Below is transcript of the Pacific Premier Bancorp, Inc. (NASDAQ:PPBI)’s Fourth Quarter 2014 Earnings Call, held on January 21, 2015 at 12:00 p.m. ET. Basswood Capital, Whitebox Advisors and Springbok Capital was among Pacific Premier Bancorp, Inc. (NASDAQ:PPBI) shareholders at the end of the third quarter.
Pacific Premier Bancorp, Inc. (NASDAQ:PPBI) is a holding company for Pacific Premier Bank (Bank). As of December 31, 2011, the Company conducted business throughout Southern California from its nine locations in the counties of Los Angeles, Orange, Riverside and San Bernardino.
Company Executives:
Steve Gardner – President and Chief Executive Officer, Pacific Premier Bancorp Inc
Kent Smith – EVP, CFO, Corporate Secretary and Treasurer, Pacific Premier Bancorp Inc.
Analysts:
Matthew Clark – Managing Director, Sterne Agee Institutional Services
Andrew Liesch – CFA, Associate Director, Equity Research Group of Sandler O’Neill
Timothy Coffey – Vice President and Research Analyst, FIG Partners
Brian Zabora – Analyst, Keefe, Bruyette & Woods (KBW)
Donald A. Worthington – Banking Analyst, Raymond James
Gary Tenner, CFA – Vice President and Senior Research Analyst, D.A. Davidson Equity Capital Markets.
Operator
Good afternoon and good morning. Welcome to the Pacific Premier Bancorp Q4 2014 Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please also note that today’s event is being recorded. At this time, I’d like to turn the conference call over to Mr. Steve Gardner, President and CEO of Pacific Premier Bancorp. Sir, please go ahead.
Steve Gardner, President and CEO
Thank you, Jamie. Good morning, everyone and I appreciate you joining us today. As you are all aware, earlier this morning we released our earnings report for the fourth quarter of 2014. I’m going to walk through some of the notable items. Kent Smith, our CFO is going to review some of the financial details and then we’ll open up the call to questions. I’ll also note that in our earnings release this morning, we have the Safe Harbor statement relative to the forward-looking comments and I would encourage all of you to take a look and read through those at you’re leisure.
We delivered strong performance in the fourth quarter, which was highlighted by our success in Business Development that resulted in more than 20% annualized growth in both Loans and Deposits. However, we had a couple of items that negatively impacted our bottom-line. The first item was $864,000 in merger-related expense in connection with our Independence Bank acquisition. The second item was a $1.7 million accrual we made in connection with the Baker class action lawsuit. The bank was named as a defendant in a class action lawsuit back in 2004, alleging various violations of Missouri Law relating to alleged excessive loan origination fees and closing costs involving approximately 16 residential loans.
Various motions to dismiss the lawsuit were denied in 2005 and 2006. After a lengthy period of inactivity, we were contacted by plaintiffs’ counsel to schedule depositions and discovery and prepare the case to go to trial in 2015. Our attorneys have analyzed the claims and evaluated the arguments and we determine to establish the accrual in consultation with our counsel. As a result of these two items, our diluted earnings per share for the fourth quarter came in at $0.23, lower than both the prior quarter and the fourth quarter of 2013. However from the perspective of our core operations we saw very positive trends in most areas of our business. We had our most productive quarter in history of the bank with $218 million in originations.
The strong level of production is a result of the investments we have made over the past few years to diversify our banking platform bringing in experienced talent across a variety of lending areas and an upgrade to our systems and process to allow us to be more responsive and efficient lenders. As we have talked about in the past year, our focus in loan production has been in C&I and Construction Lending, in order to take advantage of the higher yields it provide, as well as SBA Lending in order to boost our non-interest income to gain on sale. And we’re pleased with the progress we’ve made in all three areas. We had $72 million in C&I loan originations during the fourth quarter, which was the largest component of our production.
