Banc of California, Inc.

Hello and welcome to Bank of California's third quarter earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. 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 additional required information is available in the earnings press release. The referenced 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, 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 third quarter earnings call. Joining me on today's call are Lynn Hopkins, our 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. As noted on our earnings call for the second quarter, we expected our third quarter to demonstrate the earnings momentum we had been building toward following nearly 18 months of restructuring. I'm pleased to report that we executed well and delivered strong operating and financial results that we anticipated in the third quarter. We will get into more details later in the call, But here are just a few highlights of the positive results we generated on many fronts this quarter. We had significant improvement in our level of profitability, generating net income available to common shareholders of $12.1 million, or $0.24 per share this quarter, and $19.4 million in pre-tax, pre-provision income. Our net income benefited from a lower than normal tax rate, which Lynn will detail later. Adjusted for a normalized 25% tax rate, Net income available to common stockholders would still have been strong at 9.9 million or 20 cents per share. We were able to maintain a stable net interest margin due in large part to our continuing ability to improve our deposit base as we recorded our fifth consecutive quarter of DDA growth while further lowering our cost of deposits. We've continued to reduce our cost structure without impacting our ability to service existing clients and bring in new business. and we are actively managing and monitoring our asset quality with the majority of our deferred and non-SFR loans returning to their regular payment schedules and deferments dropping to just 5% of total loans at the end of the third quarter from 11% at the end of the second quarter. With the improvements seen in our deposit base, operating efficiencies, and asset quality, our third quarter performance underscores many of the attractive characteristics of our franchise that we have been building and that we expect will drive further improvement in our financial results going forward. We've kept a sharp focus on credit quality, closely monitoring our loan portfolio, and actively reaching out to our clients. Our loan portfolio continues to hold up well, and our exposure to areas most impacted by the current crisis remains limited. With a well-underwritten credit portfolio, predominantly secured by Southern California real estate, with relatively low loan-to-values and strong debt-service coverage ratios, we are seeing encouraging asset quality trends with limited loss exposure, a decline in problem loans, and a significant reduction in loan deferrals. This trend contributed to a lower level of provision expense this quarter, following our significant reserve build during the first half of the year and the rapid decline in deferrals. In addition, our conservative approach continues to keep us very well capitalized with a high level of liquidity. Even with the progress we have made, we still have several opportunities to improve operating leverage to further enhance financial performance, many of which are timing dependent and will benefit us in quarters to come. In the third quarter, the most notable progress came in the continued improvement in our deposit base, our mix of earning assets, and our operating efficiencies, all of which led to a higher level of earnings and improved returns. Our total cost of deposits continues to decline, as we successfully expand existing client relationships and bring new business customers to our service platform, which is further shifting the deposit base toward lower cost, relationship-based deposits. Our total cost of deposits hit 39 basis points at the end of the third quarter, down 20 basis points from the end of the prior quarter. At the same time, we've been able to effectively protect our average loan yield, as we have relatively limited exposure to repricing within our existing portfolio, given the level of fixed rate in hybrid loans, which are not scheduled to mature or reprice for at least two years. As a result, our average loan yield was relatively stable in the third quarter, declining just two basis points from the prior quarter. The lower deposit costs and relatively stable loan yields helped us to offset pressure on yields in the securities portfolio, and we held our net interest margin steady at 3.09% for the quarter. We also continue to see the positive impact of our actions to reduce our cost structure. On an adjusted basis, our non-interest expense declined by more than 2 million from the prior quarter, resulting in further improvement in our efficiency ratio and our ratio of non-interest expense to total assets. Positive trends we are seeing in these key areas resulted in a strong earnings improvement this quarter. Simply put, despite the very challenging operating environment, Relative to 2019, we are now making more money with a smaller balance sheet. The financial performance this quarter is a result of the significant changes we have made and the type of customers that we bank, the talent we have added at all levels of our organization, and the strong execution on the strategies we have identified to enhance franchise value. And importantly, having solidified our foundation through the strategic actions we have taken over the last 18 months, we are very pleased we were able to deliver results that clearly demonstrate our improved earnings power. While the operating environment created by the pandemic remains challenging, we are seeing some encouraging signs within our markets and in the financial health and behavior of our customers. Most of our commercial borrowers that received a loan deferral have returned to their regular payment schedules, and we have had very few require a second loan deferral. Total deferments and forbearances decreased by 53 percent from the end of the second quarter. Deferments are lower across the entire portfolio, with commercial deferments decreasing from $440 million to $145 million, and SFR forbearances decreasing from $164 million to $138 million. Of these balances at September 30th, the majority of the loans are on a second deferment or forbearance period. We are also beginning to see some clients utilize the liquidity they had built up in their deposit balances during the first half of the year to fund transaction and investment opportunities. For the most part, though, we were able to offset these deposit outflows through the acquisition of new clients and the expansion of existing relationships, which kept our deposit balances relatively stable. During the third quarter, newly opened DDA accounts contributed more than $340 million of low-cost deposits. The deposit engine that we have built continues to produce strong results with contributions coming from all of our business units, private and specialty banking, community and business banking, and commercial and real estate banking. Our lending teams are also gaining traction, and we are bringing in new loan relationships to help offset the planned runoff in our single-family portfolio. As a result, our total loan balance has increased at an annualized rate of 4% during the quarter, while the mix in the portfolio continued to move in the desired direction. At September 30th, loans to commercial customers increased to 78% of our total loans, up from 75% at the end of the prior quarter and 71% at this time a year ago. As I've said in the past, our goal is to show progress each quarter and keep moving the ball down the field in terms of improved operating leverage, quality deposit growth, and higher earnings. We clearly did that this quarter and improved our franchise value in the process. Now I'll hand it over to Lynn, who will provide more color on our operational performance, and then I'll have some closing remarks before opening up the line for questions.

