Banc of California, Inc.

Hello, and welcome to Bank of California's second quarter earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. 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 additional required information is available in the earnings press release. The reference presentation is available on the company's investor relations website. Before we begin, we would like to direct everyone to the company's safe harbor statement on forward-looking statements included in both the earnings release and the earnings presentation. I would like to now turn the conference call over to Mr. Jared Wolf, Bank of California's President and Chief Executive Officer.

Good morning, and welcome to Bank of California's second quarter earnings call. Joining me on today's call are Lynn Hopkins, Chief Financial Officer, who will talk in more detail about our quarterly results, as well as Mike Smith, our Chief Accounting Officer, and Bob Dyke, our Chief Credit Officer, who will all be available during Q&A. Our second quarter performance reflects both the conservative, well-capitalized bank we have built that is well-positioned to manage through the impact of COVID-19 pandemic, as well as a bank that has reached an inflection point in its transformation from restructuring to growth. We continue to benefit from the inherent advantages we had entering the crisis. Most notably, high levels of capital and a well underwritten credit portfolio, predominantly secured by Southern California real estate with relatively low loan to values. Approximately 66% of our loan portfolio is secured by properties that serve as primary residences, including the SFR, multifamily and warehouse portfolios. And we have very limited exposure to stressed industries such as hotels, restaurants, energy, airlines, and other hospitality. Through our hard work over the past year, we have substantially enhanced the long-term earnings power of the bank by improving our deposit base, lowering our cost of funds, increasing our net interest margin, and reducing operating expenses. These efforts have enhanced our operating leverage and brought us to an inflection point where we believe we are positioned to deliver profitable growth and generate higher levels of returns, subject to, of course, economic recovery from the effects of the pandemic. Despite the challenges created by the coronavirus, we continue to execute on our strategic initiatives and the transformation of our balance sheet. The runoff in our SFR portfolio continues with the low interest rate environment, while the Paycheck Protection Program enabled us to fund the type of relationship-based commercial loans that we are targeting. As a result, at June 30th, loans to commercial customers increased to 75% of our total loans, up from 73% at the end of the prior quarter and 70% at this time a year ago. In other key areas, we made substantial progress in the second quarter. Our non-interest-sparing deposits increased by $135 million, or 11% from the end of the prior quarter, with a portion of this growth attributable to PPP loan proceeds received by our commercial customers. Over the past year, our non-interest-sparing deposits have increased 40%. This has resulted in significant improvement in our mix of deposits. Non-interest-sparing deposits comprised 23% of our total deposits at June 30th, up from 16% at this time a year ago. The improvement in our deposit mix, along with the lower interest rate environment, contributed to a further decline in our average cost of deposits this quarter, which dropped to 71 basis points from 111 basis points in the prior quarter, and reached a spot rate of 59 basis points at the end of the second quarter. Largely as a result of the substantial reduction in our cost of deposits, our net interest margin expanded by 12 basis points compared to the prior quarter, reaching 3.09%. We believe the progress we are making reflects the clarity of our vision and the consistency of our execution. Our organization devotes considerable resources to providing high quality deposit products and high touch services that enable us to gather low cost deposits and to deploy them profitably into relationship based loans to small and mid-sized businesses. While the value of these deposits may not be as obvious in a time like this, over the long term, this focus and execution will provide a stable funding base that will protect both margin and earnings and translate into true franchise value. The investments we have made in personnel and technology reflect our commitment to developing multiple channels for bringing in low-cost deposits. We are seeing strong deposit-gathering contributions from all areas of the company. from our specialty deposits and private banking team to our relationship managers in both community and business banking, as well as the commercial and real estate banking teams who are successfully increasing our deposit share of existing clients and adding the operating accounts of new clients each quarter. On top of our core business strategies, we have some additional opportunities to accelerate our progress as market conditions and timing permit. One of these opportunities was terminating our naming rights agreement with LAFC, which we were able to complete in the second quarter. Under the terms of our new agreement, we have been released from over $89 million in future expense. While still retaining our position as LAFC's primary banking partner and remaining as a partner in a number of other collaborations, our restructured relationship will save the company approximately $7 million per year for the next 12 and a half years. While the one-time charge associated with terminating our naming rights