Banc Of California, Inc. Q3 FY2024 Earnings Call

Good day and welcome to the Banc of California's Third Quarter Earnings Conference Call. All participants will be in listen-only mode. Please note this event is being recorded. I would like now to turn the conference over to Ann DeVries, Head of Investor Relations at Banc of California. Please go ahead.

Good morning and thank you for joining Banc of California's third quarter earnings call. Today's call is being recorded and a copy of the recording will be available later today on our Investor Relations' website. Today's presentation will also include non-GAAP measures. The reconciliations for these measures and additional required information is available in the earnings press release and earnings presentation, which are available on our Investor Relations' website. Before we begin, we would like to remind everyone that today's call may include forward-looking statements, which are subject to risks, uncertainties, and other factors outside of our control and actual results may differ materially. For a discussion of some of the risks that could affect our results, please see our Safe Harbor statement on forward-looking statements included in both the earnings release and the earnings presentation as well as the risk factors section of our most recent 10-K. Joining me on today's call are Jared Wolff, President and Chief Executive Officer; and Joe Kauder, Chief Financial Officer. After our prepared remarks, we will be taking questions from the analyst community. For the Q&A portion of the call, we ask that each participant ask just one question and one follow-up before returning to the queue. I would like to now turn the conference call over to Jared.

Thank you, Ann. Good morning everyone and welcome to Banc of California's third quarter earnings call. I'd like to start off by highlighting our team's strong execution during the quarter to actively transform and reposition our balance sheet. We delivered on numerous strategic actions as we continue to make progress on our transformation efforts. I am very proud of the intense focus and efforts put forth by our team to create a strong, well-positioned balance sheet that generates high quality and sustainable earnings. Let me start off just by listing the accomplishments of the quarter to put into context the volume of actions that our team executed. We sold $1.95 billion of CIVIC loans at 98% of par. We deployed $1.9 billion of liquidity to pay down $545 million of bank term funding and also paid down approximately $1.85 billion of broker deposits and expensive borrowings. We used approximately $60 million of the $100 million of capital we created from the CIVIC sale to reposition about $740 million of securities and pick up over 270 basis points of incremental yield. We bought back approximately $320 million of lender finance loans at par and hired a team to grow that business. We completed our core system conversion in late July, converting over 20,000 customers and over 50,000 accounts onto a single core platform. And we continue to run our bank business as usual, serving clients, bringing in new relationships, and growing loans and deposits in key areas. And that's just the start of the list. We like to keep our head down and do our work and push through, but this was a quarter where I thought our team really shined and I'm extremely proud of all of our colleagues here at Banc of California. We are really hitting on all cylinders right now and our quarterly results demonstrate the power of the franchise we are building. These balance sheet repositioning actions, along with a few other items we executed on during the quarter, resulted in strong net interest margin expansion and higher tangible book value and capital. I really feel good about how much we have accomplished and strengthened our balance sheet and our positioning for future growth. I am also very pleased with the progress we made in the third quarter, reducing non-interest expenses. We achieved our previously communicated target range for non-interest expenses of $195 million to $200 million, a quarter earlier than expected. Importantly, we received the benefit of normalized FDIC assessment expenses in the third quarter, which significantly reduced our non-interest expense and we should benefit from that new lower baseline going forward. While reducing our operating expenses, we're also continuing to make investments in both talent and technology that will further elevate the client experience, enhance efficiencies, and contribute to the further growth of our client roster. It's also important to note that a portion of our operating expenses are customer-related expenses, which are mainly driven by our HOA business. These expenses are tied to Fed funds and have 100% beta and will decline as interest rates go lower. We have included some new disclosures on customer-related expenses, which you can find on Slide 16 of the Investor presentation. While economic conditions remain somewhat challenging, we continue to see good results from our bankers' efforts to expand client relationships and add new relationships. Over the past three quarters, we have added over 1,700 new relationships to the bank. Our end-of-period non-interest-bearing deposits for the quarter were essentially flat from the second quarter, as we saw some volatility late in the quarter. Our deposit mix has become more favorable, however, as our quarter-end non-interest-bearing deposits as a percentage of total deposits grew to 29%, given our efforts to reduce higher-cost brokered deposits. Moving on to loans. While industry activity levels remain relatively tepid in the current environment, we added $1.6 billion in loans during the quarter, which includes production, unfunded new commitments, and purchase loans. Importantly, we are continuing to be conservative in new loan production and have maintained our disciplined underwriting and pricing criteria. We continue to see growth in warehouse balances, where we are adding new clients and seeing increased line utilization among existing clients as well as growth and increasing line utilization in construction and commercial loans. The growth in these areas, along with the reacquired lender finance portfolio, offset the continued runoff of lower yielding multi-family and CRE loans, and resulted in a modest amount of growth in our total loan balances in the third quarter. New loans continue to come on the books at higher rates than those that are paying off, which is accretive to our average loan yields and to our margin. Our loan portfolio continues to perform well on a broad basis. However, we remain cautious in the current economic environment, and when we see signs of weakness in any credits, we have been quick to downgrade and slow to upgrade. We downgraded several credits to non-performing status in the quarter, including two commercial loans and a remaining CIVIC loan. We believe that the credit migration of the two commercial loans were specific to those loans, and we are not seeing any indications of broader weakness across the portfolios. During the quarter, we also had an increase in classified loans, which was primarily reflective of our continued conservative approach to managing credit, the policies that we have put in place to get frequent updates on borrowers' financial performance and collateral valuations, and proactively downgrading certain rate-sensitive loans in light of the current environment. We expect these loans to return to non-classified status as we work through the credits. Importantly, our overall loan portfolio continues to benefit from our strong underwriting standards and borrower strength. While our net charge-offs for the quarter were relatively low at $2.4 million or 0.04% of loans, the commercial real estate market remains uncertain, and accordingly, we remain cautious and conservative in our portfolio management. We continue to be prepared for a variety of economic environments and will balance our drive to increase returns and grow with protecting our balance sheet and capital. We remain prudent by maintaining robust reserves at 1.2% of total loans. I think it's also important to note that our economic coverage ratio, which incorporates the loss coverage from our credit-linked notes as well as the unearned credit mark from our purchase accounting, is substantially higher above 1.8% of total loans. Let me make a few comments on the interest rate environment before I turn it over to Joe. We believe our balance sheet is well-positioned for a declining rate environment, with our balance sheet being more liability-sensitive and set to reprice or mature over the next year. With the Fed starting the cutting cycle in September, we have started to reduce deposit pricing, and we're closely monitoring market conditions and customer behavior. On the asset side, about half of our fixed rate and hybrid loans will reset or mature within the next three years and are expected to reprice at higher rates even in a declining rate environment. We will be making competitive adjustments, of course, as appropriate. Now, I'll hand it over to Joe, who will provide some additional financial information, and then I'll have some closing remarks before opening the line for questions.

