Earnings Call Transcript - BANC Q3 2025

Operator, Operator

Hello and welcome to Banc of California's Third Quarter Earnings Conference Call. I will now turn it over to Ann DeVries, Head of Investor Relations at Banc of California. Please proceed.

Ann DeVries, Head of Investor Relations

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 also like to remind everyone that today's call may include forward-looking statements, including statements about our targets, goals, strategies and outlook for 2025 and beyond, 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, Chairman and Chief Executive Officer; and Joe Kauder, Chief Financial Officer. After our prepared remarks, we will be taking questions from the analyst community. I would like to now turn the conference call over to Jared.

Jared Wolff, CEO

Thanks, Ann, and good morning, everyone. We're pleased to report another strong quarter for Banc of California with double-digit earnings per share growth and continued momentum across all of our key performance drivers. These results once again demonstrate the strength of our franchise, the consistent growth trajectory of our core earnings and the disciplined execution of our teams. Strong Q3 earnings per share growth of 23% quarter-over-quarter of $0.38 reflects our success in generating positive operating leverage and continuing to expand our net interest margin. Since the start of the year, our return on tangible common equity has grown 231 basis points to 9.87%, while EPS has increased nearly 50% since Q1. During the quarter, we also continued returning capital to shareholders in a meaningful way. We repurchased 2.2 million shares of our common stock in Q3. And overall, under our program, we bought back 13.6 million shares, more than 8% of our outstanding shares at an average price of $13.59, well below our tangible book value per share. Repurchases have totaled $185 million, more than half of our $300 million repurchase authorization. And even with this activity, our continued earnings growth has built CET1 to 10.14% at quarter end and tangible book value per share has also increased 3% quarter-over-quarter to $16.99. We will continue to be prudent with the remainder of our share buyback program and use it opportunistically while remaining focused on maintaining strong capital levels. Core deposit trends were positive with noninterest-bearing deposits up 9% and now represent 28% of total deposits. It was driven by both higher average balances and steady inflows of new business relationships. This strong core funding enabled us to further reduce broker deposits, which declined 16% from the prior quarter and lowered our total cost of deposits by 5 basis points to 2.08%. As noted in our investor deck, core interest-bearing deposits also increased when the runoff of interest-bearing broker deposits is excluded. Our deposit strategy is both dynamic and flexible. While we continue to grow our core deposits, we will choose to shrink or expand other sources of deposits as needed, depending on pricing, our loan production and other liquidity needs. Loan production and disbursements remained healthy at $2.1 billion, with broad-based production from our business units. We purchased fewer SFR loans this quarter, down about $346 million from Q2 as yields contracted due to strong secondary market demand. Total loans declined about 1.6% from last quarter, mostly due to elevated paydowns and approximately $170 million of proactive payoffs of criticized loans, consistent with our strategy to maintain high-quality credit and exit credits that we believe are not meriting of long-term strength and support from us. Excluding that deliberate activity, our core loan portfolio was essentially flat. Pipelines remain strong, and we expect loan production activity to remain high. This strong loan production is one of the keys to the ongoing incremental growth in our earnings per share. The rate on new loan production remained healthy at 7.08%, well above the rate of loans that have been maturing. As a result, with strong loan production, even with elevated payoffs in the quarter, our balance sheet remixing accelerates our margin expansion. The loan sales we announced last quarter continued to proceed well. In Q3, we liquidated $263 million of held-for-sale CRE loans, largely through the execution of strategic sales within our targets and some proactive paydowns. We currently have $181 million of CRE loans remaining in HFS, and we expect to sell those over the next several quarters. Credit quality remained stable with criticized loans down 4% quarter-over-quarter and special mention loans down 24%. Classified loan balances increased this quarter due to a timing issue related to a $50 million CRE loan for which the borrower executed a contract for sale after quarter end as well as a revision to our risk rating framework for certain loans in the Venture Banking portfolio. It's important to mention that all of those loans are performing and on accrual status with no delinquencies greater than 30 days. The updated framework was procedural and not indicative of any incremental underlying credit weakness. Our allowance for credit losses increased to 1.12% of total loans or 1.65% on an economic coverage basis, reflecting our continued discipline to reserving and the strength of our credit profile. This was another great quarter for the company, a quarter that reinforces the positive trajectory we've established and the consistency of our performance. With a strong capital position, a valuable core deposit base and a proven team that executes with discipline, we believe Banc of California is well positioned to deliver sustainable high-quality earnings growth for many quarters to come. Now let me turn it over to Joe for some additional financial details, and I'll certainly be back to answer questions. Thanks.

