Bank of Marin Bancorp Q2 FY2021 Earnings Call

Good morning, and thank you for joining Bank of Marin Bancorp's Earnings Call for the Second Quarter Ended June 30, 2021. I am Andrea Henderson, Director of Marketing for Bank of Marin. This conference call is being recorded on July 19, 2021. Joining us on the call today are Russ Colombo, CEO; Tim Myers, President, Chief Operating Officer; Tani Girton, Executive President, Chief Financial Officer; and Beth Reizman, Executive Vice President, Chief Credit Officer. Our earnings press release, which we issued this morning, can be found on our Investor Relations page at bankofmarin.com, where this call is also being webcast. Before we get started, I want to emphasize that the discussion on this call is based on information we know as of Friday, July 16, 2021, and may contain forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, please review the forward-looking statements disclosure in our earnings press release as well as our SEC filings. Following our prepared remarks, Russ, Tani, Tim and Beth will be available to answer your questions. And now I'd like to turn the call over to Russ Colombo.

Thank you, Andrea. Good morning, everyone. Bank of Marin continued to generate momentum and strong earnings growth in the second quarter. We reported net income of $9.3 million, up from $8.9 million in the first quarter and $7.4 million in the second quarter of 2020. We continue to prioritize disciplined expense management and underwriting and consistently sound credit quality as we have across our various economic cycles over our 31 year history. Along with our proven relationship banking model, this gives us one of the strongest deposit bases in the country. Importantly, we also have a well-designed plan in place to extend our model to Greater Sacramento in Amador County, with our acquisition of American River Bank. The acquisition is on track to close in the third quarter as planned. As I have said before, this is a combination of two exceptional institutions that share complementary values and disciplined fundamentals. Our teams have diligently worked together to bring the merger toward closing. We've been thrilled with the spirit of partnership, dedication and talent that the American River team brings to the table. We are confident that we will expand our community banking franchise on a regional scale, bringing new products and services to American River customers. We will also benefit greatly from local expertise and proven talent that our new teammates bring to Bank of Marin. Upon closing, Bank of Marin will be well positioned as a preeminent business bank serving Northern California, with approximately $4 billion in combined assets. Gaining scale across the Greater Bay Area, the Greater Sacramento region and Amador County will allow us to develop new revenue opportunities and further increase efficiency, offsetting the challenges of a low interest rate environment. Our two organizations share a commitment to exceptional customer service and dedication to our local communities that we are all excited to magnify at the regional level. While the pandemic still poses significant risk, I am encouraged because vaccination rates are above the national average in our footprint, and we have begun to reach a new normal. This sets the stage for stronger economic activity ahead. Our Bank of Marin team is back in the office actively engaging with customers. Now I'll turn to the key highlights of our second quarter results. We generated diluted earnings per share of $0.71. Total loans decreased to $2 billion from $2.1 billion in the prior quarter, primarily as a result of PPP loan forgiveness. As of June 30th, the Small Business Administration had forgiven and paid off $189 million of our total PPP loans. Our commercial bankers are working to understand and meet the needs of their customers’ evolving credit needs and they are also identifying new opportunities across our markets. We expect these efforts will help us grow our portfolio over time. Credit quality remains strong. Nonaccrual loans decreased slightly in the second quarter to $9.2 million or 0.46% of total loans. Classified loans increased by $4.4 million from the prior quarter to $30.8 million. Total deposits grew $27 million to $2.7 billion, primarily driven by our customers depositing PPP funds into their accounts and new account openings. The average cost of deposits was just 7 basis points in the second quarter, reflecting the low rate environment in our relationship banking model. Noninterest bearing deposits represented 54% of total deposits. Given our strong capital and liquidity, on July 16th, the Board of Directors approved a new share repurchase program under which we may repurchase up to $25 million of our outstanding common stock. Also on July 16th, due to our continued profitability, the Board of Directors declared a cash dividend of $0.24 per share, an increase of $0.01 per share from the prior quarter. This represents a 34% payout ratio and the 65th consecutive quarterly dividend paid by Bank of Marin Bancorp. Now I'd like to recognize an important change to our leadership team. Tim Myers, Chief Operating Officer, was promoted from Executive Vice President to President in May. Tim is now responsible for the management of commercial banking, retail banking, centralized operations and technology, wealth management and trust and marketing. As COO, he proved his ability to lead in an ever changing environment and this new role is a natural progression of that success. Now let me turn it over to Tim to provide more detail on our lending activity and our expansion into the Greater Sacramento region.

