Bank of Marin Bancorp (NASDAQ:BMRC) Q2 2023 Earnings Call Transcript

Bank of Marin Bancorp (NASDAQ:BMRC) Q2 2023 Earnings Call Transcript July 24, 2023

Bank of Marin Bancorp beats earnings expectations. Reported EPS is $0.71, expectations were $0.43.

Andrea Herndeson: Thank you for joining Bank of Marin Bancorp’s Earnings Call for the Second Quarter Ended June 30, 2023. I am Andrea Henderson, Director of Marketing for Bank of Marin. During the presentation, all participants will be in a listen-only mode. After the call, we will conduct a question-and-answer session. [Operator Instructions] This conference call is being recorded on July 24, 2023. Joining us on the call today are Tim Myers, President and CEO, and Tani Girton, Executive Vice President and Chief Financial Officer. Our earnings press release and supplementary presentation, which we issued this morning, can be found in the Investor Relations portion of our website at bankofmarin.com where this call is also being webcast.

Closed captioning is available during the live webcast as well as on the webcast replay. Before we get started, I want to note that we will be discussing some non-GAAP financial measures. Please refer to the reconciliation table in our earnings press release for both GAAP and non-GAAP measures. Additionally, the discussion on this call is based on information we know as of Friday, July 21, 2023, 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, Tim, Tani and Chief Credit Officer, Misako Stewart will be available to answer your questions.

And now, I’d like to turn the call over to Tim Myers.

Tim Myers: Thank you, Andrea. Good morning, everyone, and welcome to our second quarter earnings call. Our second quarter reflected the full impact of the late Q1 bank failures, resulting in meaningful net interest margin compression due largely to the higher cost of funds on FHLB borrowings and deposits paired with slower lending activity. We believe that this impact is temporary in nature and will not be an indicator of future performance as we have continued to make significant progress by focusing on our balance sheet. In fact, we substantially strengthened the balance sheet by attracting customers, raising deposits, and improving liquidity to position the bank for efficient growth and stronger profitability. Here are a few key highlights of note.

After regional bank failures triggered significant industry deposit outflows and price sensitivity, our deposits quickly stabilized late in the first quarter. During the second quarter, we raised $152 million in new balances at below capital market rates. Additionally, we opened over 1,400 accounts for both new and existing customers. New balances, net of normal customer activity and some continued outflow largely to money markets accounts, drove deposit growth of $75 million in the second quarter. Importantly, those new deposits and investment cash flows enabled us to reduce our short-term borrowings at the FHLB by [$113.2] (ph) million or 28% during the second quarter. Deposit growth has continued post quarter-end and included seasonal DDA growth we had anticipated.

From quarter end to July 18, we added $116 million to total deposits which are now within $50 million of pre-bank failure levels in early March 2023. Our percentage of demand posits has also increased to a level higher than the pre-pandemic percentage at the end of 2019. At the same time, the rate of increase in the cost of deposits has slowed and FHLB borrowings have fallen another $126 million. Our deposit growth strategy was and continues to be driven by proactive customer outreach and relationship-based pricing discussions. We have not offered CD specials or tapped into brokered CD markets. In the quarter, we saw a natural shift from non-interest bearing to interest bearing deposits as customers saw higher yields on excess cash as well as increased FDIC insurance coverage through our reciprocal deposit network offerings.

Second quarter deposit costs increased 49 basis points sequentially due to delivery pricing adjustments that we made. We expect that funding cost increases will level-off in the second half of 2023 as Fed rate hikes and customer reallocation of funds between operating accounts and interest bearing accounts slow. Our deposit mix at June 30 consisted of 48% non-interest bearing deposits, down from 50% last quarter. However, the percentage of non-interest bearing deposits was back up to 50% by July 18. Going forward, we will continue to carefully manage deposit pricing on a customer-specific basis and as we have throughout our history, will remain in close contact with our customers to understand opportunities and risks. In alignment with our stringent liquidity standards, we continue to maintain a high level of liquidity that covers all of our uninsured deposits by over 200%.

Notably, our uninsured deposits declined to 29% from 33% of our total deposits at quarter-end. In addition, our average balance per deposit account declined slightly by $2,000 to $6,200 from the prior quarter with our largest deposit representing only 1.3% of total deposits. Our available contingent liquidity was approximately $2 billion and consisted of cash, unencumbered securities and borrowing availability from the FHLB and Federal Reserve Bank. Post quarter end, we have taken additional steps to bolster on-balance sheet liquidity by selling AFS securities and Visa B Class shares at a net breakeven and retaining proceeds in cash. In addition, we entered into fixed pay interest rate swaps to protect our other available-for-sale securities from changes in market value.