agreements impacted our second quarter results, this is a significant step forward in our continued efforts to reduce expenses and approve our future operating leverage. Let me address our near-term focus of managing the impact of COVID-19. We accommodated a significant number of deferral and forbearance requests for our clients early in the quarter, and the pace of our loan deferral activity declined dramatically as we moved through the quarter. After approving a total of 205 loan deferrals in March and April, we approved 87 deferrals in May and just six deferrals in June. We ended the quarter with 298 active deferments on $604 million of loans, or approximately 11% of the loan portfolio, and this includes both SFR, where deferments are actually forbearances, and non-SFR loans. A chart in our presentation lays out deferrals by asset class. Many of our borrowers with deferred loans are now coming up on the expiration of their 90-day deferral periods, and we are reviewing their current financials as we evaluate extensions of the deferral periods. For those commercial borrowers that demonstrate a continuing need for a deferral, we generally expect to obtain some additional credit enhancements, such as additional collateral, personal guarantees, or putting in a reserve in order for an additional deferral period to be granted. We expect the legacy SFR loans to run with a higher percentage of deferrals or forbearances due to the consumer rules, but that portfolio is well underwritten with an average loan-to-value below 60%. As the Paycheck Protection Program has been extended, We continue to offer these loans as a means for helping clients manage through the crisis. We ended the second quarter with 262 million in PPP loan approvals for businesses that represent an aggregate workforce of more than 25,000 jobs. We viewed PPP loans as an opportunity to reinforce the high-touch client experience that we offer at the bank. So rather than opening up an online portal to take applications, we had our relationship managers guide our clients through the entire process to ensure a successful application and timely funding. Additionally, we believe this approach will provide administrative efficiencies to facilitate the loan forgiveness process with our clients. While we focused on serving existing clients with our high-touch model, we also used our framework to attract new clients and used the PPP to differentiate ourselves, showing how true service can make a difference. As a result, we were able to add many new clients who are consistent with the type of commercial customers that we are targeting in our traditional business development efforts, substantially all of whom brought over their primary deposit relationship. New clients accounted for approximately 25% of our total PPP originations. We saw an increase in delinquencies and non-performing assets due mostly to one $11.5 million relationship that is well secured by both commercial and single family properties. Additionally, we took a specific reserve of $5 million related to the legacy shared national credit that has been on non-accrual for several quarters. Lynn will address the components of the provision bill under CECL for the quarter. Before I turn the call over to her, I want to briefly address our CLO portfolio, as we received a number of questions about it following a piece on the CLO market that appeared in the Atlantic last month. While it isn't our place to be defenders of the overall CLO market, and many investment banking analysts and firms did an excellent job of rebutting some of the assertions made in the Atlantic piece, and I would highlight Wells Fargo's analysis in particular. We do want to provide as much information about our particular CLO holdings as possible so that our shareholders are comfortable that we have minimal loss exposure in our portfolio. As with last quarter, in our slide deck, we have included some detailed information that should be helpful in understanding the level of risk in the portfolio. Without getting too much into the weeds on this, the key takeaways from our CLO portfolio are as follows. One, it consists entirely of AA and AAA rated securities. Our portfolio is broadly diversified with minimal exposure to severely stressed industries. Three, our analysis indicates that the underlying securities would need to experience approximately 25% of losses before we would take our first dollar of loss. And our analysis was also supported by the conclusions reached by two other brokerage firms. And lastly, and perhaps most importantly, Moody's data shows that no U.S. AA or AAA rated CLO has ever had a principal impairment. All that being said, we still consider the CLO portfolio to be non-core legacy assets that we want to diversify away from as market conditions permit. Following the dislocation that occurred in the CLO pricing at the end of the first quarter, we saw tighter spreads at the end of the second quarter that reduced our unrealized loss in the portfolio by 44.8 million, or approximately 63 cents per share on an after-tax basis. Given the level of credit enhancement we have in the portfolio, We continue to believe that at this point in time, we are best served by holding the securities until there's a more attractive opportunity to trade out of them. When the timing is appropriate, we would view this as another one of our larger opportunities to accelerate the progress of our franchise by removing the volatility that this portfolio experiences and diversifying and amplifying our investment returns. Now I'll hand the call over to Lynn, 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. First, as mentioned, please refer to our investor deck, which can be