PacWest Bancorp

Good day and welcome to the PacWest Bancorp third quarter earnings call. Today's conference is being recorded. At this time, I would like to turn the conference over to Bill Black. Please go ahead.

Thank you. Good morning and welcome to PacWest third quarter 2022 earnings conference call.

With me today are Matt Wagner, CEO, Paul Taylor, our president, Bart Olson, CFO, and Mark Young, our COO and the leader of our venture banking business. Before I hand the call over to Matt, please note that we may make forward-looking statements during today's call that are subject to risks, uncertainties, and assumptions. For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements, see our company's SEC filings, including the 8-K filed yesterday afternoon, which is also available on the company's website. Now I'd like to turn the call over to our CEO, Matt Wagner. Thank you, Bill. Good morning, everyone, and thank you for joining our call today. I want to start off by making a few comments about the overall business and operating environment. Overall business activity remains strong, but we are proceeding cautiously as we are thinking about and planning for weaker economic environments ahead. We continue to focus our time and attention on our customers, making sure we are there to serve them throughout the cycle. We slowed some of our lending businesses, given the economic environment and our desire to grow capital more rapidly while optimizing our balance sheet. Given the current economic backdrop, we believe this is a prudent thing to do. Credit remains strong and currently we do not see any negative credit trends and we continue to monitor the low portfolio closely as part of our conservative approach to credit. Finally, but most importantly, building capital as we did in the third quarter remains our primary focus and this will continue to be a key component of decisions we make each day. With that, let me turn it over to Bill to cover the key highlights of the quarter. Thanks, Matt. The third quarter was marked by a couple key events. First and foremost, all of our regulatory capital ratios increased during the quarter, including CET1, which increased from 8.24% to 8.55%, as we marched towards our CET1 target of 10% by the end of 2023. Second, our total deposits grew $228 million, and importantly, after two quarters of decreases, Our venture banking deposits not only stabilized, but grew $129 million to $12.2 billion. Third, credit quality remains strong, with non-performing assets only at 34 basis points and net charge-offs for the quarter of three basis points. We continue to monitor the loan portfolio closely and have not seen any significant signs of credit deterioration at this point. Fourth, our net loan growth remains strong and broad-based across the businesses, but lower than the prior two quarters as planned and as previously communicated. Lastly, our net interest income on a tax-equivalent basis was $338.6 million, up 3.3% from last quarter. I'd like to now hand things over to Bart, our CFO, for some specific commentary on the financial results before we go into Q&A.

Thanks, Bill, and good morning, everyone. I'm going to focus my comments on page 3, a new slide we added to our earnings presentation, which provides a condensed view of our financial results. As you can see here, interest income continued to grow, increasing 17% to $410 million during the quarter, and up 41% from a year ago, driven by higher average balances and higher rates. Interest expense also grew during the quarter, with our cost of deposits increasing to 70 basis points, driven by higher rates and higher average balances on wholesale deposits. As a result, this limited our NIM expansion during the quarter. Turning to the provision, the provision decreased by $7 million, primarily due to slower loan growth, a decrease in COVID-related qualitative reserves, offset by less favorable economic forecasts. Our CECL ratio ended the quarter at 1.03%, still above our CECL adoption level of 0.97%. Moving down to non-interest income, this was up $4.3 million due to the successful outcome of a litigation matter, which netted legal fees in 2022, added $5.5 million to non-interest income during the quarter. Meanwhile, non-interest expense was up during the quarter by $12 million, This increase was attributable to a $3.9 million increase in professional services, primarily related to the credit-linked note transaction, a $3.4 million increase in compensation related to an additional 68 FTEs, primarily related to CIVIC and our digital and innovation strategy, along with one more business day. Other contributors to the increase were a $1.5 million increase in FDIC insurance assessments as a result of higher wholesale deposits in 2Q and 3Q, and a $2.6 million accrual for a legal settlement. Excluding the $7 million in non-recurring items related to the credit-linked notes and legal accrual, non-interest expense would have been $188.6 million. From a balance sheet perspective, the only comments I would make is that we sold approximately $440 million in bonds at a net gain of $86,000 as we continue to actively manage the investment portfolio. Our AOCI unrealized loss for the quarter went from a loss of $645 million at the end of the second quarter to a loss of $848 million at the end of the third quarter, given the movement in market interest rates. Lastly, if you're looking for our outlook on the fourth quarter, I would point you to slide 11 in the presentation materials. This concludes our prepared remarks. Operator, could you please open the line for questions?

