This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk02: Greetings and welcome to First Foundation Third Quarter 2022 Earnings Conference Call. Today's call is being recorded. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star 1 on your touch-tone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing star, then 2. We ask that you please pick up your handset to allow optimal sound quality. Speaking today will be Scott Cavanaugh, First Foundation's Chief Executive Officer, Kevin Thompson, Chief Financial Officer, and David DiPillo, President. Before I hand the call over to Scott, please note that management will make certain predictive statements during today's call that reflect their current views and expectations about the company's performance and financial results. These forward-looking statements are made subject to the Safe Harbor Statement included in today's earnings release. In addition, some of the discussion may include non-GAAP financial measures for a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements and reconciliations of non-GAAP financial measures through the company's filings with the Securities and Exchange Commission. And now I would like to turn the call over to CEO, Scott Cavanaugh.
spk07: Good morning and welcome. Thank you for joining our third quarter 2022 earnings conference call. The results we reported this morning reflect the strength of our core businesses and the meaningful relationships that we have built with our clients. That said, there is no question the Fed's actions over the last six months have had a notable impact on the banking sector. It is against that backdrop that I am pleased to report our earnings for the third quarter were 29 million or 51 cents per share. Total revenues were 99.9 million for the quarter, a 5% increase from the second quarter of 2022, and an 11% increase year over year. Our tangible book value per share ended the quarter higher at $15.96. We also declared and paid our third quarter cash dividend of 11 cents per share. Our fundamentals remain strong with excellent credit quality. Our NIM for the quarter was 3.10% for the quarter. We continue to experience a steady pipeline across banking, wealth management, and trust services. Our clients' success is our success, and we are grateful for the trust they continue to place in us. Our strategic focus heading into the fourth quarter is centered around protecting the balance sheet, building liquidity, competitively pursuing deposits, and the continued retention of valuable clients. Our lending activity for the quarter was strong with loan originations coming in at 1.6 billion. MPAs remain low at 14 basis points for the quarter as our lending team does a fantastic job maintaining our high credit standards. We have established a balanced loan portfolio that continues to perform well. As we look ahead for the next few quarters, we intend to bolster liquidity and preserve capital by strategically managing our loan growth going forward. With that, I must emphasize we anticipate loan growth will be slower in the coming quarters than what we have experienced in recent record quarters. This is a prudent decision given the macroeconomic cycle, and it is certainly not a reflection of our clients, the industries we serve, or the products we offer. Dave will touch more on the current composition of the loan portfolio later in the call. Looking at deposits, as I have mentioned before, it's tough out there. and we recognize it's a dogfight. There's no question there are outflows in the overall banking sector. However, I am proud that our team has been able to maintain our base of $9.5 billion, and we're continuing to fight to attract new clients through some very attractive channels, including online, retail, and commercial. Our wealth Management and trust business continue to provide meaningful contributions to the firm. We have been successful in retaining existing clients and attracting new ones. It's times like these when the market is most volatile that clients turn to us for guidance. We have been proactively communicating with them and strategically managing their portfolios as necessary. As a result, we are seeing strong client retention across our entire wealth management platform. Assets under management ended the quarter at 4.6 billion. The all-weather portfolios we manage for our clients performed relatively well with respect to their benchmarks, even as the S&P 500 and the NASDAQ composite saw significant declines during the quarter. Let me take a minute to discuss our responses to Hurricane Ian which made landfall in our newly acquired location of Naples, Florida. Upon first learning about the storm, we immediately activated our business continuity and disaster recovery plans. I am pleased to report that we performed extremely well. Once all of our employees were accounted for and safe following the storm, we reopened all our locations with the exception of our Fifth Avenue branch in Naples, which will be closed for the foreseeable future as we repair from the damages. As it relates to our clients, we do not expect to see a meaningful impact to our portfolio and are only setting aside small provisions for potential loan losses. While our initial assessment looks good, we want to be helpful to any clients who might have been impacted. Along these lines, we have also been in contact with our deposit clients to assist with any way we can while the community rebuilds. We have been touched by the outpouring of generosity among our employees, clients, and within the local community. And we are fully resolved to help navigate the road to recovery. To conclude my opening remarks, I want to reiterate that this leadership team has been through many economic cycles, including a rising rate environment like the one we are experiencing. Many interest rate environments, although I believe where the Fed Fund actions are the most aggressive that we've perhaps ever seen. Our business model of offering clients financial solutions whenever they might be in their financial journey is designed to deliver results in any market conditions. And finally, I want to take a moment to note that this month marks the 15th anniversary of FIRST Foundation, and over that time we have established a great group of talented and dedicated professionals committed to serving our amazing clients and building a valuable business. It continues to be an honor to lead this organization. Now let me turn the call over to our CFO, Kevin Thompson.
