Q1 2024 Bank of Marin Bancorp Earnings Call

Participants

Yahaira Garcia-Perea; Marketing and Corporate Communications Manager; Bank of Marin Bancorp

Timothy Myers; President, Chief Executive Officer, Director; Bank of Marin Bancorp

Tani Girton; Chief Financial Officer, Executive Vice President; Bank of Marin Bancorp

Jeffrey Rulis; Analyst; D. A. Davidson & Co.

David Feaster; Analyst; Raymond James Financial, Inc.

Presentation

Yahaira Garcia-Perea

Good morning and thank you for joining Bank of Marin Bancorp's earnings call for the first quarter ended March 31, 2024. I'm Yahaira Garcia-Perea, Marketing and Corporate Communications Manager for Bank of Marin. During the presentation, all participants will be in a listen only mode. After the call, we will conduct a question-and-answer session. Joining us on the call today are Tim Myers, President and CEO, and Tani Girton, Executive Vice President and Chief Financial Officer, our earnings press release and supplementary presentation, which we issued this morning. Can be found in the Investor Relations portion of our website at bankofmarin.com, where this call is also being webcast. Post captioning is available during the live webcast as well as on the web replay.
Before we get started, I want to note that we will be discussing some non-GAAP financial measures. Please refer to the reconciliation table in our earnings press release for both GAAP and non-GAAP measures. Additionally, the discussion on this call is based on information we know as of Friday, April 26, 2024, it 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 statement disclosure in our earnings press release as well as our SEC filings. Following our prepared remarks, Tim, Tony and our Chief Credit Officer of Monsanto. Stuart will be available to answer your question. And now I'd like to turn the call over to Tim Myers.

Timothy Myers

Thank you, Yahaira, and good morning, everyone, and welcome to our first quarter earnings call at a high level. During the first quarter, we showed deposit stability, a declining pace of deposit cost increases and continued strong liquidity. We also added to the foundation we are building for a more robust loan origination end. Our smaller balance sheet and higher overall deposit costs resulted in slightly compressed net interest margin and core earnings reduction in the first quarter from operating expenses, which did include some seasonal increases and downward incentive adjustments were also higher on balance as we added key new commercial banking hires and our talent is already helping pipeline activity in both the North Bay and Sacramento.
Importantly, our concerns about overall credit quality and loss potential remain unchanged despite risk grade migration in the quarter, we capitalized on the dislocation caused by the regional bank failures. And as I noted, attracted proven relationship bankers helped drive new client acquisition. Notably, the pace of deposit cost increases slowed during February and March, reaching the lowest incremental levels since February 2023. These catalysts complement the strategic repositioning of our balance sheet away last year when we divested lower-yielding securities and scaled down short-term borrowings to improve our interest rate risk position for the year ahead.
We continue to our facilities optimization by consolidating two of our commercial banking offices into one, saving approximately $650,000 this year and an $800,000 annualized run rate beginning in 2025. We will continue to evaluate a range of strategic possibilities to optimize our balance sheet and expense structure, create efficiencies and increased profitability on behalf of our shareholders. We also remain firmly committed for a long established conservative approach to credit. Overall credit quality remains strong with nonaccrual loans at just 0.31% of total loans at quarter end, down from 0.39% in the prior quarter.
As we've indicated, our relationship banking model enables us to work closely with our commercial real estate borrowers most directly impacted by the current environment. We are also able to manage risk on certain CRE loans with Vacon status through enhancements to collateral either by way of cash or other income-producing properties or by having the borrower paid down the loan during the first quarter, we made good progress in this area, and it remains a key focus.
Classified loan levels did increase in the first quarter. This was due largely to three relationships of different types and geographies to our CRE loans that are fully secured and supported with personal guarantees, and we believe there is minimal risk in these credits. We are not seeing the formation of material new problem loans just previously identified problem loans continuing through to the workout and resolution process. In the first quarter, we upgraded four loans totaling more than $10 million from special mention in the past. Our nonowner-occupied office portfolio overall has made up of 151 loans with an average loan size of only $2.4 million. The weighted average loan-to-value of 60% and the weighted average debt service coverage was 1.6 times based on our most recent data. There is no notable change from what we reported at year end. Our office CRE book in San Francisco represents just 3% of our total loan portfolio and 6% of our total nonowner-occupied CRE portfolio.
I also want to note that we have minimal exposure to rent control properties within our multifamily portfolio, only 32 loans with an average balance of only $1.6 million or 2.5% of our total loan portfolio like the rest of our book. We are monitoring this very closely. As I noted, with our new commercial hires, we're seeing more new, attractive opportunities with a dramatically improved pipeline through the timing to close is difficult to predict. As such, our loan portfolio did decrease slightly as our originations in the quarter were offset by payoffs, scheduled repayment and strategic exits much of the payoffs were related to construction loans as a result of project completion.
Now turning to deposits. We maintain total deposits with quarter-end balances essentially flat from December 31, we attracted new customers during the quarter as some clients also move cash into alternative investments capture higher returns. And we also saw seasonal outflows that we often see in Q1 of each year. Our noninterest-bearing deposit level remains favorable at 44% of total deposits. We continue to focus on relationship banking with high-touch service being appropriately competitive on deposit pricing and maintaining our strong core deposit franchise. We anticipate our funding costs to further stabilize this year. We also continue to maintain high levels of capital and liquidity, and we are in a position of strength. Our total risk-based capital ratio improved to 17.05% at quarter end compared to 16.89% at the close of 2023 total liquidity of approximately $1.9 billion consisted of cash, unencumbered securities and total borrowing capacity.
In summary, we made substantial progress by adding talent and building upon our foundation for profitability improvements and long-term growth, and these efforts are ongoing.
With that, I'll turn the call over to Tani to discuss our financial results in greater detail.

