Bank of Marin Bancorp

Good morning, and thank you for joining Bank of Marin Bancorp's earnings call for the first quarter ended March 31st, 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 Gerton, 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 bankofmoran.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, 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 statement disclosure in our earnings press release, as well as our SEC filings. Following our prepared remarks, Tim, Connie, and our Chief Credit Officer, Masako Stewart, will be available to answer your questions. And now, I'd like to turn the call over to Tim Myers. Thank you, Yohana.

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 were building for a more robust loan origination engine. Our smaller balance sheet and higher overall deposit costs resulted in slightly compressed net interest margin and core earnings reduction in the first quarter. 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 town 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 migrations. In the quarter, we capitalized on the dislocation caused by the regional bank failures and, as I noted, attracted proven relationship bankers to help drive new client acquisitions. Notably, the pace of deposit cost increases slowed during February and March, reaching the lowest incremental level since February 2023. These catalysts complement the strategic repositioning of our balance sheet late 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 continued our facilities optimization by consolidating two of our commercial banking offices into one, saving approximately $650,000 this year and an $800,000 annual as-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 increase 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 non-accrual loans at just 0.31% of total loans a quarter end, down from 0.39% 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 vacancies through enhancements to collateral either by way of cash or other income producing properties or by having the borrower pay 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. Two are 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 the workout and resolution process. In the first quarter, we upgraded four loans totaling more than $10 million from special mention to pass. Our non-owner-occupied office portfolio overall is made up of 151 loans with an average loan size of only $2.4 million. The weighted average loan-to-value was 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 non-owner occupied CRE portfolio. I also want to note that we have minimal exposure to rent-controlled 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, so 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 repayments, and strategic exits. Much of the payoffs were related to construction loans as a result of project completion. Now turning to deposits. We maintained total deposits with quarter imbalances essentially flat from December 31st. We attracted new customers during the quarter, but some clients also moved cash into alternative investments to capture higher returns, and we also saw seasonal outflows that we often see in Q1 of each year. Our non-interest-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.

Thanks, Tim. 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 security 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 five-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 improvement 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 401k 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 FF securities associated with our fourth quarter balance sheet restructuring, Non-interest income of $2.8 million was stable quarter over quarter. In addition to the total risk-based capital strength Tim noted, BankCorp's tangible common equity to tangible assets ratio improved to 9.76% in the first quarter from 9.73% at December 31st. 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 at $3.28 billion on March 31st without tapping the brokered CD market or running CD campaigns. And non-interest-bearing deposits increased slightly to 44% of total deposits from 43.8% at December 31st. The average cost of deposits increased 23 basis points to 1.38% in the first quarter, compared to a 21 basis point increase in 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 Morant. Disciplined credit management remains a Bank of Marin core 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 31st. Typically, 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 25 cents per share on April 25th, 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 improvement. 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.

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 discipline 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.

At this time, we will open the floor for questions. If you'd like to ask a question, please press star five on your telephone keypad. You may remove yourself at any time by pressing star five again. And now we'll pause for just a moment. Okay. Our first question will come from Jeff Ruiz with DA Davidson. Your line is now open. Please go ahead.

Thanks. Good morning.

Good morning, Jeff.

Question on the... The hires that you had, I know you've added folks even last year. I just wanted to try to get a sense. Were there any new in the first quarter?

Yes, there were.

Okay.

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

Okay. Yeah, it's kind of leading to the next slide. Just trying to get a sense for you've had the seasonal impact bumps in professional services and other. Just trying to get a sense on the salaries line, Connie, if – Are there some puts and takes that overall expense do you moderate from here, or is that some of those new ads kind of continue to add to growth?

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

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

Yep, no, makes sense. And, Tim, the arena, the folks that were hired, their focus of lending, is it in a particular area?

No, I think it's more C&I-based or focused than we have had, but I would call them generalists, like much of our banking history has been. So we are seeing a much more diversified portfolio, professional services, general C&I deals happening. 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 have these hires. So that was part of our strategy was to grow more regionally specific to how we are aligned rather than, as I said before, buying a team that's focused on more than just one geography.

Great. And maybe just my last one then as it relates to that loan growth. I mean, you talked about in the release, you know, remaining careful of the environment. The pipeline is up. You kind of got over some maybe some construction payoffs. Wanted a 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.

We are still targeting the mid-single digit that we've talked about. It is really – We're really getting traction. Again, you can't promise you're going to get those deals approved, 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 yield churn, more activity, which ultimately leads to more closings. So 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.

