Banc Of California, Inc. Q4 FY2022 Earnings Call

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.

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.

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 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 the 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 decreased slightly quarter-over-quarter. While single-family residential non-performing loans did increase, they are well secured with very low loan-to-value ratios and we do not see loss exposure in our single-family residential portfolio. Single-family residential non-performing loans represented 38% of our non-performing loans at year end. In addition, at December 31, 35% of our non-performing loans were either loans and a current payment status but classified as non-performing for other reasons or the guaranteed portion of loans that have an SBA government guarantee. Similar to non-performing loans, most of the increase in delinquent loans was driven by single-family residential loans, 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 single-family residential 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 allowance for credit losses coverage ratio stood at 1.36% at December 31. Our allowance for credit losses to non-performing loans ratio remained healthy at 165%. At this time, I will turn the presentation back over to Jared.

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. 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 who 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. 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 a 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. Eventually, we will provide 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.

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.

Hey, good morning, Jared and Lynn.

Good morning.

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?

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 levels 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 also not pressing; the environment is pretty uncertain and we're being very selective in the deals that we do.

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?

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 that $48.5 million is 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 range as we look into the first quarter which 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.

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?

Yes. We are focused on attracting low-cost deposits, and I'm proud of our progress. We increased non-interest-bearing deposits from 12% to 40%, and while some questioned its sustainability, we believe it will hold up. As the economy slows, we anticipate some liquidity outflows but don't expect our deposit mix to change significantly. We aim to continue growing our non-interest-bearing percentage. Although we don't closely track deposit beta, we noted that our response to Fed rate increases this quarter was more measured compared to previous quarters, which helped control deposit costs. We don’t have a specific target number for deposit beta; our goal is to remain slightly asset sensitive and potentially expand our margin. Based on the Fed's guidance, we may eventually aim for neutrality to optimize long-term earnings while protecting shareholder interests. We will continue to focus on growing non-interest-bearing deposits to support our growth or investments. I know that's not a precise answer, but that's our internal approach. Lynn, do you have anything to add?

I think the only thing I would add is, I think you were looking at it relative to prior cycle and the trend of us being lower beta from the numbers that you provided is, I think a result of the fact that our non-interest-bearing deposits are a higher percentage of our deposit base or our funding base. So to that extent, when we look at a prior period versus now or prior interest cycle compared to now, I think our expectation is that it would generally be lower. And then to Jared's point, the focus on non-interest-bearing deposits and managing our core funding base, we expect that mix to continue and to have a positive impact on deposit beta as we move forward.

Okay, Great. Thanks for the color. And then last one for me. Just on capital. You started to accrete capital here again, 11.9% CET1 buybacks done. What are your thoughts on authorizing another share repurchase program at this point of cycle?

We haven't made any announcements yet. However, there are a few things we could consider. We have Board meetings scheduled for early February, where we'll evaluate our planned investments for the year and the various initiatives we have. We'll determine the best use of capital moving forward regarding dividends, buybacks, and other options. If our stock is trading at a low level, then buying it back often makes sense, and we hope it won't stay there for long.

Okay. And then actually if I could sneak one in, just a point of clarification. In your opening comments, I think you mentioned that you expect earnings to be up modestly in 2023 relative to 2022 on a core operating basis. I just want to make sure we're using the right base. I assume that's on a pre-provision basis since you had a big recovery last year.

Yes, I was considering that recovery when I made those comments. It was clearly a one-time event and somewhat unusual. When you exclude the unusual factors, we would anticipate being slightly higher and seeing growth throughout the year. As it stands now, that's the current outlook.

And our next question today comes from Timur Braziler with Wells Fargo. Please go ahead.

Hi, good morning.

Good morning.

Maybe just following up on the last line of comments. So is that assuming that there's essentially a zero provision for the year if kind of current asset growth projections play out and there's no real change in the CECL methodology?