Thank you, Russ. Excluding PPP loans, our total portfolio held steady at $1.8 billion. New loan originations in the second quarter totaled $44 million. With interest rates low and deleveraging trends continuing, however, loan payoffs of $61 million are influencing that growth. Those payoffs consisted largely of HELOC, home equity and consumer loans and commercial loans on which underlying assets were sold or paid off with cash. While optimistic about new opportunities, we remain disciplined and patient. We are focused on prudent, durable growth, not growth for growth's sake. We remained an active PPP lender until the program's funds were exhausted in early May of this year. And our second round of PPP funding totaled 1,063 loans for $136 million. We did this to support our customers and communities and help ensure a strong recovery for small businesses as we all emerge from the pandemic. PPP loans outstanding were $248 million at June 30th versus $365 million at March 31st, and $299 million at June 30th a year ago. We expect the remainder of the portfolio to steadily decline in the second half of this year as loans continue to be forgiven and paid off by the SBA. As of July 13th, a total of 1,395 loans, amounting to $202 million, have been approved for forgiveness by the SBA. Of the loans remaining, 70% or 1,072 loans, totaling $46 million, are $150,000 or less and have access to streamlined SBA forgiveness processing. With respect to the bank's payment relief program, at the close of the second quarter, we had just six borrowing relationships with nine loans totaling $43 million that were benefiting from loan deferrals or similar payment relief tied to the pandemic. We are working with these clients closely and expect the majority to resume payments. As we look ahead, we are optimistic about new growth opportunities across our San Francisco Bay Area footprint in addition to our expansion into Greater Sacramento and Amador. The Bay Area economy is among the most vibrant and prosperous in the country. Sentiment among our commercial clients is upbeat and steadily improving. The economy here is open and new opportunities are emerging. At the same time, Sacramento was growing in population, household income and new business formations. There has been more than $6 billion invested in new projects in the region over the past five years and more is underway. The greater scale and broader footprint positions Bank of Marin exceptionally well as the economy gains momentum and our clients make plans to expand. I will now turn the call over to Tani to dig deeper into our financial results.

