Pacific Premier Bancorp Q2 2023 Earnings Call Transcript

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July 27, 2023

There are 6 speakers on the call.

Operator

Good day, and welcome to the Pacific Premier Bancorp's Second Quarter 2023 Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Stephen Gardiner, Chairman and CEO.

Operator

Please go ahead, sir.

Speaker 1

Thank you, Rocco. Good morning, everyone. I appreciate you joining us today. As you are all aware, we released our earnings report for the Q2 of 2023 earlier this morning. We have also published an updated investor presentation with additional information and disclosures on our financial performance.

Speaker 1

If you have not done so already, we encourage you to related to our Q2 performance. Ron Nicholas, our CFO, will also review a few of the details surrounding our financial results, and then we'll open up the call to questions. I note that our earnings release and investor presentation include a Safe Harbor statement relative to the forward looking comments. I encourage each of you to carefully read through that statement as they apply to our comments today. We delivered another quarter of solid results in a challenging environment.

Speaker 1

Our performance reflects our disciplined Focus on prudent and proactive risk, liquidity and capital management balanced with profitable growth. Over the years, we have prepared for a wide variety of scenarios to successfully navigate through each point in the economic cycle. To that end, beginning in early 2022, we strategically prioritized capital and liquidity accumulation by intentionally moderating our growth rates, hedging interest rate risk and positioning our organization to leverage additional sources of liquidity if needed. This approach is aligned with our long standing commitment to disciplined risk management. Specifically, on the capital front, we began curtailing loan production.

Speaker 1

We strategically increased loan pricing at the onset of rising interest rates in order to manage our balance sheet and capital position. We continue to emphasize our commitment to proven Credit underwriting standards, even as other lenders aggressively pursued loan growth that we determined did not present attractive Obviously, liquidity and stable funding are Paramount in times of stress and dislocation. Although we could not have foreseen the events of the 1st 6 months of 2023, We anticipated that in an environment of rapidly rising interest rates, we would have to proactively manage liquidity, potentially sacrificing margin in the short run, while concurrently protecting our core deposit base, the foundation of our franchise. Over the past year, we opportunistically accessed wholesale funding sources by adding modest levels of term FHLB advances and brokered time deposits to complement and enhance our liquidity levels. This 2 pronged approach to liquidity risk management provides us with greater flexibility as we remain focused on maintaining A low cost deposit base and opportunistically reducing higher cost wholesale funding sources over time.

Speaker 1

The quality of our client relationships and the trust in our organization enabled us to maintain disciplined deposit pricing practices. This resulted in the average cost of non maturity deposits of just 71 basis points for the 2nd quarter. As of June 30, non interest bearing deposits comprised 36% of our total deposits. This proactive and disciplined approach to capital and liquidity management puts us in a position to capitalize on future organic and strategic growth opportunities, especially once risk adjusted spreads on new loans normalize relative to those currently available in today's market. Looking now at Our results for the Q2, we generated earnings per share of $0.60 have produced solid returns despite the macroeconomic Uncertainty and the impact of 500 basis points of Fed Funds rate increases since March of 2022, producing a return on average assets of 1.09% and a return on tangible common equity of 12.7%.

Speaker 1

We continue to prioritize capital accumulation during the Q2 as our tangible common equity ratio increased to 9.59 percent and our 2nd quarter CET1 and total risk based capital ratios Increased 80 and 91 basis points to 14.34% and 17.24% respectively. During the back half of the second quarter, we expanded new client relationships as uninsured and uncollateralized deposits decreased to 32% of total deposits at June 30. Our end of quarter liquidity of approximately $10,000,000,000 consisted of over $1,500,000,000 of cash And $8,500,000,000 of unused borrowing capacity, which equated to nearly 2 times the coverage ratio of uninsured deposits. During the Q2, average non maturity deposits declined due in part to clients seeking Higher returns for excess liquidity, prepaying or paying down loans, as well as seasonality around tax payments, And to a lesser extent, the ongoing uncertainty in the market, particularly after the First Republic Bank failure in early May. Notably, the decline in deposit balances was concentrated in the early part of the quarter and these flows have since reversed with deposit balance growing later in the quarter and continuing through July thus far.

Speaker 1

Our relationship based business model is reflected and our long tenured client base as the length of our commercial and consumer banking relationships is on average 12.5 years. Our continued focus on retaining and expanding new client relationships was supported by opportunities to gain clients given disruptions in the industry. Although we remain in a defensive posture relative to managing our funding costs and deposit flows, We are encouraged by a number of ongoing business development initiatives to expand client relationships. The size of our new account openings in our Trust division increased and we are seeing attractive opportunities to add high quality relationships In PPT, as well as new core commercial banking clients. During the second quarter, Our loan portfolio further contracted due to both a lower level of demand, particularly in CRE and multifamily, along with our actions to tighten underwriting standards and raise loan pricing.