found on our investor relations website, as I review our second quarter performance. The net loss available to common stockholders for the second quarter was $21.9 million, or negative 44 cents per share. Our net loss and net loss per share were impacted by our decision to exit the long-term naming rights agreement with LAFC, which resulted in a one-time pre-tax charge of 26.8 million and a provision for credit losses of 11.8 million. In addition, during the quarter, we recognized the $2.5 million debt extinguishment fee for the early termination of $100 million in FHLB term advances and a $2 million gain on the sale of $21 million in corporate securities. The core operating performance of the company is more accurately reflected in our adjusted pre-tax, pre-provision income of 16 million for the quarter, which compares to 12.2 million in adjusted pre-tax, pre-provision income for the prior quarter. We continue to build momentum in our core underlying earnings power, and we think we can continue that progress in the second half of the year and into the future. I will start by reviewing some of the highlights of our income statement before moving on to our balance sheet trends. We saw strong growth in our total revenues compared to the prior quarter, driven primarily by a 6.7% increase in net interest income. The increase in net interest income resulted from a combination of higher average rate assets of $165 million and an increase in our net interest margin. Our net interest margin reached 3.09%, an increase of 12 basis points from the prior quarter, as our cost of funds fell by more than the yield on our averaging assets. As Jared highlighted earlier, our average cost of deposits fell 40 basis points to 71 basis points during the second quarter and illustrates the progress we have made in improving our deposit franchise. Also as mentioned, the spot rate for our cost of deposits at the end of the quarter was 59 basis points. This is 12 basis points below the second quarter average, and it will provide us additional opportunities for NIM expansion in the third quarter. In addition, we have 497 million of CDs maturing over the next six months with a weighted average rate of about 1.7%, which will further reduce our cost of deposits. In late June, we restructured $111 million of FHLB term advances, lowering the rate of such advances by 79 basis points while extending their duration about two and a half years. And we prepaid $100 million of FHLB term advances, which had a November 2021 maturity date and a 2.07% interest rate. As a result, the aggregate cost of our FHLB advances are expected to further reduce our overall cost of funds going forward. Turning to our earning assets, our average loan yield declined eight basis points from the prior quarter. Reflecting both the challenging interest rate backdrop and the relatively limited exposure to repricing within our existing portfolio, given that a large portion of our fixed rate and hybrid loans are not scheduled to mature or reprice for at least three years. During the quarter, we collected $7.5 million, or approximately 3%, in fees on PPP loans, which we recognized through interest income over an estimated life of nine months. Funded PPP loans added three basis points to our second quarter NIM. While our loan yield only decreased eight basis points, our earning asset yield decreased 21 basis points due primarily to our CLO portfolio repricing down into the current market, as well as temporary excess liquidity being held in lower-yielding assets. Briefly, non-interest income increased $3.5 million to $5.5 million. The second quarter included a gain on sales securities of $2 million, and the prior quarter included an unrealized loss of $1.6 million to record loans held for sale at their fair value. These accounted for the majority of the linked quarter increase. I would also like to mention the three-year burnout from the sale of the bank's mortgage banking division, which contributed average quarterly fee income of approximately $800,000, concluded in the second quarter. Moving on to non-interest expense, while there's been a fair amount of volatility in non-core expenses, which I'm happy to address in Q&A, core expenses declined 13% from last year's second quarter to $42.8 million and decreased by $558,000 from the first quarter. We received some benefit from reduced regulatory assessment costs for being below $10 billion in assets for four consecutive quarters. The second quarter regulatory assessment costs are reflective of our current run rate and higher than first quarter, which benefited from an FDIC assessment credit. While the core expense to average assets ratio increased 16 basis points year-over-year to 2.22%, it's important to keep in mind that our total assets declined by 17% year-over-year as we worked to reduce non-core assets and transform into a relationship-focused business bank. Turning to our balance sheet, our total assets increased by $108 million in the second quarter to $7.77 billion as we continued our repositioning efforts. We remained focused on increasing relationship-based lending. As of the end of the second quarter, we had $262 million in PPP loan approvals, of which $250 million had been funded. The PPP production offset the expected runoff of our legacy single-family residential portfolio, which declined by $97 million and declined in most other loan portfolio segments. We continue to expect a relatively flat balance sheet for the year, but also expect our operating leverage to continue to expand. The investor presentation includes updated details on the disclosures we provided last quarter around our loan portfolio and in addition to details on deferments by loan