spk10: Thank you, Scott. As mentioned, earnings per diluted share was 51 cents in the third quarter. The return on assets was 98 basis points, with the return on tangible common equity of 13.2%. During the third quarter, the balance of loans held for sale was transferred to loans held for investment, as we no longer intend to sell the loans due to the current rising rate environment. Credit metrics remain strong in all our loan portfolios. The allowance for credit losses for loans decreased by $265,000 in the quarter to $32.9 million, primarily as a result of the release of specific reserves related to purchased credit deteriorated loans from prior acquisitions, offset by increased loan balances. The reserve ratio decreased from 37 to 32 basis points of total loans. The net interest margin declined 8 basis points to 3.1% in the quarter. With the unprecedented increases in interest rates, our cost of deposits increased 36 basis points to 0.64%, while our average loan yield increased 21 basis points to 4.07%. Our net interest income grew 7% to $87.7 million. Customer service costs also increased from $4.6 million to $13.6 million in the quarter. due to the increasing rate environment. Our non-interest income for the quarter was $12.2 million, driven primarily by wealth management revenues of $6.8 million, $2.1 million in trust administration and consulting fees, and the balance and banking-related fees. Wealth management revenues decreased $900,000 as a result of lower assets under management balances. Our advisory and trust divisions achieved a combined pre-tax profit margin of 11 percent in the quarter, Excluding a $313,000 expense related to a trading error, the profit margin would have been 14%. Noninterest expense was $60.3 million, up $11.5 million from the second quarter. Customer service costs increased by $8.9 million due to the increase in the earnings credit rates paid on the related deposit balances. Compensation and benefits expense increased $1.9 million, primarily due to a decrease in deferred loan costs as a result of lower loan originations in the quarter. Efficiency ratio for the quarter increased to 60%, primarily as a result of the higher funding costs. Finally, our effective tax rate decreased to 26.6% compared to 27.9% for the prior quarter, We are just beginning to realize benefits from our tax strategy that should continue to grow over the next several years. I will now turn the call over to David DePillo.
spk09: Thank you, Kevin. As Scott mentioned, loan originations were $1.6 billion for the quarter. Looking at the breakdown of the loans that were originated during the quarter, the percentages are as follows. Commercial, including owner-occupied commercial real estate, 43%. Multifamily, 46%. Single-family, 6%. land and construction 1%, and 4% other. Contributing to land originations during the quarter, our commercial business division funded $688 million of new commercial loans during the third quarter, of which 45% were adjustable commercial revolving lines of credit. The remaining CNI originations comprised of $196 million of public finance loans, $115 million of commercial term loans, $29 million of under-occupied commercial real estate loans, and 39 million of equipment finance loans. As mentioned last quarter, the heightened originations in the public finance channel that we experienced in July of 180 million normalized in August to our historical run rate of about 15 million a month. It's always important to note that we accomplished this without changing our high underwriting standards and our NPAs fell to a low of 14 basis points at the end of the quarter. Speaking more specifically about loan yields, we achieved a weighted average rate of 4.63 on originations, which increased substantially from the second quarter, which was 3.73. This quarter, we have started to see the impact of higher yields on loan originations due to an increase in the long end of the yield curve, and as prior lower yielding re-blocked loans have largely funded out of our pipelines. As of September 30th, Our loans held to maturity include 49% multifamily loans, 33% commercial business loans, 7% non-owner-occupied commercial real estate, 10% consumer and single-family loans, and 1% land and construction. Looking at our deposits, deposits held steady at $9.5 billion for the quarter. Deposit growth was tempered as we were experiencing the effect of S6 liquidity leaving the banking system. And as Scott referenced, there is an increased competition across all deposit channels. While our teams across the bank are working hard to bring in deposits, the reality is that we anticipate slowing loan production going forward to balance funding growth and to bolster liquidity given the economic uncertainty. Our loan-to-deposit ratio measured 108% as of September 30th. This represents an increase from store close experienced during the last few quarters, but it's still in line with our pre-COVID levels. Given lower levels of oil production going forward, we plan to actively manage this ratio. While there is economic uncertainty, our credit quality remains a key focus heading into the fourth quarter. And to reiterate Scott's comments, I am very grateful to our team's dedication to delivering excellent client service when it matters the most. At this time, we are ready to take questions. and I'll hand it back to the operator.
