Banc of California, Inc.

Hello, and welcome to Bank of California's fourth quarter earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touchtone phone. To withdraw your question, please press star, then two. Today's call is being recorded and a copy of the recording will be available later today on the company's investor relations website. Today's presentation will also include non-GAAP measures. The reconciliation for these and the additional required information is available in the earnings press release. The referred presentation is available on the company's investor relations website. Before we begin, we would like to direct everyone towards the company's safe harbor statement on forward-looking statements included in both the earnings release and the earnings presentation. I would now like to turn the conference over to Mr. Jared Wolf, Bank of California's president and chief executive officer.

Good morning, and welcome to Bank of California's fourth quarter 2019 earnings conference call. Joining me on today's call is Lynn Hopkins, chief financial officer, who will talk in more detail about our quarterly results and Mike Smith, Chief Accounting Officer and Director of Treasury, who will also be available during Q&A. 2019 was a terrific year for Bank of California, and in the fourth quarter, we continued to make meaningful progress on our core initiatives, resulting in net income available to common stockholders of $10.4 million and diluted earnings per common share of $0.20. I'll talk some more about the highlights in a moment, but first I want to welcome Lynn to our first earnings call with Bank of California. Lynn joined us just last month and brings a wealth of experience and knowledge to our leadership team. As we have previously discussed, Lynn and I have known each other for nearly 20 years and worked closely together for over a decade, so I know how much value she brings to our organization. She shares my vision of how we are transforming Bank of California into a relationship-focused community bank, and I look forward to working alongside her as we continue executing on the business strategy. I'll turn the call over to her in a few minutes. However, I want to first talk about some of the business results and trends that set us up well for 2020. When I joined the bank three quarters ago, and after careful analysis of the business, I gave our management team three initiatives to focus on in order to build short and long-term value for the bank. First and foremost, we needed to reduce our cost of deposits. During the fourth quarter, our cost of deposits was 1.27%. down significantly from the 1.67% we reported on my first earnings call. Through internal deposit incentive programs and a concentrated effort to remix our deposit portfolio, demand deposits made up almost 50% of our total deposits at year end, with non-interest-bearing deposits comprising just over 20% of total deposits, up from 13% when the year began. The second goal we set out to accomplish was lowering our quarterly expenses. Total non-interest expenses for Q4 were $47.2 million, which, when annualized, would be a 17% improvement over the full year of 2018. As we continue to transform the balance sheet and invest in business initiatives aligned with our core objectives, our operating expenses may fluctuate. I expect our operating expenses are currently in the lower end of the range for the near term. However, we will remain diligent to ensure our expenses are at an appropriate level and we'll continue to look for efficiencies. Finally, we targeted the asset side of our balance sheet, specifically non-core assets, with the goal of remixing the balance sheet in order to optimize the bank's earning power and lower our overall risk profile. During 2019, we lowered our securities portfolio from 19% of total assets at the start of the year to under 12% in Q4, and we significantly reduced balances of brokered multifamily and brokered single-family loans by 33% and 31% respectively. Our balance sheet is now much stronger with total assets at 7.8 billion. Further, as a result of these efforts, our NIM expanded to 3.04% for the quarter. As discussed when I joined the bank, the purpose of these three goals was to create a foundation that would have a sustainable franchise value and set us up for future success. We believe that foundation has now been established And while there is more work to do, in many ways we are a very different, more focused bank today than we were nine months ago. A key area of focus for us in 2020 will be keeping our balance sheet at the right size. As non-relationship loans pay off and we originate new, high-quality relationship loans that result in changing the mix of our balance sheet. This is a process, and our transition will continue through the year, but we are doing it from a base that is more representative of the bank we want to be. In addition to adding Lynn to the team, we also welcome Conan Barker and Andrew Thaw to our board of directors during the fourth quarter. Conan and Andrew have deep roots within the Southern California business community, and I look forward to their valuable contributions in 2020 and beyond. With their addition, our board is now comprised of ten directors, nine of whom are independent. Staying on the topic of corporate governance, in December we were pleased to be notified by the SEC staff that they have concluded the investigation opened in January of 2017, and that they do not intend on recommending an enforcement action against the company to the Commission. As you know, I expressed a desire to move past as much of this as possible, and we are excited to close that chapter and finish 2019 a much stronger company than when the year began, with a clear focus and stable foundation from which we intend to become a high-performing, relationship-based bank. I'll end my opening remarks by thanking our amazing colleagues at Bank of California for their tireless work this year. Our organization is filled with highly professional and capable team members dedicated to excellence and determined to ensure our clients receive the best possible service. It is through their significant efforts this year that we were able to successfully execute on all of our initiatives and are now poised to enter the new decade, a stronger and more focused community bank. Now I'd like to introduce Lynn Hopkins, who will provide more color on our operational performance. Then I'll have some closing remarks before opening up the line for questions.

