on derivative instruments and $9.3 million of transaction cost related to the proposed merger with PacWest Bank Corp, which we will discuss later.

This compared to adjusted net income of $18.4 million, or $0.32 per diluted common share for the prior quarter. Our interest income was almost flat, with a $0.4 million decrease from the prior quarter, primarily due to a $360.4 million decrease in average earning assets, partially offset by an 8 basis point expansion of our net interest margin to 3.19%. The decline in average earning assets was driven primarily by the reduction in excess liquidity that the company carried through the first half of the year. The improvement in our net interest margin to 3.19% was a result of the impact of a 16 basis point increase in the overall earning asset yield to 5.36%, while our total cost of funds increased by only 9 basis points to 2.29%. Our average loan yield increased ten basis points to 5.38%, which was largely attributable to variable rate loans in the portfolio continuing to reprice, and higher rates on new loan production.

Rates on new loan production increased 19 basis points to 8.36%. Also, the average yield on securities increased 34 basis points to 5.17%, mainly due to CLO portfolio resets. Our average cost of deposits was 1.86% for the third quarter, up 19 basis points compared to the second quarter, and since the fourth quarter of 2021, our average deposit beta is 34%. The average cost of interest bearing deposits increased 27 basis points compared to the prior quarter, largely a result of overall higher rates. Our noninterest income increased $44.8 million from the prior quarter, primarily due to a $46.2 million mark to market gain on the derivative instruments we entered into in connection with the announcement of the proposed merger with PacWest. Excluding this mark to market gain, the other areas of noninterest income were relatively consistent with the prior quarter.

Our noninterest expense increased $7 million from the prior quarter, primarily due to transaction cost of $9.3 million related to our proposed merger with PacWest. Our adjusted noninterest expense decreased $2.2 million from the prior quarter due to lower salaries and benefit cost. Turning to the balance sheet, our total assets were $9.2 billion at September 30, a decrease of approximately 1% from the end of the prior quarter, which reflects the impact of the strategies we are employing to position our balance sheet prior to the closing of the merger. Our total equity increased by $44.7 million during the quarter, as $42.6 million in net earnings and $6.3 million in lower unrealized losses on AOCI were partly offset by common stock dividends.

Our total loans decreased approximately $195 million from the end of the prior quarter, as our outlook for loan originations remain cautious in the current economic outlook environment. Our total deposits also decreased $230 million from the end of the prior quarter. As noted, we’ve refrained from adding higher cost deposits to offset outflows given the highly liquid balance sheet that we expect to have following the closing of the merger. Our credit quality remained solid in the third quarter, and excluding our SFR portfolio, which is anticipated to be sold in connection with the closing of the merger, we had declines in all of our problem loan categories. A large percentage of our delinquent and nonperforming loans continue to be SFR loans that are well reserved for and have low loan to values, so we view the loss potential as low.

We recorded a provision for credit losses of $5 million related to loans. As Joe indicated, the provision was mainly related to loans added in the Pacific Mercantile acquisition, as were the related charge offs that we had in the quarter. In anticipation of closing the merger with PacWest, we took the opportunity to accelerate resolution of these credits. Our allowance for credit losses at the end of the third quarter totaled $78.4 million, compared to $84.9 million at the end of the second quarter, and our allowance to total loan coverage ratio stood at 1.13% compared to 1.19% at the end of the prior quarter. Although the total loan coverage ratio declined, the nonperforming loan and nonperforming asset coverage ratios each improved by 3 basis points in the quarter.

At this time, I will turn the presentation back over to Jared.

Jared Wolff: Thanks, Joe. Overall, our trends were strong and we like the way it sets us up for the closing of the deal. Expansion of our margin, increase in loan yields outpacing, increasing cost of funds, improvement in core credit metrics, strong buildup in tangible book value per share, and continued growth in new relationships to the bank. Loan origination volume remained muted during the fourth quarter while we continue to execute on our core fundamentals, we look forward to closing the merger and unlocking the power of the combined institution. The thesis and the power of our deal remains unchanged. We will be the third largest bank headquartered in California. Out of the gate we will have good and healthy capital ratios, a low loan to deposit ratio, relatively high ACL coverage ratio, high cash to assets, low wholesale funding, and expanded earnings.

We have reaffirmed our EPS range for 2024 of a buck 65 to a dollar 80. We’ve been monitoring PacWest performance closely, and we remain on track from an earnings perspective. , even if AOCI is higher and tangible book value per share comes in lower, that creates significant upside, especially if you think we are at or near peak rates. All of the cost saving opportunities and balance sheet repositioning remain positive, and we, along with our investors, remain fully committed to closing around November 30. The fundamentals of the deal and the earnings and capital outlook remain very strong, and we are excited to get this done. Our track record of execution, doing what we say we’re going to do will continue to be demonstrated now and going forward.

The strong market position that the combined institution will have has become even more apparent. Given the number of banks that have completely exited or significantly pulled back from the market over the past 18 months. There is a tremendous amount of excitement through both organizations about the ability to capitalize in our various markets, to add new clients and expand relationships with existing clients, as well as to continue to attract the very best talent. Given these opportunities, we believe that we are extremely well positioned to steadily increase our client roster, generate long term profitable growth, and enhance the value of our franchise in the coming years. With that, let’s go ahead and open up the line for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Timur Braziler of Wells Fargo. Please go ahead.

Timur Braziler: Hi, good morning. My first question is around PacWest NII. It was a little bit softer than we were looking for. I think some of that had to do with probably loan sales versus improvements on the funding side. But I guess as we’re going into deal close, can we just kind of get an update on what you think PacWest’s NII run rate is going into the deal? And then are you still confident in the $90 million net benefit from further restructurings? And is that $90 million now off of a lower base, or has that entire number relatively stayed unchanged?

