Bank of Marin Bancorp

Good morning, and thank you for joining Bank of Marin Bancorp's earnings call for the third quarter ended September 30th, 2024. I am Chrissy Meyer, Corporate Secretary for Bank of Marin Bancorp. 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 Tawny Gertin, Executive Vice President and Chief Financial Officer. Our earnings news release and supplementary presentation, which were issued this morning, can be found in the investor relations section of our website at bankofmoran.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 news release for both GAAP and non-GAAP measures. Additionally, the discussion on the call is based on information we know as of Friday, October 25th, 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 a discussion on these risks and uncertainties, please review the forward-looking statements disclosure in our earnings news release, as well as our SEC filings. Following our prepared remarks, Tim, Tawny, and our Chief Credit Officer, Misako Stewart, will be available to answer your questions. And now, I'd like to turn the call over to Tim Myers.

Thank you, Chrissy. Good morning, everyone, and welcome to our quarterly earnings call. Our third quarter results reflect the positive benefits of the actions we took in the second quarter to both reposition our balance sheet and reduce operating expenses. This resulted in an increase in our net interest margin, a lower level of operating expenses, and improvements in our ROA and efficiency ratios. On a broad basis, we continue to have strong asset quality within our loan portfolio and work through previously reported matters with no new issues emerging. The combination of these positive trends and some share repurchases led to an increase in our book value per share. Our banking team, reinforced with new members, is doing an outstanding job of developing attractive lending opportunities and generating solid loan production while still maintaining our discipline underwriting and pricing criteria. During the quarter, we generated $44 million in total loan commitments with $28 million funded. Along with the portfolio of residential mortgage loans purchased as part of the balance sheet repositioning, This resulted in a small increase in our total loan balances during the quarter. We are building a more diversified pipeline of loans consistent with our discipline underwriting that are expected to fund in future quarters and positively impact both our total loan balances and our average loan yields. We also have positive trends in fee income. Additionally, total deposits increased $96 million during the quarter. primarily driven by a $55 million increase in non-interest-bearing deposits, including $17 million coming from nearly 1,200 new deposit accounts during the quarter. Our proportion of non-interest-bearing deposits increased slightly to 45% of total as we continue to benefit from our relationship banking model with high-touch service. We were able to initiate our falling rate deposit strategy in anticipation of Fed funds rate cuts. and deposit balances increased with typical third-quarter seasonal inflows. In terms of asset quality, we are seeing general stability in the portfolio with no material new problem loans. Given our improved financial performance and prudent balance sheet management, our capital ratios remain very strong with a total risk-based capital ratio of 16.4 percent and a TCE ratio of 9.72 percent. Our strong capital, and confidence in credit quality positioned us to resume share repurchases last quarter, buying back 220,000 shares totaling over $4 million. We believe this was in the best interest of our shareholders, preserving our high cap level of capital and maintaining our flexibility to make capital allocation decisions that will enhance shareholder value. With that, I'll turn the call over to Tani to discuss our financial results in more detail.