Thank you, Darren. First, as mentioned, please refer to our investor deck, which can be found on our investor relations website as I review our third quarter performance. I'll start by reviewing some of the highlights of our income statement before moving on to our balance sheet trends. Net income available to common stockholders for the third quarter was $12.1 million for 24 cents per diluted share. Our adjusted pre-tax, pre-provision income was $18.9 million, an increase of $2.8 million from the prior quarter. As Jared mentioned, our net income benefited from a lower than normal effective tax rate, which I will detail later. Adjusted for an effective tax rate of 25%, net income would have still been strong at an estimated $9.9 million, or 20 cents per diluted share. Total revenue declined $1 million, or 1.7%, compared to the prior quarter, as a 1% increase in net interest income was offset by a decline in non-interest income. The decrease in non-interest income was due primarily to a gain on sales securities of $2 million in the prior quarter versus none in the third quarter. The half a million dollar increase in net interest income was due mainly to lower funding costs more than offset by a decline in interest income. Our net interest margin of 3.09% was unchanged from the prior quarter as a decline in our cost of funds was largely offset by our lower yield on average earning assets. Our earning asset yield declined 20 basis points due primarily to our CLO portfolio repricing down into the current market, as well as the impact of temporary excess liquidity being held in lower yielding assets. The average yield on our $686 million CLO portfolio declined from 3.22% in the second quarter to 2.16% in the third quarter. However, with LIBOR beginning to stabilize after the significant declines earlier this year, we anticipate limited repricing pressure on the CLO portfolio yield in the fourth quarter. Our average loan yield declined by just two basis points from the prior quarter, due in part to lower yields on SBA loans as we extended the estimated average life of our PPP loans to 12 months from nine months. The change in the estimated life is to provide additional time to account for the government's delay in processing forgiveness applications. As of October 16th, about 25% of our PPP loan count, representing about 30% of our PPP loan dollars, were in the forgiveness process. We are actively working with our clients to help them through the forgiveness process. and using the opportunity to deepen relationships and identify additional lending opportunities. We will continue to monitor our estimated life relative to the government's ability to manage the forgiveness process. As Jared highlighted, our period end total cost of deposits fell 20 basis points to end the third quarter at 39 basis points. The average total cost of deposits for the quarter was 51 basis points, or 20 basis points below our second quarter average. Looking ahead, we have $541 million of CDs and FHLB advances maturing over the next six months with a weighted average rate of about 1.6%, which will further reduce our cost of funds. With our cost of funds likely to continue trending lower and considering our meaningful opportunities to deploy excess liquidity into loans, we see the potential for NIM expansion in the fourth quarter. Non-interest income decreased $1.6 million to $4 million. As I mentioned on our last call, the three-year earn-out 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, which lowered our other income. In addition, the prior quarter included a gain on sales securities of $2 million, while the current quarter included a gain of approximately $300,000, on the sale of $17.8 million of loans held for sale. We continue to drive operating efficiencies as core expenses decline to $40.7 million for the third quarter, a 13% decrease from the same quarter last year, and a $2.1 million or 5% decrease from the prior quarter. The most significant contributors to the decline from the last quarter were lower salaries and benefits expense, lower advertising expense, and lower legal settlements expense, the latter of which were included in other expenses. Based on our actual and projected level of earnings and tax differences for 2020, we've made a change in our estimated effective tax rate for the full year to a negative tax rate ranging from approximately 10% to 15%. As a result of the change, the effective tax rate applied in the third quarter was 13%, and we expect our fourth quarter effective tax rates to be approximately 25%. Turning to our balance sheet, our total assets decreased by $32 million in the third quarter to $7.74 billion. Towards the end of the third quarter, we reduced a portion of our excess liquidity to repay maturing broker deposits, and this temporarily reduced the size of our balance sheet. But as we selectively add high-quality earning assets in the future, both in terms of loans and investment securities. We have the flexibility to add overnight and other wholesale funding, if needed, to strategically support our growth entering assets. Our growth loans held for investment increased by $50 million during the third quarter, as growth in CNI, CRE, and multifamily loans more than offset ongoing runoff of our legacy single-family residential portfolio. The investor presentation includes updated details on our loan portfolio. The portfolio continues to be largely weighted towards real estate loans, which are supported by high quality collateral and underwritten with strong debt service coverage and low loan to value. We continue to closely monitor credits in all sectors within our portfolio. We have very limited exposure to the sectors that have been most impacted by the pandemic. Deposits were relatively flat at $6 billion at quarter end, but our mix and cost continues to improve as a result of our very focused initiative. The activity included a $90 million decrease in broker deposits, offset by a $59 million increase in non-interest bearing deposits and a $26 million increase in other interest bearing deposits. Non-interest bearing deposits represented 24.1% of our total deposits at quarter end, up from 23% at the end of the last quarter. Demand deposits, non-interest bearing plus low-cost interest checking, increased by 8% from the prior quarter, representing our fifth consecutive quarter of DDA growth, a goal we remain very focused on to drive franchise value. Over the past year, demand deposits increased to 58% of total deposits, up from 45%. reflecting the significant improvement we have made in our deposit base. This increase, combined with the lower 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 148 basis points a year ago to 51 basis points achieved this quarter. Our securities portfolio increased $70 million to $1.25 billion last driven mostly by security purchases of $48.5 million and lower net unrealized losses of $23.9 million. We ended the quarter with a slight net unrealized gain of $1.8 million. The composition of our portfolio at the end of the quarter was 88% in AAA and AA rated securities and the remaining 12% in BBB corporate securities. The majority of the BBB rated securities are subordinated bank debt investments. For the second consecutive quarter, tighter credit spreads reduced the unrealized loss in our CLO portfolio. The improvement in pricing this quarter added 25 cents to our tangible book value per share relative to the prior quarter. As the economy stabilizes and the CLO spreads continue to narrow, the improvement will contribute directly to our tangible book value. Next, a few comments on asset quality. Credit quality overall continues to show resiliency in spite of the challenges created by the pandemic. We are pleased by the trends in our loan deferrals that Jared highlighted earlier. Delinquent loans decreased $12.2 million in the third quarter to $83 million, or 1.46% of total loans at September 30th. Non-performing loans decreased $5.8 million to $66.9 million as of September 30th, 2020. However, 31.5 million or 47% of this balance represented loans that are in current payment status but are classified non-performing for other reasons. The $5.8 million decrease is a net number and included $10.2 million of cured loans since last quarter, offset by $4.4 million of new non-accrual loans. The quarter end balance includes three large loan relationships totaling $34.9 million or 52% of our total non-performing loans. These consist of one $16.1 million legacy shared national credit, a $9.1 million single-family residential mortgage loan with a loan-to-value ratio of 58%, and a $9.6 million legacy relationship well secured by commercial real estate and single-family residential properties with an average loan-to-value ratio of 51%. Aside from those three relationships, non-performing single-family residential loans totaled $17.7 million, and the remaining non-performing loans totaled $14.3 million. Based on our current discussions, we believe that it is likely a resolution will be reached during the fourth quarter on our largest non-performing loan, the $16.1 million shared national credit, without any additional reserve requirements. All things being equal, this would put us in a good position to once again show improved asset quality at the end of the year. Let me turn to our provision for the quarter briefly. 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, which include numerous assumptions, have improved modestly since the second quarter. Accordingly, the forecast component of our ACL methodology did not derive additional provision expense in the third quarter. This, combined with the improved asset quality metrics and modest loan growth, resulted in our third quarter provision for credit losses being just $1.1 million. Following the provision expense recorded in the third quarter, our total allowance for credit losses totaled $94.1 million, which represents an allowance to total loans coverage ratio of 1.66%. Excluding the PPP loans, which have a 100% government guarantee, the ACL coverage ratio was 1.74% at September 30th, while the allowance to total non-performing loans coverage ratio was 141%. Our capital position remains strong with a common equity tier one ratio of 11.64% 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. As we have noted in prior quarters, when the environment is supportive, there remains an opportunity to repurchase preferred stocks with a cost of over 7% with our current capital or through other vehicles, such as the issuance of lower coupon tax-deductible subordinated debt. At this time, I will turn the presentation back over to Jared.