Thank you, Jared, and thank you for the kind introduction. First, I'd like to start off by saying how pleased I am with the teamwork and enthusiasm I have gotten to be a part of since starting with the bank about six weeks ago. It's clear the team has been able to accelerate the bank's transformation considerably over the past ten months, and I think that is a reflection of their exceptional commitment to the company's vision, as well as the high-performance culture Jared has built in partnership with the executive team and throughout all levels of the organization. I am inspired to have joined such a great team and look forward to making a meaningful contribution for the benefit of all of our key stakeholders. Moving on to our quarterly results. Assets declined $797 million, resulting from a net decline in loan balances of $431 million, along with a decline in unsettled security sales of $335 million and a decline in cash of $153 million. These declines were offset by an increase of $137 million in securities. The bank benefited from this decline by reducing reliance on wholesale funding. During the quarter, in furtherance of our plans to create a more traditional securities portfolio, we sold the remaining $39 million of our longer duration agency mortgage-backed securities and purchased $192 million of new securities comprised of $126 million of agency commercial mortgage-backed securities, 53 million of municipal bonds, and 14 million of corporate debt securities. At the end of the year, CLOs represented 79% of our securities portfolio, and we remain comfortable with the credit quality. We will opportunistically look to transition out of the CLOs to the extent we find other interest-earning assets that provide an equivalent yield at the same or lower risk profile. At the end of the fourth quarter, our overall securities portfolio has a lower duration, and outside of our CLO balances, is transitioning to a more distributed and traditional bank securities portfolio, representing 11.7% of total assets. We expect to complete the rebalancing of our securities portfolio in the first quarter, and that securities will stay in a range of 10 to 15% of total assets going forward. We also saw positive effects from changing the mix of our loans within our total portfolio, as total commercial-related loans represented 72.4% of our loans held for investment, up from 71.3% at the end of the prior quarter. The overall decline in loan balances was due mostly to accelerated payoffs in the brokered single-family and multifamily portfolios, payoff from a few large CNI loans as we continue to timely manage our potential credit risk, and lower total warehouse loans. The decline in loans included reductions in most categories, including lower single-family residential mortgage loans of $185 million, CNI loans of $98 million, commercial real estate loans of $72 million, and multifamily of $69 million. The loan portfolio mix of brokered single-family and multifamily loans is 52% at quarter end, which is consistent with prior quarter end, but down from 59% at the end of prior year. And we expect these loans to represent a lower percentage of the total portfolio over time. In addition, C&I balances are 28% of our total held for investment portfolio, and within our target range for CNI loans of 25% to 30% of the overall portfolio. The new loan production totaled $182 million during the quarter at a weighted average rate of 4.82%. The average production rate has come down in line with the decrease in market interest rates generally. However, the fourth quarter average production rate is 11 basis points higher than the current average portfolio yield of 4.71%. On the margin, We believe this will continue to be the case as the loans we're bringing in are more relationship-based, which will then contribute to a better earnings profile and a stronger balance sheet in the long term. In the short term, the challenge, of course, will be to maintain our earning capacity as we rebuild the balance sheet against the backdrop of payoffs in the brokered portfolio. Overall, the loan portfolio yield declined by four basis points, quarter over quarter, as we have originated and repriced our loans in the lower rate environment, and as higher coupon commodity loans continued to be refinanced to other financial institutions. The fourth quarter loan yield does include seven basis points due to a higher level of loan prepayment fees and accelerated discount from the repayment of purchase loans. However, the positive impact of higher prepayment fees was not enough to offset the impact of lower market interest rates. Turning to deposits, total deposits decreased by $343 million during the fourth quarter, driven mostly by controlled runoff of higher costing deposits, including matured CDs that were not renewed and other non-maturity accounts. Brokered CDs decreased $54 million to zero, higher costing savings decreased by $157 million, and non-brokered CDs decreased $163 million. In addition, non-interest bearing deposits declined $19 million, while interest checking increased $31 million. While spot balances were down for non-interest bearing checking, average non-interest bearing checking and interest checking increased $95 million for the quarter. Non-interest bearing checking represented over 20% of our total deposits at year end. Overall, Our efforts to place a higher priority on gathering lower-costing, relationship-based deposits combined with the impact of lower market interest rates reduced our average deposit costs by 21 basis points to 1.27% from the prior quarter. We reduced our reliance on wholesale funds, including lower FHLB advances during the quarter. We used the proceeds from our prior quarter asset sales to pay down the FHLB advances by $455 million or 28%. We should continue to see the reliance on higher costing wholesale funds decrease in the coming quarters as our funding needs are expected to be achieved through our deposit initiatives. Looking at the income statement, net income available to common stockholders for the quarter was $10.4 million, or 20 cents per diluted common share. After adjusting for non-core items, along with the amortization expense associated with our solar tax equity program, our operating expenses for the fourth quarter were $48.1 million. Normalizing our tax rate to 