The biggest contributor to our C&I production was our Franchise Lending business which had $58 million in originations. This is the strongest quarter we’ve had since acquiring this team. We are definitely seeing the benefits from an increase in Business Development that we projected when we acquired the group in early 2014. When we acquired this business the team was limited to banking, the franchisees of eight brands. They now have approval to pursue 25 of the top-tier brands and they have already developed lending relationships with franchisees of 18 of them. So this business is really delivering the results we expected.
We are still a relatively small player in the Franchise Lending market, so even with the growth we have seen this year there is still plenty of opportunity to take market share. The remainder of our C&I loan production was broad-based across a variety of industries and concentrated in our primary markets within Southern California. We had $56 million in construction loan production in the fourth quarter, as we continue to get good results from the additions we made in our Construction Lending team. We have very good relationships with seasoned developers throughout Southern California. As a result of our focus on the higher yielding franchise and construction loans, we have been able to keep the weighted average rate on our loan originations above 5%.
The third area of focus for the past year — SBA Lending had a strong quarter as well. We originated $26 million in SBA loans in the fourth quarter, which was our largest quarter of the year and continued the higher production trends we saw throughout 2014. As a result of the increases in our SBA business, the gain on sale income has become a larger contributor to our overall revenue mix. During the fourth quarter, we made additional investments in the SBA group by recruiting and hiring a number of seasoned loan officers and credit personnel that we expect will benefit our production levels later in the first half of 2015. While our primarily focus is on the three lending areas I mentioned, we also want to continue to have a balanced production across all of our business lines and that’s exactly what we got in the fourth quarter. We had an additional $37 million in Commercial Real Estate production and $17 million in Multifamily Loans. So we are seeing good results across all of our businesses which is helping us to build the highly diversified loan portfolio with both attractive yields and exceptional credit quality.
Turning to deposits, we continue to see a nice pickup in inflows during the fourth quarter, particularly in core deposits as more of our commercial customers transfer over their deposit relationships and our HOA unit continues to generate new business relationships. From the end of the prior quarter, we had a $38 million increase in money market deposits and a $32 million increase in non-interest bearing deposits.
Turning to our outlook for 2015, our focus is going to be similar to last year, namely organic growth coupled with accretive well-structured acquisitions that complement our business banking focus when they arise. We will continue to emphasize Commercial Lending, Construction and SBA. Along with the SBA personnel we added in the fourth quarter, we also hired a couple of senior commercial bankers recently that should help give us better coverage in our existing markets and continue driving in new business banking relationships. Our pipeline is healthy and well-diversified and we think we will make good progress in 2015 leveraging up the capital we added through the issuance of the $60 million of subordinated debt last year.
We do expect to see the usual seasonality in loan production during the first quarter that we have experienced in the past. We are really excited about the pending acquisition of the Independence Bank which we expect will provide another catalyst for growing our franchise. Subject to shareholders’ approvals of both Independence and Pacific Premier at the respective special meetings on Friday, January 23rd, and satisfaction of the other closing conditions, we expect to close the Independence acquisition next Monday January 26th. Besides providing exceptional synergies from the cost savings we are expecting, the Independence acquisition will give us a better platform for penetrating the Inland Empire market and further growing our customer base.
As I mentioned earlier on the call, we have made a lot of investments in the business over the past few years with a goal of building a franchise that can consistently generate long-term profitable growth and we will continue to operate the business without long-term perspective in mind. We won’t pass up a good investment opportunity just because it might impact our near-term earnings. Whether it’s investing in banking talent, pursuing acquisitions, capital management through the issuance of sub debt to support our growth, we think making decisions based on what’s in the best long-term interest of the franchise is the most effective way to create value for our shareholders. We believe we have the right strategic balance. We’re making good long-term investments for the business while still positioning ourselves to have another strong year of solid earnings growth in 2015.
With that, I am going to turn the call over to Kent to provide a little bit more detail on the fourth quarter results.