Thank you, Tim. As Russ noted, we reported net income of $9.3 million in the second quarter of 2021. Diluted earnings per share of $0.71 compares to $0.66 in the prior quarter and $0.55 in the second quarter last year. Net interest income totaled $24.5 million in the second quarter compared to $22 million in the prior quarter and $24.4 million a year ago. Notable trends and drivers in net interest income include significantly lower interest rates year-over-year, interest and fee income from PPP loans and the early subordinated debt redemption in the first quarter of 2021. Year-to-date, the bank has recognized $4.3 million in fees net of deferred costs on PPP loans. As of June 30th, there were $6.5 million outstanding and yet to be recognized into income. The tax equivalent net interest margin was 3.28% in the first six months of 2021 compared to 2.7% last year. SBA PPP loans contributed 5 basis points to tax equivalent net interest margin year-to-date and 12 basis points in the second quarter. The early redemption of subordinated debt reduced tax equivalent net interest margin by approximately 18 basis points in the first quarter. In the second quarter, we recorded a reversal of the provision for credit losses on loans of $920,000 and a reversal of the provision for losses on funded commitments of $612,000. Both reversals were due primarily to improvements in economic forecast. Noninterest income totaled $2 million in the second quarter of 2021 compared to $1.8 million in the prior quarter and second quarter a year ago. The increases were mostly attributable to debit card interchange fees from increased levels of activity and higher wealth management and trust services income from new accounts and favorable market performance. Additionally, the discontinuation of pandemic related fee waivers is supporting noninterest income. Noninterest expense increased $144,000 from the first quarter to $15.6 million. Increases in charitable contributions and acquisition related costs were mostly offset by lower expenses related to stock based compensation and 401(k) resets in the first quarter. Year-to-date, noninterest expense increased $1.7 million to $31 million compared to the first 6 months of 2020. Salaries and related benefits were higher by $755,000, over half of which was related to fewer deferred SBA PPP loan origination costs. Professional services expense increased year-over-year due to some pandemic related delays in 2020 activities posted in the first quarter and $335,000 in acquisition related expenses recorded in the second quarter. Total acquisition related expenses in the second quarter and year-to-date were $351,000. The efficiency ratio was 58.6% in the second quarter, down from 64.6% in the prior quarter and up from 53% in the second quarter of 2020. Efficiency ratios for all prior periods have been adjusted to reflect the reclassification of provisions for losses on unfunded commitments from noninterest expense to a separate line item under net interest income on the income statement. Return on average assets and return on average equity were 1.2% and 10.7% respectively for the second quarter. Our total risk based capital ratio at the end of the quarter was 15.5% compared to 15.7% at March 31st and 15.8% a year ago, all considerably above well capitalized regulatory requirements. The share repurchase program approved in January 2020 was completed in May 2021. Through the program, we repurchased 298,000 shares totaling $11 million in the second quarter of 2021 with cumulative repurchases of 692,000 shares totaling $25 million. The bank continues to build a sound balance sheet, manage risk and deliver consistent and solid profitability. We are well positioned to respond to different interest rate environments. The American River acquisition, along with our relationship banking model and capital management initiatives, all serve to reinforce the long term success of Bank of Marin. Now Russ would like to share some closing comments with you.

Thank you, Tani. Bank of Marin produced strong results for our shareholders, growing both net interest income and noninterest revenue in the second quarter, while managing expenses closely and maintaining pristine credit quality. We are in an excellent position to close our acquisition of American River Bank next month. We will waste no time capitalizing on our larger, more diverse footprint and greater scale to drive new efficiencies and growth. We have successfully executed three previous acquisitions and we are drawing on that expertise and working closely with our American River colleagues to ensure a smooth integration. As always, I am proud of the discipline and dedication to excellence that has long been the pillars of Bank of Marin's success. Our core values remain firmly in place as we grow and pursue new opportunities. I want to thank you for your time this morning. And now we will open it up to your questions.

The operator provided instructions. Our first question comes from Jeff Rulis with D.A. Davidson.

If we exclude the PPP impact and adjust for the redemption in the first quarter, just the core margins are kind of in the mid-320s. Any thoughts on, I guess, if we look forward excluding further PPP adjustment and I guess American River, kind of the thoughts on the core margin led by loans? What are your thoughts on that front?

Well, I'll start and then I'll actually ask Tim and Tani to jump in. Margins are under pressure, as you know, because the interest rates are so low. And there's not a lot one can do when it comes to interest rates; they are what they are and we compete with the competition. And that's why there's been such pressure on rates. I'll ask Tim to give you a little bit more clarity in terms of the most recent opportunities that we've had.

Certainly, we're under competitive pressure like everyone else on the yields on the new loans we're funding, and we also have to prevent runoff out the other side. So that's always going to put some pressure. Every loan that pays off is being replaced by a loan at a lower rate and that's the economy right now. That's the rate environment. We are certainly doing our best. We certainly take advantage of our relationship banking model. We work as hard as we can to get the best deal we can on each loan. But there's no question in aggregate those trends are putting pressure on the loan yield.

Yes, I don't have anything to add to that. I think you effectively got to the core margin.

I think the buyback announcement signals confidence, even with the American River deal pending. Is it safe to say you'll continue to consider buybacks up until the close of that transaction?