Speaker 1

Although a level of uncertainty remains within commercial real estate markets, Our CRE concentration is steadily decreased reaching the lowest levels since the OPUS acquisition and continues to perform at a high level, exhibiting very little in the way of stresses. We remain focused on providing the highest level of service to our clients, while staying committed to originating loans that meet our risk adjusted return thresholds. Our asset quality remains solid as non performing assets declined from the prior quarter and totaled just 8 basis points of total assets, while classified assets to total assets declined 20 basis points to 0.58%. Our team is continuously and proactively managing credit risk Within our high quality and diverse loan portfolio, they are in regular contact with our clients regarding market dynamics and their impacts on business and real estate cash flows. With that, I will turn the call over to Ron to provide a few more details on our Q2 financial results.

Speaker 2

Thanks, Steve, and good morning. For comparison purposes, Majority of my remarks are on a linked quarter basis. Let's start with the quarter's financial highlights. 2nd quarter net income totaled $57,600,000 or $0.60 per share and our return on average assets And average tangible common equity were 1.09% 12.66%, respectively. Total revenue was $180,600,000 and non interest expense came in at $100,600,000 resulting in an efficiency ratio of 54.1 percent and pre provision net revenue as a percentage of average assets Net interest income decreased to $160,100,000 primarily as a result of higher cost of funds as well as a smaller balance sheet, reflecting our strategic pricing and underwriting actions implemented over the last several quarters.

Speaker 2

On the funding side, both our deposit mix as well as our higher cost of funds impacted the net interest margin, which narrowed 11 basis points to 3.33%. Our non maturity deposit costs rose 17 basis points to 0.71 percent and our total cost of deposits were 1.27%, reflecting the higher cost of brokered CDs. Partially offsetting our higher average cost of funds Was an 18 basis point increase in the average earning asset yields with loans increasing 17 basis points. With the exception of higher interest rates or the expectation of higher interest rates, we anticipate continued net interest margin pressure from higher funding costs and potential changes in deposit mix. We will continue to balance liquidity and net interest margin considerations, while evaluating opportunities to deploy our excess cash reserves We are actively monitoring market interest rates And in early July, added $300,000,000 of fixed to floating rate swaps to replenish a portion of our existing swaps that are maturing later in 2023.

Speaker 2

Non interest income of $20,500,000 decreased $647,000 driven by $1,700,000 of lower trust income due to the seasonal timing of annual tax And 345,000 in loan sale gains. For the Q3 of 2023, We expect our total non interest income to be in the range of $19,000,000 to $20,000,000 excluding any loan or security sales. Non interest income came in better than expected at $100,600,000 representing a reduction of 708,000 Compared to the Q1. Compensation and benefits expense decreased to $53,400,000 reflecting lower staffing levels and variable based incentives as well as lower legal and professional services expense. This was partially offset by an increase in deposit expense related to higher deposit earnings credit rates.

Speaker 2

From a staffing perspective, we ended the quarter with a headcount of 1383 compared with 1429 as of March 31. We continue to manage our expenses prudently and our expectations for the Q3 are approximately $101,000,000 to $102,000,000 due to expected increases in deposit expense and incentives, partially offset by lower staffing levels. Our provision for credit losses of $1,500,000 decreased compared to the prior quarter, commensurate with the smaller loan portfolio and our current asset quality profile. Turning now to the balance sheet. We finished the quarter at $20,700,000,000 in total assets as deposit decreases Were matched by loan and investment portfolio decreases during the quarter.

Speaker 2

Total loans held for investment declined $562,000,000 driven by prepayment sales and maturities of $557,000,000 partially offset by loan fundings of $148,500,000 Lower loan originations in the first half of twenty twenty three have been partially offset by lower prepayments and maturities when compared to the first half of twenty twenty two. Lastly, we opportunistically sold $77,000,000 of non relationship loan participations during the Q2, continuing to prioritize liquidity and allocating capital to strategic banking relationships. Total deposits ended the quarter at $16,500,000,000 which represented a linked quarter decrease of $668,000,000 As we noted, we are committed to remaining disciplined as which was well controlled at 78 basis points. The securities portfolio decreased $112,000,000 to $3,700,000,000 and the average yield on our investment portfolio increased 7 basis points to 2.64%. We anticipate approximately $200,000,000 in cash flow from the amortization and maturities of our investment portfolio over the remainder of the year and reinvestment will be dependent upon deposit flows and liquidity considerations.

