Banc of California, Inc. (NYSE:BANC) Q4 2022 Earnings Call Transcript

Banc of California, Inc. (NYSE:BANC) Q4 2022 Earnings Call Transcript January 19, 2023

Operator: Hello, and welcome to Banc of California’s Fourth Quarter Earnings Conference Call. All participants will be in listen-only mode. There will be a question-and-answer session following today’s presentation. Today’s call is being recorded and a 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 now like to turn the conference call over to Mr. Jared Wolff, Banc of California’s President and Chief Executive Officer. Please go ahead.

Jared Wolff: Good morning, and welcome to Banc of California’s fourth quarter earnings call. Joining me on today’s call is Lynn Hopkins, our Chief Financial Officer, who will talk in more detail about our quarterly results. Banc of California generated record net income in 2022 and I am tremendously proud of our entire team. Our results and overall performance reflect the strength of the franchise and high quality balance sheet that we have built over the last several years. We were able to achieve what we set out to do in 2022, which was to generate solid earnings by capitalizing on our strong stable deposit base and disciplined expense management. As we have continued to demonstrate over the last several quarters, our balance sheet has migrated to a balanced portfolio of high quality loans and stable commercial deposits.

As we forecast on this call many quarters ago, we said that warehouse balances would migrate down, but we would continue to move our earnings forward. These last several quarters have proven out that plan. Our fourth quarter was strong even as we remain selective in our new loan production given the macroeconomic uncertainty. As a result, while we had a slightly smaller average balance sheet in the fourth quarter, our core earnings were a bit higher than the prior quarter and we generated a significant increase in our tangible book value per share. Our growth in tangible book value per share is important to highlight as it reflects our steady financial performance and prudent balance sheet management. For the full year, our tangible book value per share increased by more than 2% notwithstanding the impact of higher interest rates on AOCI, and the significant capital actions we took, including the completion of our $75 million stock repurchase program, our $24 million acquisition of DeepStack Technologies, and the repositioning of a portion of our securities portfolio this quarter that will contribute to our future earnings.

Lynn will discuss this repositioning a bit later in the call. Our loan fundings were lower than the prior quarter due to a combination of lower loan demand resulting from higher interest rates and borrowers being more cautious given the economic uncertainty, as well as our decision to be more selective in the loans we are adding in the current environment. But excluding warehouse, we were able to slightly increase our commercial loan balances during the quarter and keep our overall loan balances essentially flat. We continue to see higher yields in the portfolio, which enabled us to realize more margin expansion. When combined with the actions we have taken this year to manage our funding costs, and our stable non-issuing deposit base that remained around 40% of total deposits.

In terms of the launch of our payments business, we remain on track with our projected schedule. Earlier this month, we completed the integration of DeepStack Technology into our internal platform and we have begun processing payments on our rails with Banc of California as the sponsor bank for select smaller clients. We continue to build out the infrastructure necessary to process transactions at scale with targeted completion around the end of the second quarter, after which we will be more broadly developing our pipeline. Now, I’ll hand it over to Lynn, who will provide more color on our financial performance. And then I’ll have some closing remarks before opening the line for questions.

Lynn Hopkins: Thanks, Jared. Please feel free to refer to our investor deck, which can be found on our Investor Relations website as I review our fourth quarter performance. I’ll 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 third quarter of 2022. Our earnings release and investor presentation provide a great deal of information, so I’ll limit my comments to some areas where additional discussion is helpful. Net income available to common stockholders for the fourth quarter was $21.5 million or $0.36 per diluted share. As Jared mentioned, we repositioned a portion of our securities portfolio during the fourth quarter and recognized a pretax loss on sale of securities of $7.7 million, which had a $0.09 impact on diluted earnings per share.