Jared Wolff: Yeah. Thanks, Timur. Rather than going through kind of because there are a lot of moving parts just achieving earnings, I think the most important thing for us to do is to reaffirm specifically the earnings range that we said before. And there are a lot of different ways to get, you know, rather than going specifically through NII, which has a lot of implications for what we have for loan yields, we’re kind of updating our pro formas weekly. I mean, we’re that close to PacWest looking at their results and looking at the pro forma numbers, which is why we feel very comfortable reaffirming our range. We remain confident in the pro forma earnings power, as we discussed on the merger call in July. And looking at the third quarter bank earnings, plus the significant benefits of the planned deleveraging of the pro forma balance sheet, with the asset sales, reducing the high cost funding, paying off the Atlas facility at PacWest with existing cash, plus the stated cost saves, and importantly, the reduction and normalization of their FDIC assessment.

Right. That’s a very high number that is going to be normalized out of the gate in Q4. So the PacWest balance sheet is carrying a lot of excess high cost liquidity impacting their overall numbers and they have not fundamentally executed on the cost saves, which is going to occur post close. So we feel excited about the kind of improving earnings power for the deal ahead. And so I think that’s kind of the most I can give you about the specifics. We’re absolutely reaffirming the range of 165 to 180.

Timur Braziler: Okay. And then I guess without delving too far into the specifics, but you brought up the FDIC surcharge and PacWest expenses were a little bit elevated. Given that, I guess, what’s the combined number for FDIC surcharge on a go forward basis or FDIC expenses on a go forward basis?

Jared Wolff: What is the number that we’re projecting it to be? Is that what you’re asking?

Timur Braziler: How much of a reduction will that.

Jared Wolff: Joe, how much guidance are we giving on that? What’s the range that we’re expecting off of where PacWest is today?

Joseph Kauder: Yeah, I think we expect it to run annually going forward, around $36 million a year.

Timur Braziler: Okay, great. And then Jared, you had brought up the AOCI effect. Can you guys provide what the unrealized loss position is on the mortgage book at quarter end for…

Jared Wolff: Well, let me provide it more broadly, which is that the AOCI that PacWest experienced through recently, we think moves tangible book value from around 15 to around 14. So that’s kind of where it is now. Interest rates are obviously moving. It could be higher than that, it could be lower than that. And there are some things that we can do to kind of affect it between now and closing. But that’s kind of the impact of where it is. It moved at about a buck from where we were and it hasn’t affected, as I mentioned in my comments, it has not affected the earnings power of the company at all. It hasn’t affected the key capital ratios that we’re focused on. And if anything, it provides upside going forward. Because if you think we’re at or near peak rates, then we’re going to get the benefit of improvement in AOCI going forward.

Timur Braziler: Okay, and then just a last one for me, just seeing what the stock price is doing and I think I know the answer to this, but is there anything in the three key results that you think puts the shareholder risk at vote or shareholder vote at risk?

Jared Wolff: Absolutely not. And I hope I was fundamentally clear in my comments that Bank of California and our investors are fully committed to closing this deal on November 30. I think the legal terms are on or around November 30. The shareholder vote is the 22nd and we’re going to close it promptly. And we’re just kind of timing it to the month end which makes sense from an accounting perspective since we’re at the end of the year. So we’re excited to get this deal done and we’re moving forward.

Timur Braziler: Great. Thanks for that color.

Operato: Thank you. Our next question comes from Matthew Clark of Piper Sandler. Please go ahead.

Matthew Clark: Hey, good morning, everyone.

Jared Wolff: Morning.

Matthew Clark: Maybe just thinking through kind of standalone bank here as we go into what will know a lot of moving parts, but on your NIM, I mean, it was up nicely this quarter, but just trying to get a sense for kind of the upcoming fourth quarter. Do you have the average NIM in the month of September? I saw the spot rate on deposits in your deck, but just want to get a sense for whether or not there might be some additional lift in the NIM here in 4Q.

Jared Wolff: Joe, you want to take that?

Joseph Kauder: We generally don’t give out monthly NIM amounts. I will say that the continued pressure on the deposit side of the balance sheet is probably having that come in a little bit softer than what you’re seeing in the third quarter, but not by significant amounts.

Matthew Clark: Okay. And on expenses, they were down on a core basis, I think a few million bucks to $46 million. Anything unusual or how do you think about that standalone run rate going into 4Q?

Jared Wolff: Well, 4Q is going to be a mess because of the merger, but absent the deal, I mean, I think it was just consistent. It was nothing unusual. It’s just continuing to manage expenses and run this company as efficiently as we can in the market that we’re in. And so it was nothing unusual. There is what I would say. Matthew. And just to comment back on the mean in looking at kind know, month end, although we don’t give them out, I will say that I would say the threat to deposit cost seems to be declining quite a bit, and we’re not seeing the same pressure that we saw earlier. Our margin, the average margin was not terribly far off from where we ended up. I think Joe’s appropriately being conservative, that saying the margin could slip a little bit, but we’re just seeing less pressure overall on deposits right now.

Obviously, when we close the deal, our margin is going to go down because we’re going to be absorbing PacWest margin, and then we’re going to be improving it by getting rid of all of their high cost deposits with all the liquidity we’re creating through the deal. But then we’re going to be building it back up pretty aggressively as we execute on our strategy on the deposit side.

Matthew Clark: Yes. Okay. And then just I know it’s kind of taken a backseat here since the deal was announced, but any update on Deepstack with going live with some customers?