Thanks, Tim. Good morning, everyone. Bank of Marin continues 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 for further earnings improvement in the future. We generated 4.6 million in net income for the third quarter, or 28 cents per share, as we began to realize the full anticipated benefit to profitability of the balance sheet restructuring we did during the second quarter. Our net interest income increased 8% from the prior quarter to 24.3 million, largely driven by an 18 basis point increase in our net interest margin, primarily due to balance sheet repositioning and a shift in deposit pricing that reversed the upward trend in deposit costs while staying aligned with the broader market. By the middle of the third quarter, our net interest margin had increased by 30 basis points over the level just prior to the balance sheet repositioning, consistent with our expectations, and we continue to see that benefit. The yield on loans was negatively impacted by nine basis points in the third quarter as a result of interest reversals on two non-accrual loans, reducing net interest margin for the quarter by six basis points. Our non-interest expense decreased by one and a half million from the prior quarter, mostly due to a decline in salaries and benefits expense due to staff reductions made in the second quarter and continued reallocation of staffing to align with the strategic direction of the bank. Additionally, the decline resulting from charitable contributions annually granted in the second quarter was offset by a $615,000 accrual for a non-repeatable legal resolution which negatively impacted earnings per share by 4 cents. Moving to non-interest income, excluding the loss on security sales that impacted our second quarter results, we had an increase in non-interest income, largely due to an increase in wealth management revenue. Our total deposits were 3.3 billion at September 30th, As Tim mentioned, we typically see seasonal inflows in the third quarter, and due to the nature of our client base with many professional services firms, we expect to see some seasonal outflows in the fourth quarter due to bonus payments, profit and other distributions, and larger business expenses. Our average cost of total deposits increased just one basis point in the third quarter compared to a seven basis point increase in the prior quarter. Not only does that continue the deceleration of deposit cost increases seen in the first and second quarters, but it also reflects a turn in deposit costs late in the third quarter. Since initiating our declining rate deposit pricing strategy, the average spot rate on non-deposit network interest-bearing balances declined 18 basis points, while the balances themselves went up approximately 10 million by September 30th. Our pricing strategy weighs rate reductions in the context of relationship pricing, balance sheet growth, and net interest margin considerations. Disciplined credit management remains a hallmark of Bank of Marin as well. Classified assets were down primarily due to one classified non-accrual loan for $1.8 million that was paid off in full, including all accrued interest. Non accrual loans had a net increase primarily related to an $8.1 million real estate loan whose renewal negotiations remain ongoing with no expectations for actual losses. As Tim mentioned, overall there were no new issues and increases were partially offset by pay downs, payoffs and returns to accrual status. 50% of non-accrual loans are paying as agreed and 80% are secured by real estate. Due to the stability in our loan portfolio, we did not record any provision for credit losses in the third quarter and we reversed 233,000 in provisions for losses on unfunded commitments. The allowance for credit losses remains high at a level of 1.47% of total loans. Loan balances of 2.1 billion at the end of the third quarter were up 8 million from the prior quarter. We had some movement from construction loans to CRE loans, while the largest area of growth was in residential mortgages, primarily due to the portfolio of high quality in-market residential mortgage loans that we purchased with part of the proceeds from the security sales in the second quarter. Given the continued strength of our capital ratios, our board of directors declared a cash dividend of 25 cents per share on October 24th, the 78th consecutive quarterly dividend paid by the company. With that, I'll turn it back over to you, Tim, to share some final comments.

Thank you, Tani. In closing, we are seeing the positive results of proactive, strategic balance sheet and expense management actions taken in the second quarter, and we expect these trends to continue. resulting in further improvement in our level of profitability. We started reducing rates in late August on liquid funds earning higher price exception rates and continued to pass through reductions in deposit rates simultaneously with Fed rate cuts in September. We have not seen any meaningful outflow of deposits, which is consistent with the historical experience of our business model, leading with service and relationship pricing, not solely on higher than average rates. We expect to see more declines in our cost of deposits, which should contribute to further expansion in our net interest margin as the yield curve normalizes. We continue to be more active in our business development efforts while remaining conservative in new loan production and maintaining our discipline underwriting and pricing criteria and are seeing an increase in the loan pipeline due to the higher level of productivity from our banking teams. We typically see some seasonal strength in loan production in the fourth quarter each year, And based on current trends, we expect that to be the case again this year. The pipeline is well diversified across industries and our markets. And while we continue to carefully manage expenses and reduce costs in certain areas of the company, we are also continuing to make investments in both talent and technology that will further enhance our level of efficiencies, improve the overall customer experience we can offer, and increase our ability to attract new clients to the bank. We also continue to have a very strong balance sheet with high levels of capital, liquidity, and reserves. Given the strength of our balance sheet and the banking talent we have added in the past several quarters, we believe we are very well positioned to increase our market share, add attractive new client relationships, and generate a higher level of loan growth as economic conditions and loan demand improves. We believe that this will help us to consistently generate profitable growth in the future and further enhance the value of our franchise for our shareholders. With that, I want to thank everyone on today's call for both your interest and support. We will now open the call to your questions.

Thank you. At this time, if you would like to ask a question, please click on the raise hand button, which can be found on the black bar at the bottom of your screen. When it is your turn, you will receive a message on your screen from the host allowing you to talk, and then you will hear your name called. Please accept, unmute your audio, and ask your question. We will wait one moment to allow the queue to form. Our first question comes from Woodley. You may now unmute your audio and ask your question.

Hey, good morning, guys. Morning. Wanted to start on expenses. They came in a little bit better than what I was expecting. You had the recent staffing restructures, and it sounded originally like a lot of those savings would be reinvested into the company. But just wanted your updated thoughts on sort of the expectation for 4Q expenses and just how you think the expenses trend from here.