Tani Girton

Thanks, and good morning, everyone. with interest rates higher for longer and lingering economic uncertainty. We continue to focus on further strengthening our core deposit franchise and maintaining robust liquidity and capital levels while delivering exceptional service to existing and new customers as we position Bank of Marin for continued earnings improvement in 2024, we generated net income of $2.9 million for the first quarter or $0.18 per diluted share compared to net income of $610,000, or $0.04 per share in the fourth quarter of last year. $4.2 million of the increase in net income quarter-over-quarter was due to losses on securities sales in the fourth quarter of 2023.
After repositioning our balance sheet out of borrowings and some securities lower earning assets, combined with the higher cost of deposits to make net interest income $1.6 million lower than the prior quarter. However, during the first quarter, we maintained our non-interest bearing deposit levels while capturing higher yields on new loans.
This largely offset increases in interest-bearing deposit costs. And as a result, our tax-equivalent net interest margin decreased by only three basis points in the first quarter following a 5-basis point increase in the fourth quarter. Taken together, our net interest margin has stabilized over the past two quarters, and we are optimistic that we will see continued stability in the near term with a bias for improvements from new loans and existing loan repricing at the same time, we continue to evaluate strategies that support margin expansion.
Our non-interest expense base increased somewhat with the new hires Tim highlighted. Additionally, the seasonal increases related to 401(k) matches tied to bonus payments and lower loan origination cost deferrals contributed to the $1.9 million increase over the fourth quarter. Professional service expenses related to the annual audit also tend to be higher in the first quarter. Increases were somewhat tempered by downward adjustments to incentive accruals in the first quarter, but there were much larger reductions to incentive profit sharing stock-based compensation and retirement plan accruals in the fourth quarter of 2023.
Moving to non-interest income. Excluding the $5.9 million loss on the sale of base FX securities associated with our fourth quarter balance sheet restructuring noninterest income of $2.8 million was stable quarter-over-quarter. In addition to the total risk-based capital strength in noted, Bancorp's tangible common equity to tangible assets ratio improved to 9.76% in the first quarter from 9.73% at December 31. Our contingent liquidity is plentiful, and our deposit base is well diversified, with businesses representing 59% of balances and 32% of accounts. Our largest depositor represented just 2% of total deposits, while our four largest depositors comprised 5.3%. We maintained our total deposits to $3.28 billion on March 31 without tapping the brokered CD market or running CD campaigns and noninterest-bearing deposits increased slightly to 44% of total deposits from 43.8% at December 31.
The average cost of deposits increased 23 basis points to 1.38% in the first quarter compared to a 21-basis point increase from the prior quarter. Underlying these changes is a clear downward trend in monthly increases since the peak in March 2023. We believe we are appropriately competitive in regard to deposit pricing, given our relationship banking model that differentiates Bank of Marin. Disciplined credit management remains a Bank of Marin for value as well. Our $350,000 provision for credit losses in the first quarter compares to a provision of $1.3 million for the previous quarter and brought the allowance for credit losses to 1.24% of total loans compared to 1.21% as of December 31.
Physically loan originations are lower in the first quarter of the year. And this year, new originations of $12.4 million were more than offset by payoffs of $21.8 million with rates on new loans averaging 266 basis points above the rates on loans paid off. Loan balances of $2.1 billion for the first quarter were down 18.8 million from the prior quarter after amortization and changes in utilization. Our Board of Directors declared a cash dividend of $0.25 per share on April 25. The 76th consecutive quarterly dividend paid by Bancorp.
We didn't repurchase any stock during the quarter instead we concentrated on building upon our strong capital, reinforcing credit protections, deepening relationships with our customers and developing new business, we regularly evaluate the merits of stock buybacks.
We also continue to assess additional possible adjustments across our balance sheet and expense structure with a focus on finding new ways to accelerate net interest income expansion and self-fund efficiency improvements. Potential actions are run through our capital plan and interest rate risk simulations, along with rigorous stress tests to evaluate long-term benefits. In addition to meaningful profitability improvements, we screen for reasonable earn-back periods, ample ongoing liquidity and capital and sustainable balance sheet strength and profitability. With that, I'll turn it back over to Tim to share some final comments.

