Bank of Marin Bancorp

Thank you for joining Bank of Marin Bancorp's earnings call for the second quarter ended June 30, 2023. I am Andrea Henderson, Director of Marketing 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. At that time, if you have questions, please press 1 followed by 4 on your telephone. If at any time during the conference call you need to reach an operator, please press star 0. This conference call is being recorded on July 24, 2023. Joining us on the call today are Tim Myers, President and CEO, and Tawny Gertens, 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. Closed captioning is available during the live webcast as well as on the webcast 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, July 21st, 2023, and may contain forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those set forth in such statements. For 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, Tim, Tani, and Chief Credit Officer, Misako Stewart, will be available to answer your questions. And now, I'd like to turn the call over to Tim Mives.

Thank you, Andrea. Good morning, everyone, and welcome to our second quarter earnings call. Our second quarter reflected the full impact of the late Q1 bank failures, resulting in meaningful net interest margin compression due largely to the higher cost of funds on FHLB borrowings and deposits paired with slower lending activity. We believe that this impact is temporary in nature and will not be an indicator of future performance, as we have continued to make significant progress by focusing on our balance sheet. In fact, we substantially strengthened the balance sheet by attracting customers, raising deposits, and improving liquidity to position the bank for efficient growth and stronger profitability. Here are a few key highlights of note. After regional bank failures triggered significant industry deposit outflows and price sensitivity, our deposits quickly stabilized late in the first quarter. During the second quarter, we raised $152 million in new balances at below capital market rates. Additionally, we opened over 1,400 accounts for both new and existing customers. New balances net of normal customer activity and some continued outflow largely to money market accounts drove deposit growth of $75 million in the second quarter. Importantly, those new deposits and investment cash flows enabled us to reduce our short-term borrowings at the FHLB by $113 million, or 28% during the second quarter. Deposit growth has continued post-quarter end and included seasonal DDA growth we had anticipated. From quarter end to July 18th, we added $116 million to total deposits, which are now within $50 million of pre-bank failure levels in early March 2023. Our percentage of demand deposits has also increased to a level higher than the pre-pandemic percentage at the end of 2019. At the same time, the rate of increase in the cost of deposits has slowed, and FHLB borrowings have fallen another $126 million. Our deposit growth strategy was and continues to be driven by proactive customer outreach and relationship-based pricing discussions. We have not offered CD specials or tapped into brokered CD markets. In the quarter, we saw a natural shift from non-interest bearing to interest bearing deposits as customers sought higher yields on excess cash as well as increased FDIC insurance coverage through our reciprocal deposit network offerings. Second quarter deposit costs increased 49 basis points sequentially due to deliberate pricing adjustments that we made. We expect that funding cost increases will level off in the second half of 2023 as Fed rate hikes and customer reallocation of funds between operating accounts and interest-bearing accounts slow. Our deposit mix at June 30 consisted of 48% non-interest-bearing deposits, down from 50% last quarter. However, the percentage of non-interest-bearing deposits was back up to 50% by July 18th. Going forward, we will continue to carefully manage deposit pricing on a customer-specific basis and, as we have throughout our history, will remain in close contact with our customers to understand opportunities and risks. In alignment with our stringent liquidity standards, we continue to maintain a high level of liquidity that covers all of our uninsured deposits by over 200%. Notably, our uninsured deposits declined to 29% from 33% of our total deposits a quarter in. In addition, our average balance per deposit account declined slightly by $2,000 to $62,000 from the prior quarter, with our largest depositor representing only 1.3% of total deposits. Our available contingent liquidity was approximately $2 billion and consisted of cash, unencumbered securities and borrowing availability from the FHLB and Federal Reserve Bank. Post quarter end, we have taken additional steps to bolster on balance sheet liquidity by selling AFF securities and Visa B class shares at a net break even and retaining proceeds in cash. In addition, we entered into fixed pay interest rate swaps to protect our other available for sale securities from changes in market values. We also continue to actively engage with and support our borrowers, and we are optimistic about identifying compelling lending opportunities in the second half of this year. While lending activity has slowed, the new loans that we are bringing onto our books are high-quality credits coming on at notably higher yields than those being paid off. This is providing a boost to our interest income, and moving forward, we believe should help us protect our NIM as we continue to fund our pipeline. Additionally, approximately 29% of our loan portfolio will reprice in the next 12 months. If those repricings occurred at today's rates, we estimate it will provide an incremental lift of roughly 30 basis points for the loan portfolio. While loan demand is eased, our teams continue to focus on achieving attractive risk-adjusted returns while maintaining solid credit quality. We are sticking to the prudent lending policies and standards that we have always had, carefully monitoring our loan portfolio and proactively adjusting risk rating. While there has been some risk rate migration, largely in special mention loans, there were no meaningful surprises in the quarter. During the second quarter, non-accrual loans held steady at just 10 basis points of total loans. Classified loans comprised only 1.81% of total loans at quarter end. Classified loans did increase during the quarter centered primarily around the non-office CRE loan, the CNI term loan, and increased usage on a previously downgraded line of credit. I'll take a moment to provide added color to our commercial real estate portfolio as it is the largest concentration in our loan book representing 73% of our total loan balances at the end of the second quarter. Of our total CRA loans, 22% are owner-occupied, which we believe carry a different risk profile than non-owner-occupied loans in this environment. Our $366 million of non-owner-occupied office portfolio consists of 142 loans with an average loan size of $2.6 million, the largest loan being $17 million. The average LTV was 55% and the average debt service coverage was 1.67 times based on our most recent annual review process. Lastly, we are actively recruiting proven talent as recent industry disruption has made available a considerable number of seasoned bankers. We have taken advantage of the recent market changes and expect to announce some meaningful recruiting news soon that we believe will help boost lending activity and deposit growth and deliver greater value to our customers and our shareholders. Now I'll pass it over to Tani to discuss our financial results in greater detail.