Yes. We have a lot of confidence in our bank in total. We have well-managed expenses and the teams are coming back. We've all come back to work now, interacting directly with clients. That to me is very encouraging and you should see volumes increase because of that. So when you put all those things together, we're pretty encouraged. And so far in the American River acquisition, we've seen nothing but positive things. We're very, very encouraged by the bank, the loan portfolio, the people that are coming over from American River. This has been—and the cultures match so well together. A lot of these things can work or they can't work if the cultures are not a match, but we've seen nothing but positive things out of the American River staff. So we're very encouraged about what we can do in Sacramento as we move forward and bring some of our products; for example, they don't offer HELOC products at all and we will bring that over to them. Because of our size, we'll be able to up-tier a lot of relationships. In my mind, this acquisition is perfect timing and it's also a perfect fit for two organizations. And we found nothing to dissuade us from exactly that as we've gotten in there to work.

Just one quick last one, Russ. The fires in the state looked like mostly east of your footprint and even east of American River. But I just wanted to confirm that, at least as of now, are you seeing any impact on those?

I haven't seen any impact at this point. They are pretty far east of where we are. But obviously, we keep our eye on it. This is fire season in California and the last few years have been pretty rough. So we're keeping our fingers crossed; so far, nothing in our footprint.

Our next question comes from Matthew Clark with Piper Sandler.

Just getting back to the core margin. Can you give us a sense for where new money yields are coming on for both loans and securities in the latest quarter?

I don't have that new loan yield for the quarter number in front of me, Matthew, but we can get it to you.

So I can tell you just the back trends a little bit on the new loans, not including PPP, are roughly in the same area where the portfolio stands with the exception of HELOC because I think we lowered our rates on those. But otherwise, that's pretty stable. The investment side is pretty tricky; you have to go out quite far to get yields over 1.25% when you're looking at solid credit quality. So we're just doing our best to purchase opportunistically there. And we did have a couple of opportunities over the quarter and we continue to keep our eyes open for those. But to the extent that we can extend our duration a little bit, not too much and still achieve more than we can get at the Fed, which is not much, we are doing that.

And then just shifting gears to the pipeline, the loan pipeline. Any commentary there as it relates to growth year-over-year linked quarter?

We're certainly seeing the pipeline. As Russ mentioned, our bankers are out and calling in person, and we are seeing an almost immediate impact of that on the pipeline. Now the probabilities and the timing of those things moving from state to state and closing is always in question, which is why we're always reluctant to comment on that too heavily, but we are seeing very encouraging trends and that direct customer and client calling activity resulting in opportunities to look at.

Matthew, I'd add one thing. The way we operate our bank is really this relationship-based model. And it's so important to have face-to-face interaction with our clients and with our prospects. The pandemic, we all made it through based on a lot of people working from home and working remotely. But now that we're back in the offices and actually able to go out and visit clients, I expect it to have a real impact on results going forward. It's encouraging to see what we're seeing from our lenders out in the commercial banking offices.

And then as it relates to the reserve, what are your updated thoughts on where that ratio could start to stabilize? I mean are you in the camp that believes you'll kind of stabilize around pre-pandemic levels, or do you feel like you could dip below that based on better macro factors under CECL?

So I think that the reduction in the forecast or the improvement in the forecast this quarter was not as dramatic as last quarter. The model is very much based on the quantitative results and the forecast. So it's really difficult to predict what the levels will be going forward. But I think based on where the forecasts stand right now, that's what the current reversals reflect. And like I said, I don't have a lot of confidence in projecting where those forecasts are going to go but they probably won't go down as much as they did or won't improve as much as they did this quarter versus last quarter.

And then just last one from me on expenses. If you adjust for the merger charges at about $15.2 million run rate, it looked like you were a little heavy in terms of charitable contributions this quarter. How do you think about that kind of stand alone run rate for the back half of the year, excluding American River?

The charitable contributions, what we did was we expensed them all in the first quarter for the year. And so that's going to be — those dollars are going to be distributed out over the years. So that's why they're heavy in the first and second quarters.

And then just the overall run rate to, Tani?

I think the overall run rate is pretty stable. But of course, we've got the acquisition in there and we're just starting to see the acquisition costs. So that's going to have a big impact on expenses over the next couple of quarters here.