spk02: The floor is now open for questions. If you'd like to ask a question at this time, please press star 1 on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing star, then 2. We ask that you please pick up your handset to allow optimal sound quality. Thank you. Our first question is coming from Matthew Clark from Piper Stanley.
spk05: Hey, good morning, guys. Good morning. Good morning. Maybe just on the loan-to-deposit ratio and the outlook there, you mentioned you're planning to manage it. I guess how should we expect that ratio to trend here over the next couple of quarters? Is there an internal limit, and are you looking to get that back down to 100% or sub-100%? Just trying to get a sense for your outlook for the pace of slower loan growth and deposits.
spk07: Yeah, so what I would say is 108 is already up to a level, which is why we're giving a much more cautious approach to our lending. I don't know that there's an internal limit, but I would say that we already feel like we're either there or very close to it. Last quarter when we did our earnings announcement, I was confident. that our pipeline was pretty full in terms of deposits that we had on tap. And I got to say that pretty much 100% of what we thought we had in the pipeline did not come to fruition. That being said, we've already taken great strides to continue to operate on it. But I think what you're going to see is just a continued slowing of loan growth over the next several quarters to the point that we will get it back under 100% is our goal.
spk09: I would say that we're looking at, you know, between 100 and 105%, kind of in an operating range in the near future. As noted in previous years, we do have some cyclical outflows in the fourth quarter. related to some of our larger MSR clients that have taxes that are due during the period. The good news is we're starting to receive pretty decent inflows from some of the channels that Scott had mentioned before, specifically retail and online, to offset some of that. That being said, we're selling production on a relative basis. Current plan is to you know being the 3.3 to 3.5 billion dollar range down from six billion uh run rates that we're currently on and uh slightly ahead of what the our historical run rate and uh you know the two and a half to three billion dollar range so although we're slowing loan originations at least on a planned basis um on a relative basis it's still going to represent some pretty significant uh originations for us going forward.
spk10: And one thing I will add is, you know, during a time of rising rate environments, you often see, as expected, prepayments decrease drastically. We still have a portfolio that turns over even in a rising rate environment over time. However, I think a lot of borrowers are taking a pause to see where the Federal Reserve goes. So our prepayment speeds have slowed drastically. And we expect them to increase over the next several quarters as things stabilize somewhat and people get a clue of where the Federal Reserve is headed. And we start on that treadmill again. So between the seasonal outflow of deposits, the slowing of prepayments, the good production we had this quarter, we believe this is the height of our loan-to-deposit ratio for the foreseeable future.
spk04: Yep. Agreed. Our next question comes from Gary Tender from DA Division near Davidson.
spk08: So to follow on the loan growth conversation, David, I just wonder if you could kind of put into context for us the mix of the loan growth you might see from here. Obviously, you've been growing the commercial business lending piece quite a bit. But as you actively slow loan growth, where is it going to come from?
spk09: That's a good point. We are going to have an emphasis on commercial loan growth, at least in the foreseeable future. The majority of that will be in variable rate, SOFR-based. Part of the issues we face in the income property channel is, you know, when we're originating at 4.5, that seems like a good rate until the Fed increases, and then 5.5 seems like a good rate until the Fed increases. And now... you know, we're kind of settling in the high fives and low sixes. And we're not sure that's going to be a good rate, depending on where the Fed's movement's going forward. So we are going to continue to support our franchise. However, there will be less of an emphasis on income property growth and more of an emphasis on C&I growth. So we're probably going to have 60% growth in CNI and about 40% in other channels. At least that's what we're forecasting. Demand is still extremely high on the commercial side. There's still a lot of free cash flow and companies are doing very well. So we're going to tend to focus more on the commercial originations until we can get some guidance from the Fed
spk08: when they're going to moderate their pace. Thanks, David. And then a question on the customer service charge expense line. I just wanted to clarify that because the increase there was bigger than we had and I think broadly expected. But is there any sort of cap as to where that goes as the Fed rises or do those fees or costs basically participate all the way through as far as the Fed goes.