Joseph Kauder, CFO

Thank you, Jared. For the third quarter, we reported net income of $59.7 million or $0.38 per diluted share, which was up 23% from the adjusted EPS of $0.31 in the prior quarter. Net interest income rose 5% from Q2 to $253 million, and net interest margin expanded to 3.22% driven by higher loan yields and lower deposit cost. Our exit net interest margin at quarter end was 3.18%, which is normalized for excess accretion income in the quarter. We expect our margin to continue to expand from this level in the fourth quarter. Average yield on loans increased 12 basis points to 6.05%, reflecting the benefit of portfolio mix shift towards higher-yielding C&I loan categories, including Warehouse, Lender, Venture. Our loan yields also benefited from higher accretion income, which was up approximately $3 million from Q2 due to loan payoff activity. The spot loan yield at the end of the quarter was 5.90%, reflecting the impact of the September rate cut on the variable rate loans and normalization for accretion income during the quarter. Total loans ended the quarter at $24.3 billion, down slightly from last quarter, largely due to the intentional payoff activity and elevated paydowns that Jared mentioned. Excluding that, underlying core loan balances were stable. Deposit trends were strong as we saw favorable mix shift towards more noninterest-bearing deposits and reduction in broker deposits. As a result, cost of deposits declined 5 basis points to 2.08%. Our spot cost of deposits at 9/30 was 1.98%, and our cumulative beta in this down rate cycle for interest-bearing deposits is approximately 66%. The interest rate sensitivity on our balance sheet for net interest income remains largely neutral as the current repricing gap is balanced when adjusted for repricing betas. From a total earnings perspective, we remain liability sensitive due to the impact of rate-sensitive HOA deposits, which are reflected in noninterest expense. We expect fixed rate asset repricing to continue to benefit net interest margin as we remix the balance sheet with high-quality and higher-yielding loans. We have approximately $1 billion of total loans maturing or resetting by the end of 2025 with a weighted average coupon of approximately 5%, offering good repricing upside. Our multifamily portfolio, which represents approximately 25% of our loan portfolio, has approximately $3.2 billion repricing or maturing over the next 2.5 years at a weighted average rate that offers significant repricing upside. Noninterest income was $34.3 million, up 5% from last quarter, primarily due to higher fair value adjustments on market-sensitive instruments. Normal run rate for noninterest income remains at about $10 million to $12 million per month. Noninterest expenses of $185.7 million were relatively flat across most expense categories as we continue to maintain disciplined expense controls while supporting our growth initiatives. The combination of stable expenses and higher revenue drove a more than 300 basis point decline in our adjusted efficiency ratio to 58%. We continue to make progress on expanding positive operating leverage while still investing thoughtfully in technology and talent to support future growth. We expect 4Q expenses to be consistent with prior quarters and be at or below the low end of our range as we continue to make progress on managing core expenses. As Jared mentioned, credit quality remained stable with net recoveries of $2.5 million and declines in our criticized loan balances. Provision expense of $9.7 million was largely related to portfolio growth and updates to risk ratings and the economic forecast. Our allowance for credit losses ended the quarter at 1.12% of total loans or 1.65% on an economic coverage basis, consistent with our prudent approach to credit management. Looking ahead, we remain on track with our 2025 guidance. We continue to expect loan growth for the full year to be in the mid-single-digit range and net interest margin to remain within our 3.20% to 3.30% target range for the fourth quarter. We also expect to maintain our strong capital and liquidity position while delivering steady high-quality earnings growth. With that, I'll turn it back to Jared.

Jared Wolff, CEO

Thank you, Joe. This was another excellent quarter for Banc of California, one that highlights our strong performance, positive operating leverage and the consistency of our results. Since completing our systems conversion in the third quarter of '24 following our merger with PacWest, we have been building core earnings while improving the balance sheet, managing expenses and efficiently deploying capital. With 4 quarters of high-quality earnings growth under our belt and foreseeable EPS growth in sight, the track record and the path ahead should be very clear. Our teams continue to execute with discipline and focus, driving growth and continuing to build one of the best franchises in California and everywhere else we operate. We have a proven business model that is delivering high-quality earnings through a diversity of lending channels, a valuable and growing core deposit base of deep client relationships and a culture of performance and accountability. We believe the opportunity in our markets remains significant as we capitalize on the dislocation in the California banking landscape and win new relationships. We continue to add high-quality talent to support our growth as our teams continue to win new business and bring new relationships to the bank while serving our clients and keeping safety and soundness front and center. The consistency of our results, the strength of our balance sheet and momentum in our business demonstrate why Banc of California is well positioned to continue our success and why we're so confident in the long-term trajectory of our franchise. Thank you to our employees for their dedication and commitment to serving our clients and community each and every day. With that, operator, let's open up the line for questions.

Operator, Operator

The first question comes from Jared Shaw with Barclays Capital.

Jared David Shaw, Analyst

Just to start off, the credit trends this quarter were really good. And Banc of California was pulled into sort of a story of the Cantor loans and I think, just sort of broader concern around NDFI lending and structure. And clearly, from the numbers you put up, you must feel that there's not a lot of loss there, and it feels like you have good collateral protection. Can you just give a little color on how you structured that exposure and why you feel that there's not loss there? And is that sort of reflective of the broader view of how you're going after some of the non-mortgage NDFI lending?

Jared Wolff, CEO

So thank you for the question, Jared. When you say how we structured that, you're speaking specifically to what was mentioned in the articles?

Jared David Shaw, Analyst

Yes, in terms of like being able to get additional commercial real estate collateral and being sure that you have the senior lien position.