Kent Smith, EVP, CFO, Corporate Secretary and Treasurer
Thanks, Steve. We provided a significant amount of detail on our earnings release today so I am just to going to review a few items that I think some additional discussion is warranted. I am going to start with our Income Statement. Our Net Interest Margin was 4.02% in the fourth quarter, down 12 basis points from the prior quarter. The decline was primarily due to a higher borrowing cost resulting from the full quarter impact of the sub debt in longer term FHLB advances that we added during the third quarter. On a positive note, we actually saw a slight bump up in the average yield on loans during the quarter, as we remain disciplined on our loan pricing and as our new loan production is weighted more towards higher yielding portfolios. With the impact of the higher funding costs we added fully reflected in our fourth quarter results, we don’t expect to see any additional meaningful increase in our funding costs in the near-term. With our funding costs stabilizing, we should be in a better position to mitigate pressure on our net interest margin.
During the fourth quarter, our Non-Interest Income increased by $935,000 from the prior quarter, even though our third quarter non-interest income included non-recurring legal settlement proceeds totaling $1.1 million. The increase in the fourth quarter was primarily due to three factors: first, we had a increase in gain on sale of loans of $904,000, which are related to sales of SBA loans of $22.0 million at a premium 9%, and $21.9 million in sales of CRE and multifamily loans at a premium of 3%. For comparison purposes, we sold $14.6 million in SBA loans last quarter at a premium of 11% and we sold $10.5 million in CRE loans at a premium of 2%. Second, we did some rebalancing in the securities portfolio in preparation for the securities we will add in the pending Independence Bank acquisition. The security sales resulted in higher gains in the current quarter of $661,000. And third, we had a higher level of prepayment fees in the fourth quarter, which resulted in $258,000 increase in our loan servicing fees. Our non-interest expense increased by $3.1 million from the third quarter, which included $864,000 in merger-related expense. Aside from that item, the most significant contributor to the increase was an accrual of $1.7 million related to a litigation matter that Steve mentioned earlier.
And finally our compensation and benefits cost increased $349,000, primarily due to an increase in personnel. We expect to recognize all the remaining Independence Bank merger-related expense during the first quarter, which should be approximately $6 million. Of course we encourage those modeling to take those costs into consideration. Outside of the additional expenses we’ll add through the Independence acquisition, we would expect the non-interest expense for the base business to increase modestly in 2015 in the range of 3% to 5% in order to support our continued growth.
Turning to our balance sheet, our loans increased $79.2 million or 5.2% from the end of the prior quarter, which was the result of the organic loan production that Steve discussed and $7.8 million in loan purchases. The loan growth was broad-based throughout the portfolio, and compared to the end of the prior quarter, C&I loans increased $67.5 million, Construction Loans increased $22.6 million and SBA loans increased $7.9 million. These increases were partially offset by a $27.0 million decrease in owner-occupied commercial real estate loans, which was primarily due to loan prepayment. As I mentioned earlier, we did some rebalancing in the securities portfolio which reduced the portfolio by $80.6 million from the end of the prior quarter. Following these sales, the duration of the portfolio declined to 3.1 years. Our total deposits were up $87.4 million or 5.7% during the fourth quarter. The increase was primarily in money markets, increasing $37.6 million, non-interest bearing deposits, increasing $31.6 million and CDs increasing $17.6 million. The growth in the CDs was primarily driven by $22.1 million in brokered CDs that we added with the weighted average term of 17 months in an all-in cost of 67 basis points. As with the brokered CDs we added in the third quarter, we wanted to lock-in longer term fundings to support our strong loan growth while also managing our interest rate risk.
Finally looking at asset quality, we continue to see good stability within the loan portfolio during the fourth quarter. Our Non-Performing Assets were virtually unchanged during the quarter and are still just 12 basis points of total assets. The loss experienced in the portfolio continues to be very low, and we had net loan recoveries of 12,000 during the quarter. We recorded a provision for loan losses of $1.4 million which was primarily related to the strong growth we had in the portfolio. This brought our allowance to total loans ratio to 75 basis points. Although when the fair market value discounts related to acquired loans are included in the total, then our ratio increases near 87 basis points. And we continue to have very strong coverage of our non-accrual loans with an allowance that represents 845% of our non-accruals at the end of the quarter. While we expect to continue to see very good credit quality in 2015, we expect to make continued steady progress in bringing our overall allowance level more in line with peers. Ultimately, we’d like to be in the 1% of total loans within the next 18 to 24 months. Given the continued growth we are expecting in the portfolio and our goal to raise the allowance level, we would expect our level of provision expense to be in the range of $1.5 million to $2.0 million per quarter in 2015.