Thank you, Jared. On a GAAP basis, we reported a net loss of $0.01 per share for the third quarter, which includes a $60 million loss for the securities repositioning that we completed during the quarter. Excluding the loss incurred on the securities repositioning, on an adjusted basis, our earnings per share was $0.25 for the third quarter, a significant increase from the prior quarter results, reflecting the execution of our core strategy to grow net interest margin, the positive impact of our successful balance sheet transformation, and the reduction in our operating costs, including the normalization of FDIC assessment expense. There were a few noteworthy items largely in non-interest income that had a positive impact on our third quarter results, which we have laid out on Slide 6 in our Investor presentation. The collective impact of these items was a benefit of approximately $0.05 to EPS. We generated $232 million in net interest income, which was slightly up from the prior quarter. While average interest-earning assets were lower in the third quarter by $1.4 billion due to the sale of the CIVIC loans, this impact was offset by an improvement in our net interest margin. Our net interest margin in the quarter increased 13 basis points to 2.93% due to a 13 basis point decline in cost of funds, partially offset by a 2 basis point decrease in the yield on average earning assets. Our cost of funds declined from 2.95% to 2.82% and the yield on average earning assets decreased from 5.65% to 5.63% in the quarter. The decrease in the cost of funds was driven by a 6 basis point reduction in the cost of interest-bearing deposits from 3.58% to 3.52% and a 13 basis point reduction in the cost of interest-bearing liabilities from 3.93% to 3.80%. The reduction in the cost of interest-bearing deposits was driven largely by a $1.85 billion reduction in brokered deposits and growth in the average non-interest-bearing deposit ratio from 27% to 28%. The reduction in cost of interest-bearing liabilities was largely driven by the payoff of $545 million of high-cost BTFP borrowings. Note, the overall cost of deposits was down 6 basis points to 2.54%. The decrease in yield on net earning assets in the quarter was driven by the impact of the sale of the $1.95 billion CIVIC portfolio, which had a combined yield of over 6%, which offset the benefits from higher rate net loan originations and the security repositioning. During the quarter, our loan balances grew as our loan production and line utilization of $1.8 billion outpaced paydowns of $1.5 billion. Yields on new loan production increased to 8.29% from 7.80% last quarter. Our yield on gross loans was stable at 6.18%. As Jared mentioned, we used a portion of the capital raised through the CIVIC sale to do some repositioning in our securities portfolio. We sold $742 million of securities, with an average yield of 2.94% and purchased $724 million of securities with an average yield of 5.65%. This action has positively impacted our average yield on earning assets and is expected to generate $4.8 million of interest income per quarter. Our net interest margin is expected to trend higher as the third quarter only included the partial benefit of our balance sheet repositioning actions due to timing. We expect further improvement in our net interest margin in the fourth quarter with the full quarter benefit of the securities repositioning and reduction in higher cost funding sources, as well as new loans continue to come on the balance sheet at higher rates than what is paying off. We provided our fourth quarter outlook for our net interest margin to be in the range of 3% to 3.10% as detailed on Slide 10 of the Investor presentation. This assumes that our balance sheet will be relatively consistent and one additional Fed rate cut in November. Our total non-interest income was negative in the third quarter due to the impact of the $60 million loss recognized on the securities repositioning. Excluding the loss on the securities, our adjusted non-interest income increased significantly from the prior quarter, due to several noteworthy items, including a $6.4 million gain on the sale of a lease residual, positive fair value adjustments on our credit linked notes, and dividends and gains on equity investments. Our total non-interest expense was $196.2 million, a decrease of $7.4 million from the prior quarter, which was primarily due to a decrease in our FDIC assessment expense, which came one quarter earlier than we originally projected. With the cost savings we have now realized, there's still more expected to come as we get the full quarter benefit of the systems conversion and reduction in headcount. We reached our target level of non-interest expense of $195 million to $200 million one quarter ahead of our prior outlook. Turning to the balance sheet. Our total loans held for investment increased by approximately $300 million, primarily due to increases in our mortgage warehouse, construction, and lender finance loans, which offset lower balances and discontinued portfolio loans and runoff we are seeing in lower-yielding CRE and multi-family loans. Our total deposits declined in the quarter, primarily due to the reduction in broker deposits as we continue to use our liquidity to let high-cost deposits run off. During the quarter, we opportunistically added $500 million of putable FHLB advances with a funding cost of just about 3%, which we view as an attractive source of funding for borrowings that have a 10-year duration and can't be put back by the FHLB for at least two years. We continue to be well-positioned for rate cuts, as we have intentionally kept the duration of our liabilities relatively short, with $7.3 billion more in liabilities repricing or maturing than assets over the next year. Over 90% of our interest-bearing deposits have no term or mature in less than one year. As rates decline, we should continue to see a lower cost of funds, particularly as we continue to add new clients that bring non-interest-bearing deposits to the bank. As Jared mentioned earlier, with the September rate cut, we have started to reprice our deposits down. To date, we estimate our deposit beta at just over 50% based on rate changes that we have passed through to our customers. Furthermore, we have $2.7 billion in loans with a weighted average coupon of 4.67% set to reprice and mature over the next year. With yields on new loan production at over 8%, we believe there's ample opportunity to reprice these loans higher even in a declining rate environment. At this time, I will turn the call back over to Jared.