We also continue to actively engage with and support our borrowers and we are optimistic about identifying compelling lending opportunities in the second half of this year. While lending activity has slowed, the new loans that we are bringing on to our books are high quality credits coming on at notably higher yields than those being paid off. This is providing a boost to our interest income and moving forward, we believe should help us protect our NIM as we continue to fund our pipeline. Additionally, approximately 29% of our loan portfolio will reprice in the next 12 months. If those reprices occurred at today’s rates, we estimate it will provide an incremental lift of roughly 30 basis points for the loan portfolio. While loan demand has eased, our teams continue to focus on achieving attractive risk adjusted returns while maintaining solid credit quality.

We are sticking to the prudent lending policies and standards that we have always had, carefully monitoring our loan portfolio and proactively adjusting risk rating. While there has been some risk rate migration, largely in special mention loans, there were no meaningful surprises in the quarter. During the second quarter, non-accrual loans held steady at just 10 basis points of total loans. Classified loans comprised only 1.81% of total loans at quarter-end. Classified loans did increase during the quarter centered primarily around the non-office CRE loan, the C&I term loan and increased usage on a previously downgraded line of credit. I’ll take a moment to provide added color to our commercial real estate portfolio as it is the largest concentration in our loan book, representing 73% of our total loan balances at the end of the second quarter.

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Of our total CRE loans, 22% are owner-occupied, which we believe carry a different risk profile than non-owner occupied loans in this environment. Our $366 million of non-owner occupied office portfolio consists of 142 loans with an average loan size of $2.6 million, with the largest loan being $17 million. The average LTV was 55% and the average debt service coverage was 1.67 times based on our most recent annual review process. Lastly, we are actively recruiting proven talent as recent industry disruption has made available a considerable number of seasoned bankers. We have taken advantage of the recent market changes and expect to announce a meaningful recruiting news soon that we believe will help boost lending activity and deposit growth and deliver greater value to our customers and our shareholders.

Now, I’ll pass it over to Tani to discuss our financial results in greater detail.

Tani Girton: Thanks, Tim. Good morning everyone. Now that Tim has provided a picture of how our balance sheet is evolving, I will walk through earnings. Bank of Marin generated net income of $4.6 million or $0.28 per diluted share in the second quarter. As Tim said, the decline from the first quarter was largely due to a higher interest expense, both on the rising cost of deposits and higher average borrowing balances. Our second quarter tax equivalent net interest margin of 2.45% was down 59 basis points from the prior quarter as rapid deposit pricing adjustments and higher borrowing balances far outweigh gradually increasing loan yields. While lagging deposit rate increases delayed NIM compression, and contributed to 2022 earnings, it also resulted in more change concentrated in the second quarter of 2023.

We expect pressure on our net interest margin to continue in the second half of 2023 but to abate somewhat as deposit rates have caught up with market rate changes and loan yields are expected to continue improving. Additionally, we have taken steps early in the third quarter to mitigate the impact of further rate hikes by paying down another $126 million in borrowings, selling $83 million in securities to retain proceeds in cash and entering into $102 million fixed pay interest rate swaps. We made a $500,000 provision for credit losses in the second quarter based on increases in qualitative factors related to our multifamily and non-owner occupied commercial real estate office portfolios impacted by trends in criticized and classified loans and collateral value.

Subsequent to quarter-end, we sold our only other real estate owned property at a slight gain. Non-interest income of $2.7 million was down modestly from the first quarter, primarily related to the recognition of policy payments on bank-owned life insurance in the first quarter somewhat offset by higher debit card interchange fees and wealth management and trust services income in the second quarter. Non-interest expenses remain well controlled at $20.7 million for the quarter, up from $19.8 million in the first quarter. The increase included $589,000 in annual giving program charitable contributions, $486,000 in salaries and related benefits, which included annual merit increases, $393,000 in deposit network expenses and a $377,000 FDIC assessment base rate adjustment.

These increases were partially offset by reductions of $482,000 in depreciation and amortization expense and $434,000 in occupancy and equipment expense related to first quarter branch closures. In addition, professional services decreased by $326,000 related to the timing of audit work performed. Our second quarter earnings translated into a return on assets of 0.44% and return on equity of 4.25%, down from 0.92% and 9.12% in the prior quarter. The efficiency ratio increased to 76.91% from 60.24% in the prior quarter due to both higher interest and non-interest expenses. All capital ratios were above well capitalized regulatory requirements at June 30. The total risk-based capital ratios for Bancorp and the Bank increased to 16.4% and 16% respectively.