Jared Wolff, CEO

This is a crucial point to clarify. The fraud cases linked to Zions, Fifth Third, and Western Alliance primarily involved NDFI lending, typically secured by collateral pools. We were mentioned due to a loan to a related borrower, but our loan was not tied to NDFI; it was strictly a real estate loan. We financed a property, specifically a hotel on the beach in Laguna, many years ago. This loan is currently on nonaccrual status and has been classified, with a lawsuit filed several quarters back. It is included in our financials, but it is unrelated to our NDFI lending, as it was merely a straightforward real estate loan. The loan became problematic due to a business dispute among the partners involved. Some of the issues surrounding that situation affected our overall operations, but we are fundamentally a real estate lender. We have guarantees from the borrower and believe we are secure since the repayment relies on the property, which we believe has adequate collateral backing. Additionally, I believe Zions mentioned our first position in their lawsuit. However, they were referring to loans within a collateral pool, while our loans were solely real estate loans, including two single-family loans that are no longer part of our portfolio as they were sold with a larger group of loans. We have not lent to any entities involved in the fraud allegations, such as Tricolor or First Brands, nor did we engage in NDFI lending with Cantor or related parties. This distinction is essential for clarity. We fundamentally operate as a real estate lender and maintain strong security through the mortgage deed when making these loans. In our investor deck, particularly on Page 14, we demonstrate that a considerable portion of our NDFI lending is directed towards mortgage warehouse and fund finance, areas that are generally well understood. Our mortgage warehouse loans are effectively managed by a skilled team that has been in place for years. We believe we manage all of our credits well, including lender finance loans that cover business credit, consumer credit, and additional mortgage credit. When removing mortgage warehouse, fund finance, and other mortgage-related credits—which account for 11.6% and 13.7% of our total loans—you're left with less than 5% of our loan exposure being tied to NDFI. Historically, we have not encountered any losses in this area, and I encourage looking at our 10-year historical loss rate, as PacWest has been operating for a long time, particularly in mortgage warehouse activities, and our loss rate remains minimal. It’s important to note that while losses can occur, our approach is carefully structured. Our internal audit team implements robust anti-fraud measures, frequently tests collateral, monitors cash collections and payment histories, and conducts mortgage title checks. We personally assess any collateral pool, conduct samples, verify trustees, and ensure we understand our standing through comprehensive sampling. I want to stress that I do not intend to criticize my peers, as they are all competent lenders. I can only speak to our methods and history, and I am very confident in them. I’ll stop here and welcome any further questions.

Jared David Shaw, Analyst

Yes. No, that was great color. I think good insight into how you're structuring it. Maybe just as a follow-up, shifting over to the margin. When we look at the guide for the margin of 3.20% to 3.30%, is that a good normalized level? Or as we sort of end the year and start looking into '26, how should we be thinking about margin, especially with the likelihood of some cuts? And I think your guidance does not assume cuts. Is that right?

Jared Wolff, CEO

Correct. It doesn't assume cuts. I'll start and let Joe add his input. We are certainly sensitive to liabilities when considering the ECRs, and we do expect our margin to expand. The accelerated accretion we experienced last quarter occurred in the middle of the quarter, which is why it impacted our overall margin, bringing it to 3.22%. However, when excluding that, our margin was around 3.18%, indicating a solid improvement from the previous quarter. We anticipate our margin will continue to grow, with the main question being at what pace. I'm pleased that our teams have achieved a relatively high level of beta while being disciplined in managing our deposit costs. We expect to reach at least 50%, if not higher, on our deposit beta going forward. Our margin will keep expanding. Joe and I discussed this before the call, and it appears that the primary driver of our margin expansion is our increased loan production, which is replacing loans that had much lower rates. A significant item we are managing is our $6 billion multifamily portfolio, with half maturing or repaying in the next 2.5 years. This portfolio makes up 25% of our loan assets and has an average rate of 4%. Even with rates decreasing, the new loans are coming in at significantly higher rates, and many of them are floating rate loans as well, which also have minimum rate guarantees. Joe, do you have anything to add?

Joseph Kauder, CFO

No, I think you captured it, Jared. As we look into the future, your original question was whether we have a solid run rate looking at 3.20% to 3.30%. I believe that's a starting point. As Jared Wolff mentioned, we intend to grow it from there. The remixing of the loans is a strong accelerant to that. Additionally, as we did this quarter, we are continuing to focus on growing noninterest-bearing deposits and reducing our cost of deposits and funding. You might also see some intermittent upside related to the accretion, which we experienced this quarter. Overall, we feel pretty positive about it.

Jared Wolff, CEO

Jared, as we approach the fourth quarter, it will be easier for us to provide guidance on the margin for next year, as I expect you may be looking for that. Currently, at 3.20% to 3.30%, we anticipate finishing the quarter at around 3.18%, even without a full quarter of rate cuts. Therefore, we likely will end up in the low 3.20s for the fourth quarter. For 2026, I foresee a starting point between 3.25% and 3.35%, which allows us some flexibility. While our priority is earnings first and margin second, I believe that margins will continue to grow, and we should have more guidance as we near the end of the fourth quarter.

Operator, Operator

The next question comes from Timur Braziler with Wells Fargo.

Timur Braziler, Analyst

Maybe just back on that margin discussion. I guess just looking at margin kind of not the combined effect with the ECR reduction, just are you still liability sensitive from a margin standpoint or relative to the comments you just made, rate cuts are going to be punitive maybe upfront and then you get that ECR benefit on the back end?

Jared Wolff, CEO

They're definitely not punitive to us. We are, at worst case, neutral with rate cuts when you take out ECR. And I'll let Joe correct me if I'm wrong there, but we believe that we really are fundamentally neutral that our deposits and loans are kind of repricing in balance, and then ECR gives us that liability benefit. But our margin expansion is really being driven by this loan production that we're seeing. Joe, do you agree with that?

Joseph Kauder, CFO

Yes, that's correct. Right now, as we stand today, we're a neutral balance sheet if you were to exclude the HOA deposits with the ECR benefit.