Thanks, Joe. As I've indicated in the past, we take a lot of pride in doing what we say we're going to do. We have kept our head down, focused on executing on all the key merger integration milestones up to now, and are now starting to realize the positive benefits of our financial performance. With the balance sheet repositioning and major integration milestones we have completed in the third quarter behind us, including the core systems conversion and consolidation of 12 branches, we are now at an inflection point. We are shifting our focus from transforming our internal infrastructure to external growth, and capitalizing on the strength of the franchise and the balance sheet we have built and the exceptional customer experience we can offer to add new attractive client relationships. We are benefiting from our ability to attract high-quality banking talent and are now being more active in our marketing efforts, including launching a new branding campaign in our markets to promote the superior banking experience that we can offer. As we fully realize the benefits of the strategic balance sheet repositioning and merger integration efforts completed so far, we expect to see further growth in our financial performance. While we expect to benefit from a reduction in rates, we are not solely reliant on lower interest rates to improve our performance. And with the capital and liquidity we have, we can still consider additional balance sheet repositioning actions, should we see opportunities that would positively impact our earnings power down the road. While near-term economic conditions remain uncertain, we believe we are well-positioned to increase our market share and expand our client roster as economic conditions improve. With the balance sheet we have built, the superior level of technology and expertise we can offer, and the talented banking teams that we have, we look forward to steadily adding attractive client relationships in the future, generating profitable growth and consistently enhancing the value of our franchise. None of these accomplishments to date or in the future would be possible without the dedication of our incredibly talented colleagues at Banc of California. Every day, our teams come to work focused on helping our clients, improving our communities, and delivering for each other and for our shareholders. I'm very privileged to lead this team, and I want to thank them for their ongoing efforts. With that, operator, let's go ahead and open up the line for questions.