Timothy Myers

Thank you, Tani. In closing our enduring relationship-based banking model, healthy capital and liquidity levels and favorable mix of deposits and solid funding base, provide Bank of Marin, a strong foundation for loan growth, margin expansion and increased profitability in coming quarters. Over the past few months, we have added a number of highly productive bankers, implemented a more active approach to developing new client relationships and increased our use of technology to enhance those efforts. All of these have positioned us to generate a higher level of loan production going forward.
While we maintain our disciplined underwriting, we also continue to evaluate our physical footprint and optimization opportunities as well as other ways to manage expenses while also investing in talent and technology to maximize customer satisfaction, attract new clients and further enhance our ability to generate long-term profitable returns.
With that, I want to thank everyone on today's call for your interest and support. We will now open the call to your questions.

Question and Answer Session

Operator

(Operator Instructions)
Jeffrey Rulis, D.A. Davidson.

Jeffrey Rulis

Thanks. Good morning. I have a question on the hires that you had. I know you've added folks even last year. I just wanted to trying to get a sense were there any new in the first quarter?

Timothy Myers

I guess there were. And we haven't -- I think we talked about before not having a team there. They're spread out among our different regions, but we did have costs in Q1 associated with that and we haven't -- it's more of a timing issue haven't offset that yet with the cost rationalizations and other areas that we said we'd do to fund that so that there's a bit of a timing gap there.

Jeffrey Rulis

Okay. That's leading to the next. I just trying to get a sense for you've had the seasonal impact bumps in professional services and other. I'm just trying to get a sense on that salaries line. Just are there some puts and takes that overall expense the you've moderate from here? Or is that some of those new adds kind of continue to add to growth?

Tani Girton

Yes, I'd say puts and takes on. We had some positives that offset some of the negative seasonal stuff. And so when you look at it on balance than we have been, we do have a higher base on salaries. And you know, this is the beginning of the year. So medical insurance costs are up and down. We do have some strategies that will be kicking in the costs for which will be kicking in later in the year on again, we're trying to self-fund those, but I would say we are moving into 2024 with a higher salary base.

Timothy Myers

And then one more point, Jeff, whilst not in the salary line, I mentioned in the script that we did consolidate two offices.
So in the quarter, the very end of the quarter. So we'll save about $800,000 a year in lease expense there and in part are largely so that we can fund the personnel acquisition. So we'll continue to look for ways like I know it's hard to quantify at this point, but we'll continue to do those kind of things.

Jeffrey Rulis

Make sense. And Tim, we probably know the folks that were hired with their focus of lending? Is it in a particular area?