24%, operating earnings from core operations were 18 cents per diluted common share for the fourth quarter. Reconciliations for this are located within today's earnings presentation. For 2020, we expect our tax rate to be in the 22% to 24% range. Net interest income was $56.7 million in the fourth quarter, down $2.3 million from the prior quarter due to the impact of lower average earning assets offset in part by a higher net interest margin. Average earning assets decreased $781 million and our net interest margin increased 18 basis points to 3.04%. The net interest margin expansion is due mainly to a 20 basis point decline in our overall funding costs to 1.55%, while the yield on interest earning assets remained flat at 4.50%. The earning asset yield remained flat due to an improved asset mix as higher yielding loans represented a higher percentage of our interest earning assets combined with an increased yield on our securities portfolio and offset by a lower loan portfolio yield. Loan interest income was down by $6.4 million from the third quarter due to a $478 million decrease in average portfolio balances combined with the four basis point decline in average yield as previously described. Interest income on securities declined by $2.2 million on lower average balances offset by a 12 basis point increase in the average yield to 3.72%. The increase in the securities yield is due to the higher yielding CLO portfolio representing a higher percentage of this earning asset class, offset by an overall lower yield on the CLO portfolio as the CLOs have reset lower based on three-month LIBOR. Fourth quarter interest expense from deposits decreased by $4.6 million due to lower average interest-bearing deposits of $468 million and a 21 basis point decline in the average cost of such deposits. Interest expense on FHLB advances decreased by $2.1 million from the prior quarter due to a lower average balance of $313 million and a four basis point decline in the average cost of these funds. The overall average cost of interest-bearing liabilities decreased by 18 basis points to 1.85%. Average deposit balances decreased by $408 million due to the decline in average interest-bearing deposits offset by a $60 million increase in average non-interest-bearing deposits. Average non-interest-bearing deposits represented 19.4% of total average deposits and this contributed to the lower total deposit costs and lower total funding costs as previously described. Looking ahead to the first quarter, we have a good opportunity to continue this trend and maintain our net interest margin above 3%. We will continue to focus on remixing our loan portfolio away from single family and into other high yielding loan types, which should help to offset the impact of the September and October market rate changes. In addition, With continued emphasis on relationship banking, we expect to improve both the mix and pricing of our funding base. We recognize the reversal in our provision for loan losses during the quarter of $2.7 million due to the $431 million reduction in total loan balances. The allowance for loan loss coverage ratio of non-performing loans is 133%, while the overall allowance ratio to held for investment loans is 97 basis points. Total non-interest expenses for the quarter were $47.2 million, and as I mentioned a few minutes ago, adjusting for non-core expenses, fourth quarter core operating expenses were $48.1 million, or 2.42% of average assets annualized. We expect, on average, our quarterly run rate expenses to remain below $50 million for the near term. As a reminder, there are historically more expenses built into the first quarter of the year, so we expect to see an uptick in expenses for Q1. Our capital position remains robust and above well capitalized, due mainly to a smaller asset base. Tangible common equity increased to 8.68%, up from 6.34% one year ago. Our Series D preferred stock is redeemable in June 2020, and we're currently evaluating various options for funding the redemption of our Series D preferred stock. In addition, the company filed a shelf registration statement on Form S3 with the Securities and Exchange Commission yesterday to provide the company with flexibility and enable it to access the public capital markets to respond to financing and business opportunities that may arise in the future. The company's prior shelf registration statement expired in August 2019. Finally, I'll move on to credit and asset quality. Asset quality remains strong as total criticized and classified loans declined by $25.8 million in the quarter. Our non-performing assets also decreased $1.8 million to $43.4 million as of year end. The decrease in non-performing loans was due to the sale of 11.9 million of non-performing loans and 4.1 million returning to performing status. offset by 14.3 million of loans being placed on non-accrual status. Our non-performing loan balance includes two large loans that make up 54% of our total non-performing loans. One is a $14 million shared national credit that went on non-performing status in the third quarter, and the other is a $9 million single-family residential mortgage with a 38% loan-to-value ratio that went on non-performing status in the fourth quarter. Aside from those two loans, non-performing loans totaled $20 million and approximately 48% are single-family loans. We believe the risk of loss on the single-family portfolio is low and that we are appropriately reserved, but due to consumer rules, single-family loans tend to take longer to work through. Our nonperforming loans to total assets ratio was 55 basis points at the end of the year, up from 52 basis points at the end of the prior quarter. The increase is due to a decline in total loans relative to the decline in nonperforming loans. The total delinquent loans increased by 1.3 million to 57.6 million, resulting in a year-end delinquent loans to total loans ratio of 97 basis points. The increase in delinquent loans for the linked quarters includes the addition of one $5 million CNI loan with a real estate developer that is expected to be worked out. Single-family loans represent 75% of the total delinquent loans, and the other segments reflect continuing positive results. That will finish up my summary of the fourth quarter financials, so I'll go ahead and turn the call back over to Jared.