Yeah, so I'll talk high-level, Woody, and then Tani can add any other details. So the expense savings are, yes, both from the reduction in force, other cost-saving measures, and frankly, we're ahead of spend expectations on a number of our technology and digitalization initiatives. So we'll continue to look for ways to accomplish our strategic objectives there. There are some positions still left to fill, but overall, I believe we're still ahead of what we thought we would accomplish vis-a-vis those cost saving efforts. Tony, anything to add?

Yeah, yeah, I think that that, actually, no, nothing to add. I think that sums it up quite well. We will have net some reductions in our original projections for those investments. There also have been some delays. So some of those costs don't hit exactly when we projected. But I think, and then also, you know, we continue to look for talent, but those expenses will hit when we find the right talent.

Yeah. All right. That's that's great color. Maybe shifting over to the margin. So we got the we got the bump from the recent restructure and it sounds like some interest reversals were ahead when the third quarter. So we should get a nice take up in the fourth quarter. But but how do you think, you know, additional rate cuts from here impact the forward outlook to the margin?

So if we look at the September net interest margin versus the third quarter average, it was higher by about two basis points, but some of that noise was still in there. So I think we're going to get some lift from that. We still have 26 basis points in upward loan repricing embedded, considering a flat balance sheet and flat rates. Our proactive deposit strategy, we're closely monitoring that. but continuing forward with that strategy. So that should be a tailwind for us on that. The cash position, that can fluctuate. So depending on what's going on with deposit balances and our cash position and then where the Fed goes with rates, that could have some impact on it. But if you consider that the most likely scenario is a Fed move in 2020, November with a steeper yield curve, that could also help. So while I don't want to put a number on it, I think, you know, you identified some of the bigger movers and then we still have some, you know, there are some things that obviously we can't control, but the things we can control, we're still watching and working on very diligently.

Yeah, got it. And then last for me, I just wanted to shift to the buybacks. You know, the first time you all repurchased some shares since the start of 2022. Could you just talk about what made you comfortable reengaging on the buyback? And is there further appetite from here?

Yeah, certainly our credit quality, you know, as we got more comfortable. with the credit quality, the loss potential, certainly in light of our capital ratios, our very strong capital ratios, and the valuation. Obviously, we continue to believe the stock's undervalued. And once we got a better sense that we didn't think there were a lot of hits to capital lurking in there, we got a lot more comfortable. So we'll continue to look at that. We always have to juxtapose that option with all the other available options, but we'll continue to keep an eye on that.

All right. Thanks for taking my question. Thanks, Woody.

Our next question comes from Matthew Clark. You may now unmute your audio and ask your question.

Hey, good morning, everyone.

Good morning, Matthew.

I just want to get back to the expense run rate, if you could be a little more specific. I mean, net-net, do we think we're flat here in 4Q? Do we grow? And then what's your expectation for the seasonal increase in the first quarter. I think historically it's, you know, it's been high single digit, I think, but more recently, I think you guys have obviously tamped down on that seasonal increase. Just want to get your updated thoughts there too.

Yeah. So, you know, typically we do have some expenses hit in the fourth quarter sort of for all our true ups. We also try to true up our bonus, you know, and incentive payment accruals to the extent we can. And as you said, we are trying very, very hard to minimize the The reversals in the first quarter are associated with that, but it's always really hard to project exactly what those are going to be. But we will still have, you know, the annual resets of the 401k and then the bonuses. So we will have the typical pop in the first quarter in expenses that we normally see.

Okay. And then you also give us the all-in spot rate on deposits. I know you excluded some balances there, but just want to get the all-in cost of deposits, either total or interest-bearing.

Yeah, let me grab that.

And the average margin in September, even if it's adjusted or unadjusted, either one.

The average margin in September, you mean the net interest margin? Yep.

Yep. Yeah.

Okay. That was 270.

Okay, consistent with the quarter. Does that include the six basis point negative impact, or is that excluding the six basis?

Yes, that includes it.

Okay.

And then, okay, sorry. You said you wanted the spot rate on the deposits all in.

Yep.

Let me come back to you with that. I've got a lot of pieces of paper in front of me and I want to make sure I'm looking at the right one. Was there one other thing you had, Matthew?

Yeah, one other question just around the San Fran office credit from last quarter. I think your specific reserves were $6.7 million and just want to get an update there whether or not that number has changed and is it fair to assume those are realized out of existing reserves in the fourth quarter?