Speaker 2

The combination of solid earnings and a smaller balance sheet further strengthened our risk based capital ratios this quarter. In addition, our tangible common equity increased 39 basis points to 9.59 percent and our tangible book value per share We continue to operate the institution from a position of capital strength to maximize strategic optionality as well as investor and regulatory expectations regarding capital maintenance. Lastly, from an asset quality standpoint, non performing loans were 0.13% as a percentage of total loans, 5 basis points improved from the prior quarter. Although total delinquency increased slightly to 0.23%, Our classified loans fell to 0.88 percent from 1.14% in the 1st quarter. Our allowance for credit loss remained a healthy $192,300,000 and our coverage ratio increased to 1.41%.

Speaker 2

Our total loss absorption, which includes the fair value discount on loans acquired through acquisition, finished the quarter at 1.76%. We would not anticipate any decreases in our coverage ratio given the broader economic uncertainty and could see a potential increase if an economic downturn materializes. With that, I will turn it back to Steve.

Speaker 1

Great. Thanks, Ron. I'll wrap up with a few comments about our outlook. As reiterated over the last several quarters, we will continue to take a conservative and disciplined approach to managing the business, while simultaneously playing both offense and defense. Offense from the standpoint of consistent business development efforts focused on new client acquisition as well as ongoing investments in our people and technology.

Speaker 1

Defense through proactive communication and outreach to existing clients in an effort to deepen our relationships and expand the products and services that we can deliver for them and their businesses. Historically, this approach has been effective through a variety of cycles and enabled us to consistently deliver strong relative financial results while building franchise value. In terms of capital management, we'll maintain a prudent approach while remaining flexible to capitalize on potential opportunities that will help expand our business, better serve our clients and maximize long term shareholder value. At this point, it's difficult to forecast how market dynamics and the economic environment will unfold. That said, we are prepared for a wide variety of outcomes.

Speaker 2

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Speaker 1

Our passcode has evidently been confirmed. That's fabulous. And so we're well positioned for potential or further dislocations in the credit, funding and or capital markets and simultaneously prepared to move to a greater offensive posture should our outlook become more constructive. On the M and A front, we remain open minded to transactions that will complement our franchise and maximize long term value to our shareholders. Our business has always been centered on relationships, The services we provide and the quality of our teams.

Speaker 1

I want to recognize our entire organization for their commitment to providing unparalleled service for our clients and our colleagues. On behalf of the Board of Directors And our entire executive leadership team, I want to congratulate and thank every one of our team members for their achievements and perseverance through a challenging backdrop during the first half of twenty twenty three. That concludes our prepared remarks. Rocco, will you open up

Operator

Today's first

Speaker 3

This is Andrew Lechner on for Chris McGratty. How is it going? Good.

Speaker 1

How are you, Andrew?

Speaker 3

So I know you mentioned in your prepared remarks that deposit flows reversed towards the end of the quarter and into July. But I think you're referring to toll deposits. Can you speak to trends you're seeing in your non interest bearing deposits, if there's been any stabilization there towards the end of the quarter or more recently in July?

Speaker 1

Yes, that's pretty consistent. That's what we were referring to is non maturity and that includes certainly Non interest bearing as well.

Speaker 3

Okay, great. Thank you. And obviously, so like the last few quarters, you've been tightening standards on credit. How should we start how should we think about loan growth in the back half of the year? And Yes.

Speaker 3

What do you need to see or like what will it take for you to get more comfortable extending credit? Thanks.

Speaker 1

I think as we move through the second half, Ron had mentioned that we're seeing a slowing, appears to be a slowing at this point in prepays and pay downs. So that in and of itself will help on the absolute level of the portfolio. I think as we've started to see a bit more stabilization in the deposit market We're becoming incrementally more comfortable around lending, but it's got to have the kind of returns that we Earns that we expect and frankly we just haven't seen that at this point given that there are Some lenders out there that are still lending at what we consider just unacceptable Risk adjusted rates. So we'll see how it plays out. I think our team is doing an excellent job in developing full banking relationships And the types of loans that we're putting on the books today are very attractive.

Speaker 1

So we'll continue that approach.

Speaker 3

Okay, great. Thanks for the color. And just one more if I can. So we saw the merger between Bank of Cowen and PacWest earlier this week. Just curious if you've been a little more active, and if conversations start to pick up and if you could just remind us on your idea Like what your ideal target would be in terms of asset size, geography and maybe product type?

Speaker 3

Thank you.