On an adjusted basis, net income totaled $26.88 million for the fourth quarter or $0.45 per diluted common share when the loss on sale of securities, net indemnified legal costs and net losses on investments in alternative energy partnerships are excluded. This compared to adjusted net income of $26.7 million or $0.44 per diluted common share for the prior quarter. There were no securities sold in the prior quarter. It is also worth noting that on an adjusted basis, net income has more than doubled since the fourth quarter of 2021. Our net interest margin increased 11 basis points from the prior quarter to 3.69% as our overall earning asset yield increased by 46 basis points and our total cost of funds increased by 38 basis points. Our earning asset yield increased to 4.79% due to higher yields on both loans and securities during the fourth quarter.

Our average loan yield increased 38 basis points to 4.92% due in part to the higher rate on loan production and the average yield on securities increased 81 basis points to 4.19%. The higher securities portfolio yield is due mostly to the CLO portfolio resets and the impact of the investment portfolio actions we accomplished in mid-November. We sold $119 million in securities, recognized a net loss of $7.7 million and reinvested in the net proceeds in securities with a higher average yield of approximately 230 basis points compared to the securities we sold. We estimate this allocation of capital has a tangible book value earn back period of about three years and will cause the overall investment portfolio yield to increase 20 basis points to 25 basis points going forward.

Our average cost of funds was 117 basis points, up 38 basis points compared to the prior quarter and our average cost of deposits was 79 basis points for the fourth quarter, up 32 basis points. This increase in our average cost of deposits was primarily driven by rate increases in our money market and interest bearing checking accounts, as well as the impact of the CDs that we have added to lock in some longer term funding as market interest rates have continued to climb. This was partially offset by the positive impact of our average non-interest bearing deposits increasing to 41% of total deposits in the fourth quarter from 38% in the prior quarter. As market interest rates have increased and liquidity has continued to be absorbed by the market, the expectation of deposit yield has also increased.

And while our cost of deposits increased 32 basis points quarter-over-quarter, the average federal funds rate increased 147 basis points over the same time period. As a result, the difference between our average cost of deposits and the average federal funds rate widened from 171 basis points last quarter to 286 basis points for the fourth quarter. The net interest margin drivers page in the investor presentation deck illustrates this information. Our non-interest income decreased $7.1 million from the prior quarter due to the loss on sale of investment securities. Other areas of non-interest income were relatively consistent with the prior quarter, with the most significant variance being higher gains from equity investments of $724,000. Our adjusted non-interest expense increased $1.1 million from the prior quarter, which was a reflection of an increase in a variety of areas focused on internal projects, including, but not limited to, DeepStack.

All of our other areas of non-interest expense were relatively consistent with the prior quarter as we continue to maintain disciplined expense control while investing in areas of the business that we believe will create long term franchise value. The effective tax rate for the fourth quarter was 29.6% up from the prior quarter’s rate of 29.1%. The higher effective tax rate for the current quarter decreased net income by approximately $170,000 compared to the prior quarter. For 2023, we estimate an annual effective tax rate to be approximately 28%. Turning to our balance sheet. Our total assets were $9.2 billion at December 31, down slightly from the end of the prior quarter. Our total equity increased by $7.6 million during the fourth quarter, that’s $21.5 million in net earnings and $1.7 million positive shift in AOCI were offset by capital actions, which included common stock dividends and the repurchase of $19 million in common stock.

With the fourth quarter repurchases, we completed the $75 million stock buyback program announced earlier this year and during 2022 we repurchased 7% of our previous outstanding shares. Our non-interest bearing deposits remained strong, averaging 41% for the quarter and ended the quarter at 40%. We continue to use wholesale funding sources to strategically manage both liquidity and funding costs when we believe these sources are better options than rate sensitive client deposits. This included adding $100 million in FHLB term advances in the fourth quarter. Turning to credit quality. Our credit quality remained strong in the fourth quarter. Non-performing loans excluding single family residential loans or SFRs decreased slightly quarter over quarter.

While SFR NPLs did increase, they are well secured with very low loan to value ratios and we do not see loss exposure in our SFR portfolio. SFR NPLs represented 38% of our NPLs at year end. In addition, at December 31, 35% of our non-performing loans were either loans and a current payment status but classify non performing for other reasons or the guaranteed portion of loans that have an SBA government guarantee. Similar to NPLs, most of the increase in delinquent loans was driven by SFRs, which totaled $60.8 million or two-thirds of total delinquencies at period end. As frequently happens, we saw a drop in delinquency after quarter end and our SFR delinquencies dropped by $23.7 million by the middle of January. We did not record a provision for credit losses in the fourth quarter given the lower loan balances which offset the impact of weaker economic forecasts.