Yes, thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, Please press star one, and we do have a question from Jared. Please go ahead.

Hey, guys. Hey, everybody.

Good morning. Thanks for the question. I guess just maybe a little thought on how we should be thinking about beta from here. You, I think, accelerated into the quarter. Should we be thinking that there's you know, more room to go here as we move through the cycle? Or what's your thoughts on, I guess, beta through the cycle to start off with?

Yeah, Jared, good morning. You know, the current cycle of rising interest rate environment, we're at 41 basis points for interest bearing and 26% for toll deposits. I'm looking ahead or updated forecast on deposit betas over the next 12 months is for that to increase. to 50% for interest-bearing deposits and 31% for total deposits. Okay.

All right. Thanks. And then as we – you mentioned a slowing outlook on loan growth. How should we be thinking about the funding of that? Is that going to see a continued increase in loan-to-deposit ratio? Should we assume that deposit growth is lagging that? You know, should we be thinking that the deposits at that beta should keep pace?

Well, again, the guidance that we have on deposits is, you know, flat to up depending on, you know, venture banking predominantly. So, we'll see where that goes from a deposit perspective. I think those slower long growth is obviously part of that. If loans, we'll probably do some funding with wholesale, obviously, if the deposits don't grow at the same pace as loans.

Okay. I guess maybe just finally for me, maybe a bigger picture question for Mark on the venture side. Good to see the deposit growth there, but Maybe we'd be interested to hear your thoughts on sentiment in terms of the sponsors and pace of potential investment as we end the year and go into 23.

Hi, Jared. Yeah, Mark. Yeah, I would say our lookout had been that transaction exhibitors start picking back up here end of Q3 and getting a little bit more robust into Q4. You know, the numbers are out for the broader U.S. venture market. I mean, transaction levels did come down meaningfully in Q3. Part of it aided by, you know, the summer seasonal slump. We are expecting there's still $290 billion of dry powder. I know it's a name. A number has been restated. $160 billion of it is estimated to be used for new investments out of that dry powder. So we do think the VCs will be under some pressure here to put that money to work before year end. So, you know, we continue to believe that transaction activities should come up into Q4. But again, it's not going to be 2021 or 2020 pandemic year transaction levels. It's going to be more like pre-pandemic transaction levels, but aided and assisted by this tremendous amount of dry powder in the ecosystem. So we continue to be cautiously optimistic here into Q4. And we'll see where we end up here.

Great. Thanks very much. Yep.

And our next question comes from Christopher Marinak.

Yes. Good morning. I wanted to ask about the percentage of core funding of the balance sheet. Do you see that changing further as we go into next year? I'm just kind of curious on sort of, I guess, on the same line, kind of how DDAs may play out as well.

Yeah, I mean, I think core funding, you know, is, again, tied to venture with that. And so I think, you know, again, the guidance we have, we think it's, you know, flat to up depending on venture. So I think from a core perspective, that's going to be probably the key driver. I think we expect community bank to continue to grow, soften, decrease in the third quarter. But, you know, expect that to grow as it typically does.

And is the wealth management kind of funds that are off balance sheet, is the beta on that materially different from what we see at the bank overall?

Well, it's off balance sheet, so that's not in our numbers, right? So it has no bearing what those betas would be.

We've actually had initiatives, Chris, this is Matt, to bring a lot of that funding back on balance sheet, project boomerang, I think we call it. And we're having some good success with it.

But of course, we're paying up for that money

Great. Yeah, that's what I just wanted to establish. So thanks, Matt, for that. And then just the final point for me is on the expense guide that you gave us for the fourth quarter, how applicable is that for the first part of 2023? Is that a good number to kind of read through for the early part of next year? I know budgeting is still going on.

Yeah, I mean, the budgeting process, you're right, is going on. We're in the midst of that right now. It's probably a good jumping off point. But we are taking a look at our expenses closely as we go through the budget process. And so that'll be a big focus for us as we go through that. But I think from a jumping off point, that's probably a good guide.

You know, Chris, some of the businesses that we're in, you know, you can logically look at them. And I'm not going to name names necessarily. But it's activity. You're going to slow down that activity. pretty dramatically, like a lot of fixed rate lending and those kinds of things. And if you slow down activity, you need less people. And so you'll see some initiatives coming from us. We don't have, I guess I wouldn't call it necessarily a formal hiring freeze now, but every new hire, including replacements,

Great. Thank you, Matt. Thank you, Bart.