Thank you, Lynn. Looking ahead, as long as we don't have any meaningful setbacks related to the pandemic, we are optimistic that we will be able to make additional progress on our key initiatives to deliver continued improvement in financial performance. As we mentioned on last quarter's call, having completed our restructuring, we are now in profitable growth mode, albeit tempered due to the pandemic and a slower economic environment. We are carefully managing credit and will be prepared to grow more rapidly as the economy improves. But we believe there are still good opportunities to be had, even in this more cautious environment. We expect to continue to make progress on improving our deposit base and managing expenses as we did in the third quarter. And as we emerge from the current crisis and commercial loan demand returns to a more normalized level, we expect continued growth in earning assets to drive additional operating leverage, higher earnings, and greater returns for shareholders. We will likely continue to see significant runoff in our single family portfolio, but our loan pipeline is steadily building and as previously communicated, we expect the balance sheet in terms of loans and investments to end the year more or less flat with the year end 2019. Looking at other areas of our balance sheet, we believe we have other levers that we can eventually pull that will positively impact our financial performance and create additional value for our shareholders. CDs that will reprice, preferred stock that we may redeem, and CLO values we expect to continue to return to a more stabilized level to positively impacting our tangible book value per share. To expand a bit more on these opportunities, as Lynn mentioned, we have significant amount of CDs maturing over the next six months. As always, our goal is to replace these deposits with lower-cost DDAs. But even if we replace them with CDs we are issuing at current rates, it would drop the cost of these deposits by at least 100 basis points. We expect to optimize our capital. When permissible, we expect to take advantage of the opportunity to redeem preferred stock. Subject to regulatory considerations, Initiating a stock repurchase program will certainly be on the table for discussion as well, particularly as our common stock continues to trade at a level that we believe would be good investment for our company. As we approach the end of 2020, we are very excited about what we have been able to achieve this year and the dramatic improvement we have made in the quality of our franchise. We are effectively managing through an unprecedented pandemic and have maintained good credit quality and capital strength. while continuing to provide an exceptional level of service to our customers during a challenging time. We've streamlined our operations and reduced expenses while continuing to invest in the right areas in terms of technology and talent to help us build the foundation and culture of a deposit-focused institution. We are clearly seeing the results of our efforts in the quality and quantity of new client relationships that we are bringing into the bank on a daily basis. While the ongoing pandemic creates a level of near-term uncertainty, We believe that we are very well positioned to generate earning asset growth, expand our net interest margin, realize additional operating leverage, and deliver a higher level of earnings and returns for our shareholders as the economy strengthens. We have done so notwithstanding the environment, and an improved economy will only accelerate that progress. I want to thank our Bank of California colleagues for their tremendous effort and tireless dedication during these challenging times. Bank of California has become the standout bank in our communities thanks to their hard work and execution. Bank of California is the go-to relationship-focused business bank in our markets. Our team is proving day in and day out to both existing and prospective clients that Bank of California has the people, products, and services to deliver an exceptional banking experience. Thank you for listening today. I hope that you and your families are safe and healthy, and I look forward to sharing more about Bank of California's progress in the coming quarters. With that, operator, let's go ahead now and open up the lines for questions.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Timur Rezidler of Wells Fargo. Please go ahead.