We will now begin the question-and-answer session. Our first question comes from Matthew Clark of Piper Sandler. Please go ahead.

Hey good morning everyone.

Good morning.

First one for me, just around the ECR deposits, it looks like they were $3.7 billion on average. Do you have that figure in the prior quarter? And what's your outlook for those balances going forward? Do you expect any growth? Or should we just assume they're flat?

No, we fully intend to look up what the prior quarter was, or we might need to publish it later if we can't find it quickly. However, we fully expect to grow our HOA balances. We have strong leadership and a great team, and we're actively working to establish new HOA relationships with the bank. Not all of our relationships have an ECR component, but many do, and as mentioned, they are tied to Fed funds. If you were to assign an interest rate to that ECR component, the overall cost across our entire HOA deposit base is a little over 3%, and we have the opportunity to reduce those costs as rates decline.

Great. And then just on the borrowings, do you happen to have the spot rate at the end of September on the $1.6 billion of borrowings? And then any update on kind of the cost of fund improvement that you had been expecting last quarter by the end of the year, down 20 to 25 basis points? Do you still feel good about that range, or do you think you could do better than that?

I'll let Joe address that.

Yes. We haven't disclosed the spot rate on the cost of borrowings, but we can find that information for you, Matt. What was the second part of your question?

Just on the cost of funds improvement that you had targeted last quarter of down 20 to 25 basis points by the end of the year, any update on that range?

The range we provided in our net interest margin guidance of 3.0% to 3.10% reflects our ongoing efforts to reduce our cost of funds. We believe that the restructuring actions taken in the third quarter will carry over into the fourth quarter, allowing us to benefit fully from them. Additionally, as we focus on growing our non-interest-bearing deposits and managing our loan portfolio by replacing lower-yielding loans with higher-yielding ones, we anticipate continued improvements in our net interest margin. Therefore, we expect our net interest margin to continue to expand in the fourth quarter.

NIM is currently at 2.83%, and we projected a range of 2.90% to 3%. Achieving the upper limit would require a significant expansion of 17 basis points, moving from 2.83% in the third quarter to 3% in the fourth quarter. There are factors that might prevent that from happening. Joe noted that we are currently experiencing about a 50% deposit beta regarding the rate benefits following the recent rate cut. It's still early, as not all customers have received their statements yet, and we're monitoring how this develops. While the initial signs are encouraging, there is a possibility it could reverse and impact our margin negatively. However, at this moment, things look promising.

Thank you.

Thanks, Matt.

Our next question comes from David Feaster of Raymond James.

Hey everybody. Jared, following up on your comments about transitioning from an internally focused operation to a growth-oriented approach, I wanted to get your thoughts on the loan growth outlook. There are definitely several positive factors at play. You mentioned $1.6 billion in originations, but much of the growth this quarter came from warehouse lending and loan purchases. I'm curious about how you view the loan growth outlook moving forward. You've made several new hires and are expanding your business lines. Where are you seeing opportunities? How much of the activity this quarter was strategic versus optimization? And what is your perspective on organic loan growth going forward?

Loan growth overall is likely to remain subdued until interest rates decrease by another 50 basis points. A significant portion of our market is real estate, and while there is a slight increase in construction and positive activity in warehouse lending and fund finance, it isn't at the levels we would expect due to high rates, which are discouraging borrowers from engaging in new transactions. Multi-family transactions are significantly down compared to previous levels. Based on discussions with our clients, I believe that a further 50 basis point reduction is necessary for the market to open up. We are focusing on positioning ourselves effectively to take advantage of opportunities when they arise, and I believe we are well-prepared. Our teams are strategically placed, connected with key individuals, and our branding efforts are making an impact. We have the necessary balance sheet to begin lending, and as lending resumes, we anticipate an increase in payoffs, including a surge in refinancing. While we have seen some promising loan originations, I think it will take a bit longer for growth to materialize. We are eager for growth but are cautious about pushing too hard during a slower economic period. We will be ready to act when the economy begins to improve.

Got it. Where do you see opportunity for growth, I guess, in the relatively short run?