spk09: It's an interesting point. I think most of us that are participating in that space have been pretty much writing dollar for dollar as the Fed increases. And in some cases, some have increased beyond, so more than 100% beta for some clients, not necessarily related to us. Our expectation are those will continue as the Fed increases to have close to 100% beta on the larger clients. But we do anticipate at a certain point, given that most people are kind of temporary and moderating their growth, that that beta should start slowing down. But due to the, I think, evaporational liquidity in the system, A lot of banks have been very protective around these books because they take years to establish and they are valuable clients that unfortunately we're going to continue to probably have to ride with them until the Fed moderates the increase.
spk07: Gary, I would say that honestly you've got a heightened awareness from clients the higher the Fed goes with rates. And talking to my peers out there, they're experiencing, you know, demand from clients for higher deposit costs. And I think it's just starting to permeate throughout the industry. So I think, you know, we're trying our best to keep betas as low as we can. But when you're talking about retention or, going backwards in terms of your deposits. As I said, it's a dogfight out there, and I think it's becoming more accentuated.
spk10: In past rate cycles, we've seen we've had more time to adapt. The beta's been slower. Clients haven't pushed quite as hard. The The dogfight, as Scott mentions, between banks hasn't been as hard. But we're seeing it even in this rate cycle, the money center banks paying really high betas on these types of sophisticated clients to maintain the relationship. Again, as a reminder, most banks or sites don't have the sophisticated systems and process to be able to support these types of clients. And we do, and they're great clients that we want to retain. eventually the Fed will stop and we'll be glad that we retain these great clients. But for now, it's time to hunker down and be prudent.
spk09: So one of the other comments we would make is, you know, we aren't anticipating significant growth in that channel and are pivoting into our retail, online, and other channels to kind of make up for the higher costs that we're seeing, you know, through the commercial deposit service So I think you'll see a pivot more towards online and retail in the next few quarters.
spk04: Thank you.
spk02: And once again, that is star and one if you'd like to ask a question. Our next question comes from Andrew Terrell from Stevens.
spk06: Hey, good morning.
spk02: Morning.
spk09: Good morning.
spk06: I've got several questions on the margin, but maybe just starting at the top. I think there's a lot of moving pieces, so it'd be helpful. Do you guys have just a range of where you think the margin settles out in the fourth quarter?
spk10: It depends on several items, as you know. It depends on how the Fed acts here in February and December. As we've talked about, we are strategically managing our loan growth. And so we'll focus on really high quality, higher rate loans. We have a deposit strategy that we're working on as well to ensure that we're bringing in the lower cost funding, maintaining our high quality deposit portfolio. And it depends, of course, on prepayments as well. So we're currently working on our budgets. for next year, and that will include the fourth quarter of this year. We'll know more soon, but I do anticipate we'll dip below 3% in the fourth quarter.
spk09: Yeah, I echo that and the fact that we do have fundings in the fourth quarter that are still because of rate locks at rates below the current market rates as that's shifting almost daily as as we've seen the middle end of the curve push up. So some of the funding out of the current pipeline, even though it's significantly higher than even last quarter, will still have a little bit of impact into the fourth quarter. But the larger we get, even with large, significant funding set to margin, it's just harder to impact the margin due to the size of it. the overall balance sheet.
spk10: I'll just add one thing. These issues are, I would say, short-term issues. As we talked about, these are unprecedented times with the Fed raising rates. We don't have as much CNI as maybe some banks have where their rates are adjustable immediately. We have about a billion on our books that is adjustable immediately. So it takes a little bit of time to turn the ship and to get loan production So over time, we actually anticipate the benefit from this rising rate environment once the dust settles and we're able to get our loan production up to date with our deposit status.
spk06: Got it. Okay. So maybe some near-term pressure, but expanding kind of from there. Okay.
spk10: That's right.
spk06: Do you have the spot deposit costs either interest-bearing or total at the end of the third quarter? And then on the FHLB, I saw you guys added in the quarter, I guess just given some of the commentary around deposit growth in the fourth quarter, would you expect to reduce any of the FHLB position going forward or should it be relatively consistent?