Hi, good morning. Good morning. Maybe starting off where Jared left off and looking at some of the remaining opportunities, you guys have done a good job in checking off a lot of the boxes that you outline on slide four. Looking at the two remaining green marks there, the redemption of the preferred stock, we could start there. Is the conversation now just what's the best option to replace it with, or is there still a scenario on the table where you choose not to redeem that and keep that as part of the capital stack?

Well, good morning. It's nice to speak with you. We still intend to redeem our preferred stock, and we'll likely find a way to do it issuing sub-debt. We do need regulatory approval to redeem preferred stock, and so any action that we take is subject to regulatory approval. The Fed has made it clear that banks, you know, they have, my understanding is, based on everything that I've read, is that The Fed is not looking right now at allowing a whole bunch of banks to redeem capital. And so we just are waiting for the right time, and when we think it's appropriate, we'll approach them. But we think that's something that we're likely to be able to do down the road.

Okay. Would you take advantage of the attractiveness of the market now in issuing sub-debt maybe in advance of the redemption, or would that be more of a –

No, I think we would look at that. I mean, it's really hard to time it perfectly. And so, you know, market conditions being what they are, we're constantly looking at what would be a good option. But I think it would be too hard to time it to try to, you know, do both at the same time. So we're going to be opportunistic.

Okay, great. And then switching over to the CLO portfolio, the reduction in unrealized losses, that reduction of $23 million, was that entirely on the CLO book? And I guess what's the remaining negative mark on that portfolio right now?

Lynn, you want to address that?

Sure. So the improvement in the unrealized net loss in the portfolio that moved to a slight gain was not entirely due to the CLO portfolio. There was an improvement generally in the market across all the securities, but the majority was related to the CLO portfolio, and it has a remaining net unrealized loss of about $17 million.

Okay.

And that's pre-tax, so after tax it's a little bit lower.

Okay, thanks. So maybe looking out a little bit longer when more of that loss is recovered, can you just talk us through the transition out of that CLO book? Is that really as things mature, they just kind of are replaced with something else? Is a larger kind of broad sale on the table, or is that going to be too detrimental to balance sheet levels where it is likely going to be piecemealed off?

Sure. So I think generally we recognize that we're working in a pretty low interest rate environment with a flat yield curve. To the extent that these are able to recover to their carrying costs, I think we would look to what other opportunities there are to transition out and to lower the concentration risk related to the CLOs on our balance sheet. That's something that we've talked about. It is a goal. But I think from a transition standpoint, we would be needing to look at what other alternative investments that would be available to us, you know, kind of on a risk-adjusted basis and what kind of returns we could get. I think we'll be opportunistic there as well.

Okay, great. And then one last one, if I could. Just looking at the remaining level of deferrals, It seems like roughly half of that balance is in resi. I know you made the comment that majority of what's remaining is second deferrals. Are the resi deferrals also on the second request, or is that still a portion six months that was originally granted?