So you're talking about the reserve we took in the prior quarter. No, nothing's changed there. In fact, the leasing activities picked up. They've signed three new leases in Q3 on that property. So we continue to see that kind of trend overall in San Francisco. But no, that provision was down to a less than 100% loan to value on a recent valuation prior to these new leases being signed. So no further deterioration or further provision on that large property.

Okay, thank you. You're welcome.

Matthew, the spot rate on deposits on September 30th was 1.43%.

Perfect, thank you.

Our next question comes from David Feaster. You may now unmute your line and ask your question.

Hey, good morning, everybody. Good morning, David. Maybe just touching on the growth side. I mean, curious kind of what you guys are seeing. You know, origination slowed a little bit. I'm curious, is that a function of demand? And just where are you seeing opportunities and the appetite to continue to supplement organic growth with potential pool purchases?

Sure. So, you know, yes, linked core originations were down, but that's just a function of timing. We don't have a real granular pool of loan types that we do. So there is going to be some lumpiness. We expect it to be better. We have close 10 million since quarter end that just got pushed over. And we feel very good about the quarterly pipeline. So when you're looking from a longer term growth perspective, we're very happy with the trends we're seeing in Activity. Activity begets originations. Obviously, that begets results. So we see a consistent trend in higher levels of activity that are generating higher pipelines. That's pretty diverse throughout our footprint. The loans closed were diverse throughout our footprint. We're seeing kind of a shift from CNI last quarter to more CRE this quarter. But again, that's, you know, they're lumpy. So that'll shift, I think, quarter to quarter. You know, construction loans, we've had some refinance into permanent. The new ones we're seeing are much smaller, more granular, two, three million dollars for infill projects and no real big projects coming from there. So it's a lot of blocking and tackling, David. It's a nice mix between our new people. We did hire a new producer. in Q3, and that's already resulted in closings. But it's a nice mix between that and our existing team. So it's just getting a more consistent approach to, again, calling activity that leads to pipeline building, that leads to closing. So while every quarter won't be on the exact same trend line, we're optimistic with what we're seeing.

Okay. And then where are you seeing new loan yields on, on production today? And then just following up on your commentary about hiring where, you know, you talked about an appetite for continued hires. Obviously it's gotta be the right people at the right time. Curious where you're seeing opportunity, how those conversations are going and any, what segments or markets you're looking to add, add to at this point.

Yeah. So if you look at the people we've both hired and the ones we're talking to, it's really speckled throughout the, So, and if you look at some of the banks that, you know, we're hiring from, they might not have had as much of a regional, micro regional focus as we did, meaning they focus on the entire Bay Area. So their specific location is not necessarily indicative of within the greater Bay Area where that growth might come from. Back to the yield question. Just looking at the commercial loans last quarter, we're at about a 6.5% yield on new loans versus the 563 that paid off. So, you know, it's still very competitive for high-quality loans, but those are the loans we're booking.

Okay. And then maybe last one for me, just, you know, touching on the core deposit side. It's great to see the growth, especially on the NIB front. You touched on on some of the seasonal impacts there. I was hoping maybe you could quantify how much, you know, is seasonal versus I mean, you guys have been, you know, pretty successful opening new accounts like you talked about. So just kind of curious what some of those seasonal if you could quantify the seasonal impacts and just how do you think about core deposits going forward and where you're having success?

Yeah, thank you. We did have the seasonal inflows, but we also had some seasonal outflows. About 18 million of the growth and non-interest bearing came from new relationships. Those are deposit accounts we expect to fund up, but again, the timing of that's unclear. So a lot of that was seasonality, but we did have a nice gain from new fundings and new account openings. And that was about split pretty evenly between consumer and business.

And I would say that the new accounts, that's been pretty consistent over the last several quarters. I mean, we've been getting around 1,200 to 1,300 new accounts every quarter for several quarters running now.

That's great. Thanks, everybody. Thank you, David.

As a reminder, if you would like to ask a question, please use the raise hand button, which can be found at the bottom of your Zoom application. Once called upon, please unmute your line and ask your question. And our next question will come from Jeff Rulis. Please go ahead with your question.

Thanks. Good morning. Question on the, maybe a couple of follow-ups, Tani, if I could. The expense level, 20.4 this quarter, but included, you know, elevated costs. legal accrual that you called out that's 600,000 plus. So thinking about fourth quarter and you mentioned some resets or some true ups in the fourth quarter and the bump in maybe first quarter. But I think quarter to quarter or sequentially, safe to assume the legal don't recur and we're flat to down in the fourth quarter. I just wanted to clarify that.