Thank you, Lynn. was a truly transformational year for Bank of California. We accelerated the transition of the bank into a relationship-focused business bank. We executed on meaningful capital management activities to unlock value within our balance sheet and deployed excess capital into areas which better optimized our business. We are remixing our entire balance sheet to drive the earnings power of our franchise, and we reduced our expenses to better fit our size and footprint. What you have now is a bank with a solid foundation upon which we can build a high-performing, relationship-focused business bank for the long term. We would not have been able to accomplish so much this past year if not for our talented Bank of California colleagues and their unyielding dedication to meeting and exceeding our clients' expectations. By providing superior service and solid solutions for our clients, we develop relationships built on trust and instill confidence that our clients will have all of our resources at their disposal and our high-touch service to meet their banking needs. Our focus on service is a hallmark of PANCA California, and we look forward to serving you via more business clients in the upcoming year. We make sure that we listen to what our clients are telling us. Last quarter, I updated you about various technology initiatives we were working on, and some of which resulted from feedback from our clients. We will constantly evaluate how we can improve our clients' experience and continue evolving our technology to meet the increasingly integrated needs of our business clients. Now that we've successfully executed on our strategic initiatives for 2019, we are well positioned heading into 2020 to show improvements on both sides of the balance sheet. Our teams are focused on bringing in relationship loans and deposits, and as a result, we expect to improve our mix of deposits as well as our overall costs while maintaining our loan yield as much as possible. The loan remixing will also result from the normal course payoffs of brokered SFR and multifamily loans. and we will redeploy that capital into lower duration, higher yielding, C&I, and bridge real estate loans. As we've stated before, over time, CRE loans, which are comprised of commercial real estate, multifamily, and construction balances, should move closer to a range of 70% to 75% of our total loan portfolio, while C&I loans make up the remaining 25% to 30%. This will be due mostly to initiatives to grow our portfolio of relationship real estate loans, and the incremental business it is expected to generate for the bank. Over the next few quarters, pure earnings might be a little more tempered as we build assets back up. However, we are building this bank the right way for the long term and creating true franchise value in the process. As we head into 2020, we have several key objectives we are focusing on for the year. Cost of deposits, the mix of our loans and deposits, and our net interest margin are the areas where we expect to show progress throughout the year. Additionally, our key objectives for 2020 include the rollout of technology initiatives, as well as the further training and development of our colleagues to ensure our teams have the skills and strategies to succeed in this highly competitive market. We are in the midst of an exciting and rewarding multi-year transformation, and I look forward to showing progress on these initiatives as much as we succeeded in 2019. Thank you for listening today, and I look forward to updating everyone on our progress toward those initiatives during our next quarterly earnings call. With that, let's go ahead and open up the line for questions.