With that, we’d be happy to answer any questions you have. Jamie, would you please open up the call?
Question and Answer Session
Operator
We will now begin the Question and Answer session. And our first question comes from Matthew Clark from Sterne Agee. Please go ahead with your question.
Matthew Clark, Sterne Agee
Hey good morning guys.
Kent Smith, EVP, CFO, Corporate Secretary and Treasurer
Good morning Matthew.
Matthew Clark, Sterne Agee
Maybe first if we could just talk through the margin going forward and what we have seen happened to the curve, it’s good to see you guys have put on new production still above five, I think that’s origination is down 10 basis points, portfolio is still around 526 so that relative gap is not too wide, but just wanted to get an update on what you might be seeing here year-to-date on pricing.
Steve Gardner, President and CEO
I think that our goal here is obviously to maintain it at the level we saw in the fourth quarter. I think as we all know, competition for loans is very fierce, but that has been the case here for the last couple of years and we have maintained our discipline in pricing and we are going to continue that approach going forward. From the funding side, we obviously saw the full impact of the sub debt and then the FHLB borrowings that we fixed towards the latter part of the third quarter and that had the biggest impact on the margin. Going forward, we don’t see anything else on the horizon that should impact our funding cost anywhere near that level. And as we mentioned, we had very nice inflows on the deposit accounts in the fourth quarter.
Matthew Clark, Sterne Agee
Okay, great. With the acquisition closing next week, can you just remind us of what, if any, purchase accounting benefits that might come through the margin? Or do you think their pro forma margin will be somewhat comparable to where we are today?
Steve Gardner, President and CEO
We think that the pro forma margin will be pretty fairly comparable. Independence has fairly clean asset quality. The marks are not substantial there and so any impact on the margin will be pretty de minimis.
Matthew Clark, Sterne Agee
Okay and on the gain on sale lines, can you help us think about the pipeline here going forward and your ability to sustain that level of production of premium?
Steve Gardner, President and CEO
As I mentioned in the prepared remarks, we expect to see some of that that typical seasonality that we’ve seen in the last couple of years in our production in the first quarter of 2015, although heading into this year, our pipeline is quite a bit stronger than it has been in the last couple of years, so we’re encouraged from that standpoint. I also mentioned that we added some loan officers in the SBA side, although those folks came on in the mid to latter part of the fourth quarter, and by the time they get everything closed out in their old pipeline and start to originate loans we don’t think we’ll see an impact from those folks until most likely the second quarter of this year. But overall we expect to continue to grow the SBA line of business and we would expect to gain on sale to benefit that as we move through 2015.
Matthew Clark, Sterne Agee
Okay, I understand that. Thank you.
Operator
Our next question comes from Andrew Liesch from Sandler O’Neill. Please go ahead with your question.
Andrew Liesch, Sandler O’Neill
Hi guys. For the last few quarters loan deposit ratio has been right around 100% and added some brokers I guess to keep it around that level, are you comfortable running it here or would you be comfortable running it higher? I know it sounds like you are going to have good deposit flows on other business accounts, but just kind of curious how you think about the loan-to-deposit ratio?
Steve Gardner, President and CEO
I addressed it Andrew I think it was at the end of the second quarter last year when had first time had crossed over 100% loan-to-deposit ratio. And at that time I said, we are comfortable running the business above 100% loan-to-deposit ratio for a period of time and that remains true today as well. And so, we will look to manage the balance sheet from a variety of different perspectives, whether it’s from a liquidity interest rate risk standpoint and take advantage of opportunities where we see them. We had historically not accessed the broker CD market, but we took advantage of that in the third quarter and then a little bit in the fourth quarter. We have plenty of room on the FHLB line and so we are comfortable running the business above 100% loan-to-deposit ratio.