spk10: The spot rate on interest-bearing deposits is 1.25%. And in terms of FHLB, we are strategically managing the funding portfolio. In some cases, FHLB is less expensive and more flexible. We have other access to broker deposits and other wholesale funds. And, of course, we're looking at our branch deposits as well. So we are every day looking at the best way to fund our business and being really smart and strategic about it. We do anticipate... still needing to use some wholesale funding over the next while. We'll probably use more broker deposits and bring down FHLB funding to lock in some rates.
spk07: Yeah, I would expect to see the home loan bank advances decline over this next quarter.
spk09: Yeah, I think we're pretty much forecasting that it's about the high level for advances for us. And we're still about 97% core funded, so we have some room for, as Kevin mentioned, to bring in some ladder broker deposits to kind of solidify some of the rate environment until we see where the Fed ends up. But, yeah, I would say this is probably a high point for us.
spk06: Okay. That's very helpful. I appreciate it. If I could sneak one more in, just on the efficiency ratio overall, I know that Talking last quarter, it's telling me it could be pressure near term. I guess as we think about kind of going into the fourth quarter, should we expect a similar kind of, I guess, magnitude of pressure on the efficiency ratio quarter on quarter? And then it's fair to think about the efficiency ratio kind of as holding the same trajectory as what you'll see from a margin standpoint, where it could be pressure the next couple of quarters and then kind of rebound from there.
spk09: Yeah, that's correct. There's really two areas that have impacted us significantly. Obviously, the higher deposit service cost is the most material. However, on the FASB deferral piece, our average loan size has been probably double of what we've historically experienced, and our FASB deferral has been impacted because of that. you can kind of anticipate if they move in November and potentially in December, it'll, at least on the customer service costs, have some near-term impact.
spk06: Yep. Okay. Thanks for taking the questions. I'll hop back in the queue.
spk03: Our next question comes from David Feaster from Raymond Jeans.
spk01: Hey, good morning, everybody.
spk04: Morning, David.
spk01: Could you just help us just following up on that expense question? That's a good point. I guess as you kind of take this all together, including the likelihood for a November and December hike, I guess how do you think about the run rate in 2023 if we do have this slower pace of originations, which leads to less deferrals? We also got some inflationary pressures. Just curious how you think about expenses, especially as we start looking into 2023.
spk09: Yeah, we've already started looking at our overall expense profile. You know, the hard part is we're relatively lean as an organization. Obviously, the customer service costs has had a dramatic impact to increase costs and impacted our efficiency ratio. However, we're looking at every area of the bank, including, you know, potential delay of initiatives that would have a, you know, a material impact to our G&A structure. So I think what you'll see is our overall comp and benefits and other lines staying relatively stable, maybe even down. We're not really necessarily seeing huge significant impacts in areas of cost in our structure that have been impacting us. So I think it really boils down to two areas. One is deferral and the other is customer service. The deferral ebbs and flows. We expect over time, even though we'll have lower volumes, the average size of the loans may normalize back to what we have seen historically. On a relative basis, it's a much smaller number. So it's really managing the customer service line. At some point, that'll level out and stabilize. But the rest of our cost structure, I think we've been very thoughtful in maintaining a relatively efficient operating platform and don't expect to have significant cost impact, at least over the foreseeable future.
spk01: Okay. That's helpful. And then you touched on an interesting point about talking about the portfolio continuing to reprice higher. I guess just based on the current backdrop and Fed forecasts, When would you expect the NIM to trough? I mean, is that a mid-2023 or late-2023 event, or is that more realistically 2024 at some point around there?
spk07: No, I think it's a 2023 event and probably in the first half of 2023. Okay.
spk01: Okay, that's good. And then you talked in your prepared remarks about having a good pipeline in wealth management and trust services. Obviously, there's some challenges in the market just given valuations and everything, but just curious how you're seeing growth there, especially in the new markets of Florida and Texas and the opportunities on that front.