Thank you. Ladies and gentlemen, we will now begin our question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our roster. The first question today comes from Matthew Clark of Piper Sandler. Please go ahead.

Good morning.

Good morning, Matt. How are you?

Good. Maybe the first question, just wondering what the spot rate was on your interest-bearing deposits at the end of the year.

Spot rate. Hi, Matt. This is Lynn. We did not disclose that in our materials quite yet, so we will be providing that subsequent to the disclosure.

We can tell you what the averages were. So for overall, it was 125, as you know. For CDs, it was 224. And there's a big bulk of CDs that are going to be repricing in the first quarter. And so we expect you know, to have the opportunity to reprice those down. Interesting. Yep.

That's fine. Okay. And then just on the size of the balance sheet, it looks like it might be down a little bit further here in the first quarter. But I guess what are your thoughts on the size of the balance sheet from here and your net loan growth prospects?

Yeah, it really depends on the payoffs. If the payoffs continue at the same pace that they did in the fourth quarter, I would expect for the year for a balance sheet to remain flat. or perhaps a little bit larger, but not much. If payoffs reduce, then we should be able to show more growth through the year. The single-family and multi-family loans that are on our books that are higher yields are repricing notwithstanding prepayment penalties. That's how much of a delta there is with rates. And so it's just to be seen how much they're going to reprice.

Okay. And then Just on capital, I mean, smaller balance sheet, your capital ratios jumped quite a bit this quarter. And you comment in the release about opportunities to deploy it to optimize, franchise, and improve earnings. Can you just talk more about what you mean there?

Sure, sure. So, obviously, the balance sheet size coming down means we do have a lot of excess capital. So, We did file the shelf registration statement yesterday with the SEC, so that should give us options as we look forward to 2020. The preferred stock, Series D, is redeemable in June, so we're taking a look at that. And then we're evaluating other options as well with the additional capital.

Okay. And then just any update on CECL and what the day one impact might be?

Sure. I believe in the third quarter release, the 10Q, we had given a range of about 0 to 25%. So as the balance sheet has come down during the fourth quarter and we've continued to run our models there, I think we've refined our range to be between 0 and 15%.

I think it will be the upper end of that range as of now. We're going to keep looking at it and You know, we have until 331, but I think it's going to be, you know, as of now, Matthew, it's feeling like it's the middle to upper end of that range. Okay, great. Thank you.

The next question today comes from Tamir Braziller of Wells Fargo. Please go ahead.

Hey, Tamir, we can't hear you.

I'm sorry. Is this better?

Yep. How are you?

Good. How are you? Sorry about that. Good. Am I correct in that you exited all of the brokered single-family mortgages this quarter?

No. I mean, we still have a portfolio of brokered single-family mortgages. That's fairly substantial. They are truly brokered. They're non-relationship-based. We don't have much of a connection with the borrowers, and so we ceased that business originating those loans several quarters ago. And so there are payoffs that are going to occur with that portfolio.

Okay, so the business has been exited. Okay, and so I guess what's the balance of the brokered SFR and multifamily loans?

I don't think we break out the distinction between what's brokered and what's not in our financials. So we can tell you the size of the portfolios, but we don't break out what's brokered and what's not. It's kind of a mixed bag. You know, I would look at the pace of payoff in the last quarter, and as of right now, we don't know that that's going to change. And so we're originating new loans to replace those loans. And so we think the remix will improve our balance sheet. We'll have more – you know, we're getting deposits with every loan that we bring in. And, you know, I'm pleased that we were able to hold our portfolio yield pretty well. And so we're getting the leverage from, you know, reducing our deposit costs much faster than our loan yields are declining. But – It's to be seen. I mean, it's just something we can't control, and we just want to keep putting on really good loans.

Okay, that's helpful. And you had mentioned that there's a large chunk of CDs that are maturing in the first quarter. Can you quantify that number and what the expected cost benefit is if you do keep those on, or is the expectation that they roll off?

While we're looking for the exact number, Lynn, what's our going rate right now for the CDs that we think?

They're in the range of $150 to $175. Specifically, in the near term for the first quarter, the CDs that are coming up are around $250 million, and they have a weighted average rate right now around the $240 mark. So they'll be pricing down into the current rates.

And our retention rate on those CDs is around 50%, maybe a little bit higher? So we're not gonna save all of them. Some of them are just, they're just gonna go shop at the highest rate, but our retention rates have gone from like 18% all the way up to 50 as we revise our model and figure out what we wanna keep. We could keep all of it. It's just I think we can do better than that, and we're trying to get the most pricing leverage we can.

Okay, and as that translates into broader funding costs, impressive move this quarter. Is the expectation that the pace of future funding cost declines kind of decelerates, or as you guys look out at the funding schedule, is this type of pace going to be sustainable for at least the next couple of quarters?