And our next question is coming from Matthew Clark.

Hey, good morning. I wanted to start on deposit costs. Do you happen to have the spot rate on the spot rate at the end of September on interest-bearing deposits to give us some visibility going into next quarter?

Yeah, the spot rate was 85.

Okay. I thought it was 115 this past quarter, but okay. I'll have to circle back on that.

The 85 is total. Matt, the 85 is total.

Total. Thank you. Okay. Got it. And then in terms of borrowings, they came down this quarter. Should we assume that they continue to come down? And as it relates to the wholesale deposits you're willing to take on, you know, what rates are you seeing relative to the duration you're willing to do?

Yeah, on the borrowings, I mean, that's going to fluctuate a little bit, again, just with, you know, long demand and growth and how we decide to fund that, whether we do it borrowings or whether we do wholesale. You know, going through the third quarter, wholesale was cheaper than overnight, but that gap is narrowed. And so I think, you know, when you look forward, I think we've probably – You know, have a little bit of wholesale in there and then use the overnight as well. So I think it'll be a mix. And really just depends on what the rates are. We did during the 3rd quarter and throughout the wholesale process that we did do. You know, it's laddered and so we'll continue to do that. And see where it goes, but it's, you know, the. Probably in the 3 and a half to 4 range on the wholesale.

depending on the duration. Got it. And then just on the guide for slower loan growth in the fourth quarter, are we talking low to mid single digits? And how should we think about overall earning assets? Would they be flat from here or flat to down?

Well, we're trying to hold the loan side of the balance sheet more towards flat. There will be some growth in the fourth quarter. And looking out into 2023, again, I think you'll see little growth, but there will be some growth.

Yeah, and Matt, I would just add to that that we've talked about for the last couple of quarters of optimizing the earning asset mix and optimizing the overall balance sheet. And I think the comment that Paul made is more of the net balance of that. There's obviously going to be ebbs and flows of different things that'll grow and different things that may come in and out. But the net result of that should be a flattish loan portfolio and a flattish balance sheet 23.

Yeah. Okay. And then just on your guide around modestly higher NII, you know, from here, Is that, you know, is that assuming you're going to get some additional lift in the NIM or do you feel like the NIM is kind of near a peak?

No, I think we expect NIM to continue to expand. I mean, it was, you know, limited expansion this quarter because of the deposit cost, but I think, you know, we see the loan yields continuing to rise. You know, deposit costs will rise, but we think that we'll see expansion in the NIM looking ahead.

Yeah, I think it's a mixture of basically the higher rates and the remixing of the earning assets on a flat balance sheet. Yeah. Okay, I'll step back. Thanks.

And our next question comes from Gary Tenner.

Thanks, guys. Good morning.

I just wanted to ask, and I think you may have addressed this in part by, you know, talking about a flattish loan portfolio in 2023. But, you know, as it relates to your 10% CET1 goal, you know, obviously added 30 bps this quarter, 20 of that was the CLN transaction. Can you talk about any, you know, additional transactions or strategies you're thinking about in terms of growing that beyond just internal capital generation as we look at over the next several quarters?

Yeah, I think we're looking at everything, you know, to make sure that we meet or exceed the 10% CET1 by the end of 23. So I think you'll see the company go through a process. We'll be announcing things and looking at everything we can to improve capital.

You know, Gary, everything's kind of up for grabs. This is Matt. And, you know, things like, you know, obviously we're going to have amortization of our multifamily loans. And, of course, you're also going to have some activity there where loans, you know, properties will be sold as, you know, in the normal course of business. Maybe not as quick a velocity as you would have in this rising rate environment because they're not doing re-buys. You're going to have the same with our SFR portfolio. You're going to have amortization, and you're going to have people, you know, you're not going to have the refi activity, but you're going to have people move and sell their homes and that sort of thing. And just, you know, in the nature of PacWest, and you'll see this quarter, we had payoffs and paydowns of approximately $2.2.5 billion, I think, wasn't it, Mark? Yeah. Which is down somewhat from... are more average, which is like two and three quarter billion. On a quarterly basis, it's paid off. And these are things like, you know, construction projects, a lot of which we do, the majority is multifamily, coming to completion, certificate of occupancy is issued, and long-term lenders stepping in and taking us out. And we still see that kind of activity, and we don't expect that to slow down. So, when you think about the portfolio, In general, you've got about between $8 and $10 billion in natural runoff on an annual basis, which is 30% of our portfolio, more than 30 a third. And so, you know, we still have to be out there making loans and, you know, making them to our customers, our customers that provide us core deposits, and we'll continue to do that. It's not going to be like we're going to be sitting around flat-footed in order to keep the balance sheet in check, we still have a lot of work to do.