They're either in second request, they're in second deferral, or they're in the process of being reviewed. SFRs, you know, we've is managed by a third party. It's serviced by a third party. And it's a legacy, not core portfolio for us. And the consumer rules being what they are, you've got to manage it, obviously, in a very different way. We're focused on it, though. I mean, we're constantly having conversations with our servicer to get our arms around the portfolio. I think one thing that's really clear about the single family loans is, unlike some other deferments, You can't expect people after three months, six months, whatever the initial deferment period was, just to come up with a huge lump sum of money and make a whole bunch of payments. And so if they were out of a job, they don't have the money. Or if they were on furlough, they don't have the money. And so as it relates to single family, generally what happens is you take the missed payments and you put them at the end of the loan, and you're going to get paid on them at a re-fire sale. And then they start making their new payments you know, they start kind of the new period going forward current. And so we manage that a little bit differently than the rest of the portfolio. But I don't think there's a lot of loss content there. We're working really closely with our servicer. But, yes, the answer to your question is most of those loans are either in second deferment or in the process of being reviewed for second deferment. There is a kind of a lag. It just depends on when it started. But most of them are moving to second. Bob Dyke, any comments there?

No, Jared, I think that's a very accurate representation. We have moved through most of the first deferral buckets because, as Jared said, they didn't all come on at once, and most of them have moved either into a second or under consideration. Thanks, Bob.

Okay, that's great, caller. Nice quarter. I'll step back there. Thanks.

Yeah, thanks, Timur.

The next question comes from Matthew Clark of Piper Sandler. Please go ahead.

Hey, good morning.

Good morning, Matthew.

Sorry if I miss it. I'm jockeying between another two calls here. But the PPP-related income this quarter and net interest income, do you happen to have that number offhand so we can isolate a core name? Sure. Lynn, do you have that by chance?

Sure. I believe it's – $2.1 million is the fees that came through interest income this quarter. It positively impacted our net interest margin, 11 basis points.

Okay. Got it. And then on the On the pipeline, both loans and deposits, can you give us an update there? Where are you seeing new business opportunities on the commercial side? And again, both on the deposit side as well.

Sure. So, look, we had a great quarter, and the pipelines are building as we thought that they would. We're seeing a lot of opportunities, continue to see opportunities in multifamily on the bridge side and on permanent financing, and we're taking opportunities there. We're seeing it throughout all of our business units in terms of good commercial opportunities for lending, lines of credit and term loans, even some SBA opportunities as well. It's pretty balanced, opportunities in health care, some opportunities in entertainment as things get back to normal. So we're looking across all of our business units to show production. We still believe that we're going to be able to end the quarter at a place where the production outpaces runoff in terms of outstandings. so that we end flat or slightly up from the end of last year. And that will provide a really good platform, especially with our lower expense base, to deliver really solid earnings next year and keep improving quarter over quarter. On the deposit side, we're seeing the same thing. Even though we're starting to see some use of liquidity, as we mentioned, we're bringing in a lot of new relationships and new deposits. And so while the balances from our existing client base are going to fluctuate, that's being offset by new relationships that we're bringing in. And deposit flows continue to be strong. You know, I expect that this quarter will show positive DDA growth as we have the last five quarters, which we're really, really proud of. Everybody in this company is very focused on delivering very, very high-quality services and bringing new relationships in in terms of loans and deposits and making sure that we have the most that we can from our existing clients. And, you know, we're actively working managing that as well as we're managing, you know, looking very closely at credit. I want to go back to the NIM for a second, Matthew. You know, I think the NIM, it got hurt a little bit by the CLOs repricing, but we are bringing on loans at good yields. And, you know, it's hard to know exactly where it's going to end up because I would say that in this environment, because we're focused on quality, we're likely to go after the highest quality loans, which may mean that we're going to protect the which may have a lower yield. I just think given the visibility down the road in terms of the economy and credit, if we're going to bring on loans and we're going to grow, we want to do the safest type of loans right now. That's not to say that we won't take some loans at higher risk, but we're very selective about it. And so I do see them holding up. I think our deposit costs continue to drive down. I was pleased with how well our loan yield on origination has actually held up in the quarter. But it's hard to see kind of where things are going. But as of now, we believe that our NIM is going to hold and maybe expand a little bit. We still have so much room to go on the deposit side.

Great. And then along those lines, did you happen to have the weighted average rate on new production this quarter?

Yeah. I'm not sure what that is. Production yield for this quarter was around 4% weighted average. Last quarter, it's hard to see because it was lower because of all the PPP loans that came on. I don't have it broken out without that in front of me, but it was around 4%, which blended across everything that we're doing. I thought it was pretty good.

I know you guys have been cutting costs for quite a while now. That run rate dropped even further here, just under $41 million adjusted. overhead ratio around 2.1%. I assume we're kind of hitting a bottom here, but knowing a lot of other banks are announcing all these cost initiatives, just curious if you still think there might be some incremental opportunities.

Lynn, you want to?