Warehouse operations are performing well, and there is ongoing refinancing activity. People continue to buy homes and refinance their existing mortgages, and even with higher rates, they have decreased to levels that are not historically daunting for homebuyers and refinancers. We have noted an increase in refinancing inquiries following the hurricane, prompting us to maintain some of our lines due to this uptick in activity. We anticipate that lender finance will experience growth over the next few quarters. While it’s challenging to pinpoint growth to any specific quarter, we do expect overall growth in that timeframe. We believe there is a shortage in the market for banks offering this service, and we are pleased to step in to meet that demand. Fund finance has been performing well, and we have gained market share, although line utilization has dipped as clients have not been deploying funds. However, we are prepared for this and have been acquiring new clients, expecting these lines to be utilized as opportunities arise. Moreover, we predict an overall increase in commercial and industrial activity as the economy improves, although the current pace is relatively slow.

Okay, that's helpful. And maybe just on the other side of the coin, core deposit growth is obviously a huge focus for you all. You've made a lot of progress. I'm curious, how do you think about deposit growth? Do you think you can keep deposit growth kind of in line with loan growth, just given that you're kind of towards the midpoint of your loan-to-deposit ratio? Or is there some appetite to potentially use some of the excess cash to fund growth as it comes?

I don't think so. It would be difficult because loans usually grow much quicker than deposits. That's why during this period of slow loan growth, it's essential to strengthen our deposit relationships and seek new ones to maintain a comfortable loan-to-deposit ratio. I anticipate our loan-to-deposit ratio will increase when business activity picks up again. We may also see some growth in deposit balances, which is why we’re actively building new relationships to ensure we have the liquidity to fund loans without relying heavily on external sources. We're committed to operating within our means and avoiding a high loan-to-deposit ratio. While we will strive to expand in the mid-80s range, we’re not looking to use the broker market extensively for deposit growth. If necessary, we would consider it if it's profitable. I'm proud of our team's efforts in fostering new relationships, even if they sometimes don't reflect immediately due to fluctuations in existing deposit balances. The focus on new relationships is crucial for the long-term growth of the bank.

Our next question comes from Jared Shaw of Barclays. Please go ahead.

Hey everybody. Thanks.

Morning.

Could you please provide the details on the margin? Specifically, when did the restructuring occur, and how much will it impact the current quarter? Additionally, if we experience two rate cuts instead of one, how should we anticipate the year-end margin and the starting point for the first quarter based on those assumptions?

The restructuring actions took place throughout the quarter. The CIVIC portfolio sale occurred at the start of the quarter, followed by securities repositions over the period, and the FHLB putables at the end. This resulted in a consistent level of activity during the quarter. We have detailed the financial impacts on Slide 7 in the Investor deck. Looking ahead, we expect to gain a full quarter of benefits from these actions in the fourth quarter, which should be quite significant.

Okay. But if we see two cuts, does that speed up the expansion?

An additional cut would be beneficial to us. We're still assuming a very conservative beta on that as it's too early; we are still having some conversations with our customers. However, you would think that could add around $0.01 or so, which is a rough estimate of the earnings impact.

Okay.

Jared, to your point. I mean, a second cut is going to happen probably pretty late, so the benefit is really going to be in Q1 and not Q4.

Exactly.

It was encouraging to see the progress on expenses reaching our goal a quarter early. Is this a suitable run rate for FDIC? Are there additional opportunities to further reduce expenses, or should we consider this a stable rate moving forward?

As you can see on our notable items slide, there was a one-time benefit that came in the quarter on FDIC, which is not repeatable. That being said, I think that there should also be a slightly improved FDIC core number for the fourth quarter. So, I think the number you're seeing this quarter is probably about a pretty good run rate going forward, taking those two things into consideration.

Great. Thanks.

Our next question comes from Andrew Terrell of Stephens. Please go ahead.

Hey good morning.

Morning.

I would like to ask for more information regarding the deposit costs. Do you have the spot interest-bearing balance or the interest-bearing costs at the end of the period? There seems to be a lot to consider with the broker reduction and the rate changes that occurred later in the quarter.

Yes, I think the best way to approach this is by acknowledging that our restructuring efforts have created some variability in our monthly numbers. I'm not certain if sharing that specific number would be particularly useful for your modeling needs. Obviously, it's somewhat higher than the 2.93% we have for the year. So, perhaps a couple of basis points above that would be a reasonable estimate for your modeling purposes.