Our next question comes from Jackie Bohlen with KBW.

Just sticking to expenses or taking a little bit of a different turn. When you look at your headcount for legacy Bank of Marin, where do you stand today versus full employment? I'm just curious if you have any open positions presently.

We do have open positions. I think we're about 9% below full employment at the bank right now. So there are positions open. And certainly the pandemic had something to do with that during that time; it was tough to hire. But the majority of the positions are not in leadership roles, they're primarily lower level in the bank.

So while it's 9% to full employment, it's not 9% to overall compensation.

No, that's correct. It's going to be lower cost. And honestly, we never run full employment. We always have a certain number of positions open. So you can't interpret that number too literally.

And I know in the past, Russ, you talked about the potential of work from home as opening up new recruiting doors for you. And now that we're starting to get back to normal just wondering what your updated thoughts are on that.

We're still looking at that. We tried to separate pandemic working from home from working from home in the future because we did the work from home and remote work during the pandemic out of necessity as opposed to evaluating what jobs could specifically be run outside of our locations. We have a strategy in place. We're looking at that and we anticipate we'll have a number of positions that will have either full or part time remote options because there are some jobs that don't necessarily need to be here. That being said, our primary focus as a relationship bank is in person—not only for client reasons but for internal collaboration. There's a lot that can be gained from the discussions that happen when people are working together side by side. It's hard to measure the value but it's very valuable in my mind.

Yes, I would agree with that on collaboration. And then do you have either an estimate or an update on when you might look to do the conversion, given that the transaction sounds like if you're looking to close that next month.

We're looking to close next month but the conversion doesn't happen until the spring. The reason for that is we have been given a date by our core processor, FIS, and that's the date. Because the close is going to occur in August, there's a blackout period by FIS for about three months—November, December, January—during which integrations are not allowed. So everything got pushed back and we're scheduled for March. That's when it's going to happen but we're working towards that date.

Our next question comes from Tim Coffey with Janney.

Origination activity on the loan side was really strong this quarter. And I'm wondering if you can provide a little bit more color on where you're seeing the best win rates.

It's actually fairly dispersed. As has historically been the case, we are getting most of our new volume out of our markets with the most relationships and the largest portfolios to build on. The biggest increase was on the commercial side as opposed to HELOC or consumer loans, and this is a year-to-date perspective. But the biggest increase was on the commercial side, which includes our construction lending group, which has also been very positive. Certainly, our payoffs on the retail consumer loan side have been down and that activity, just as Russ was talking about being out meeting with our relationship banking clients, tends to be more commercial and construction oriented. That is by loan type where we saw the biggest increase year-to-date.

And then from the perspective of legacy Bank of Marin, what are you seeing on deposit growth? Do you still expect that to be strong going into the back half of this year?

I would say, yes, there's an awful lot of liquidity in the market, and banks in general benefit from it and we certainly do. These are relationship deposits that we have. I think that will continue through the year. Beyond that, as projects and reinvestment in businesses start, you'll start to see the deposits run off and it's hard to predict exactly when that happens. But through the end of this year and the beginning of next year is when I would expect to see some changes; I'd look more toward 2022 as a time when you might see those deposits start to not grow as quickly.

Our next question comes from David Feaster with Raymond James.

I just wanted to kind of follow up on that question and touch on liquidity. I mean you guys have done a great job deploying the liquidity through some off balance sheet, investment securities. Just curious what your plans are for that $257 million in cash. Is some of that just built up ahead of the deal and to help improve the AMR deposit base to maybe run off some of the noncore stuff? I mean you touched on some opportunistic securities purchases. Just curious your thoughts on deploying that liquidity? Is there even an opportunity to move to more off balance sheet or is that even of interest, just curious on that front?

Well, not a lot is noncore. Our deposits are almost entirely relationship based and we don't have CD specials and things like that. So all of the money sitting in our bank is really customer relationship-based deposits. And we're at 7 basis points. I'm not sure how much you can run off at this point unless we start charging people to keep their money. But Tani may have some thoughts about the liquidity side.