Quarter-end tangible common equity was 8.6% for Bancorp and 8.4% for Bank of Marin as compared to 8.7% and 8.3% in the previous quarter, respectively. After adjusting for $85 million after-tax unrealized losses in our HTM securities portfolio, our TCE ratio would be 6.7% for Bancorp. Our Board of Directors declared a quarterly cash dividend of $0.25 per share payable on August 11, 2023. This represents the 73rd consecutive quarterly dividend paid by Bank of Marin Bancorp. The Board also approved a new share repurchase program for $25 million effective through July 2025. Our ample capital position and high-quality investment portfolio provides strength and liquidity for the ongoing operations and investments in the future of Bank of Marin. We evaluate the Bank’s interest rate, liquidity, economic value and market price risk under various scenarios regularly and we stress test underlying assumptions.

We believe that our unwavering emphasis on the fundamental of relationship banking and credit, liquidity and capital management will continue to position Bank of Marin to navigate challenging cycles profitably. Now I’ll turn it back to Tim to share some final comments.

Tim Myers: Thank you, Tani. In conclusion, while the current rate environment and the effects of the recent bank failures caused a significant impact on our net interest margin and earnings in the second quarter, we continue to believe those effects to be temporary. Due to our intense focus on the balance sheet, we considerably enhance our prospects for NIM and EPS improvement going forward, while doing nothing outside our normal business model. And we have seen material improvement post quarter-end. With that, I want to thank everyone on today’s call for your interest and support. We will now open the call to your questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question is from the line of David Feaster with Raymond James. Please go ahead.

David Feaster: Hey, good morning, everybody.

Tim Myers: Good morning, David. How are you?

David Feaster: Maybe just starting out on the deposit side and the flows, look, it’s great to hear the commentary that you had about what you guys — been very active this far in the third quarter already. But I’m just curious, if you could characterize some of the NIB flows, it sounds like it’s a lot of seasonality. Curious how much is continued account growth? And then just how do you think about continued deposit growth going forward and your efforts there, your strategy to continue to drive growth? And then is the kind of the plan to continue to have deposit growth outpace loans and pay down the borrowings hopefully by the end of the year?

Tim Myers: So, good question. So the movement in demand deposit accounts in the quarter and after quarter end were reflective of our normal seasonality. You had payroll and taxes in there on the outflow side and we have some seasonal increases that we mentioned on the call last quarter where they start to go up. Maybe $10 million or so of that deposit raising effort was in checking accounts. Most of that was in interest bearing as you can imagine because we’re going out and soliciting funds. So the bulk of the money we mentioned we raised through our deposit initiative was interest bearing, but what was nice is the weighted average rate on that was 3.20% for the whole pool. So still well below our cost of borrowing. So the goal is to continue to raise deposits.

Our goal is not to shrink loans, our goal is to grow loans. We continue to build a pipeline. We did have some closings we expected to happen get pushed into next quarter. When you talk about issues with office real estate, tenancy issues or vacancy. We’re seeing that affect us kind of more in the pipeline than we are in portfolio. Our portfolio has maintained very steady. What we have had to do in our pipeline activity is weed out where there’s a lot of lease turnover risk, et cetera, valuation risk. So we continue to build the pipeline. We’re looking to make some hires in the near future to help drive that growth. So the goal is to continue to build deposits, pay down the borrowings and continue to drive a pipeline that will result in loan growth.

So long winded answer, we’re trying to do both but we did have a very concerted effort on the fundamentals in the quarter of raising deposits at the lowest rates we could because those will retain as customers when all this goes away and those rates will eventually subside and we are trying to maintain that mix of non-interest bearing and interest bearing as close to that level as we are today as we can.

David Feaster: Okay. That’s helpful. And I want to touch on the growth side in just a second, but before we get there, there’s a lot of moving parts for all the things that we’ve talked about as it relates to the margin. And just hearing, Tani, kind of your commentary, it sounds like expect a bit more pressure in the back half year, but it sounds like we’re getting close to the trough. I was hoping just given all the moving parts in there between the borrowing pay downs, the deposit growth you’ve seen in your quarter, if you could just help us think about the timing of a trough and kind of the NIM trajectory as we look forward?