Thanks for that call every minute. And then just to make sure that I'm clear on, as you were talking about, you know, optimizing the balance sheet, as you think of the asset side, if you're kind of not growing loans or the balance sheet overall, is it more of optimizing the mix within the loan portfolio? Or as you look at the broad categories of loan securities and cash, shifting that mix more from where it is right now.

Well, that, you know, but, you know, we're not selling our securities portfolio off unless we can do it at a pretty neutral level. So, yeah, as, you know, as what is our monthly maturities part?

40 million? Yeah, it's gone down. It was about that during the quarter, but, you know, forward-looking, it's around 30.

30 million a month and just run off of the securities portfolio. Yeah. But, yeah, I mean, it's optimizing what we want to do, I mean, with our loan portfolio. Again, you know, we know rates are going to continue to go up, at least through probably the first quarter of next year. So why would you possibly be making a fixed-rate loan now? I mean, we still have some flow, and we still have some commitments in Q3 that we had to honor, particularly for our good customers that are also large depositors. But that pretty much has flushed its way through the system, so you won't see much more of that. So, you know, I'm pretty optimistic. And, you know, I'm also happy to see the deposit flows improving, particularly with venture. And I think that, you know, it's not going to be like 20 to 21 again, as Mark said, but I think it's going to stabilize. The community-based deposits, which are our other big chunk of deposits, continue to grow, although it's never been an exciting growth. It's a little single-digit kind of growth. Yeah, the one thing I would add to that is that when I think you look at it, optimizing the balance sheet is not necessarily optimizing a single part of it. It's optimizing the whole. And so we're really trying to manage the balance sheet for capital and liquidity and overall long-term use of it. So, the ebbs and flows of one part of the balance sheet are less important to me than they are the whole. And I think when we're talking about optimizing it, it's not necessarily loans will be that or this will be that. It's really trying to maximize the overall balance sheet.

And we have to keep in mind that the balance sheet runs off about $2.5 billion a quarter. So, we're going in, just looking at all of our types of loans. and going with the most profitable best loans that we can to fill that $2.5 billion bucket.

Yeah, and that's when we talk about optimizing. It also gets back into the capital side of it, and that's how we can see the clear path to the CET-1 of 10% by the end of next year. I mean, if you look at it, Gary, on the CET-1, you know, we're at $8.55 million. You know, that's 145 that we've got to get. That's 29 basis points a quarter. Can you achieve that? Absolutely. I mean, the profitability is certainly there. It's just a matter, you know, we can't grow the balance sheet at $3 billion a quarter and do that. So, but it's not likely that you're going to see that. I mean, as you guys know, I'm a very customer-centric guy. I'm talking to a lot of people and I'm headed to the West coast today to see other customers and people are pulling back. I mean, projects, projects that made sense at 4% interest rates and, you know, aren't going to make sense at seven and a half, you know, and that sort of thing. So they're naturally, the business is naturally slowing down. And I think you'll see that throughout the country and with the banks. And, you know, so I think you just, You just keep an eye on everything. And, you know, again, you got to be there for your best customers. And our best customers are deposit customers. And, you know, again, I emphasize this often in these kind of calls. You know, if you take a look at our venture businesses, I think our loans came in just a little over $2 billion for the quarter, of which a huge chunk of that's capital call. I mean, you know, we've never been a giant capital call lender, just pretty moderate one, but our deposits related to those businesses, both the tech, life sciences, and capital call lending are $12.2 billion. I mean, that's just remarkable, more than six times. And, you know, we've got to take care of those customers, and we will be out there. Mark and his team are, you know, we're seeing a lot of lending requests from those groups because they don't want to raise capital right now. they'd probably be looking at a down route.

So it's a dynamic environment. Great. Thanks, guys. I appreciate it.

And our next question is coming from Brian King.

Hey, this is Brandon.