I don't think it's reasonable to expect zero provision this year. I think that we're going to have to look at the landscape. We feel really, really good about our credit quality. There's an uptick in delinquent loans and some single-family residential loans, but we've never seen any loss in that portfolio. We don't expect it now based on how it's underwritten. Overall, our quarter was really solid. We do, as Lynn laid out, I thought really well in her comments, like our coverage ratio is pretty darn high; it's certainly relative to peers with similar portfolios and every time we stress our portfolio, we come out well. I'd like to have some loan growth this year that makes sense. If so, we'll have to look at whether provisions are appropriate and they would be for growing our portfolio. If the portfolio stays flat and the economic climate deteriorates, I would think that provisioning would be appropriate. We just haven’t seen it yet and so it’s a little bit economy dependent to more, but I see what everybody else sees in terms of where things are going right now.

Yes, that all makes sense. And then maybe just circling up again on DDA, which you guys have done an excellent job in keeping in house and appreciate the comments that it will keep kind of the mix shift unchanged, while the liquidity picture plays out. I guess how much liquidity is still at risk here? Is there much visibility and does that kind of outflow lag the last rate hike or is much of that already effectively in the numbers?

Let me begin by saying that we're seeing ongoing pressure on deposit pricing. This situation is not completely settled yet. An article that was published yesterday discussed the potential consequences if the government defaults on its debt, which could lead to liquidity issues for banks. However, we feel very confident about our various sources of liquidity, which are substantial and in excellent condition. We are currently managing a 100% loan-to-deposit ratio quite comfortably while maintaining our desired earnings level. That said, liquidity stress is still present in the market. We are not worried about it due to the actions we've taken and our ability to adapt. I want to emphasize our tangible book value growth and our minimal AOCI impairment compared to other institutions. Lynn and her team have done an outstanding job managing our securities portfolio, which represents real liquidity for us. We don't have significant marks that would force us to sell or lead to a sharp decline in capital if we decide to access that liquidity. We don't foresee any issues arising from that front. We believe our situation is stable and well-managed, which distinguishes us, especially given our current high levels of capital.

Great. And then just last from me, looking at the expense base at $48 million to $50 million range. Is that encompassing the investment needed to stand up DeepStack? And then I guess how should we be thinking about that investment both in magnitude and kind of timing?

Lynn, do you want to take that?

Sure. Yes. Thanks for following back up on that. The $50 million does include the additional expense from the fourth quarter with DeepStack. As we look forward, we do expect that it will move with some higher fee income. We expect to be able to leverage the expense base that we have for some of the initiatives including DeepStack. So I think it answers your question, yes, it includes it, Timur.

Thanks, Timur.

Good morning. Lynn, I wanted to ask about the broker deposits added in the quarter. If you could kind of give us an idea of what the timing and kind of term and rate is on those deposits?

Our observation, we've kept our balance sheet I think fairly nimble. So as we've brought down some of the warehouse balances, we've let some of the funding associated with that also migrate off. A portion of the broker deposits are shorter term in nature versus using maybe overnight advances; so they can be 30 to 60 days. They're actually less expensive to a certain extent compared to overnight. And then the rest have terms that move out to about two years.

Okay, thank you, that's helpful. Jared, I appreciate your confidence, and I understand you're taking a careful approach to building out that business. I had expected you might share more about your initial expectations for the year regarding that business. Specifically, how are you thinking about deposit flows or key performance indicators throughout the year as they relate to that business?

Sure. We want to get everything established properly. As I mentioned earlier, we've started bringing clients onto our platform, but we're proceeding cautiously to ensure we do it correctly. It's important to get various aspects right, especially in terms of regulatory and compliance requirements, and to ensure that all our systems are functioning effectively. This will allow us to monitor all transaction volumes properly. We have a detailed plan for how we're rolling this out, and our team is performing well. By the end of the second quarter, we expect to be closer to full scale, at which point I'll feel more confident in discussing our pipeline and setting expectations. For now, we're looking back at the data as it comes in, and we will share updates as we progress through the second quarter, making it easier to offer forward-looking insights.