Timothy Myers

No, I think it's more C&I based or focus. And we have had, but I would call them generalist like Mike, much of our bank and history has been. So we are seeing a much more diversified portfolio of professional services, general C&I deals, but it is spread out. So we're seeing a lot of growth in the pipeline in Sacramento, the North Bay, Walnut Creek, those are all the different places we had these higher. So that was part of our strategy was to grow, become more regionally specific to how we are aligned rather than, as said before, buying a team that's focused on more than one was just one geography.

Jeffrey Rulis

Great. And maybe just my last one, then as it relates to that loan growth immediate, you talked about in the release of remaining careful of the environment, the pipeline is up. You kind of got over some maybe some construction payoffs. Wanted to make big picture on loan growth from here. I know, Tim, you mentioned timing is difficult, but get a sense for your expectations for loan growth on any --

Timothy Myers

We are marketing the mid-single digit that we've talked about. We it is really -- we're really getting traction again. I can't promise you're going to get those deals approved or but it's really those people in the markets are getting traction. And so we have a much higher confidence level that we'll see more deal churn, more activity, which ultimately leads to more closings on the timing of that, again is hard to predict. It can be lumpy, but we're pretty optimistic at this point of how that's shaping up.

Jeffrey Rulis

So Q1's net runoff doesn't deviate from mid-single digit for the full year?

Timothy Myers

That is still our goal.

Jeffrey Rulis

Okay. Thank you.

Operator

David Feaster, Raymond James.

David Feaster

Hey. Good morning, everybody.

Timothy Myers

Good morning, Mr. Feaster how are you?

David Feaster

Doing great. I wanted to maybe follow up on the loan growth kind of commentary on originations were down in the quarter. I'm just curious, though, how do you think about and what drove that like, how much of that is weaker demand, maybe less appetite for credit? And just kind of your where do you expect growth to be coming from? You touched on more C&I. So it seems like that might be a bigger driver So just wanted some of those coming.