Jared Wolff, CEO

And Timur, we often discuss this internally. When creating these models, particularly the IRR models, they depend on a static balance sheet. However, nothing in banking is ever truly static. I believe these models can be somewhat inaccurate. Although they provide directionally correct insights, they don't capture the full picture due to the dynamic nature of the balance sheet. The key question is how they may be misaligned. I feel we can achieve greater benefits because that aligns with my approach, which focuses on driving results. Even with a static or slightly dynamic balance sheet without production, I believe we can influence deposit costs more effectively, which can reduce expenses. We need to make assumptions about how deposits will reprice and the pace of that repricing. I tend to think we can adopt an aggressive stance as long as we are succeeding with our growth initiatives. However, technically, we are entirely neutral.

Timur Braziler, Analyst

Okay. That's good color. And then just looking at the third quarter deposit growth, particularly in DDA, I guess how much of that is tied to warehouse? There wasn't really an increase in related ECR costs. Was that more back-end driven and we might see the higher average balances impact 4Q numbers? Or was a lot of that growth kind of ex ECR driven?

Jared Wolff, CEO

It seems you mentioned warehouse, but I think you meant HOA. If I understood your question correctly about whether it was HOA related, that's not the case, right?

Timur Braziler, Analyst

I mean just ECR-related deposits.

Jared Wolff, CEO

Yes, the ECR is mainly related to our HOA business. We typically experience inflows of HOA deposits at the start of a quarter, which then taper off as the quarter progresses. Therefore, you won't observe average balances increasing in relation to ECR. Additionally, our highest ECR costs are tied to larger depositors in HOA, and we haven't been increasing balances from them because we want to manage our costs and concentration. Even if we expand our HOA, we won't necessarily see a corresponding rise in ECR costs. To clarify, the ECR we pay is not the same for the new balances we are acquiring from HOA. Our team has done an excellent job ensuring that our ECR costs are significantly lower than they were in the past. We have some larger relationships with pricier deposits, and we're not looking to expand those. Overall, I believe the deposit growth has been quite widespread. I expect that deposits will grow over time as we work diligently on building relationships. Given the current national liquidity situation and Fed policy, liquidity is tightening, and it's likely the Fed will need to implement measures to restore liquidity in the market. As I've noted in previous quarters, maintaining flat deposits during a liquidity outflow is a win, especially when many customers have less to offer. This quarter was strong, showing balanced growth with new relationships and good activity from existing clients. We'll see the results in Q4, but I anticipate that we'll continue to succeed in attracting new deposit relationships.

Operator, Operator

The next question comes from Matthew Clark with Piper Sandler.

Matthew Clark, Analyst

Just on the loan and deposit growth for the year, targeting mid-single-digit growth, it implies a decent step-up here in 4Q. Maybe just speak to the pipeline on both sides of the balance sheet and maybe mid-single digit is 4% to 6%, so 4% would kind of be in that range on the loan side. But on the deposit side, it just implies a steeper step up.

Jared Wolff, CEO

Yes, you’re right. We don't shy away from our goals. We will evaluate our performance at the end of the year. However, this suggests we may need to achieve significant growth this quarter, and we’ll see if we can accomplish that. Our teams are working hard. We might not meet this goal, but I’m confident in being held accountable for our results. I believe our shareholders are benefiting from our earnings growth. I want to highlight all the initiatives we have in place and how they are producing results for shareholders. The market has its own dynamics. When we focus on the core loan growth, excluding sold loans, we will likely reach the 4% to 6% range, which seems reasonable. Deposits will be more challenging, so we’ll see how that turns out. I felt it was important to maintain our goals. Our teams understand them and are diligently working to achieve them. Production has been excellent, and I’m very pleased with the performance of our teams. Payoffs do occur, but as I mentioned, earnings continue to grow despite this. I’m very satisfied with our progress so far.

Joseph Kauder, CFO

Jared, I want to emphasize that we align our deposits with our loans. We aim to avoid having an excessive amount of deposits. If we do find ourselves with too many, we will take steps to optimize our balance sheet. There is a range of deposits available to us, and if loan growth is strong in the fourth quarter, we can adjust those deposits accordingly to support that growth.

Jared Wolff, CEO

Yes, I'm glad you mentioned that. It's one of the points I had in my prepared remarks, which is that we are quite dynamic in managing the balance sheet to optimize earnings and avoid holding cash at levels where we believe we can achieve a better return elsewhere. Depending on our flows, we aim to maintain a balance between our loan-to-deposit ratio and our liquidity levels. Our team, especially the treasury team in collaboration with our finance team, does an excellent job of optimizing in a very dynamic manner when it comes to bringing on broker deposits, considering the cost, duration, and our current needs based on other deposit flows. I'm glad you brought that up.

Matthew Clark, Analyst

Great. And then just the other one for me on the Venture business, can you just provide a little more color on what changed in the way you're risk rating those loans that may have caused a little bit of creep in the classified?