Hey, Brian. Hey, yes. I want to get an update on civic loan production. I know it's pretty strong in the quarter. And given, you know, high interest rates is affecting housing demand and lower house prices. I'm curious what your outlook is for that, if they can keep up this pace or if you're expecting slowdown from there as well.

Hey, Brandon, it's Bill.

So you've seen higher rates start to translate throughout the balance sheet, and that includes civic. Higher rates is naturally slowing production. You'll see that happen in the fourth quarter as that ripples through. You're seeing a maturation of the portfolio, so the payoffs are starting to kick up. And so I thought you saw good production, good solid credit stats. Our underwriting has remained relatively consistent for the past couple of years. And I think overall, that the net growth will obviously slow as rates go up and payoffs kick up. Bill, you might want to, since you brought up civic, you might want to touch on Florida.

Sure.

So obviously with the types of natural disasters that we've had, you know, we went through a deep dive of the entire portfolio, both within civic and externally and the overall amount of properties that, that were severely damaged were a little more than a handful. Low single digit million dollar exposures, all properties where we have insurance policies in place. So a really nice outcome in terms of the team doing the work and having the quick diligence to jump on the phones. Obviously a horrible disaster, but I think our teams did a great job in the face of a really tight timeframe So we're pleased with the underwriting and the structure there. And I would add to that, that includes other lending that the bank does in Florida, and it looks really good. And in terms of yield, I had to step out just really quickly there. We had a nice bump in yield for the civic production in September, a jump of about 34 basis points at 747, which was quite good. And hopefully that trend continues. They have raised their advertised rates, and we still have a nice inflow of business. Yeah, what you're seeing there in terms of the pipeline is that the pipeline from origination to fund kind of is creeping through the balance sheet. I mean, the numbers that Matt mentioned are going to keep creeping up there as that kind of continues to flow through the pipe. Yeah, I mean, these deals often are committed 30 days in advance, right, Bill? Yeah. I don't know if we call them a rate block, but it's almost a moral obligation to do what we said we were going to do, and we don't like to retrade deals. So some of that is still working through the pipeline. It worked through the pipeline in QC3, but I don't think we have any more of that really in Q4 in CIVIC or in the core bank.

Got it. Got it. And then lastly, I wanted to touch on credit. I mean, charge-offs have been very low for a while now, and I'm curious, now that we're kind of going into an economic downturn, that's kind of the general consensus, where do you think net charge-offs could go to kind of in a more normalized level or in a slower economic environment?

You know, it's really tough. to peg that in a bank like ours. I mean, we're not very actuarial. You know, we're not very consumerish. But we continue to do deep dives in all of our portfolios, focusing on things that are more hot buttons and headlines like office properties and things like that. And, you know, we're pretty optimistic on what we see within our portfolio. And for that matter, it's the banking industry overall. Again, you know, I think, great lessons were learned in the Great Recession, and banks were much more conservative in their underwriting and lending, and I think pretty optimistic about that. So I don't see any real ugly patches ahead, Bill. Do you have anything to add to that?

Yeah.

What I would say to that, Brandon, is that the past five to seven years inside of this company have really, in my mind, played itself out in terms of the stated numbers. You've seen mentions, non-accruals, really be at the lower end of our historical range. And I don't think that's a fluke. I think that's the direct result from all the work that's done. The composition of the balance sheet is materially different than it's ever been. And I think when you look out, you know, could you see like a bump here or there in terms of an individual credit? For sure. But I think the overall loss content, as I think we've continued to prove out quarter in and quarter out, I think is very, very manageable. So I don't think you're, like, I know that there's historically been some thoughts of the credit here, and I would point to the fact that the non-approval numbers have been near the lowest that we've ever had, and all the other metrics jive with that, special mentions, classifieds, criticized. So, you know, the intense scrutiny that Matt talked about we're doing on a daily basis is our job. That's what we get paid to do, and I think you're going to see it continue to show up in some pretty strong loans I mean, Bart, in venture, for instance, what has our charge-offs been for the past three years? I think net zero. Yeah, it's been very, very low. Which is pretty, just damn, what a great job.

Yeah, Matt, we're not recovering about $1.2 million through this year.

Yeah, yeah, I mean, and that's, but I mean, if you look at the previous two years, Mark, we were net positive too, I think, in recoveries.

Yeah, 2020 we were, but 2021 we were as well, yeah.