Our allowance for credit losses at the end of the fourth quarter totaled $91.3 million compared to $98.8 million at the end of the prior quarter and our allowance to total loans coverage ratio stood at 1.28% compared to 1.36% at the end of the prior quarter. The $76 million decrease in the allowance for credit losses was due primarily to a $7.1 million charge off of a specific reserve for a purchased credit deteriorated loan from the PMB acquisition. Excluding the reserves associated with loans individually evaluated for impairment, the total coverage ratio increased from 1.24% to 1.25% quarter-over-quarter. And excluding warehouse loans, which have lower relative risk in our reserve methodology, the ACL coverage ratio stood at 1.36% at December 31.

Our ACL to non-performing loan ratio remained healthy at 165%. At this time, I will turn the presentation back over to Jared.

Jared Wolff: Thank you, Lynn. 2022 was a very successful year for Banc of California in terms of executing on our strategic initiatives, delivering strong financial performance and continuing to build long term franchise value. And I want to thank all of our colleagues at Banc of California for their outstanding effort and performance. One of the pages in our deck lays out what we set out as goals for 2022 and how we checked each of those boxes. It is important we continue to deliver for our shareholders by doing what we say we are going to do. Turning to 2023, we believe that the franchise we have built positions us well to manage through the current environment and to continue delivering strong financial performance. We have a very stable base of non-interest bearing deposits as a result of the work we have done over the past several years to bring in high quality commercial relationships that value the level of service and expertise that we provide.

We have a well-diversified conservatively underwritten loan portfolio and we have a high level of capital with our total capital ratio and TCE ratio finishing the year at 11.4% and 9.3% respectively. We have been very successful in attracting talent to the company and we expect that to continue this year as we see many highly productive bankers that want to be part of Banc of California. We also continue to invest in technology to further enhance efficiencies and elevate the client experience, with a priority being placed on investments that will further improve our ability to attract low cost deposits. Since my first day as CEO, our goal has been to build a robust core deposit gathering engine, which we have successfully done. We firmly believe that franchise value is driven by the deposit base.

And we remain committed to ensuring that we have the best-in-class technology, service levels and specialized expertise for targeting deposit rich verticals that will enable us to continue taking market share and adding more commercial deposit relationships. 2023 has begun with economic uncertainty, which makes it challenging to forecast at this point, most notably around the level of loan growth, which is going to be largely dependent on the economic environment and there’s a wide range of possible outcomes. But with our consistent success in deposit gathering, we expect to have opportunities to profitably invest those inflows and generate higher earnings. If we don’t see enough lending opportunities that we like, then we can put money to work in the securities portfolio, given the attractive yields that are now available.

Absent an economic turnaround, we would expect earnings to be slightly up in 2023 compared to 2022’s core results. Recognizing that the first quarter tends to be slower than the fourth quarter and we expect earnings to build throughout the year. We remain steadfastly focused on credit quality and continuing to grow a high quality deposit base by bringing new commercial relationships to the bank. Let me take a minute to touch on the vision we have for this company going forward. Today, we have over $9 billion in assets with 40% non-interest bearing deposits, a slightly asset sensitive balance sheet with a healthy net interest margin, growing earnings, plenty of capital, a very safe credit portfolio of which approximately 65% is secured by residential real estate at low loan to values and we are located at the heart of the fifth largest economy in the world.

We have a core banking business serving commercial clients with exceptional solutions and niches in real estate, entertainment, healthcare, education and in few other areas. As the world moves away from checks and toward card and cashless transactions, we are building on payment and core merchant processing solutions that allow us to be the hub of this ecosystem. Processing card transactions directly on behalf of the merchant without intermediate software or sales partners with a promise of greater visibility into transaction activity and faster receipt of funds for the client. And eventually, card issuance as well, helping our clients with payments in a very complete way. We have a significant number of existing clients that will benefit from these solutions and we know there are an even greater number that we will target that are not our clients today.