Okay, understood. I appreciate it. And then just Jared, as you've gone out to clients and you guys have lowered deposit costs following the Fed move. Just curious, any kind of pushback you've received specifically knowing that earlier in the year, you kind of proactively or preemptively ahead of rate cuts that already moved some down on the cost side. Just curious, if you're getting any kind of pushback or if you feel like at a 50% beta already, as you mentioned in the prepared remarks, if you have any more room to go beyond that?

We definitely encountered some resistance, which is why we didn't move to 100% beta. My goal was to achieve as much as possible, so we categorized our relationships in various ways. We assessed who is sensitive to rates and who is not, and who is focused on rates versus those who aren’t. Our relationship managers then needed to engage with clients carefully to communicate the relationship and the changes we want to introduce. Although we experienced some pushback, we made an effort to work with clients and highlight the valuable services we provide. I believe we reached a good position overall for our company. This situation is still unfolding, Andrew. It's quite early since this just occurred, and we need to allow it to develop further. More changes are on the horizon. A significant part of our current efforts is to make our clients aware of where things are headed. Our clients truly appreciate the relationships and services we offer, particularly the support from our treasury management and lending teams, along with overall relationship management. I am confident that we are not losing clients due to rate cuts because we are managing the situation and communicating it effectively. This is an iterative process. If we do lose any clients due to rate cuts, those were not genuine relationships. Some clients were attracted by higher rates that the company had to offer due to specific circumstances at that time. As we review the situation, we realize that we no longer require those deposits. They may have seemed like relationships, but they weren't true relationships. If a client only has a money market account earning 4.5% or 5%, that isn't likely to be a lasting relationship at the bank as rates decline, unless we can expand our services for them.

Our next question comes from Gary Tenner of D.A. Davidson. Please go ahead.

Yes, I apologize. Good morning. Hey, I wanted to ask about loan yields. I know Joe, you had mentioned the 6.18% kind of flat quarter-over-quarter all-in loan yield. Just to get a sense of kind of where new production was kind of impacting loan yields. Do you have a sense of kind of what that impact would have been quarter-over-quarter adjusted for the CIVIC loan sale? In other words, just kind of what the more apples-to-apples 2Q to 3Q would have looked like from a yield perspective?

I think the total of 6.18% would have been higher if not for the CIVIC loan sale. I don't have a precise number for you, Gary. However, another way to look at the new production is that we had many new originations coming in around the 8% level, and we also acquired the lender finance portfolio, which was at 8.8%. That's one way to consider the new production.

In the third quarter, our new production yield was approximately 8.3%, following a yield of 7.8% in the second quarter. The second quarter figures did not include lender finance, which is generally above 8%. It’s important to note that you cannot apply that third-quarter number across the entire portfolio, as it will not be repeated, and some rates are decreasing. Construction rates are currently higher due to new originations, compared to the previous situation where we dealt only with existing loans at lower rates. While single-family residential is increasing, commercial and industrial is expected to decline, and multi-family and equipment finance will likely see reductions as well. Almost all floating rates are projected to decrease. However, they remain substantially higher than what is involved in refinancing and payoffs. Thus, even with falling rates, we anticipate our margins to expand and expect our loan yield to gradually increase over the next few quarters.

That is helpful, and I appreciate it. In previous quarters, you mentioned some ranges or targets for expense to average assets. I did not catch that this time while you were discussing ROA and ROTCE. The expense to average assets did decrease significantly this quarter. Is there any change in how you are targeting that number, with or without customer-related deposit costs?

Yes, I think we need to exclude the customer-related deposit costs when considering that figure because it is indeed an interest expense that is incorporated into the operating expenses. Our target range remains around 2%. I believe there’s still some leeway for us regarding expenses, and it’s not as straightforward as it may appear. It seems we’ve landed in the middle of the range, but as Joe noted, there were some exceptional items this quarter that pushed us to the upper end of the range. I want to emphasize that we still have significant work ahead. As well as our company has performed and how optimistic I am, there is still a lot to address to reach our goals. It won't necessarily be easy, but I think we've accomplished much of the more challenging work, allowing us to concentrate more on growth when the economy rebounds rather than just managing internal matters. Our outlook is now more positive; we’re focusing on expansion and seeking new opportunities. However, I don’t see the economy moving quickly at the moment. But as I mentioned earlier, we'll be prepared when it does.

Yes. And Gary, if you didn't already see it on Page 15, we have the NIE to average asset ratio at the bottom of the page on both a base and reported and adjusted basis.

Yes, right. Okay. thanks very much guys.

No problem.

The next question comes from Ben Gerlinger of Citi. Please go ahead.

Hey, good morning.