spk07: Well... Florida is coming along actually fairly nicely. We've had some trust people and some investment management people join us. Unfortunately, we seem to fight through things like Hurricane Ian and dealing with the community, rebuilding, which is first and foremost, I think, at this point. I am pleased to say that the referrals over on that side have been fairly significant, even given the challenges of going through a major event like that. Texas, we still haven't added either a trust or an investment management. We continue to look. But what I would say is here, with the staffing that we've had on that side, we've already achieved 600 million of new client assets this year. Um, or five, it's between five and 600. Um, so, uh, you know, we've had not only strong retention, but we've had quite a bit of new assets coming into the system. Um, and, and that's great, but you know, also at the same time, you got a backdrop where the S&P is down 20 some odd percent. And so every time we take in a new dollar, unfortunately, assets under management have also declined because losses on the 5.7 billion we used to have have impacted us to the point that I think we ended at 4.6. But I think I'm very optimistic with the clients this time. I would say in past events when we have been in a rising interest rate environment and the cycles have been extremely tough, we've had way more outflows than we have this time around. So I think our folks are doing an incredible job of maintaining those relationships, getting it in front of clients, talking through with the issues are. And all I can say is they've done a tremendous job in terms of retention.
spk10: I'll add one thing. An interesting phenomenon that happened in the early 2000s when the market was so good is you saw an outflow of wealth advisory clients from the banks to the brokerage houses. Then when the great financial crisis happened after that, you saw that flow back to banks. Customers wanted to work with their clients their trusted bank with someone who they felt was more conservative. I suspect we may see that kind of flow back to banks again. Our portfolio has outperformed S&P 500 because of our conservative approach. Our clients appreciate that. And it may be a really good time as a bank to be in the wealth advisory business. That's great.
spk07: And I might add, David, that on the trust side, you know, we're garnering a lot of attention and a lot of referrals from CPAs, attorneys, bigger firms. As you know, our assets under management, most of them are custodied at Schwab. We have an unbelievable relationship with Charles Schwab and are in constant communication with him. So I am very hopeful and believe that the trust side will continue to garner that attention that's taken years to build.
spk01: That's great. If I could just squeeze one more in. I was hoping you could give us an update on the multifamily market. I've spoken with some investors that are a bit cautious on multifamily, and I think there's just some misunderstandings on regional dynamics maybe across the country. I was just hoping you could give us an update on the competitive landscape, just the health of multifamily on the West Coast, and Any other overall insights or thoughts on that space?
spk09: Sure. On a competitive landscape, it's kind of interesting. There's the same regional players have really been active in the market. We've noticed JPMorgan Chase is back a little more competitive than they have been in the past on a relative basis. So they're still, quote, the market leader. And then us and a few others are, you know, continue to service the market well. There's relatively strong demand in the market. However, with the long end of the curve moving up so quickly, some of the demand has slowed due to kind of the rate shock by borrowers. So what we're seeing is There's still high demand for refinance for individuals who have fixed rate debt that's rolling over and they need to refinance. So it's more of they have to versus playing the right environment. Also, people are kind of scurrying into market trying to lock in rates because there's a fear that maybe rates will continue to go up. So there's still demand there, but there has been somewhat of a disruption in the market due to kind of the rate shock we've seen over the last three or four months, especially in the last month or so where rates have accelerated. Sale activity is still relatively strong. From a performance standpoint, at least in California, market demand is extremely high rent appreciation is still outpacing inflation at this point. We haven't seen any weakness in any of the markets that we serve. We predominantly serve workforce housing, and even the pricing that we see on sales hasn't seen any impact at this point. So from our borrowing base, the durability of cash flow is extremely high. Our expectations are as the consumers start to weaken, and we're certainly seeing that in other aspects of the economy as their savings get depleted and costs start to impact, there will be some impact down the road, we believe, in overall rents over time, which we actually feel is a good thing. We want to see certain levels of moderation and rent growth over time. That being said, you know, what it tends to lead to is, you know, individuals having to double up in occupancy as affordability continues to erode. So, but from a cash flow performance standpoint, our portfolios are as strong as they've ever been. We don't see any econometric modeling that would show any weakness in the foreseeable future.
spk07: Sorry, David. Our average LTV is 54%. And I think people get confused. As Dave said, we do workforce housing, which, you know, is the average Joe Q public out there, not the upper end rents. And rents are holding firms. And you have to know that as prices go or interest rates go up on housing, affordability continues to decline, especially in the state of California. So I think that bodes well for rents on multifamily. Do we think that they're going to moderate? Yeah, because there's got to be a tipping point that...