Okay. And just to clarify, when you say onboarding clients to bank rails, that means you're moving existing DeepStack clients over to your platform, correct, as opposed to onboarding?

We have successfully onboarded one or two new clients this quarter, which is encouraging. We aimed to do this in what I refer to as a soft test environment. It's important not to introduce too much volume all at once. Instead, we want to manage a volume we can closely monitor so that if any issues arise, we can address them without causing disruption. Everything is progressing as we anticipated, and our team is performing exceptionally well. We're eager to eventually ramp up operations, but we first need to thoroughly test the system to ensure we can meet all compliance requirements before proceeding further.

All right. That's helpful. Thank you.

I was able to pull that one piece of detail for the benefit of everybody. Our brokered CDs have a tenure of about nine months and our weighted average rate is about 3.85%.

Hey, good morning.

Good morning.

You have been quite active in technology and payments, especially with the Finexio investment and DeepStack, showing a forward-looking approach. At a high level, are there any other innovative areas in banking that you are considering expanding into? Are there additional elements that could complement your current businesses, or do you feel you have everything you need and now it's mostly about execution and growth?

I believe we have assembled all the necessary components and the right people. We recently welcomed a new head of payments risk with extensive experience in the payments sector, and she joined us just yesterday. Her expertise will significantly enhance our team. Not many individuals in this industry combine such a long tenure in payments with experience at banks, so we are very pleased to have her on board. We are committed to continuing to attract top-tier talent. In terms of our vision, we have the personnel and technology, and as I previously mentioned, we aim to create a comprehensive ecosystem for payments. We are actively developing both our DeepStack solutions and exploring opportunities in issuing. Our Chief Operating Officer is overseeing both initiatives simultaneously. We are in the process of rolling out solutions for clients that we believe will offer a complete answer. We have the potential to serve as both an issuer and a merchant processor. Historically, JP Morgan established a closed-loop system that encompassed both sides of the transaction, which is undeniably appealing if you possess the appropriate systems to achieve that. We are taking a forward-looking approach, considering innovative angles that may differ from others, and working to assemble the elements required to seize as many opportunities as we can, although it is still in the early stages. I'm enthusiastic about sharing our vision, but we must focus on executing and demonstrating each component before we can become too optimistic about the final outcome.

And still kind of thinking about it kind of breakeven this year more contribution in 2024?

Yes. If we're able to outperform that, that would be great. But I think that's right with a look at it.

Okay. And you touched on this several times about having maybe a bit more of a cautious outlook, which makes a ton of sense. I'm just curious, where are you seeing loans come across your desk that still bring attractive risk-adjusted returns? And just any other thoughts on or commentary from the demand side from your standpoint, where demand is slowing, where it still remains solid, especially just in light of some of new hires that you've made?

That's a good question. We continue to identify attractive opportunities, particularly in financing streaming content. Although there has been a slight slowdown, content creation is still active, and these channels need to be filled. This area has been stable for us, and our team excels at it. Many clients are approaching us for financing, and we've developed strong programs. Healthcare also remains a thriving sector, with promising opportunities in specialty hospitals and financing for physician practice groups. Our team is knowledgeable in this area. We have carved out a niche in education, specifically with charter schools, where we provide deposit-rich financing through revolving lines of credit that help them manage state receivables. Few banks have the expertise to do this, and we have been successful at it. On the real estate front, the market is very slow, especially regarding permanent financing. Current activity is primarily driven by urgent needs, such as borrowers converting to floating-rate notes or reaching maturity. There is some bridge financing, but the most experienced borrowers are struggling with those who can no longer afford their loans and are looking for opportunistic solutions. We aim to support strong guarantors who have a proven track record and personally guarantee the loans. However, this market segment is moving much slower than before and is still affected by rising rates. Overall, other areas are experiencing considerable sluggishness, particularly in commercial and industrial lending. I am concerned about businesses facing oversupply issues and slow payments from their buyers. We're proceeding with caution, which reflects the current landscape.