Jared Wolff, CEO

Yes, I previously mentioned that we were going to adopt a stricter internal grading system because it serves as an effective early warning mechanism. This means that we can re-evaluate credits using a new methodology, which may not reflect the historical performance of those credits, but indicates that we are monitoring them more closely due to changes in the environment or our risk tolerance. Our assessment of venture credits is based on a matrix of several factors, which tie back to the core activities of our Venture operations. In fund finance, we deal with capital call lines of credit. In the Venture sector, we often have more deposits compared to loans, so we lend selectively. Typically, we provide lines of credit to support companies during funding rounds. For example, when a company raises $20 million at a $200 million valuation, those funds come into our bank. If we secure a line of credit for them, a portion of that amount will be kept in their operating account, while the rest will be in a money market account to generate some earnings, as they might not be profitable yet. If they request a $5 million line of credit, it may remain unused unless needed for extended capital raising efforts. We keep a close watch on the remaining months of cash they have as they spend, ensuring that the debt does not exceed their cash. If our debt level is generally zero or lower than their cash balance, we are in good shape. The strong relationships we cultivate through treasury management and various services are valuable to these companies. When they plan to conduct another funding round, they may discuss their cash position with us and if they need to draw on the line of credit for additional time. While this typically goes smoothly, there have been exceptions. Consequently, we have tightened our criteria for evaluating these loans, considering factors like sponsor and VC support, business plan performance, remaining cash months, and cash-to-debt ratios. We have refined our assessment matrix, leading us to rate credits differently. Although the credits themselves might be unchanged, our new evaluation framework could alter our perspective and prompt further discussions with the sponsors and VC firms, which was a decision made to enhance our standards.

Operator, Operator

The next question comes from David Feaster with Raymond James.

David Feaster, Analyst

I wanted to touch on the loan growth aspect. When we consider the growth dynamics, it's clear that payoffs and paydowns have been a challenge. It seems like you're anticipating that improved production will be the key driver for growth, rather than just a slowdown in payoffs and paydowns. Is that an accurate assessment? Additionally, what do you identify as the main factors contributing to the increase in production? Also, how is the pricing landscape currently?

Jared Wolff, CEO

Let me start by addressing your question from the end. This quarter, we have a very strong pipeline that looks promising. The fourth quarter typically experiences good activity, which depends on the economy. Currently, people appear to be doing well and remaining active. I believe that rate cuts will generally boost activity, which suggests a positive outlook for the quarter. Pricing is stable at 7.08% on new production. Although yields are slightly lower than previous quarters, they remain strong. When I examine the yields from our individual lending units, production yields have held up fairly well. Construction was flat, slightly up, while Commercial & Industrial (C&I), Venture, and Warehouse yields were up. SBA yields dipped slightly, as did Equipment Lending, while Fund Finance remained relatively flat. Lender Finance saw a decline of over 50 basis points, primarily due to floating rate credits closely tied to SOFR. Despite being very active this quarter, yields overall were decent. Last quarter, we had a yield of 7.29%, which dropped to 7.08% this quarter, down from 7.20% in the first quarter. The second quarter experienced a spike, but the third quarter showed a slight decrease. Rates tend to lag, so we will see where they stand based on last quarter's rate cuts. Overall, production levels are strong. It's challenging to predict payoffs in any given quarter since circumstances fluctuate. Our clients are very active; for example, one client won a lawsuit, bringing in numerous deposits, and subsequently paid off a significant loan with us. We didn’t anticipate that, but such occurrences are normal. We always strive to retain loans when we foresee them being paid off. If it's a multifamily payoff, we want to bid. Generally, we are content with construction payoffs and will seek new construction since we won’t pursue some of the longer-term mini perm loans at low rates due to the high debt involved. Just because we handled the construction doesn’t mean we will necessarily take on the mini-perm; it varies based on the project. David, could you help reframe this so I can ensure I’m addressing all of your questions?

David Feaster, Analyst

Yes, the other part was just with the increasing production that you were talking about, what are some of the key drivers of that increase in production?

Jared Wolff, CEO

In terms of our lending activities, commercial and industrial sectors are performing well. In California, our commercial and community bank is experiencing strong production across the board. In the middle market segment, which consists of more established and larger companies, we are also witnessing solid production locally and across California, with referrals from our business units for companies nationwide, which is encouraging. Lender Finance remains a strong contributor. Ann noted that we provided back leverage for loans sold last quarter in this segment, which may have slightly reduced loan yields due to the attractive rates offered, but they still remained higher than the rates of loans being paid off. We continue to observe robust demand for construction related to low-income housing tax credits, although these projects take time to generate returns. Additionally, there is consistent refinancing and home purchasing activity in the Warehouse segment, leading to growth there as well. Fund Finance, however, did not perform strongly last quarter, marking one of its slowest periods following three solid quarters. We are optimistic for the fourth quarter, as they are anticipating good fundings, which could lead to better performance this time around, but it did not significantly contribute last quarter.

David Feaster, Analyst

Okay. And maybe shifting back, I mean, you guys have been very proactive managing credit. That's been a part of what the payoffs and paydowns that you're seeing, some of which you're pushing out. The industry is obviously hyper focused on the credit outlook today, just given some of the recent issues that we've seen in the industry. I think you kind of put the NDFI issue to bed. But outside of that, I mean, is there anything where you're seeing any pressures or that you're watching more closely or that maybe you're pulling back from just that risk-adjusted returns don't maybe make as much sense just given competitive dynamics or underlying issue? Just kind of curious if there's anything you're seeing.

Jared Wolff, CEO

Yes. Despite the robust market, we remain cautious, particularly regarding our office lending comments. I recently attended an event hosted by one of the investment banks featuring Blackstone, where Jon Gray spoke to CEOs about their observations, and they are currently increasing their investment in the San Francisco office market. Midtown Manhattan has also shown a strong recovery. However, we believe there's no need for us to engage in office lending, so we're stepping back from that sector. We just finalized a significant lease in Downtown Los Angeles where we're consolidating two offices into one with slightly more space and rooftop signage for a lower cost than our previous two buildings combined. We're trying to be proactive and take advantage of current opportunities, but that also reinforces my stance against being an office lender right now. Furthermore, we are avoiding any properties associated with government tenants. We've exited certain properties where the government was a tenant, instructing to terminate the loans rather than renew them. This includes at least one credit we moved away from in the last quarter, despite it being a stable property due to the presence of a large government tenant. This reflects our proactive approach in this area as well.