Timothy Myers

Yes, no problem. On the weakness side, I think you hit on it. I think there is weaker demand, but we are seeing a bit of a normalization as people get more used the higher rates and higher for longer that we're seeing a lot more activity either they can't wait it out or it's not quite as good for them as we thought. So we are seeing a higher level of interest. There is a component of no, we're not going to an office property in San Francisco with 30% vacancy, even if it looks good as a smaller property or even in other parts of our footprint where there's lease rollover risk and you're just not going to step into a situation where where it could, you know, start deteriorating relatively soon. So there is a greater degree of oversight, but we are seeing a greater degree of deals where the credit meets our criteria are more geographically dispersed and more it's dispersed by type of loans. So it's always hard to predict from a point in time what that means, but we are seeing all that all the above right now.
Okay.
And then maybe just touching on credit, right, you've got a great reputation as an aggressive and proactive manager of credit that's evidenced in the quarter on you touched on a few of the credit issues in the quarter, but I'm curious maybe how you think about managing those issues on your thoughts after stress in the CRE book and maybe the health of the CRE market in your footprint and just high level, how you think about approaching digital modifications?
Yes, that's a great answer to your question, let me ask Misaka Steward, our CCO designed to jump in.
She's the one that does most of that work than mine.
So I'm glad you mentioned the credit quality and credit management of our portfolio is still pretty solid. I mean very solid, I would say in terms of managing the credit immediate, it's it's a it's a close close management every quarter. We're getting updated information. We're looking at values and we're talking to our borrowers. I mean of our classified loans, all of them are supported by personal guarantees or the owners or the owner and the direct borrowers. And so we are constantly in discussions with them on how to kind of them remediate to find resolution, find a mutual agreement compromise on how to rightsize or get the get the loan to a more conforming level, if you will. And that conversation continues. As you know, the balances in our are graded loans is not always a great reflection of the movement that we see and there is a lot of movement up and down in our portfolio. And last quarter, we had very little by way of migration from past to criticized or classified. And even in the downgrades to them, some are special mention to our substandard in a majority of those are vacancy issues, but they're not necessarily that vacancies have gotten worse. They just haven't gotten better. And with the passage of time, you know, it warrants closer attention and those are the reasons for the downgrade. So we do take a pretty aggressive approach and how we monitor the credits and debits and how we risk rate.
That's helpful.
And then just kind of another part of that delta CRE market across footprint.
I'm sorry that again, David?
Sorry, just the health of the CRE market across your footprint and the Saka you want to take that was anything Helsinki?
Yes, it depends on the asset by asset class. You know, I think industrial still continues to perform well, mainly depends on our footprint. As you know, office is not, you know, not bad in that we every market that we're in and staying with retail. So it is it is different. Multifamily is still continues to be continues to be a strong asset class for us.
So it's Ed.
It's hard to say how it is overall since it is different in each market, it is uneven, David, and the valuation declines obviously are most pronounced in our footprint in office. But even then within Office, it can be 20% decline from some one region up to the kind of declines. We're seeing 40 50% in San Francisco, again, heavily dependent on the size of the property, all that kind of stuff. So it is it is uneven. Industrial is strong and a lot of our footprint. So and as Misaka said, multifamily is strong and we haven't had a lot of issues there that are just we are reducing Craddock unrelated to what's going on in the world. So that's how it's holding up in many of these categories.
Okay.
That's great.
And then I just wanted to touch on your just kind of get a high-level thoughts on how you think about managing the balance sheet higher for longer environment? You've noted that there's some opportunities that you're considering. You guys have already been active with the securities book with our cost saves still investing in the franchise with new hires. But I'm just curious what types of initiatives you're considering and given the like again, last quarter, we're talking about rate cuts. Now we're talking about a higher for longer environment. What are your thoughts on managing the balance sheet?
Have a change at all that we are actively considering all those things, and I'll let Tony jump in here.
Yes. So we had a, you know, and a series of sales last year, we did about $83 million in the second quarter and then another 132 million in the fourth quarter. And we still have a significant AFS portfolio that gives us a lot of flexibility too and opportunistically sell those securities and get those funds redeployed into higher yielding investments, loans, whatever opportunities we have there. So the timing is important on, but we are looking at it as Tim said on Barry and I in a very concentrated manner and done, we'll continue to do so plus Version one.
Thank you.
Next question will come from the line of Andrew Terrell with Stephens. Your line is now open.
Bagger.
Morning, Andrew or fill out our Yes, sir.
Tom, maybe if I could start just on the deposit front. It looks like the interest-bearing deposit cost increase this quarter was actually maybe a little bit of an acceleration from 4Q. You have got up 33 basis points and it was 31. I believe in the fourth quarter. I'm just trying to maybe square that with some of your commentary around the deposit cost deceleration, it may be more on kind of a month to month basis throughout 1Q. So maybe be helpful. Could you share just kind of how deposit costs progressed throughout the first quarter, but you're 100%, right?
And I'm sorry, if that was unclear. So yes, we saw a couple of basis point increase in the overall cost quarter-over-quarter, a big deceleration. I can't give you specifics, but by the time you hit March, there was the lowest level we've seen since before this crisis.
Yes. So if you look back at March 23, we had a 60 basis points, a 60 basis point pop on interest bearing and 29 overall. So I'll stick with the overall cost of deposits. So that has trended down on a monthly basis. It is fell down pretty steeply to 16 and 12 and then it popped up a little bit of 14. And then by July 23, it was down to six and then five and it popped up a little bit in September and stayed up a little bit around seven to nine and then peaked in January at 10 and then back down to six and two. So you know the it's a clear trend down.