Thanks, Tim. Good morning, everyone. Now that Tim has provided a picture of how our balance sheet is evolving, I will walk through earnings. Bank of Marin generated net income of $4.6 million or 28 cents per diluted share in the second quarter. As Tim said, the decline from the first quarter was largely due to a higher interest expense, both from the rising cost of deposits and higher average borrowing balances. Our second quarter tax equivalent net interest margin of 2.45% was down 59 basis points from the prior quarter as rapid deposit pricing adjustments and higher borrowing balances far outweighed gradually increasing loan yields. While lagging deposit rate Thank you for joining us today. Additionally, we have taken steps early in the third quarter to mitigate the impact of further rate hikes by paying down another $126 million in borrowings, selling $83 million in securities to retain proceeds in cash, and entering into $102 million fixed pay interest rate swaps. We made a $500,000 provision for credit Thank you for joining us. and the Board of Directors of the Board of Directors Board of Directors Board of Directors 486,000 in salaries and related benefits which included annual merit increases, 393,000 in deposit network expenses, and a 377,000 FDIC assessment base rate adjustment. These increases were partially offset by reductions of 482,000 in depreciation and amortization expense and $434,000 in occupancy and equipment expense related to first quarter branch closures. In addition, professional services decreased by $326,000 related to the timing of audit work performed. Our second quarter earnings translated into a return on assets of 0.44% and return on equity of 4.25%. down from 0.92% and 9.12% in the prior quarter. The efficiency ratio increased to 76.91% from 60.24% in the prior quarter due to both higher interest and non-interest expenses. All capital ratios were above well-capitalized regulatory requirements at June 30. The total risk-based capital ratio respectively. Quarter end tangible common equity was 8.6% for Bancorp and 8.4% for Bank of Marin as compared to 8.7% and 8.3% in the previous quarter respectively. After adjusting for 85 million after-tax unrealized losses in our HTM securities portfolio, our TCE ratio would be 6.7% for Bancorp. Our board of directors declared a quarterly cash dividend of 25 cents per share payable on August 11, 2023. This represents the 73rd consecutive quarterly dividend paid by Bank of Marin Bancorp. The board also approved a new share repurchase program for 25 million effective through July 2025. Our ample capital position and high-quality investment portfolio provide strength and liquidity for the ongoing operations and investments in the future of Bank of Marin. We evaluate the bank's interest rate, liquidity, economic value, and market price risk under various scenarios regularly, and we stress test underlying assumptions. We believe that our unwavering emphasis on the financial Thank you, Tani.