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

That is still our goal.

Okay. Thank you.

Our next question will come from the line of David Feaster with Raymond James. Your line is now open.

Hey, good morning, everybody. Morning, Mr. Feaster. How are you? Oh, doing great. Doing great. Um, I wanted to maybe follow up on the loan growth kind of commentary. Um, you know, originations were, were down in the quarter. Um, just curious, you know, how do you think about, um, you know, like what drove that? Like how much of that is, is, is weaker demand, maybe less appetite for credit. Um, And, you know, 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 kind of some of those comments.

Yeah, no problem. On the weaknesses 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 to the higher rates and hire for longer, that we're seeing a lot more activity. Either they can't wait it out or it's not quite as scary 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 do 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 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, more geographically dispersed, and more dispersed by type of loan. So, you know, it's always hard to predict from a point in time what that means, but we are seeing all the above right now.

Okay. And then maybe, you know, 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. You touched on a few of the credit issues in the quarter. But I'm curious maybe how you think about managing those issues, you know, your thoughts after stressing the CRE book and maybe the health of the CRE market in your footprint. And just high level, how do you think about approaching potential modifications? Yeah.

Yeah, that's great. That's a good question. Let me ask Misaka Stewart, our CCO, who's on, to jump in. She's the one that does most of that work.

Good morning. So, you know, as you mentioned, the credit quality and the credit management of our portfolio is still pretty solid. I mean, or very solid, I would say. In terms of managing the credits, I mean, it's a close management. Every quarter we're getting updated information. We're, you know, 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 direct borrowers. And so we are constantly in discussions with them on how to kind of – remediate or find resolution, find a mutual agreement compromise on how to right-size or get the loan to a more conforming level, if you will. And that conversation continues. You know, the balances in our 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, you know, we had very little by way of migration from past to criticized or classified. And even in the downgrades from our special mention to our substandard, you know, majority of those are, you know, 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 in how we monitor the credits and how we risk grade.

Okay. That's helpful. And just kind of another part, that just helped the CRE market across your footprint. I'm sorry. Say that again, David. Sorry. Just the health of the CRE, you know, marked across your footprint.

Misako, you want to take that?

Yeah, the health of the seat. Yeah, it depends on the asset class. You know, I think industrial still continues to perform well. And it depends on our footprint. You know, office is not, you know, not bad in every market that we're in. And same with retail. So it is different. Multifamily is still, you know, continues to be a strong asset class for us. So 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 one region up to the kind of declines we're seeing, you know, 40, 50% in San Francisco. Again, heavily dependent on the size of the property, all that kind of stuff. So it is uneven. industrial is strong in a lot of our footprint. And as Misako said, multifamily is strong, and we haven't had a lot of issues there that aren't just weird, idiosyncratic, unrelated to what's going on in the world. So it's holding up in many of these categories.

Okay, that's great. And then I just wanted to touch on, just kind of get high-level thoughts on how you think about managing the balance in the hire-for-longer environment. You noted that there's some opportunities that you're considering. You guys have already been active with the securities book, with cost saves, still investing in the franchise with new hires. But I'm just curious, you know, what types of initiatives you're considering and, you know, given the like, again, last quarter we're talking about rate cuts. Now we're talking about a hire-for-longer environment. What are your thoughts on managing the balance sheet have changed at all?

We are actively contemplating all those things. I'll let Connie jump in here.

Yeah, so we had, you know, a series of sales last year. We did about $83 million in the second quarter and then another $132 million in the fourth quarter. We still have a significant AFS portfolio that gives us a lot of flexibility to opportunistically sell those securities and get those funds redeployed into higher positions. yielding investments, loans, whatever, you know, opportunities we have there. So, you know, the timing is important, but we are looking at it, as Tim said, in a very concentrated manner, and we'll continue to do so.

All right. Thanks, everybody. Thank you.

The next question will come from the line of Andrew Terrell with Stevens. Your line is now open.

Hey, good morning. Hey, Andrew. How are you? Doing well. How are you guys? Good. Maybe if I could start just on the deposit front. Looks like the interest-bearing deposit costs increased this quarter was actually maybe a little bit of an acceleration from 4Q. I've 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, and maybe you mean more on kind of a month-to-month basis throughout 1Q. So it may be helpful. Could you share just kind of how deposit costs progressed throughout the first quarter?

You're 100% right, and I'm sorry if that was unclear. So, yes, we saw a couple basis point increase in the overall cost quarter over quarter, but a big deceleration. Connie can give you specifics, but by the time you hit March there, it was the lowest level we've seen since before this crisis.