So in terms of deploying off balance sheet, a lot of the deposit networks, because there has been so much liquidity in the system, have actually frozen their ability to take more off-balance sheet deposits. So we were in really good shape because we sold early and we haven't brought those back yet and we continue to try to redeploy what we have on the balance sheet, which is the $250 million plus that you mentioned, David. We are really working to deploy that in investments when we have the opportunities and trying to balance moving it out of cash with not stressing the portfolio yields too much, but also between those two balances, the on-balance-sheet and the off-balance-sheet cash we have available, making sure that we're ready when the loan volumes pick up to fund that. So I think we're in good shape.

And then I just wanted to touch on the fee waivers. Just curious if you had an estimate for how much in foregone fees you may have had? And then just maybe how much incremental fees you might expect now that those are reinstated?

That is a really difficult number to put our fingers on, because so much of it is transaction-oriented and balance-oriented put together because some of our accounts are analyzed and so there are offsets to fees based on the balances that they hold. And not only that but because behavior has changed over the course of the pandemic, it's really difficult to pinpoint how much lift we might get out of that. That said, we are starting to see some lift but we only saw that for half of May and June. So we don't even have a full quarter of activity to base any analysis on yet.

And then just curious on the Wine Lending front and the expansion into Sonoma, I believe you guys hired a new lender last year. Have you continued to add to that team? And then just curious how growth has been in that business and what you're hearing from clients and just trends in the wine industry.

The individual that we put in charge of the commercial banking operations in Santa Rosa was one of our wine lending experts. So that office in Sonoma County wasn't new but he did make a hire of someone with wine industry background. That in part was part of the team covering the Central Coast wine industry calling activity. What we're trying to do is bring the expertise we had in Napa to both Sonoma County and the Central Coast. We've been very active certainly with the world opening up with pandemic restrictions being relaxed. That activity is really picking up. That will take some time to build the pipeline, but they've been very active and we've been very excited about some of the opportunities that we've had the chance to look at as we've been able to get out with our customers and prospects.

We have a follow-up question from Jackie Bohlen with KBW.

Just one last one for you, Russ. We're kind of approaching the two year anniversary of when you originally announced that you were looking to retire and then the pandemic happened, you obviously put that on hold, guided a bit successfully through. So I just wanted to see if you had any updated thoughts to share on that front?

Has it been two years, Jackie? Circumstances dictated what happened. Obviously, we started the search and then the pandemic hit and I committed to stay through the pandemic. We're coming out of the pandemic. Along that time, we've been able to increase the responsibilities for Tim and now promoted him to President. He's taken on a lot more responsibility, which is great. We don't have a definitive timeline at this point but we're making progress. So I don't have an answer for you; there's nothing to report at this point.

There are no further questions on the phone at this time.

We do have one question, which came from a shareholder, and the question was this. Since completing the acquisition of American River Bank, the Bank of Marin share price has fallen 20%. This represents a $100 million reduction in the market value of BMRC from $500 million to $400 million. Are you still confident the deal is good for shareholders? I am actually way more confident today than I was the day we announced the deal. As we've gotten into this project, we found incredible cooperation from the people and talent. A bank is only as good as the talent that you have. The American River people are so cooperative and so eager to help and to make this work, that it has made our decision to acquire them even better; I am more confident today than I was when we announced the deal. I will say the market has also dropped, so not all of the 20% is as a result of this. One of the other things that we heard was, 'oh, you're going in Sacramento, you have reservations about that.' Well, if you go into Sacramento as a de novo, you don't know the market then there's some issues. We're going in and we're getting a bank that's been there for many years with a lot of talent and a lot of knowledge and a lot of good customers, great customer relationships. What we projected in our presentation when we first did the deal was 14% accretion in the first full year. I am very confident that we will easily achieve that number. This acquisition is going to be extremely successful. I am not only confident but extremely confident of our success going forward on this. I want to thank everyone for listening today and for asking your questions. I look forward to speaking with you again next quarter. If you have any follow-ups, please feel free to call us. Thank you for your time this morning.