Operator, Operator

The next question comes from Chris McGratty with KBW.

Christopher McGratty, Analyst

Jared, I know you mentioned the buybacks in your prepared remarks, particularly the opportunistic buybacks related to private equity. How are you approaching CET1 levels in light of the earnings improvement, the growth you discussed, and current regulations?

Jared Wolff, CEO

I believe the appropriate range is between 10% and 11%. More people are coming down to us rather than moving up to above 11%. Previously, I mentioned that 10.5% was perfectly acceptable, and currently, we are between 10% and 10.5%. We have ample capacity and are increasing our CET1 at a rate that surpasses our earnings growth, thanks to certain tax advantages that Joe can explain. This allows us to grow CET1 while repurchasing stock. I feel our valuation is significantly undervalued, and we need to address that by continuing to enhance earnings growth. The market is beginning to recognize this, and we will continue building on our established track record. I believe there is potential for margin expansion, but I don’t want to miss the chance to buy back our stock. We will be strategic in our approach while maintaining capital levels within an appropriate range.

Christopher McGratty, Analyst

Okay. Continuing to buyback. Got it. And then on the ECR betas, maybe a question on for Joe. I guess what are you assuming for betas on the ECR deposits? I may have missed that.

Joseph Kauder, CFO

So it is approximately the way the contracts work is about 75% for every basis point move.

Christopher McGratty, Analyst

Okay. And then, Joe, I wanted to ask about the tax item that Jared mentioned. What should we consider regarding tax strategies and rates? Is there anything out of the ordinary?

Joseph Kauder, CFO

No, I think 25% is probably a good tax rate for us moving forward. We do have a significant deferred tax asset generated from past net operating losses and a considerable amount of tax credits accumulated through our low-income housing initiatives. As we utilize these assets while generating profit, the way the tax law operates restricts the benefit of that deferred tax asset in our CET1. Therefore, as the deferred tax asset is used, it recycles back into CET1. Consequently, our CET1 is likely growing a bit faster than our earnings as the effects of the net operating loss diminish over time. It's a complex issue, and I'm happy to elaborate further if needed.

Jared Wolff, CEO

Yes. I'm just interested if I think about utilization of it over the next couple of years, like how much of a CET1 benefit are we talking? Because I think it plays right into the buyback narrative.

Joseph Kauder, CFO

Yes. I believe we may provide some guidance on that as we approach the end of the year.

Operator, Operator

The next question comes from Andrew Terrell with Stephens.

Andrew Terrell, Analyst

I had a question just around the classified loans. Jared, I heard you mention in the prepared remarks, the $50 million of the pickup sequentially was more of a timing issue. So I guess, one, should we expect classifieds moving down in the fourth quarter? And then I appreciate all the color on the venture business and the loan portfolio there. Any other areas left across the loan portfolio that you feel like you need to review kind of the matrix on risk rating? Anything we should expect incrementally there?

Jared Wolff, CEO

I don't think so. The $50 million loan they signed the contract to sell for well above our loan amount will close this quarter. I would say that classifieds will likely remain flat, but I hope they decrease. While things can happen that might not lead to a loss, I have to be cautious. In a stable situation, I would expect a decrease. However, unexpected events could cause it to go up or remain flat. Fortunately, I think our team is performing well. Regarding your second question about other areas under review that might affect our credit metrics, I don't anticipate any issues. Our team has addressed most of the concerns. We've been implementing this venture initiative over several quarters, and this quarter had the most impact as we started applying it. So, I don't foresee any additional issues; there isn't anything else I'm currently aware of.

Operator, Operator

The next question comes from Gary Tenner with D.A. Davidson.

Gary Tenner, Analyst

Most of my questions were asked, but I wanted just to ask about the timing of the buyback through the quarter. It looks like just based on the average purchase price, it was kind of weighted towards the last bit of the quarter after the stock had run up a little bit. Was that kind of delay just more of a function of getting visibility over where kind of growth in capital was going to go over the course of the quarter before you became more active later in the quarter? Or were there other...

Jared Wolff, CEO

I don't know if I can confirm that, Gary, not because there's anything confidential there. It's just because I don't know that that's right. I'd have to go back and look at it. These are average prices that we're giving you and it affects how much was purchased when versus purchased elsewhere. And then also we had a block that we purchased from Warburg. So it's hard for me to confirm that. Joe, I don't know if you have any...

Joseph Kauder, CFO

Well, in the deck on Page 24, we show how much we purchased and the average price. I'm not sure I understood the question.

Gary Tenner, Analyst

Well, the average price I think was unclear, right?

Joseph Kauder, CFO

Yes.

Gary Tenner, Analyst

During the third quarter, the stock generally did not reach a significant level until late August, and it maintained that level throughout September. This context led to the question.

Jared Wolff, CEO

Okay. Your question was whether it was influenced by ensuring we had the appropriate capital levels. I believe that was the main point of your inquiry, correct?

Gary Tenner, Analyst

Yes, your question was whether or not it was driven by making sure we had the right capital levels. I think that was the heart of your question, though, right?