Continuing on that topic, what are some of your concerns from your perspective? I know you have a low-risk loan portfolio, but when you look at the market, what do you see that raises some concerns? Investors seem to be particularly focused on commercial real estate, especially in areas like office space. From your standpoint, which segments do you think require more caution and where are you likely to pull back? What’s your view on the credit environment and the market from a credit perspective?

Hospitality is not something that we traffic in. I would start by staying away from that. Second is office; we don't really have much and we would stay away from it now for sure. I mean, there isn't a business that I have heard of that isn't thinking about reducing their space. When leases come up, how that's going to perform? Construction is obviously something that you've got to be careful about. The good side of construction is that supplies are more available, teams are more available, and the best developers know that downturn is sometimes the best time to build because you're building when there's no demand, and soon as you come out of the ground, you can fill it up pretty quickly. Certainly for infill housing, there's opportunity. I wouldn't say that you would avoid all construction, but what's the price of the land that they're contributing? What's the building cost today? Some of the building costs have actually gone down that can offset some of the rate increases. But I would say on most cases, you're going to be extremely careful on construction. I go back to just core C&I, things that are going to get triple hit with interest rates, labor shortages and supply chain. If you're doing C&I right now, you better have a good ABL team. That's one of the safer ways to do C&I in this sort of environment, but even there you have to be super cautious. I would say on the other side, single-family residential remains safe and we continue to see opportunities on the single-family residential side that look very attractive. If it makes sense to pull the trigger, we will. We don't originate, but we have unique channels to get that asset. If we see good stuff, we wouldn't hesitate.

And our next question today comes from Andrew Terrell with Stephens. Please go ahead.

Hey, good morning.

Good morning.

Jared or maybe for Lynn, just looking at the 2023 strategic objectives. Hoping you could just maybe expand on what type of balance sheet opportunities you might look to take advantage of when speaking about enhancing longer-term earnings? Just maybe some incremental color there.

I think we briefly mentioned this earlier, and it's a good question. There are opportunities to purchase securities that might be more appealing than loans. Borrowing to buy securities can be beneficial if done correctly, as when rates decrease, funding costs will lower and the yield on securities is likely to increase. There are good opportunities available. We're seeing lending opportunities, but they are not very strong. Lynn, do you have anything to add?

I agree with your comments. I think we started out talking about looking at average earning assets maintaining them and to the extent that there's not opportunities in the loan portfolio. I think we view that there's opportunities in the securities portfolio. Especially as we continue to manage funding costs. I think those are primarily, and I think we have to recognize the economic landscape that we're going to be operating within, but I think there's an ability to accomplish that.

Yes. Okay. That's helpful. Thank you. And maybe if I could move really quickly to the non-interest bearing deposits. I know the end of the period was down maybe a bit more than the average was throughout the quarter. I was hoping just to hear any kind of color you have regarding trends so far in January?

We're currently at a similar level as we were at the end of the quarter. The average for the quarter was 41%, while the period end was 39.5%, which is quite close. We usually expect a reasonable fluctuation within a 5% range, although we didn't anticipate such a wide range. As I mentioned earlier, the pressure on pricing is ongoing. I wouldn't say it's increasing; it’s just continuing. It's likely we will see rate bumps a few more times, which will cascade down as it typically does. We are focused on optimizing our relationships. Our approach is selective, avoiding a complete repricing of our deposit portfolio by merely promoting rates. We are pricing relationships on an individual basis and closely monitoring them, emphasizing the service we provide, and when customers request higher rates, we engage in direct discussions. This requires more effort, but it helps protect our overall deposit base. This is part of why we've sought funding from the broker market and the broader non-core market. It allows us to acquire in bulk without having to reprice groups of deposits since many customers aren't actively seeking higher rates. Many of our CDs renew automatically, so we're being selective and strategic.