Yeah, it's pretty remarkable. You know, that's a business that, as you know, in tech and life sciences, if something goes wrong, that's a donut. I mean, it goes to zero. Now, we often can recover money, but you're not recovering at a high level. But I think our people have done a great job, and we've been able to keep the customers, and most importantly,

you know, keep that $12.5 billion, $12.2 billion in deposits. Got it. Thanks for all the color, and thanks for taking my questions. You bet.

And our next question comes from Chris McGrady.

Hey, good morning. On the NII guide, the slow growth or modest growth in Q4, If I put the pieces together for next year, like downish, flattish balance sheet, heard your comments on margins. Do you think NII can grow from that fourth quarter number into 2023, or is there going to be some pressure on that? We think it will grow in 2023. Okay, so grow off the Q4. Great. And then second, within the venture book, I think you said it was $12.2 billion. where's the composition of that in your deposit portfolio? How much is interest-bearing versus non-interest-bearing?

Yeah, they're breaking. I don't know if I have that breakdown here. Mark, do you happen to have that?

I don't have that breakdown, not for venture specifically.

We'll get back to you on it, Chris.

Okay. Thanks, Matt. And then maybe we'll actually do that.

Go ahead. No, go for it, Matt. The majority is going to be interest there. Yeah, I mean, you know, it's a money market.

Yeah. I mean, you're over 50 million, and there's a lot of depositors in that population that are over 50. But you have the overall, what's the rate on the overall portfolio of inventories?

It's 93 basis points.

Yeah, yeah. So it's more expensive, but it's

It leads, it's more driven by the 50 and over depositors for obvious reasons. You know, they're big depositors. They're going to put their hand out. When interest rates are at historic lows, they don't really care.

Got it. And just to make sure here, Chris, as well, I mean, the betas for the venture banks specifically have been tracking against other uprate cycles, too, so there's no anomaly here in that sense.

Yep, yep, got it. Thanks, Mark. Just one on the expenses for next year. I think there's an assessment for the industry, FDIC assessment that's going to go through. Is that, how should we think about the magnitude of that for you guys?

Yeah, I mean, we haven't calculated that out. I mean, we're going through the budget process now and looking at the assessments. Obviously, like I mentioned, we saw an uptick this quarter because of the assessments being higher on wholesale, so that had an impact on the Q2 assessment, and that'll have an impact on Q3 assessments. And so, you know, we'll see how that continues to play out based on where those deposits go. And then we'll look at the increase.

I read that too, Chris, and it looks very modest to me.

But we'll have to calculate it ahead.

Okay. Yep. Understood. Thank you.

Yep.

And our next question is coming from David Long.

Good morning, everyone. I wanted to circle back on the credit side of things. And, you know, a lot of your peers have been building reserves here ahead of any pressure, despite seeing no sort of kinks in the armor at this point. What would it take for you guys to really start building that reserve level up? Is it something you need to see Moody change their forecast? Okay, go ahead.

I mean, you have to see, you know, classifieds going up dramatically. You have to see some real you know, waves out there. But, I mean, if you go down and look through the components of our portfolio, you don't see a lot of risk there. I mean, our multifamily portfolio has held up, you know, and across the country, it really has. I mean, multifamily portfolios have held up really well. You know, I don't know. There has to be a big wave change. I just don't see it happening. But, you know, maybe I'm an eternal optimist. I don't know. Bill, you got any comment or Paul? No. What I would say about that is, look, we're preparing for whatever gets thrown at us. We're not seeing it today, and that's just capital and reserves. It's not singled out towards one of them.

You've got to keep in mind our NPA ratio is at 34 basis points, which is pretty low.