Yeah, sure. I'll jump in here. I think you worded it correctly. I think there is incremental opportunities. I think we continue to look at expenses and refine them and look for opportunities, whether it's operating efficiencies or leveraging technology, have it fit with our current objectives and operations. So I think there's probably some small opportunities, but we're probably getting to where we need to have an expense base so that when things return to maybe more normal operations that we'll be able to sort of leverage it when things return back to normal.

I think we're at a pretty good spot right now. We'll find incremental stuff. We're constantly looking. We're constantly evaluating everything, as I'm constantly sharing with our team and our team's constantly looking at just because we've done something a certain way in the past doesn't mean we should be doing it that way in the future. And, you know, is that the most efficient way to do things? So we're constantly looking, but we've got to layer on more earning assets on top of our existing base to keep growing earnings, and I'm confident we can do that.

Okay. Thank you.

Thanks, Matthew. The next question comes from Gary Center of DA Davidson. Please go ahead.

Thanks. Good morning, folks. Morning. You know, real strong quarter. I was curious about, as you're thinking about 2021, you know, we've talked about kind of the journey to 1% ROA as sort of an interim term target or goal. 81 basis points this quarter, I think, you know, but with a lower tax rate and pretty low provision. So just kind of as you're thinking about 2021, is the path to that ROA level still in front of you, do you think, for next year?

I think we do. You know, it's hard to know which quarter we're going to hit it in, but everything that I'm seeing suggests that we will. It's really about earning assets and putting them on. There's a tremendous amount of opportunity we have on the expense side still in terms of, you know, deposit costs. We have 500 million plus of CDs that are maturing where we know we're going to be able to take out 100 basis points. We have some other, you know, mature borrow – we have some other deposits that are kind of time-based. with some larger relationships that are going to reprice. We talked about the preferred stock and incremental benefit that can give us. So I think there's really a lot of leverage still in the numbers on the expense side, and then in terms of putting on good earning assets, I believe that our teams can do that. And so I see that as achieving a one-hour away on a normalized basis is something that we'll be able to do next year. Hard to know exactly, but we're certainly pushing really hard to try to get there. You know, the other thing is, just in terms of pure fundamentals, you know, our tangible book value is just going to continue to climb. We still are finding plenty of opportunity of things that were kind of missed in the past that will be additive to our tangible book value. Not only are the CLOs going to continue to reprice as the economy improves, and we're obviously making money that's going straight to tangible book value, but there's some legacy stuff that our teams have done an exceptional job of collecting on, whether they're reimbursements that the insurance company owed us that we didn't get and things like that that they've gone back and tried to find, whether it's litigation that we finally are resolving where we're the plaintiff, where we're going to get some money back for things that maybe were charged off in the past. So all of those things are going to contribute to tangible book value, which are going to contribute to a higher share price, in addition to the fact that we're going to be expanding our earnings. So I'm optimistic about both of those things.

Great. Thanks for that. thoughts there. And then just to clarify, I think you said that you expect period or year-end loans to be flat year over year. Is that what I heard you say?

Yeah, I think we think about quality earning assets. So in terms of loans and investments, because we bought a whole bunch of bank sub-debt, which was a good replacement in our investment portfolio earlier in the year. I think in terms of the combination of loans and, you know, investments should be flat to up at the end of the year relative to the end of the year last year. The variable there being cash, which, you know, at different points we run with higher or lower amounts of cash.

Yeah. Okay. So it sounds like, though, actually if I was to isolate loans because of where we are right now versus the end of 2019, loans will be lower, but the overall combination of loans and investments you're saying likely up.

No, loans might, let's see, at fourth quarter of 19.

Yeah, go ahead, Lynn. Let me make one comment. You know, I think, you know, we have some visibility into where we think there are growth opportunities. The one thing that, you know, the PPP loans, we only have about 260 million of those on our balance sheet at the end of the third quarter. We believe the forgiveness process may be starting, so expect that there are would be some decrease actually in that portfolio. I think that may somewhat drive the overall loan balance in addition to other growth in our loan portfolio. So, you know, to pinpoint that number, I think there is, you know, that's a little bit beyond our control. As I mentioned in my comments, you know, we're dependent on the governmental agency to help move that through the process?

We're most focused on obviously putting on high quality loans and then, you know, where we have the ability putting on high quality investments and between the two of those earning enough to, you know, continue this company earning more and more each quarter. And so if we find really high quality investments that have a great duration and the proper duration and a great yield, then obviously we're going to put those on as well. But we want to get this company to the right place from an earning asset perspective to make sure that we keep earning well going forward.

All right. Thank you.

Yep. The next question comes from David Feaster of Raymond James. Please go ahead.

Hey, good morning, everybody. Morning, David. I just wanted to start. kind of follow up on that, that earning asset, uh, topic. Um, you know, you guys have done a great job on the growth front. First of all, I guess how much of the, you know, CNI was, was, uh, solidly this quarter. Just curious how much of that was warehouse and what you're seeing on there. And then I guess just as we look out to 2021, what like as the runoff of single family kind of abate somewhat and, you know, you continue to, uh, be that go-to business bank, as you alluded to. How do you think about loan growth as we head into next year?