spk09: rents can't continue to go up at the same time that calls for food and other things are going up as precipitously as they are we are seen anecdotally in some of the other markets that we don't necessarily participate in throughout the united states that there is you know some form of rent concessions coming back into the markets um uh you know, owners being a little more defensive around their active portfolio management and not necessarily aggressively going out and buying in a lot of these markets that kind of we'd say over accelerated during this kind of rapid growth period. So, you know, there is some pockets of weakness in some of the Sunbelt states that we've seen on a relative basis. It's fairly immaterial, but it's going to have a little bit of impact on some of those markets. Fortunately, we have very little exposure, little to none in a lot of those markets. So we're going to continue to support the high-demand markets where the supply and demand imbalances appear to, you know, going to continue for the foreseeable future. It's just they can't. you know, create enough supply to satisfy the demand. And as residential real estate has become less affordable, obviously because of interest rates, it has pushed potential owners back into the rental market. So as the economy weakens, multifamily typically does extremely well in times where affordability on residential real estate tends to, you know, push them into that market. So we're still very bullish on it. I think the biggest issue for us is not relative to performance. It's more of, you know, trying to find a sweet spot to lend aggressively again without worrying about, you know, where the Fed's going in their next meeting. So we're going to take a more cautious approach more around rate and yield versus expectation of market performance.
spk10: That's great, Collar. Thanks, everybody.
spk04: Thank you. Thanks.
spk03: Our next question comes from Matthew Clare from Piper Sandler.
spk05: Hey, sorry about that. Call dropped. Back to the customer service costs, can you give us the average balances, average deposit balances associated with those earnings credits you know what were they on average this quarter versus the second quarter so we can sensitize they're fairly flat at about 2.2 billion on average okay okay is it fair to assume you know we had 150 basis points of rate hikes in um 3q timing's a little different with the first one in july the second one in september this time around we're going to have november december a similar amount i mean should we expect a similar step up in customer service costs based on another 150 base points of hikes or, you know, plus or minus?
spk10: That is what we anticipate at this point. And, of course, we will work strategically to lower that as possible.
spk05: Okay. And then just last one for me on expenses. You know, I think in the first quarter you tend to have a, a decent step up seasonally in compensation. What are your thoughts in terms of the magnitude of increase this coming year in the first quarter, given inflation and given your desire to obviously manage expenses more aggressively now?
spk10: We do have a seasonal increase in the first quarter. We still anticipate that as part of paying bonuses and the tax impacts, etc., However, we are seeing some sign in the inflationary pressure around compensation. And so I think there's some strategic work we can do there to ensure that we're not increasing too much as we're controlling expenses across the board and being very smart. Of course, with our strategic loan approach, that helps us control expenses and in other areas as well. But that is offset, of course, by the lower loan production. a lower amount of loan deferral expense. So that will impact us negatively as well.
spk04: Got it. Thank you.
spk03: Our last question comes from Andrew Terrell from Stevens.
spk06: Hey, thanks for the follow-up. Scott, I know you mentioned kind of prepare to mark. One of the priorities was bolstering capital position. I guess some of that will be done by just a slower pace of balance sheet growth, but I'm curious if you could provide a target of where you'd like to grow capital to, and then do you proceed doing that all on an organic basis or any kind of inorganic capital needs?
spk07: We're still evaluating that. We're more towards the end of our budgeting process than the beginning. But it still is a question mark as to whether or not we would want to go out to the marketplace. I think, you know, given the growth of slower growth that we anticipate, along with fewer payoffs, but still having payoffs, I think there's a reasonable chance that we could grow capital or create capital without having to go to the markets, but we're still evaluating that.
spk04: Okay, makes sense. Thanks for the question.
spk03: This concludes our allotted time for today's question and answer session.
spk02: I will turn the call back over to Mr. Scott Cavanaugh for closing remarks.
spk07: Thank you again for participating in today's call. As we enter the last quarter of 2022, I am confident we are well positioned to end the year strong. We have the right team in place, the best clients in our markets, and a strong business model that is highly competitive. Thank you and have a great remainder of your day.
spk03: Thank you, ladies and gentlemen. This concludes today's conference. You may now
Disclaimer