When you think about it, our ECL is still above our seasonal adoption slightly. And, you know, you have to think about where it's going to, I mean, where's, I think about it every day to tell you the truth. You know, where are the hot spots going to be? I mean, leverage finance, we're not in there. I think the consumer has got a lot of, you know, there's trouble ahead in my mind for the consumer. I mean, there is true inflation. I mean, I don't spend a lot of time at the grocery store, but I get a lot of comments from my spouse about, you know, how much more everything costs. What I do understand is when we go to a restaurant, I usually pay the bill, and I'm looking at it, and it's dramatically higher in, you know, costs, that sort of thing. I look at our bank. We're giving people raises, you know, much higher raises than we have in the past due to inflation, and that's here to stay. I mean, there's real inflation out there. And the consumer isn't keeping up with it. We hear that every day, you know, if you listen to the news. I mean, a 5% raise isn't going to keep up with what's going on with gas prices, food costs, and that sort of thing. So there's going to be, you know, there's going to be pain out there. I just don't think it manifests itself in a portfolio like Patent West so much. And, yeah, I think the other thing that you've got is your non-bank lenders have been much more aggressive. When you look at a large real estate project, what you commonly see is the senior debt, which is a bank, is, you know, anywhere from 50% to 60% leverage. And then there's 20% of MES after that. And the MES is charging them, you know, probably double-digit rates and then the equities. I mean, you're non-bank lenders of the guys that have a big risk on whether it's office or any kind of CRE, in my mind. And so I think you're going to see it there. The other thing a bank can do, and you guys have probably all heard me say this over the years, you know, when times do get tough and a borrower gets stressed, and we even went through that as most recently as the pandemic, particularly as it related to hospitality, we can be flexible with our borrower. We're not a CMBS. We're not a structured CLO or whatever. And we can, you know, we could back off the rate for a while, looking to fight another day and maybe getting, you know, improving loyalty from that customer. You know, we give up some income in the short term, but you, you know, you can keep from having a problem. And, you know, I've been in this business for decades and, you know, I've seen that happen and I've, As a CEO, I've been involved in those kinds of transactions, and it's really worked out well. That's the way to go about it.

No, that's great, Collin, and a testament to the way that you guys treat your customers. I appreciate the update on the underwriting yields on Civic. Do you guys have a specific reserve for that part of your portfolio? No.

We do. It is. Sure.

It's treated like every other loan asset class that we have. So it has its own reserve based on the history both inside and outside. You know, when you think about that business, and I do, not as much as Bill does probably, you know, you think about that business, there's decent down payments on these properties. And, again, our average loan size is $355,000. And there's real equity in those deals. And there's still just a huge need, you know, for affordable housing out there. It's going to get tricky. I mean, you know, again, a lot of these would be considered starter homes. And are people in that category going to go out and pay up 6.5%, 7% for a mortgage? Maybe not. So a lot of this business could end up fixed to rents. of which we have a sizable portfolio of that today, too. And that could be where it ends up in the short term. But I'm still pretty optimistic. I mean, we have much higher delinquency rates in that portfolio. We have, you know, as a percentage, we have higher non-accruals and that sort of thing. But in the end, we don't take losses. We have other people that are willing to step into those properties and finish them or whatever it might be. So I'm still pretty optimistic about that. And the Florida thing is going to be fascinating because there's going to, you know, there's clearly going to be rebuild in Florida. People want to be there. And, you know, some of these, some of the most desirable areas in that state got the hell kicked out of it and they're going to rebuild. It may not be the, the person that lives in that home today, but that person may be selling, uh, what's left of their house, uh, for land value and something better will be built there. I think, I think you've seen it all natural disasters. And I think somebody said that to us yesterday or later, you know, Katrina, I mean, they build back better by far. And, uh, not, isn't that a Biden thing? Go back. I'll take that back. But anyway, so, I mean, I think that you're going to see that, um, You know, going way back to the Northridge earthquake, you know, in California, you definitely saw that.

So, anyway, got it. Thank you. Thanks guys. Appreciate the color. Yeah, we had a question come in through the web chat.

So, it was asking for an update on the HOA acquisition. So, Bill, maybe you want to talk about that?

Yeah. So, the HOA business has been a great app for us. We spent the vast majority of 2022 integrating the platform into the bank, as well as starting to combine our legacy business with that business into one HOA business. Overall deposits have been stable and I believe somebody was asking about the betas there. Our betas in that group are amongst the lowest in the bank in terms of that. So we feel good about where we are. The plan was get it integrated and then look for growth in 23 and beyond. I would say that that was the plan and that's what we produced. So we feel really good about the diversity of funding and what it gives us for the bank Um, and we think it's, um, like we're really excited about all the hard work that our team has done, uh, to put it together and we're excited about what's to come there. Yeah. We're going to, we're going to really concentrate on the staffing there and, uh, try to really ramp it up. I love that business and I want to see, you know, we, we took our time to integrate it as, as, uh, effectively as possible and not lose customers, which we haven't. And, um,

And now it's time to grow it. Any others? Operator, are there any more questions?

And once again, if you'd like to ask a question, please press star 1, and we'll take our next question from John Arstrom.

Hey, good morning, guys.

Well, good job.

Good job. Can you talk a little bit about momentum and your production yields? I know you touched on a little bit at Civic, but you've got the 592 average for the quarter. What does that look like today?