Well, I think a lot of the low-hanging fruit has been eliminated. I would be very pleased if this quarter we were able to match last quarter. I appreciate your comments, and I agree it was a healthy drop. It's really going to depend upon our pace of bringing in DDA, non-interest-bearing and low-cost checking accounts. And I think we have a big opportunity there. We have some chunky CDs, but we have less than we used to. And so over time, the bigger impact is going to be coming from the pace of new clients with new money coming in at low rates with business accounts and less from repricing our existing portfolio.

Okay, and just one last one for me. Looking at the gain on sale of loans category, any help you can provide there and how we should be thinking about that going forward? I know that line has kind of been all over the place recently, but any guidance there would be helpful.

So I think we have the opportunity to do that going forward. It's just going to depend on – we have a great multifamily engine. we have the opportunity to generate loans that we might not want to hold because of the low yield, but, you know, the market will give us benefit for it and we can have some gain on sale. And while we build up our other business lines and while the teams that we hired, you know, get stabilized and start building up their pipelines and generating growth, that may be a lever that we choose to pull. You know, I don't believe that long-term having a huge gain on sale line is is true franchise enhancing. But I think, you know, we want to keep earnings up. We want to keep producing money for shareholders. And so to the extent that that's a lever we choose to pull, we would look to do so. Great. Thank you.

The next question today comes from Luke Wooten of KBW. Please go ahead.

Hi. Good morning, guys. Hey, Luke. I just wanted to talk – I think you guys had given – the CDs you guys said were repricing, they're currently out of 240, and you were saying you guys are – current offering rate is 150 to 175. Did I hear that right?

Let me just clarify. These are – we're working with the clients on a relationship basis, so we're reaching out to them and looking to work with our customers. So it's not gonna work for everybody. This isn't necessarily a posted rate. So this is us doing outreach with our customers and valuing those relationships. So we do expect them to re-price down.

Okay, that's definitely helpful. And then I think just one of the earlier questions was just on the brokered single family residential portfolio. Just kind of trying to frame what the yield cutoff would be just as those pay off. I mean, with that portfolio currently yielding around, I think it's like 394. So we should see that come down. Is there a rate that you guys are posting for the single family portfolio that we can kind of use as a benchmark? Or is it still kind of not disclosed?

When you say rate that we're posting for, what do you mean? Because we're not originating single family.

Okay. But I didn't know if there was – so that entire – I mean, just based on that single-family portfolio, I mean, you said that there was a portion of it that was brokered and then a portion of it that I imagine was originated and held internally. So I didn't know if there was anything.

Luke, I will tell you that a massive part of that portfolio was just broker-originated. I mean, there are no deposits associated with it. Okay. So, you know, they're all strong loans. We think, you know, the credit quality is good. It's a disproportionate percent of our NPLs, but, you know, relative to the size of the portfolio, it's very, very small. And so we think it's good credit quality. I'd be happy to keep it. I think for a community bank and for a relationship-focused business bank, obviously, you know, having a large SFR portfolio is not what you would normally see in the mix. So we anticipate replacing those loans over time with better-yielding relationship loans where we get deposits. I don't have a cutoff for you of where that's going to settle in terms of loans. My expectation is that payoffs are going to slow. I mean, I think if to the extent that you wanted to reprice your multifamily loan or your single-family loan, just in talking to clients, people wanted to take advantage of interest rates when they moved, and they wanted to do it before interest rates moved again. you know, at the possibility that they could go the other direction. So I think there was a huge urgency around it, and I think people repriced it. There may be others that lag, and so I expect there will be more payoffs. I have a hard time thinking the payoffs are going to be at the same pace, but it's to be seen, and our expectation is that we're going to replace that runoff with new high-quality loans.

Okay. That's really helpful, Collar. Thank you for that. And then, Lynn, just a question for you. I mean, touching on the investment portfolio, there was great success in the repositioning this quarter given the pickup in yield and just kind of wanted to know what reinvestment rates are on that portfolio and if we should see – I mean, because obviously it's moved from I think essentially all CLOs to now just I think they're roughly 70%. And I didn't know if there should be more repositioning in that manner towards diluting the effect of the CLOs in the securities portfolio or – Do you mind giving us a little update on that?