Jared Wolff, CEO

Yes. So let me try to address that. We absolutely want to ensure that when we buy back our stock, our capital levels are sufficient. We definitely consider where we think capital will be at the time of the buyback. This is part of our calculation and analysis. While I won’t specify when we bought stock, I can confirm that we take this into account. It's likely a fair conclusion, but we ended comfortably above. It's challenging to calculate due to our dynamic tax range and the NOLs we have, which affect our CET1. The calculation can be iterative, and we sometimes lack complete feedback. However, based on last quarter, we were at around 9.90% or 9.95% on CET1, and now we're comfortably above 10%. I believe this was likely a one-quarter issue that shouldn't concern us moving forward. Additionally, we're always considering a variety of capital uses. We have $115 million left on our share repurchase authorization, and while it’s unlikely we will use all of it as we plan to retain some, we intend to be active when we believe our shares are undervalued. However, we will also be looking at other capital opportunities. They are not mutually exclusive, but we perceive our shares as significantly undervalued. Over the past few quarters, we've been growing tangible book value by more than $0.25 per quarter. It seems that if we're not trading at $1.25, $1.30, or more of tangible book, which we should be, considering our clear earnings path, strong balance sheet, quality of the franchise, and sizable footprint in California, our stock is undervalued. So we'll remain opportunistic.

Operator, Operator

The next question comes from Anthony Elian with JPMorgan.

Anthony Elian, Analyst

Jared, just a direct follow-up to your comments you just made on the buyback, right? Why not be more aggressive here given the stock is still trading near tangible book value before you potentially get to that $1.25 or $1.30 of TBV. Is it just because you don't want to get below 10% CET1 and you want to retain some capital?

Jared Wolff, CEO

We may consider your suggestion, but I believe it's not wise to disclose our plans or timing to the market as it tends to be counterproductive. I hope you understand this dynamic. I want to emphasize that we will act opportunistically without specifying when. So far, we have performed well, with an average purchase price of $13.59 for our whole program, indicating our effectiveness overall. It's about selecting the right moments and conditions. While I agree with your strategic assessment, I need to be cautious about what I commit to.

Anthony Elian, Analyst

That's fair. And then my follow-up, Joe, on the NIM guide, the 4Q NIM guide, I know you don't assume rate cuts. But if we do get a cut next week in December, could you quantify the impact that would have to the 3.20% to 3.30% guide? And then if we assume the forward curve next year, how would that impact the jumping off point of 3.25% to 3.35% you mentioned earlier?

Joseph Kauder, CFO

Yes. As we mentioned earlier, our core net interest income remains unchanged, but we are experiencing liability sensitivity in our HOA ECR book. The ECR deposits for HOA ECR activate on the first day of the next quarter following a rate cut. Therefore, if there is a rate cut in the fourth quarter, we will not see any benefits until January 1. Thus, I would not expect to see much impact from that rate cut in the fourth quarter.

Jared Wolff, CEO

And then Tony was asking about how rate cuts affect our margin guidance.

Anthony Elian, Analyst

Specifically on the 3.20% to 3.30% NIM guide. Just if we do get the cut next week, I mean that's going to be more impactful coupled with the September cut. So how would that change?

Jared Wolff, CEO

I think we need to see because a lot of our net interest margin depends on our loan production. There's a bit of a lag, so we need to observe how that flows through. Joe, what do you think?

Joseph Kauder, CFO

No, that's exactly right. It gets complicated because the technical answer is straightforward: a 25 basis point rate cut for our ECR relates to about $6 million a year of pretax income. However, there are other factors involved. If rates decrease while the economy remains strong, that should increase lending and benefit us. Many of our loans have floors, so we need to consider when we reach those floors. It's more complex than simply assessing how quickly we can reduce deposits and what kind of deposit beta we can achieve with our customers. It's a bit challenging, but the technical answer remains as I mentioned earlier.

Jared Wolff, CEO

And Tony, the straightforward answer is that I anticipate our margin will increase as rates decline because our production and loans are being issued at higher rates than deposits, which are decreasing as loans are being repaid. Currently, we're at 3.20% to 3.30%, and I expect to finish the year in the low 3.20s. I'm not sure what it will be for the fourth quarter, whether it's 3.20%, 3.21%, or something else. That will serve as the baseline for next year. Generally, we do not predict rate cuts, although we do consider them to some extent. If the estimate for next year is 3.25% to 3.35% or whatever it may be, I think we'll update it as needed moving forward.

Operator, Operator

The next question comes from Tim Coffey with Janney.

Timothy Coffey, Analyst

Jared, if we were to look at your noninterest expenses and back out the earnings credit rates, they've been essentially flat the last year. And not to say that it hasn't been something that you've been paying attention to, but has something changed with your philosophy of cost control in the last year that has become more of an emphasis?

Jared Wolff, CEO

I'll start by saying that our finance team and the entire company deserve a lot of credit for thoughtfully managing expenses. There have been shifts in expectations regarding hiring timelines. While we've been adding talented individuals at all levels, the pace has been more staggered as our teams seek efficiencies. As we prepare our budget for next year, we've asked everyone to evaluate where they will see the benefits of our investments in technology. We've emphasized that if technology isn't generating benefits, we need to reconsider its use. It's important to incorporate these technological benefits and our gearing ratios into hiring plans for 2026. This includes determining the number of portfolio managers needed per lender and relationship managers for new client relationships. The effectiveness of technology impacts our ability to monitor and manage BSA, and we are utilizing tools like Copilot and ChatGPT across the company. Our IT team has done excellent work in training staff to use these tools for greater efficiency. I want to clarify that while we're not planning layoffs, the hiring process may be slower since we may not require as many new hires immediately. Our teams have managed this well. Joe, I apologize for the lengthy introduction—could you provide the details now?