Well, let me take the second part first. I don't think we broke out what's warehouse versus other parts of CNI, so I don't think we have that in our publicly disclosed stuff. But like I said before, it was pretty balanced. I mean, we had production across all of our business units, and we feel good about it. Hard to predict in terms of next year if you're trying to figure out kind of how the balance sheet is going to grow. I mean, it's really economy dependent. There's no reason why we would be growing slower than the economy and certainly not slower than our peers, you know, if the economy holds up. In this environment specifically, we're taking a relatively conservative approach and trying to go after the highest quality credits possible. because we feel we need the visibility to make good decisions, not knowing how long this pandemic is going to last. And so we're sticking to what we know and doing it well and trying to lend to the strongest borrowers. That's not to say we're looking at it. We aren't looking at everything. We are. But I think our pipelines are building. I really have a lot of confidence in our teams that have come here. They're working really hard to bring in new relationships and mine existing relationships. So David, I don't have a number that I'm throwing out there in terms of production for next year, but I know that we need to put on the highest level of earning assets that we can on our existing expense base to march toward and past a one ROA. And so assuming the economy gets better and provisioning returns to normal levels, I think that's what's going to happen. Okay.

Sharon, I would just add I would just add one comment. I think in the investor materials, we do provide some additional detail related to our CNI portfolio. And so I think that's in both the second quarter and the third quarter. And you can see, I think, the finance and insurance sector within our CNI portfolio. So the majority of the CNI growth is centered in the finance and insurance. part of our portfolio, which includes our warehouse credit line.

Okay.

And I would say regarding warehouse, we haven't built our company around it, and we've said that we're going to make it an appropriate portion of our growth. But it's very favorable from a CECL perspective in that it's very short duration. We've never had a loss in that portfolio, and our team is very experienced and I'd say that we get above average yields because we focus on midsize mortgage bankers as opposed to the largest folks. And we have several hundred million of very low-cost deposits, you know, below 10 basis points that come out of that portfolio because we're lending to institutions that have their deposit relationships with us. So it's very balanced. But we keep it within a size range so that it doesn't become kind of, you know, take over our portfolio.

Okay. Yeah. And then just kind of following up on that a bit, I mean, the path to margin expansion is pretty clear, right? I mean, through deposit repricing, you're getting good yields. The CLOs aren't a headwind. I guess as you think forward, kind of where do you think the margin expands back to? Like kind of what's your target for where we should get that NIM back to? based on the earnings power of your franchise?

Yeah, it's a good question. So the way that we're trying to set the company up right now is to feel somewhat liability sensitive because we're obviously, you know, emphasizing the ability to drive down our deposit costs. But because we're putting on non-interest-bearing deposits and low-cost checking from businesses that really neither have really much expectation of yield because they're very service-focused, that deposit base will not reprice when rates move back up. certainly not as fast as interest rates are going to move. And we're putting floors on all the loans that we're originating today. And so we expect to participate heavily in a rising rate environment, and we'll be able to take opportunity more so on the upside than the downside. So in terms of where our margin would go to, it's a function of how quickly rates move. but in a, you know, I don't know why our margin wouldn't be, so I think we'd have to play with some scenarios, David, of, you know, where are interest rates relative today? Lynn, I don't know if you have any comments on that.

No, I think that's a good summary, and I think it would be difficult to, you know, pay a number. I think, you know, we're working with the same interest rate environment, and we'll take advantage of the opportunity to improve the mix and cost of deposits through our business initiatives, and then As Jared mentioned, I think the loan pricing, the loan structure is important. And then, you know, obviously in a rising rate environment, we'd expect, you know, stronger earnings growth, which would help with NIM expansion as well. But all things being equal, I think we're still in a good position to have some improvement there.

That's for sure. So, okay, I appreciate that. And then just last one. So on the $89 million, you guys have done a great job on the deferral front. Of the $89 million in CRE deferrals that are remaining, just curious whether there's any concentrations in there. Was there any trends that you noticed in there? And then I guess as these second deferrals expire, how do you think about a potential third round for those borrowers that might need additional relief? Or would you rather just kind of put it on non-accrual or TDR at that point and go ahead and work it out?

Well, let me address that first and I'll open up to Bob and Lynn. So when we look at putting a loan on deferral and we're looking at secondary forecast, we're actively looking at, you know, whether or not that loan needs to be risk rate changed as well. So it's not a blind, okay, it's on deferral, let's leave everything as is. We're actively looking at the loans and making sure that we're aware of any lost content to the extent that we can see it and making sure that our risk ratings are appropriate. So it's not just kind of a, you know, let's check it, let's look at it again in another couple months. That being said, you know, we're also giving our clients, if they have a path, and, you know, we're fundamentally a secured recourse lender, so we're looking at our borrowers, looking at their statements, we're looking at what collateral they have. If they have a path to recovery, and fundamentally it's been the pandemic that has kept them where they are, then, you know, we're working with them. And I don't think there's any reason we shouldn't. The rules are there for a reason, and we're doing everything we can to help our borrowers in this time while still holding the ground and making sure that we're not being taken advantage of and that we're working through things as quickly as possible. In terms of, we've been really giving three-month deferments and kind of monitoring it every three months, so we're not doing longer deferments. I'll let Bob answer if there's any that I'm not aware of, but generally we've been doing three-month deferrals. Bob, any color there on our deferment strategy?