segment. The portfolio continues to be largely weighted towards real estate loans, which are supported by high-quality collateral and underwritten by low loan-to-values. We also continue to have limited exposure to sectors that are most at risk from the pandemic, energy, hotels, restaurants, airlines, and other hospitality. Deposits increased $475 million to $6.04 billion at the end of the quarter, with non-interest bearing deposits reaching $1.39 billion and representing 23% of total deposits. Demand deposits, non-interest bearing plus interest checking, increased from 41% to 54% of total deposits from the end of the second quarter of 2019 to the second quarter of 2020. This increase combined with the rate environment and our proactive efforts to reduce deposit costs and bring in new relationships drove our all-in average cost of deposits down from 162 basis points to 71 basis points over the same time period. As previously mentioned, we believe building a strong, truly low-cost deposit base is one of the most valuable things we can do to create franchise value. While we recognize a portion of our non-interest-bearing deposit growth relates to the PPP loan program, overall, our progress is generally ahead of plan due to our investment in products and systems and the tremendous dedication of our team. We have posted six consecutive quarters of growth in average non-interest-bearing deposits And our mix of non-interest-bearing deposits and interest-bearing checking to total deposits continues to grow, even on a growing deposit base. With deposit growth exceeding loan growth, our loan-to-deposit ratio declined from 102% at the end of the prior quarter to 94%. Our securities portfolio increased $207 million to $1.18 billion last driven mostly by net additions of 94 million of corporate securities and 61 million of agency CMOs and the $54.7 million reduction in the net unrealized loss of our portfolio. We ended the quarter with 88% of the portfolio in AAA or AA rated securities and the remaining 12% in triple D corporate securities. The majority of the BBB-rated securities are subordinated bank debt investments. As Jared discussed, tighter spreads reduced the unrealized loss in our $668 million CLO portfolio. However, the CLO portfolio continues to weigh on our tangible book value with an unrealized pre-tax loss of $35.3 million at the end of the quarter. Turning to asset quality. Credit quality overall is showing resiliency given the challenges created by the pandemic. Nonetheless, delinquent loans increased to $95.2 million or 169 basis points of total loans and non-performing loans increased to $72.7 million or 129 basis points of total loans. The increases in delinquent loans and MPLs of $10.2 million and $16.2 million are due mostly to one $11.5 million lending relationship that is well secured by both commercial and single-family residential properties. A quarter and non-performing loans included three relationships totaling $37 million or 51% of total non-performing loans. These are the $11.5 million relationship added this quarter and the legacy $16.4 million shared national credit and $9.1 million SFR with a 58% loan-to-value, which have both been discussed in prior quarters. We believe the risk of loss on the single-family portfolio is low, given the weighted average loan-to-value is below 60%. However, due to consumer lending regulations, single-family loans tend to take longer to work through and can temporarily elevate our total delinquents and non-performing loans. As a result, we show our asset quality metrics for both the entire portfolio and for the portfolio excluding SFR in our investor deck. Let me turn to CECL and our provision for the quarter. As we've discussed in the past, our ACL methodology uses a nationally recognized third-party model that includes many assumptions based on our historical and peer loss data, our current loan portfolio, and economic forecasts. Economic forecasts published by our model provider have deteriorated since the first quarter, with June baseline unemployment rate forecasts for 2020 and 2021 increasing and real GDP growth rates declining. Using current economic forecasts and the estimated impact of the pandemic on our portfolio's lifetime credit losses, we recognize the second quarter provision for credit losses of $11.8 million. The provision included $5 million in general reserves reflecting the deterioration in the macroeconomic variables and the updated forecast and other qualitative factors, offset by a decrease in total loans. And $6.8 million in specific reserves, including the $5 million related to the previously disclosed legacy non-accrual shared national credit. We also had a nominal amount of net recoveries with no charge-offs in the quarter. As a result, our total allowance for credit losses increased to $94.6 million, which is an allowance coverage ratio to total loans of 1.68%. Excluding the PPP loans, which have a 100% government guarantee, the ACL coverage ratio totals 1.76%. Our capital position remains strong. with a common equity tier one ratio of 11.7%, and has benefited from the strategic actions completed over the past several quarters. We will continue to be prudent and strategic with the use of our capital to maximize benefits to shareholders and to build franchise value, while protecting our very well capitalized position at a time when the outlook remains uncertain. While we are currently operating in a capital preservation environment, We plan to deploy our excess capital over time through organic growth, preferred stock redemption, resumption of share repurchase activity, and other opportunities in the market. At this time, I will turn the presentation back over to Jared.