Joseph Kauder, CFO

No, I think you pretty much nailed it, Jared. We've been very disciplined about the headcount and projects, which are the two main factors affecting our costs. Regarding headcount, our team has been very thoughtful about where to add people and has often found efficiencies elsewhere to balance that. For projects, we begin the year with a detailed list of what we want to accomplish. As we delve deeper, we take significant time to reevaluate and prioritize, determining what is truly necessary and how we can execute the most efficiently. We identify elements that would be nice to include but aren't essential, allowing us to streamline our efforts. Our goal is to complete these tasks in the most effective way for both our shareholders and the bank. The team has excelled in this, as Jared mentioned. Looking ahead to 2026, we anticipate an increase in costs due to standard wage inflation and the amortization of project investments from this year. However, we remain focused on maintaining strict control over expenses to ensure they align with our revenue, further enhancing our operating leverage.

Jared Wolff, CEO

Tim, just another thought there. We have an initiative in the company called Better Bank. And we ask our employees to submit recommendations for improvement of anything that they see that they think is suboptimal. And we have a team that reviews those submissions, evaluates them, ranks them and then gives a response to the person that submitted it. And this is online for everybody to see in the company. So we're constantly improving the company. And I believe to my core that, that has actually created a ton of efficiencies in our company. When we have people that don't have to fill out the same forms that a third form when they've already filled out 2 others, they have the same information or they can get 2 forms down to 1 or we can do something faster for our clients so we can eliminate steps or get rid of things that just aren't necessary anymore because of our thoughtful employees who are on the front lines are saying, I can see a better way to do this and you actually listen to your team, you can create a lot of improvement. And I wouldn't look past that as also a reason why we've been able to keep costs in line.

Timothy Coffey, Analyst

That was great information. My next question is about the expense guidance. I don't think you're receiving recognition for keeping expenses flat over the last four quarters. It seems to me that the expense guidance is conservative. Are you anticipating significant investments in the business in the upcoming quarter or next year?

Joseph Kauder, CFO

Well, I think we just changed our guidance in the fourth quarter to say that we expect to be either at the low end or below the low end of the range. And I think we also further say somewhat consistent with what we've seen. So we're beginning to lean into that. And yes, I think it is fair to say maybe we've been a little conservative to date.

Jared Wolff, CEO

The project spending is substantial, Tim. If you ask people to list their desired projects, the list is quite extensive. However, our team is mature and recognizes the importance of focusing on a few projects and executing them exceptionally well instead of spreading ourselves too thin. We will address additional projects once we complete the initial five effectively. In my experience at various companies, I've observed that there aren't enough resources available to manage all proposed projects within the desired timeframe. Realistically, you can only manage about five significant projects simultaneously while ensuring quality and timeliness. There are always smaller tasks and fixes, but for major projects, it requires a committed and skilled team, who typically have other responsibilities as well. That’s our current approach to project management.

Timothy Coffey, Analyst

No, I can definitely understand that point. And then on the multifamily book, I mean, we talked about it earlier in the call, right? $6 billion, average yield around 4%. What strategies have you implemented to maybe bring forward some of those repricing timelines?

Jared Wolff, CEO

It's quite challenging to persuade someone with a 3.5% rate to refinance sooner because market rates are significantly higher, for example, around 4%. However, we monitor which loans are nearing the end of their fixed rate periods or are about to mature, often because they are 10-year loans with 5-year fixed rates or 5-year fixed rate loans. We reach out to those borrowers to see if they are interested in refinancing with us. The advantage of refinancing with us includes lower documentation requirements, reduced fees, and greater certainty. Currently, Fannie Mae and Freddie Mac have rates ranging from about 5.75% to 6% for a 5-year fixed rate loan. In comparison, we are offering rates between 5.90% and 6.1% for a 3-year fixed rate loan with different prepayment options. While Fannie and Freddie may have lower fees and costs and not require a new appraisal, there are still benefits to refinancing with us, even for shorter terms. We've had a success rate of approximately one-third with the borrowers we've approached.

Operator, Operator

And we have a follow-up from Chris McGratty with KBW.

Christopher McGratty, Analyst

Of course, I want to ask this respectfully. There's not a lot of banks at book value today, and we're in an M&A environment where good assets have bids. So can you balance buying your own stock versus partnering and bridging that gap to the 13% ROE a little quicker?

Jared Wolff, CEO

Look, I understand why we're attractive and why people mention our name. We have a very valuable franchise that's scarce. We're growing like crazy in one of the most dense and attractive markets in the country. We've got a really talented team of people. So I get why people might say, but I've heard that forever wherever I've been. I think the most important thing that we can do is put our head down and run this company well like we're going to run it forever and take care of our shareholders and put our heads down and keep growing earnings and everything else seems to take care of itself. So that's what we're focused on. We're focused on growing this franchise and being really successful. And I don't think you're going to see any secret where we are, but our teams are doing a fantastic job, and we're really focused on delivering excellent results for our shareholders.

Operator, Operator

This concludes our question-and-answer session and Banc of California's Third Quarter Earnings Conference Call. Thank you for attending today's presentation. You may now disconnect.