You're absolutely right. Three-month is our philosophy and our practice that gives us an opportunity to, as you indicated, examine the borrowers and their fundamentals and And the phrase that you used I think is the most appropriate. We're looking at them to determine a path to recovery. If, but David, to answer your question, if we get to a need for a third, it's going to be only considered if we do continue to see improvement and movement down that path to recovery. Otherwise, if it doesn't look like we're going to get there, it's better to deal with that problem right away.

And then on the CRE, I do look at retail. On page 20 of our deck, we have a breakout of what's in CRE and where we have concentration and what the risks are, whether it's office retail, multifamily, hospitality. We have very low exposure, as you know, to the high-risk areas. So retail is an area where I have a lot of focus on. Our top 25 retail borrowers represent about 68% of our retail exposure. As I mentioned last quarter, we are looking very carefully at that group. We went through every relationship and marked it red, yellow, and green. We have far more in the green category than we did last quarter. And so the migration of that group is moving along as we hoped it would. And so I feel good about it. Most of it is pharmacy and grocery-anchored shopping centers that are with well-heeled borrowers. And so we're monitoring that very closely. But that's really kind of the CRE concentration that I would be most concerned about. Our office is holding up. And as you know, we have very little hospitality.

Okay. Thank you very much.

Yeah, no problem, David. Again, if you have a question, please press star then 1. on a touch-tone phone. The next question comes from Steve Moss of B Reilly. Please go ahead.

Good morning. Good morning, Steve. Most of my questions have been, Jared, most of my questions have been asked and answered here. A small one, just as we think about the balance sheet mix longer term, and obviously you want to grow loans, I was just kind of curious, how do we think about how large the securities portfolio should be relative to earning assets?

Lynn, what's the target that we've talked about there?

So, yeah, let me talk about that for a moment. You know, there's been a lot of liquidity in the marketplace. So I think that generally speaking, you know, cash and securities have had probably a larger percentage than, you know, historically. So I think as liquidity is to normalize, I would look for, securities and cash to, you know, trend back down to between call it, you know, 10 to 15% versus being above 15%. Given that a portion of our portfolio does have the concentrations of CLOs. And then we did invest in the triple B rated corporate debt is in that portfolio as well. I think it would probably be closer to the 15% versus, you know, driving down lower since it is our on-balance sheet liquidity.

Okay, great. I'm sorry, go ahead, Lynn.

No, go ahead.

Oh, okay. And I guess just maybe, you know, one just on, you know, the provision here and how should we think about expense going forward? I mean, obviously, the economy seems to be heading in the right way. So should we just think about, you know, provision perhaps in future periods relatively matching charge-offs? Kind of curious as to any thoughts you may have there.

Sure. You know, I think with the adoption of CECL, I wish it was just as simple as, you know, you have a charge-off and then you get to fill the bucket again. You know, we are going through a robust process, taking a look at the the portfolio, the macroeconomic variables that drive the models, you know, what do the forecasts look like. Fortunately for us this quarter, I think not only do we have our positive asset quality trends, but also the positive economic forecasts. We did have the modest loan growth, which we did factor into and is reflected in the provision. But the provision is also a function of the mix of the loan portfolio. And some of the loan product has higher, if you will, coverage ratios than others. So if I was to look forward, you know, as the economy improves, I think we do have to remain cautious for the fact that we all recognize that the damage from the pandemic may have been not realized quite yet and may be pushed into 2021. So, you know, To the extent that we're participating in loan growth, I would expect that there would be some provision, and then we would have to address, you know, what the charge-offs are. But even in the absence of charge-offs, I think we still, you know, could expect some expense as we grow loans.

Yeah, I think everybody's getting comfortable with CECL, and, you know, it's a little bit – models are still getting tweaked. Mark Zandi tends to have a lot of power these days, it seems, if you're using Moody's. I think that, you know, the pandemic is a huge variable here. And, you know, when people get back to work, we are, you know, not back to work in Los Angeles in terms of people being in an office environment. There are parts of Orange County which are. There are parts of San Diego. But L.A. fundamentally is still, you know, working remotely. And that's going to happen through the end of the year, most likely. And a lot of schools aren't back yet. And I think that the longer this lasts without a major stimulus bill, I think the economy is probably going to suffer. And we obviously would get hit like everybody else. I think based on the makeup of our portfolio, we're going to get hit pretty late because we're 67% secured by residential real estate. And that has held up very, very well in this pandemic and other other difficult times. But there'll be a lot of stuff that gets hit before us. But if it lasts long enough, we will too. Hopefully that's not the case. And hopefully, you know, more stimulus will be coming here if we don't have a vaccine.

All right. Thank you very much. I appreciate that. Thank you, Steve.

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