Sure. So I'm going to say generally with the investment portfolio, we're looking to keep it in the range of about 11% to 15% of the balance sheet, probably at the lower end of the range. The CLOs now represent obviously a higher percent of that. At the end of the third quarter, there was some unsettled securities that came in in cash, and that was re-deployed during the fourth quarter, which I addressed. There's still a portion that we're addressing during the first quarter. But during the fourth quarter, I'm going to say the reinvestment rates ranged between about 240 up to, at the high end, I think 4%, I'm going to say. The key there is that the duration is shorter. So to the extent that we came out of a 240 rate, those were longer duration. And we went back in at a 240 rate for a shorter duration. So they were better structured, even if the rate was similar. So the range is about 240 up to about 4% based on the type of security. And we're looking to invest in sort of the same diversified basis that we were able to do in the fourth quarter. As far as the CLOs, just generally, we don't necessarily have any plans to sell them specifically. I appreciate that they are a large portion of the portfolio, but until such time, we have an opportunity to redeploy them into another interest-earning asset class with similar credit quality. We'll probably hold on to those.

Okay. That's definitely helpful. And then... Just one last one for me. I mean, and you kind of touched on it earlier just with the S3 filing and everything like that. I know historically you guys have kind of tempered with the idea of potentially issuing some sort of sub-debt just to kind of either buy back stock or pay down the preferred. And I didn't know if that was still in the toolbox or, I mean, given the current capital ratio, if you think that you wouldn't have to kind of issue any capital in order to redeem some of the outstanding.

We probably don't have to. I mean, you know, we have $96 million come in due in June of 2020, and then we have another slug come in due in June of 2021. We want to be smart about it. You know, we don't know which way rates are going to move, and we want to be, you know, appropriate with our capital. So we are looking at issuing subdebt. We haven't made a decision yet. Rates are pretty attractive. There's obviously, you know, with the trading at seven and three-eighths, the preferred, You know, obviously with sub-debt, you would have interest expense deductible above the line. And so whatever rate we go out at, you know, is going to be immediately accretive relative to the preferred. I don't think we're going to need to issue $100 million. You know, we have plenty of capital, so we can use a combination of stuff. But we're looking at all those options.

Okay. That's really helpful. Thank you guys for taking my questions. Thanks, Luke.

The next question today comes from Gary Tenner of DA Davidson. Please go ahead.

Thanks. Good morning. Morning, Gary. Hey, a couple of questions here. So on the loan production for the quarter, you know, understanding that the payoff activity obviously drove numbers down, but, you know, can you talk about specifically within CNI and CRE where you're having the most success bringing in the types of credits that fit your profile and kind of relationship banking focus?

Yeah, sure. So, you know, I think there's two areas where we're going to show the most growth, both in actual dollars and percentage dollars. So on a percentage basis, we're going to show the most growth in traditional CNI loans to businesses in our footprint. And I think we've talked about in the past, you know, I don't think we were doing a very good job at that previously. We didn't have the right team in place. We've built the right team. We're adding players as we talk. And I think just traditional lending to businesses in our footprint of all stripes, you know, lines of credit and term loans is going to show good growth for us because we're starting from a relatively low base. They're all coming with deposits. These are, you know, doctor offices. These are manufacturing facilities. These are, you know, local businesses that need our specialized service and appreciate our execution. From a dollar percentage, I think we're going to show probably the most impact from bridge lending on the CRE side. Lending to well-heeled real estate sponsors who are active in denser markets where we have our footprint, who are buying properties, they need to rehab them, and then ultimately they'll take them out with permanent financing from us or somebody else. That's a big part of the market in Southern California. You get paid more for execution and for ready access to capital. And when you're lending to people who do this over and over again for multifamily and other types of properties, you can build up a good track record and they call you and say, hey, that building we did last time, we got another one just like it, and you become their go-to lender. And we're really focusing on that with the team that we've brought in. You know, as I said in the prepared remarks, it takes time to build this stuff up. And we're in the middle of a process in terms of transforming our bank. it's not gonna happen overnight. And so over this year, we look to remix the balance sheet and I think the real growth is gonna come in terms of higher levels of loan growth next year. I could be wrong because payoffs could temper and then we'll have the opportunity to show real growth along with deposit growth. But for right now, I think it's gonna be kind of a remixing story and hopefully that's gonna make us more profitable.

Okay, thanks for the color there. And then just one other question. You guys have been under $10 billion for four consecutive quarters now. Can you remind us what the mechanics are for a bank to get out from under Durbin if it dwells under $10 billion for some period of time, and just from an impact perspective, if that would be meaningful?