Yes. There's nothing I'm aware of in particular that would take them higher. And that legal settlement, that type of claim is not a repeatable. Once it's settled, that one's finished. So that won't come back again.

Okay. And if we net all that out, I just am looking for a broader, if we're thinking about 2025 and given the efficiency improvements you've undergone this year. What's a good growth rate for next year? Understanding that you'd be opportunistic on talent if it comes up, but as you budget today, should we assume sort of a 3-4% growth rate in 2025?

I think typically when we start our strategic planning process, we will start with 3% and go from there. But we still have the tail end of some of our strategic investments in there. But if we look forward... you know, 25 and forward, we're looking at efficiency improvements every year going forward. So, you know, over the next four to five years. So I know that's not as specific probably as you want, but that's how we do it.

OK, you start at three and you're going to be working hard. OK, fair enough. And then on the margin, I just wanted to clarify, Tony, I thought you said that the September margin was a couple of basis points above the quarterly average.

Yes. Oh, and I said you're right. I said that wrong. It was 272 in September, not 270. Thank you.

Got it. Okay. And with inclusive of some negative headwinds that maybe I think you framed it up as there's tailwinds to that going forward, even exiting at 272, right?

Yep.

Okay. Thank you. And then just on the credit side, it sounds like the loan that moved to non-accrual kind of

administrative in in in nature um any more color on on that loan or i think you mentioned maybe real estate but um yeah it's uh it's office cre some of our loans uh have a uh a mechanism whereby if certain conditions are met the loan extends out beyond its original maturity There are times depending on an agreement or disagreement about whether those conditions have been met. It's in a part of San Francisco that has actually an attractive trends for obviously this activity and there is sponsorship. It's just a protracted process of negotiating those conditions such that that extension can take place. So it's a little more technical and administrative in nature than certainly some of the other ones.

Okay. Last one for me, Tim, you've mentioned the pipeline a couple of times. Do you happen to have the quarter over quarter, like what, where we sit today versus where you entered the third quarter just in dollar terms?

It's quite a bit bigger, but I'm really reluctant, Jeff, as you know, to do that. It fluctuates, and again, there's a lumpiness aspect to it, so we don't give that guidance, but it's considerably bigger today than it was at the start of the quarter, last quarter.

Okay, and so I lied on the tax rate. Tony, do you have any read on what we should model or think about, go forward on taxes?

Yeah, so for this year, because we had the big loss, the tax rate is inflated because every quarter that we have income, we're basically reversing some of the tax benefit from that loss. But I anticipate that the tax rate will return to normal levels in 2025. Okay.

which is around 25 I think you've said previously 25% it was, I think, closer to 26. Okay. Thank you.

yeah Thank you Jeff.

Our next question will come from David feaster your line is open for free to ask your question.

Hey, sorry. I just wanted to hop back in and maybe ask a little bit about the margin trajectory as we look forward. I mean, you touched on a lot of the dynamics, but that 26 basis points of embedded loan repricing, is that all next year? I'm just looking at the repricing chart and we talked about loan growth coming on in the mid sixes, but- you know, some of what's maturing is coming on or like coming off around the low sevens. So I'm just kind of curious, like, how do you think about the trajectory of the margin? Um, as we look out to next year?

Yeah, that 26 basis points is over the next 12 months.

Okay.

Um, so, uh, but the margin, you know, is, is marching, marching higher. Um, you know, but not in, not in any big steps, you know, it's just kind of a march.

Yeah. Okay. Okay. Thank you. Thank you, David.

And our next question comes from Matthew Clark. Please go ahead.

Hey, thank you. Um, Your beta, your deposit beta on the way up, interest bearing I think was 47%. This cycle, what are your thoughts on the beta on the way down this time around?

We use a lower beta than that on the way down, and we also lag it. And so on the interest rate risk position, you'll see a different position this quarter when we published the queue than we saw last quarter because of the repositioning. So we are a little more sensitive to falling rates because we have a higher cash position and also the investments that we made in new securities were at shorter durations. And then, you know, I think we also have some swaps on the books that if as rates go down, those will also have a negative impact. So, again, the cash position has a pretty big impact on our sensitivity, and that is somewhat dependent on the cash flows associated with our deposits.

Okay, great. Thank you. Mm-hmm.

We have no further questions at this time. I'll hand it back to Tim Myers for closing remarks.

Thank you, everybody. We appreciate interest in your questions. Please feel free to reach out if you have any further ones. Thanks.