Good morning.

You've made significant adjustments so far, especially in the third quarter. Jared, in your recent comments, you mentioned that there is still much to be done. However, looking at the positives, it appears that you are on track for improved margins, better operating leverage, and new hires that will benefit your portfolio as you head into 2025. It looks like you are positioned for growth, which also brings leverage. Can you elaborate on any additional areas for improvement? It seems like your operations are gearing up for a big push, so while focusing on enhancements is important, I'd like to know what other opportunities exist.

Yes. Well, thank you for that. We're always tough on ourselves, but I also think that I'm hesitant to declare victory of anything. We have a lot of work to do, and we've set some targets that we are not yet close to achieving, but we fully intend to achieve, and we expect to make progress as we've outlined through next year, and then hopefully get to those targets. And so I'm not going to be really very happy until I've seen better operating performance and better efficiency. Our teams are doing great. We've got tremendous people. I would say that some of the stuff that you can't see is we have some whole bunch of technology initiatives of beyond the core conversion that we have. We have some system initiatives that are in place that we're working very hard on to put together some technology that needs to work better. I would say that we have a program on data internally that we're working very hard on to ensure that we get data in a more efficient way, and then it's delivered to our teams in a way that they can self-service with that data and that also flows through to how we serve our customers. All of these things will cost money and are enhancements that are important. Our payments initiative is still going to make some progress. We have a lot going on there, but that's not going to really show signs of benefit until next year. As I mentioned, this year, even if it is showing benefit, it's de minimis given the size of this company relative to what it would have shown on a stand-alone Banc of California. So, we're not going to talk about that until it's meaningful enough to talk about as of this combined company. Those are some of the things that we're working on that will cost money. I also think stuff is going to show up. I mean, I'm glad that we keep provisioning around the $9 million to $10 million level. We want to keep our total reserves at the highest possible level to make sure that we get rid of any headwinds to keep us from performing at a high level next year. And we're going to remain highly conservative on downgrading credits and we'll be pretty slow to upgrade them. And I think that it's important that we maintain that posture now. We can afford it. And it's the right thing to do in this environment. It doesn't mean that things that we migrate to classified, they're still on accrual, it doesn't mean they're not coming back. But it's the amount of prudence that you take in an environment like this to make sure that you are properly looking at things and not kidding yourself about that things may take longer than it appears while interest rates stay higher for longer.

Got you, that's helpful. I have a question about HOA-related deposits. I know a few other banks handle this, as well as the ECR. Considering the longer-term nature of the contracts, how often are they renewed or negotiated? I'm thinking about it from a behavioral perspective. With potential rate cuts on the horizon in the next 12 months, I would like to secure a better rate in the next negotiation. How does this process work moving forward?

Yes, our relationships are negotiated annually, and we're in that process right now. And it's not uncommon that you agree to some sort of formula tied to Fed funds. It could be plus or minus or a percentage of Fed funds. And then as Fed fund comes down, that formula gets applied to whatever Fed funds is.

Got you. Okay, that's helpful.

Yes. Thanks, Ben.

Our next question comes from Timur Braziler of Wells Fargo. Please go ahead.

Hi, good morning.

Morning.

Maybe just circling back on the margin discussion. So, 4Q benefits from some of the activities in 3Q; they get the full quarter impact. I'm just wondering as we look past that, your liability-sensitive kind of over the next 12 months? Should we just assume kind of a step-up higher in margin subsequent to some of these actions from 3Q playing out in 4Q? Or is there a lagging period where maybe margin expansion slows before the liability-sensitive balance sheet actually plays out?

I believe we will see benefits in the fourth quarter from the restructuring actions we've taken, and that should be quite significant. We are remaining cautious regarding the rate cut environment, our betas, and so on. As we stated, we only have one rate cut included in our forecast for the remainder of this year, and we are anticipating a moderate beta. I believe this is reasonable given the uncertainty and various factors in the economy, including the election and its effects. Looking ahead, our strategy is to continue improving the margin by reducing the cost of funds, seeing lower-cost loans roll off, and higher-cost loans roll on, while positioning the balance sheet for growth in areas like warehouse and lender finance where we can achieve favorable margins and returns.

Okay. And then speaking of lender finance, I guess, maybe a two-part question. A, just some of the rationale in making that acquisition this quarter, some of those purchases? And then, if I'm not mistaken, I believe warehouse and lender finance were kind of the largest C&I categories of legacy Banc of Cal. I'm just wondering, what your expectation is for lender finance kind of as that business gets rolled out? Is that going to be one of the larger areas within commercial? What's the overall role you expect lender finance to play for the bank?