Yeah. So we have effectively no Durbin impact here, but I can talk more generally about being at $10 billion and what it means from a regulatory perspective. Generally, the regulators want to see you stabilized. for a long period of time to make sure you're not bouncing back and forth between, you know, the different tiers of regulatory oversight. So, you know, if there's no prospect of going back over, they'll kind of look at you and say, okay, it looks like you're below $10 billion and we'll treat you as such. We don't see a major impact from being below $10 billion. You know, we have a really good relationship with our regulators. It could be the timing of exams. Maybe you'd have them less frequently, or they might group them a little bit differently. We're not that complex a business to begin with. We're pretty simple. But we don't see a major impact from a regulatory perspective being above or below $10 billion.

Great. Thanks, Eric.

No problem.

The next question comes from Steve Moss of B Reilly FBR. Please go ahead.

Good morning. Morning, Steve. I want to start off on credit. I realized from the comments on the call that there was a decrease in classified and actually an increase in criticized. I'm wondering, in particular, if you could give some color around the $24.9 million commercial credit that was downgraded in the quarter, what industry type and so forth.

Yeah, it's a C&I credit. You know, it's a client that we know they were going through some changes. We expect that loan to be upgraded possibly this quarter, but, you know, if it's not this quarter, it'll be next quarter.

Okay. And then just as we think about the loan loss provision in the reserve, ignoring CECL for the moment here, you know, kind of hard to see whether or not, you know, call it relatively stable balances. What would you expect for credit costs here going forward?

You're right. This is a tough one given we're going to adopt CECL on January 1st. So, What I would expect is with the balance sheet or the loan portfolio continuing to undergo its remixing, to a certain extent the balances will be, let's just call them relatively flat as the single family and multifamily continue to pay down and we're originating loans in our core business line. So, based on the factors and the modeling, we would expect that there would be provisions related to the new production, but it's You know, again, we're assuming the impact to be, you know, around between the, call it 10 to 15%, and then we'll be carrying it forward from there based on our current quarters production. As we all know, we're recognizing the provision for the entire estimated life of the loan at the time we put that on the balance sheet. So, it could be elevated levels as we move forward.

Yeah, I mean, Cecil really penalizes duration. And so to the extent that we're no longer originating long term fixed rate loans, we're going to benefit there. But we can't, you know, what we have in our portfolio is what we have in our portfolio. And, you know, that's going to get marked under Cecil day one. Also, Cecil has, you know, different peer averages for the different classes of loans that you put on. And so we're, you know, by March 31st, we will have gone through this process and figured it out. I think one thing that's going to affect banks generally is is they're going to have to price loans differently. The CECL impact could be punitive, and you've got to figure out and make sure that you're making money on your loans, and so that could change pricing on some loans. And that's something that we're looking at very carefully. And it's something that we thought about as we thought about the asset classes and the types of loans that we wanted to go into going forward to make this bank as good as we can. On credit generally, though, Steve, I will tell you that we feel really good about it. I mean, our credit is is very stable. Overall, criticized and classified loans went down by $25 million. We had an uptick in the classified, as you mentioned, but criticized went down by $40 million. And so the combined group went down by $25. So I think we feel good about it, and I'm not seeing any signs of weakness on the horizon that make me nervous. We've got those two large NPLs, one's in SFR, which is $9 million in is a low loan to value and it just takes time to work out. And the other one is the shared national credit we've talked about in the past and everybody knows we're not doing those anymore. So overall, I feel good about our credit quality.

Okay, that's helpful. And then on the securities portfolio, you guys talked about completing the remixing here in the first quarter. Just wondering for the purchases, should we look for a similar level of municipal securities and corporate debt securities purchases? And kind of what is the level of credit risk you're interested in taking within the securities portfolio?

So generally, I would start with the credit risk that we're taking in the securities portfolio. It will be a high-quality securities portfolio, so there'll be limited credit risk, generally speaking. And we are interested in some municipals as well as agency securities. So I think you can expect to see a similar mix going forward.

Okay, so the BBB portion of the portfolio is not likely to grow much, basically?

Yeah, that's a fair comment.

Okay, that's helpful. And then in terms of just the – on the capital front, one more time. Sorry if I missed this. In terms of return, it sounds like you guys are looking to return capital. I know it's about the preferred capital. but does that include any thought on buybacks?

We're evaluating everything. I mean, we're looking at it all, and we obviously have enough capital to take more than one action, and so it's something that we're currently evaluating. Okay. Thank you very much. No problem. Thank you.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.