There are some some peaks and troughs in that trend, but it is it is pretty solid trend down, garner good, very good potency and two in January, February, March definitely seems like a big step down to March, though. And then if I could ask another one kind of margin related as well from, I think the release mentioned about a 260 basis point spread for new originations versus what was being paid off this quarter. I'm just curious your thoughts on what paid off most heavily this quarter was construction, which I would imagine is a little higher yield. Just as we as I contemplate 10, you guys getting back to that kind of mid-single digit type loan growth growth ramping later this year, would you expect that spread of new originations to payoffs to widen from this 200, 60 level?
Yes, it's hard because as you said the cost of loans paying off profile a little bit higher. So the loans came on, again, it's so small sample, but I think it's consistent. What we're seeing is in the low eight 8.18, I think was the rate of the loans that came on in the quarter. So a material difference from a lot of our other fixed rate loans. So it just depends on the timing and the category rate of payoffs. But I think that is a clear trend just again, also whether it's going to be fixed rate or variable rate, some of the fixed rate for attractive real estate lending out there still awfully competitive may seem to see the same delta rates coming on Brazos going up but that's where we were for the quarter.
About eight one eight.
Yes.
Okay.
It has on me. If you just look at the existing portfolio and assuming a static balance sheet no change in rates. We've got 36 basis points of residual repricing in the loan book for the next 12 months.
Yes.
Okay.
And that's heading pretty consistent with kind of how we thought about loan repricing when we discussed it last quarter. Is that right?
Yes, yes.
17, 18% a year is our run rate of loans repricing of the book Okay.
Tom, if I could ask one more just around the dividend. I mean, clearly above 100% payout ratio this quarter, and I understand you guys have a lot of capital, a very healthy capital position. Just would love to hear kind of your thoughts, Tim, on comfortability around the dividend and where it's at today and whether that's a maybe hold up as you contemplate any incremental capital return opportunities or securities restructuring?
I think you just summarize what have you answered your own question very well. The dividend is really important to us and we understand the importance of it to our investors. And so yes, we have a lot of capital as we work through this compressed NIM. rate environment, but as you said, also, we're looking at restructuring or other things we can do with our balance sheet to help provide more visibility into an expanded margin where that wouldn't be such an issue. It is all part of our ongoing discussions that we are currently involved.
Okay now.
No, I appreciate it. And actually, Tony, just one more quickly. I think if I look back at 2023, the charitable contribution lines steps up in the second quarter. Should we expect something similar in 2Q of 24?
Yes. Yes, we and we're very committed to those contributions and the timing is going to stay the same this year in the second quarter.
Okay.
Tom, that's it for me. Thank you for taking the questions. I appreciate it.
Thank you, Andrew.
Next question comes from the line of Bonnie Lee with KBW. Your line is now open.
Hey, good morning, guys. Partly relate to wanted to start on noninterest-bearing deposits. I mean, they saw a slight increase on the quarter, which was and great to see. I mean, were that were there any seasonal impact the non-US bearing bucket and are you beginning to see that mix shift for Premier?
I will I'll start and I'll let Tien jump announcing. We saw anything unusual. We did have an outflow from non-interest bearing or even some cases interest bearing into alternate investments, higher yielding about 27 million. But we brought in 97 million total across various types. So we're just going to have those fluctuations. We just I know we've said it in it, you know, happening in Q1 of last year compounded that concern, but we get some big fluctuations up and down in our non-interest bearing commercial accounts, and we haven't seen any trend that leads me to believe that anything has changed.
Yes, I think we often have outflows in this first quarter and the efforts that our team has made to make sure that we bring in inflows and compensate for that is he's really good.
That's good to hear. And then maybe turning over to the loan growth. I think in the release you cited some new compensation plans work. We're helping a pipeline. But just any color you can give on sort of what those new compensation plans are?
Yes, I would say the comp there's two components. One is a more frequent route frequency of our paying people, right? We had always been an annual shop and so I think as those generations change expectations change, we that's one area where I think we can really tried to drive behavior. People do what they get paid to do and the another end would be to bring in some of the really quality producers would be have more upside built into the plan. So face value, it's not going to cost us anymore unless they really hit a different level of production targets. And that was really that's all new that was designed to meaning newly applied that was designed to help with the people we were bringing. And so that was more aimed at getting those people. The former will DMD aimed at behavioral, so still new, but that face value don't anticipate it costing us more money necessarily unless again, they hit it out of the park and then we'll all be Cherry, Matt, anyway?
Yes.
All right. And then last for me, just another follow-up on the classified movement. Just any additional color you can give on the types of CRE loans that moved into that bucket where they were the in the office portfolio?
I'm sorry, could you want to take that, please, sir?
And your first one was office one was retail in different locations and both are supported by unified by A.M. Strong, meaningful support by way of the guarantees with liquidity.
Yes.
All right.
That's all for me. Thanks for taking my questions.
Yes, thank you.
There are no further questions on the line. I'll now turn the call over to Tim Myers for closing remarks.
Yes, it appears we do not have any online questions. I want to thank everyone for your diligence and questions. And if anyone has any further, please, by all means, call Tommy or I and we're happy to further dive into some of these issues.
With that, we'll see you next for the meeting.
Has now concluded. Thank you for joining. You may now disconnect.