Yeah, so, you know, if you look back at March of 23, we had a 60 basis point – or 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. You know, it – fell down pretty steeply to 16 and 12, and then it popped up a little to 14, then by July of 23 it was down to 6, and then 5, then it popped up a little bit in September and stayed up a little bit around 7 to 9, and then peaked in January at 10, and then back down to 6 and 2. So, you know, it's a clear trend down. There are some peaks and troughs in that trend, but it is a pretty solid trend down.

Got it. Okay, very good. So kind of 10, 6, and 2 in January, February, March. Definitely seems like a big step down into March, though. And then if I could ask another one, kind of margin-related as well – I think the release mentioned about a 260 basis points spread for new originations versus what was being paid off this quarter. I'm just curious your thoughts on if I look at what paid off most heavily this quarter was construction, which I would imagine is a little higher yield. Just as we contemplate, Tim, you guys getting back to that kind of mid-single-digit type loan growth, the growth ramping later this year, Would you expect that spread of new originations to pay off to widen from this 260 level?

Yeah, it's hard because, as you said, the cost of loans paying off were probably a little bit higher. So the loans came on, again, it's a small sample, but I think it's consistent. All we're seeing is in the low eights. 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, right, of the payoffs. But I think that is a clearer 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 is still awfully competitive. May not seem to see the same delta of rates coming on versus those going up, but that's where we were for the quarter, about 818. Yep. Okay.

Great.

On the, you know, if you just look at the existing portfolio, 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.

Yep. Okay. And that's... I think pretty consistent with kind of how we thought about loan repricing when we discussed it last quarter. Is that right?

Yeah. Yeah, 17%, 18% a year is our run rate of loans repricing in the book.

Okay. 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, 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 summarized what we're at very well. 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. That is all part of our ongoing discussions that we are currently involved in.

Okay. I appreciate it. And actually, Tani, just one more quickly. I think if I look back at 2023, the charitable contribution line steps up in the second quarter. Should we expect something similar in 2Q24? Yep.

Yep. We're very committed to those contributions, and the timing is going to stay the same this year in the second quarter. Okay.

That's it for me. Thank you for taking the questions. I appreciate it. Thank you, Andrew.

The next question comes from the line of Woody Lay with KBW. Your line is now open.

Hey, good morning, guys.

Morning, Woody.

Wanted to start on non-inspiring deposits. I mean, they saw a slight increase on the quarter, which was great to see. I mean, were there any seasonal impacts to the non-inspiring bucket? And are you beginning to see that mix shift flow from here?

I'll start and I'll let Tanya jump in. I don't think we saw anything unusual. We did have an outflow from non-interest bearing or even in some cases interest bearing into alternate investment, higher yielding. That was about $27 million, but we brought in $97 million total across various types. So we're just going to have those fluctuations. I know we've said it and it You know, happening in Q1 of last year compounded the concern, but we get some big fluctuations up and down in our noninterest-bearing commercial accounts, and we haven't seen any trend that leads me to believe that anything has changed.

Yeah, I think we often have outflows in the first quarter, and the efforts that our team has made to make sure that we bring in inflows to compensate for that is really good.

All right, 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 were helping the pipeline, but just any color you can give on sort of what those new compensation plans are.

Yeah, I would say there's two components. So one is around frequency of how we're paying people, right? We'd always been an annual shop, and so I think as generations change, expectations change, that's one area where I think we can really try to drive behavior. People do what they get paid to do. And the... Other end would be to bring in some of the really quality producers would be have more upside built into the plan. So face value is not going to cost us any more 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 in. So that was more aimed at getting those people. The former will then be aimed at behavioral. So –

uh still new but that face value don't anticipate it costing us more money necessarily unless again they they hit it out of the park and then we'll all be cheering that anyway yeah all right and then last for me just uh another follow-up on the classified movement just any additional color you can give on the types of cre one that that moves into that bucket where the where those in the office portfolio masaki do you want to take that please

Sure. Yeah, one was office, one was retail in different locations. And both are supported by, you know, by strong, meaningful support by way of the guarantees with liquidity.

Yeah. All right, that's all for me. Thanks for taking my questions.

Thank you. Yeah, thank you, Woody.

There are no further questions on the line. I'll now turn the call over to Tim Myers for closing remarks.

Yeah, 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 quarter. Thank you.

The meeting has now concluded. Thank you for joining. You may now disconnect.