What's that? You want to say to Bart?

I think, so what I would say is that you've seen the movement in the loan production yields move up pretty significantly. We talked about it a lot in the second quarter. about how both higher rates and mixed shift is going to continue to help that. I think you're going to continue to see that. And a lot of that is going to be a lot of the same stuff we've talked about, right? Higher rates, mixed shift, incremental production going to a higher yield. All of those things are going to contribute to that. I just think if you look at where our variable rate loans are, just off of spreads compared to how much LIBOR or SOFR has moved, you'll see that incremental yields will continue to keep creeping up from there. And it's super hard to be specific because it'll depend on the type of loan that is in there. Because you can see pretty wide variances between asset classes. But we feel it's going to continue to creep up.

Yeah, okay. That was a big step up in the quarter. Just a couple, Bart, what's left to do on hiring? You talked about Flanish expenses, but what do you feel like you have left to do?

Well, you know, we've, as Matt mentioned, we, you know, we're looking at every new hire, whether it's a new ad or a replacement. We have a process around that that we implemented in September. But we still are committed to our digital and innovation strategy, our Vision 2025. And so they had a slow start. We talked about this at the beginning of the year that there was going to be investment in this area. Very slow start in the first quarter. Saw the FTEs ramp up in Q2 and Q3, although Q3 was down from Q2. But we still have some hiring to do in that group to get to where we want to be. But I think the pace slows through the combination of the people they've already hired. and just taking a hard look at just FTEs overall. But I do think there's probably a little bit more there that we'll see in the fourth quarter, and then we'll see where that goes next year. I don't know, Paul, if you want to add to that.

Yeah, you know, that's an area we're looking at very seriously, and we are going to get more aggressive on that. As we've stated a couple times during that call, this call, I look at every new hire and every replacement that's VP and above. And I've got to sign off on it in order for it to be filled. So we're getting very serious on FTEs. That's been a lot of the increase. Civic is fully filled out in terms of FTEs. So there'll be no more civic creep. That's been about a half of our FTE increase. So again, we're going to get very serious about expenses here.

I mean, you just got it, guys. I mean, I think we're not going to be the lone rangers in the industry. I mean, you've got to look at every nook and cranny right now.

Okay. Last question, and I hate the question, but I'm actually kind of interested in the answer. But just, Matt, can you touch on, or Paul, just the quality of deals that you're seeing in competitive behavior? You know, some people say larger banks are pulling out of CREs. Other banks, you know, some of your peers are putting up kind of 8% to 10% annualized loan growth. But I'm just curious what your assessment is of the competitive environment and the quality.

Yeah, I think the deal flow, first of all, John, we've really curtailed the deal flow with the exception of, you know, very large deposit customers. And I think the deal flow has been good and the underwriting has been good and we've you know, you got a lot of guys pulling out, you know, maybe that was somewhat summer, but you got a lot of guys, you know, that were, you know, I mean, the rates are better, and not just the rates, the spreads, you know, where we were looking at, we were facing, you know, SOFR plus, you know, 275 on certain kinds of projects, those are clearly up 1%, SOFR 375.

But we've seen no real decline in the quality of the deal. Again, we're trying to slow it a little bit. We had tremendous growth in the first half of the year. And, you know, we've got to rebuild capital here. But also, we've got to prepare for, I mean, I think most of us believe there's some rocky waters in front of us, too. I think by slowing down, that's going to help insulators from potential losses, too.

I don't see competitors being willy-nilly or being overly aggressive right now. The aggressiveness we've seen, but it's not specific to this year. If somebody wants a product, they just price to win. It's not structured.

Very little decline in underwriting.

But, you know, we got a couple of deals that we have special mention on. We've got a big hotel that's being taken out by a debt fund. And I'm very happy about it. I mean, we didn't see a lost potential in it anyhow. But we just found that out this week, which is good news. And there was one other deal like that, too. Once again, it was a debt fund. And, listen, you're going to pay up if you go into a debt fund.

because they're going to give you more leverage. That's generally why they want to do it. That's good news. All right. Well, thanks, guys. I appreciate it. Thanks, John. Thanks, John. Anything else? Okay, great. Well, if there's no further questions, we really appreciate everybody's attendance, and we look forward to speaking with you next quarter. Thanks. Thank you very much.

This concludes today's call. Thank you for your participation and you may now disconnect.