Okay. And then last one for me. I just wanted to ask about the non-accrual loans, which were up about $12 million this quarter. I was hoping to get some insight on what drove the increase and whether this was an acquired credit that already had a PCD mark or one that Banc of California originated.

We believe that the charge-off we took was specifically reserved against a PMB credit, and it proceeded as planned, with adequate reserves in place. I'm not sure whether the other loans are from PMB at this moment. We own the loans and bear the responsibility for them. While I can't confirm if there were specific reserves for those, we are confident that our current reserves are appropriate, and we don't anticipate significant credit issues in the future. Throughout my time here, our underwriting practices have generally kept credit noise at bay, and I believe we can manage these loans effectively. From my perspective, this isn’t a trend we are concerned about.

Okay. Very good. Well, thank you for taking the questions.

Yes. Thank you very much.

And our next question today comes from Kelly Motta at KBW. Please go ahead.

Hey, good morning.

Good morning.

Thanks for the question. Most of mine have been asked and answered already, but if I could swing back to the warehouse book. I know that's difficult to predict, but wondering if there's any sort of minimum amount of activity you expect that to bottom out at? As well as if you remind us the deposit relationships that come with that in terms of either loans deposits?

First of all, we have a really, really good warehouse team that does a fantastic job of managing relationships and managing kind of quality of credits. They're very selective in who we're going to lend to and how we're going to manage it. We've been fortunate that things for us have gone smoothly despite kind of the rundown and kind of that industry generally. Let me tackle the deposit piece first. We have a good amount of deposits with that business. Those deposits are very stable; they're institutional depositors who operate through warehouse but not necessarily on the origination side; sometimes they're on the buy side; they're buying loans that have already been funded. So in that way, it's true C&I. They're kind of sitting there with cash buying loans as needed and we're helping to fund that. The deposit flows have been very stable and as warehouse balances have come down, warehouse as a business, a higher percentage of it is self-funded. We monitor that very closely, but it's pretty stable. In terms of where the balances are going to flow out, I'm trying to pull up the most recent numbers. Lynn, you may have them in front of you have kind of where we think warehouse will fall out. I tell you, I don't know whether it's going to go down more. At the end of the fourth quarter it was $600 million, $603 million. I don’t know.

I think it's important to note that we expect warehouse activity to continue declining. This decrease aligns with broader market trends. Looking ahead, we anticipate that the decline will slow down due to changes in rates, and while it may experience some reduction, it won't reach the levels we saw in the fourth quarter. Overall, we expect the averages to remain consistent and believe it will pose less of a challenge moving forward. Additionally, we have expanded business in other areas.

Yes, I think to that point, Kelly, if I can just add. We certainly feel like we've done a good job of diversifying our portfolio outside of the concentration warehouse that we before and continue to grow earnings through that. We don't see warehouse getting way back up even as rates come back down, but our team has done a good job of staying within a band. And so we've always said like up or down $100 million, warehouse was kind of the band. As it shrunk, maybe that's too big a band now, but we're going to be, I don't know, between $600 million and $650 million probably. It's hard to peg it exactly. But that’s our guessing today and I'd say that's probably pretty close.

I appreciate all the information from both sides; it's very helpful. My last question is a bit specific. I've noticed that customer service fees have decreased quarter-over-quarter compared to previous quarters. I'm curious if this is due to less customer activity or if there are any structural changes, such as modifications in service charges or how you're implementing those charges. I would appreciate any insights you can provide for future consideration.

I can probably add a little bit. Yes. So included in there are both deposit and loan customer service fees. With some of the loan production volume being a bit lower, I think that affected the number for the quarter. I don't see much change in the deposit service fees. While we are still competing heavily for our customers' business, I expect that we will have similar deposit customer service fees. What we're seeing in the fourth quarter is mostly related to the loan side, and I don't anticipate that we will see it go any lower.

Thanks, Kelly.

And ladies and gentlemen, this concludes today's question-and-answer session and today’s conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.