The synergy of banking and payments should be abundantly clear and our track record of execution should also be very clear by now. While we have laid out general timing, it is important to stress that we are building solutions for the long term and focused on doing it right. While our progress remains on track, we are building a true business line and these things take time to do it right and we will not be deterred however long it takes. Even with an uncertain economic backdrop, given the fundamentals I just laid out and the strategic initiatives we have underway, 2023 is going to be an exceptional year for Banc of California. I can’t be exactly sure where the loan growth will shake out, but I do know we have amassed an incredibly talented team, we have an exceptional mission driven and values based culture and with the vision and roadmap we have ahead, 2023 will be a year that continues our track record of driving even greater returns and long term value for shareholders.

With that, operator, let’s go ahead now and open up the line for questions.

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. Today’s first question comes from Matthew Clark at Piper Sandler. Please go ahead.

Matthew Clark: Hey, good morning, Jared and Lynn.

Jared Wolff: Good morning.

Matthew Clark: Maybe just starting on the earning assets. I know loan growth is difficult to pinpoint, mortgage warehouse may be nearing the bottom. But give us a sense for how you’re trying to manage maybe overall earning assets? Is the plan to kind of stabilize them from here and maybe even grow them incrementally with some leverage or not?

Jared Wolff: Sure. Good morning. I think we’d like to keep assets relatively flat. If we can grow them great, there’s probably opportunities to use a little bit of leverage and maybe grow them a little bit more. But we’d like to at least target asset level staying flat where they are to keep earnings power where it needs to be. And then if we see opportunities to grow a little bit, we’ll do it. The pipelines are not huge right now. They’re probably the slowest they’ve been since I’ve been at the company, but we’re not — we’re also not pressing, the environment is pretty uncertain and we’re being very selective in the deals that we do.

Matthew Clark: Okay, great. And then maybe for Lynn, just your thoughts on the non-interest expense core run rate, the $48.5 million this quarter, where that might go this coming year?

Lynn Hopkins: Sure, sure. I think we’ve provided previously a range of $48 million to $50 million, we were at the lower end of the range. I think our expectation is $48.5 million probably the lower end. I think the range is still appropriate though at $50 million. Maybe I think we’d be at the higher end of the as we look into first quarter has seasonally higher expenses. And then as the year unfolds, I think we’ve continued to invest in many initiatives. And I think that will put us, like I said, closer to the higher end of the range.

Matthew Clark: Okay. And then just any updated thoughts on your interest bearing deposit beta where you think it might settle out this cycle, 39% in cycle to date? And I think it was in the mid-50s last cycle?

Jared Wolff: Yes. I mean, we continue to focus on bringing in low cost deposits and I’m really proud of kind of how our — I know there were questions. We grew non-interest bring deposits from 12% to 40% and people said, is that real? Is it going to hold up? And what we’ve said last quarter and the prior quarter was, as the economy contracts, we expect there to be outflows of liquidity, but we don’t expect our mix to change very much because it’s — the economy is moving downward overall and that’s what we’re seeing in our book and that’s what’s been holding up. So we’re going to try to keep growing our non-interest bearing percentage and our deposit beta is really — it’s not something we track very much honestly, Matthew, because it’s an outflow.

Excuse me, it’s an output of kind of all the other efforts that we have. And this quarter what Lynn pointed out to me was that, our% of the Fed increases was much lower than prior quarters, which meant we did a better job of not increasing deposit costs as much relative to the market. So I don’t know that we have a target number. We just want to — we’re still slightly asset sensitive. We think there’s probably a little bit of room for our margin to expand. But I would say that given we’re getting closer to peak interest rate increases based on what the Fed has indicated they’re going to do. We’re likely to move at some point to neutrality to optimize earnings for the long term. And we’ll be smart about it and protect shareholders. So we don’t have a specific deposit beta number.