You are correct that warehouse was one of the larger areas for Banc of California, but we didn't have lender finance since that was a legacy PacWest area. PacWest had sold a significant portion of that portfolio to a private equity firm while continuing to service it. We were very familiar with those loans, so when the private equity firm indicated they were looking to exit, we were able to buy them back at par with full awareness of the portfolio contents. I had kept in touch with the team and we already had several hundred million in those loans on the books that hadn't run off. Adding $320 million brought us above $700 million, which made sense. If we were going to do it, we wanted to bring back this talented team to re-enter this area, especially since we noticed a lack of participation from other lenders. We are quite positive about this sector as it has historically experienced very low losses, if any. The coverage ratio for CECL related to this and warehouse are fairly low due to the relatively short-term nature of the loans. Although they don't generate a lot of deposits, we can manage that when we have other areas that do. We appreciate the benefits of this business highly, and I believe our team will successfully expand it. I prefer not to disclose an exact size, but currently, our warehouse business is about $1.2 billion. At Banc of California, we kept it a bit lower due to the size of our balance sheet, but I could see warehouse growing to $2 billion without issue. For lender finance, we need to give it a couple of quarters to see how it develops and what opportunities arise that make sense. I don’t want to set expectations that might pressure them into hitting targets. They're focused on credit quality for now. Fund finance is similar; it can expand as well and has been fluctuating between the mid-7s to the upper 5s, indicating it also has growth potential. We are positive about all three of these business areas.

Great. Thanks for the color.

Yes, thank you.

Our next question comes from Tim Coffey of Janney. Please go ahead.

Great. Thank you. And thanks for the opportunity to ask a question.

Hey Tim.

In the investor deck, there's a couple of bullet parts about opportunities to optimize the balance sheet. I'm wondering, if you can kind of share what some of those might be? And would any of them result in lower assets by year end?

Currently, we are not considering divesting any assets. On the contrary, we prefer to maintain the right asset base for growth. Selling assets is not on our agenda at the moment. When I think about enhancing our balance sheet, I consider optimizing our capital structure and addressing upcoming obligations related to preferred shares or subordinated debt. We also evaluate if we need to increase our liquidity and capital to manage those obligations. These are opportunities I hope to pursue when we identify excess capital. We've been experiencing stable and predictable financial results, which makes it sensible to consider capital actions when the time is right. However, we haven't reached that point yet. As mentioned, our goal is to achieve excess capital, ideally closer to a CET1 ratio of 11. While I won't specify an exact figure, I believe there are opportunities to improve the balance sheet on that front rather than by selling assets.

Okay, great. That's helpful. And then just looking out more long-term, if I look at the mix of earnings assets, say about 70% is loans, 15%-ish of securities. Is that the right mix of earning assets longer term?

I think 12% to 15% securities is probably right. Joe, what do you think?

Yes, we manage our liquidity effectively. Depending on how things develop over time, we might reduce our cash position slightly while increasing our securities. However, we are quite comfortable with our current levels of combined cash and securities.

Okay. Thank you very much.

Thank you.

The next question comes from Chris McGratty of KBW. Please go ahead.

Hey, good afternoon. Jared, I want to push a little bit on the capital question. I mean you're going to be pretty close to 11% in early 2025. You did mention share buybacks with your stock at tangible and maybe re-rank the priorities for us?

Yes, you're correct. We will need to evaluate all options at that time. The possibilities include buying back the preferred shares. We're continually investing in our company, and these options can coexist. It might involve a buyback, a dividend, or repurchasing the preferred shares. The preferred shares have a price limit, and any buyback analysis should be conducted when we plan to execute it, as we need to understand the trading levels at that point. If our stock remains at the current levels, which I hope it won't, I honestly don't expect it to as we make strides in our earnings. I would be surprised if our stock continues to trade at this level. We would definitely consider a buyback at this lower tangible book value. If it remains low due to prevailing conditions, that would be a high priority for us.

Great. And then, Joe, maybe just a question given the movements in non-interest income in the quarter. Just any guidance or ranges where like a reasonable jumping off point into the next couple of quarters would be great?

Yes, I think we've said historically that the run rate of about $11 million a quarter of non-interest income. And on a core basis, I think that still holds true. We've had some noise in the last two quarters, and I can't promise you we won't have noise again because when we have to run fair value marks through non-interest income, it's kind of hard to predict. But on a core basis, I think that $11 million a month number is a really solid number.

All right. Perfect. Thank you.

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