Andrew Liesch, Sandler O’Neill
Gotcha. And then I guess on similar lines with the security sales this quarter, I mean your comments for that you sold them in preparation of what was coming on with the Independence still but I mean it also provided a decent bit of liquidity as well. Would you expect more security sales could be coming after the deal closes?
Steve Gardner, President and CEO
I would not think anything material. If you look, with what we’ll be adding with Independence, that will put us at approximately round numbers $250 million and the securities portfolio at about the 10% level. We don’t want to run the business much below that — that’s sort of the target in our own mind. And so we would not expect to see significant levels of security sales, if we did there will likely be offset with purchases if we look to re-balance the portfolio.
Andrew Liesch, Sandler O’Neill
Gotcha. Thanks for taking my questions.
Steve Gardner, President and CEO
Alright, Andrew. Thanks.
Operator
And our next question comes from Timothy Coffey from FIG Partners. Please go ahead with your question.
Timothy Coffey, FIG Partners
Good morning, gentlemen.
Steve Gardner, President and CEO
Hi Tim.
Timothy Coffey, FIG Partners
Steve, are you anticipating any additional litigation expenses right now?
Steve Gardner, President and CEO
No. I think that if you follow the company Tim, historically we have been fortunate we think and we rarely have litigation matters arise. This has been something that has been out there for obviously a long period of time, and unfortunate but the history of the company has been that we run a pretty clean operation and we are certainly hopeful that we don’t experience litigation expense of this level in the future. I think that at the same time, as the company continues to grow and expand, we are obviously going to become potentially subject to that, but I think that what mitigates that there again are the solid internal controls that we have at the business we avoid those high risk areas that potentially lead the litigation and as such we do not expect to see that kind of expense going forward.
Timothy Coffey, FIG Partners
I’m sorry I should have been more specific, I meant related to this specific issue, not in general, but just with this specific issue.
Steve Gardner, President and CEO
We would not, as we stated in the release at December 31, 2014 with the information that we have in consultation with our counsel, we felt that the accrual that we put up was the appropriate amount.
Timothy Coffey, FIG Partners
Okay. And given what’s happening in the interest rate environment has that increased potential usage on the warehouse lending?
Steve Gardner, President and CEO
We saw that warehouse outstanding was up just a little bit at the end of the fourth quarter, that market is still fairly over saturated with lenders who provide warehouse loans. The pricing on that product has come down substantially but we’re not willing to drop our pricing into the levels that would be required for us to significantly grow that business. We’re hopeful we’ll benefit from what’s taken place in the mortgage market at least what we have read, as far as the increase in applications and flows in mortgage banking but I would not see that as a significant driver of our growth in the near-term.
Timothy Coffey, FIG Partners
Okay, great. Well thank you for answering all my questions.
Steve Gardner, President and CEO
Thank you.
Operator
Our next question comes from Brian Zabora from KBW. Please go ahead with your question.
Brian Zabora, KBW
Thanks. Good morning.
Steve Gardner, President and CEO
Hi Brian.
Brian Zabora, KBW
So a question on Infinity, you had very strong growth this quarter. Are you starting to see originations also in the West or is it still more in the East?
Steve Gardner, President and CEO
No, we’re seeing the originations in the West. The production is fairly well diversified. We’re spread across 30 states with approximately 50% of the balances in those more highly densely populated states in New Jersey, Texas, New York, California and Illinois.
Brian Zabora, KBW
Okay, that’s great. And then, on the pay downs this quarter, was there any sizable pay down that you had or was there any lumpiness in the quarter?
Steve Gardner, President and CEO
It was pretty broad-based and spread across the portfolio I think that typically the fourth quarter and year-end is usually one of the strongest periods of pay down and we would expect that some of that carries over into the first quarter of the year as well.
Brian Zabora, KBW
Okay. And lastly, on the building of the reserves to I guess approximately 1%. Are you including in that ratio purchasing kind of a fair value discounts? I guess maybe I am looking at it in Sandy and it seems like a pretty good ramp if you are including Sandy, depending on how you are looking at that because you have no reserves come over?
Steve Gardner, President and CEO
With that 1% figure that we said that we’d like to get to over the next 18 to 24 months does not include any credit discounts or purchase accounting marks.
Brian Zabora, KBW
Great. That’s very helpful. Alright, thank you for taking my questions.
Operator
And our next question comes from Don Worthington from Raymond James. Please go ahead with your question.
Don Worthington, Raymond James
Good morning Steve and Kent.
Steve Gardner, President and CEO
Good morning.
Kent Smith, EVP, CFO, Corporate Secretary and Treasurer
Good morning Don.
Don Worthington, Raymond James
In terms of the litigation issue, again, was there any statute of limitations that was driving reviving this case after so long?
Steve Gardner, President and CEO
Well, as we mentioned in the earnings release back in 2005 and 2006, we had argued on a statute of limitations and federal preemption at that period of time and the State Court denied it.
Don Worthington, Raymond James
Okay. And then, in terms of the loan purchases in the quarter, $7.8 million, what types of loans were those?
Steve Gardner, President and CEO
Predominantly Commercial Real Estate related.
Don Worthington, Raymond James
Okay.
Steve Gardner, President and CEO
And there — and Don, I think we have talked about this a number of times, each quarter we are actively in the market we’re buying and or selling loans and where we can take advantage of opportunities we do so from either side of the ledger and you saw we took advantage of some sales and booked some nice gains and at the same time we buy a little bit when the pricing is attractive and the loans are well-structured and meet our needs.
Don Worthington, Raymond James
Okay, thanks for the color. And then one last one small housekeeping question, looked like the total share count was down about 165,000, fourth quarter versus third. What was the reason for that?
Steve Gardner, President and CEO
I’ll have to double check and I’ll have Kent get back to you on that Don.
Don Worthington, Raymond James
Okay, but, it wasn’t buyback or anything like that?
Steve Gardner, President and CEO
No it wasn’t.
Don Worthington, Raymond James
Alright thank you.
Steve Gardner, President and CEO
Alright, very good.
Operator
Our next question comes from Gary Tenner from D.A. Davidson.
Gary Tenner, D.A. Davidson
Good morning.
Steve Gardner, President and CEO
Hi Gary.
Gary Tenner, D.A. Davidson
Our question’s have largely been answered. I just want to make sure I was clear on the comment on the 1% reserve target. Was that, again relative to the 75 basis points GAAP number reported at 12/31, or the 87 basis point adjusted number that Kent mentioned?
Steve Gardner, President and CEO
The 75 basis points.
Gary Tenner, D.A. Davidson
The 75, okay, the fully loaded GAAP number, alright. Thank you very much.
Operator
Our next question is a follow-up from Matthew Clark from Sterne Agee. Please go ahead with your question.
Matthew Clark, Sterne Agee
Hey guys, just hoping if you can clarify your expense guidance for the year, I think you talked about 3% to 5% growth in expenses on the base business. I assume that is excluding the pending acquisition, but I am just wondering if there is anything else that you might be excluding?
Steve Gardner, President and CEO
No that’s the only item that we would be excluding as Kent had mentioned, we expect approximately $6 million in merger-related expense here in Q1 given some of the significant cost savings that we see going forward after closing, but no we’re not excluding anything else.
Matthew Clark, Sterne Agee
Okay, thanks.
Operator
And at this time I am showing no additional questions. I’d like to turn the conference call back over to Mr. Gardner for any closing remarks.
Steve Gardner, President and CEO
Thank you, Jamie. And I want to thank everyone again for joining us this morning. If you have any further questions, please feel free to give either Kent or myself a call and we would be happy to talk with you. Have a great wet day.
Operator
Ladies and gentlemen, that does conclude today’s conference call. We do thank you for attending. You may now disconnect your telephone lines.