Speaker 1

Sure. Yes, I would certainly say that over the last several weeks, it appears that conversations have in fact picked up. We'll see whether that materializes into anything in the future. M and A always, Whether it's conversations or deals coming together, ebb and flow, but I think the pressures on the industry Are greater today than they've ever been. Scale matters.

Speaker 1

We certainly We have a fundamental belief that this is a consolidating industry and at times that consolidation maybe slows down, But there are likely opportunities for it to pick up materially in the not too distant future, we would think. From our standpoint, not many things have changed from an acquisition standpoint, geography, principally in the West Coast, Those that are fundamentally relationship based banks that are focused on small and middle market businesses, There are not a plethora of targets out there for us. We've talked about that. And we've always been open to considering a variety of options to maximize Shareholder value and we're going to continue to do that.

Speaker 3

Okay, great. Thank you for the questions.

Operator

Sure. Thank you. And our next question today comes from Matthew Clark at Piper Sandler. Please go ahead.

Speaker 4

Yes. Good morning, Steve and Ron. Maybe just a few questions on the NIM outlook. Ron, did you have the average NIM in the month of June? And I saw the spot rates.

Speaker 2

I don't have that right with me at this point. Obviously, it's down a little bit from the quarter average. But

Speaker 1

we don't have July, June, we'd have to come up with.

Speaker 5

Yes. That's

Speaker 2

We will see continued pressure from the funding as we saw here in the second quarter.

Speaker 4

Yes, understood. And then how much did the hedges contribute to net interest income in 2Q and 1Q? I just don't seem to have The 1Q number? Hi there.

Speaker 2

They contributed consistently. They increased about 4 or 5 basis points From the prior quarter in the Q1 here, I think that's in our IP.

Speaker 4

In terms of order of magnitude though in dollars?

Speaker 2

Let me just see here, About $9,000,000 for the quarter.

Speaker 4

Okay. And then just your outlook on borrowings with Deposits starting to flow back in. I guess, how should we think about your borrowing balances In the second half?

Speaker 1

Those are term borrowings. I don't think we have anything Sure. In the Q3 here, but we may have a little bit in the Q4. We had layered those out, but that's true with The broker deposits, I think we've got roughly $450,000,000 that will mature here towards the end of the third quarter. And Depending upon how things transpire with from the loan side, the deposit flows and the like, We are carrying a lot of liquidity that we'd anticipate paying those down or off.

Speaker 1

It just depends. We've never thought of wholesale funding as adding much in any kind of value to the franchise. And so our intent is to pay those down and off over time.

Speaker 4

Okay. And then as we look into next year and some of these swaps start to run off, Just trying to get a sense for whether or not you think you can kind of mitigate that assuming the forward curve and still Expand the margins as you look into next year if that's possible or not again with the swaps running off?

Speaker 1

Yes. No, I think That's reasonable. We did just add, as Ron mentioned, dollars 300,000,000 of notional swaps that Already in the money and weeks and that was just here in July. And from some of the other things we're seeing as we Talked about given where the core deposits are, we can reduce those brokered deposits. That's going to go a long way to paying that to impacting non interest expense.

Speaker 1

And We would expect that over time here as the loan portfolio continues to modestly reprice Higher and we add continue to add good quality relationships that all of those Factors are going to benefit the net interest margin.

Speaker 2

And Matt, also keep in mind that the swaps, They are laddered across roughly a year and a half maturity Starting in the Q4 here, as Steve mentioned. So we've got we're going to have a Still a pretty healthy notional position as we move into 2024 as well.

Speaker 4

Okay. And then just on the M and A Topic, did you guys consider PacWest and why or why not?

Speaker 1

We don't comment on other

Operator

Our next question comes from Andrew Terrell with Stephens. Please go ahead.

Speaker 5

Hey, good morning.

Speaker 1

Good morning, Andrew.

Speaker 5

I wanted to start on the I think you said there were 77,000,000 Participation sold this quarter, were those syndicated credits or club deals? And then are there any more planned selloffs Of participations, are there any remaining?

Speaker 1

Those were syndicated deals typically that we inherit from Acquisitions over the years, there we'll continue to look. We don't have very much in a way. It's a very small amount Have the loan portfolio, but we'll continue to track and monitor it. And if there's Opportunistic times where we can liquidate those, we very well may. But as I said, it's a pretty small amount.

Speaker 5

Yes. I didn't see it anywhere, but were there any marks taken on those this quarter? No. The 77? Okay.

Speaker 5

No. And then just overall on just the size of the loan portfolio and the growth Moving forward, I mean, it looks like on an annualized basis down, call it, 14%, 15% annualized on the HFI book the past 2 quarters. I guess, should we think about the magnitude of that compression slowing a little bit in the back half of the year, but Still loan balance compression from here as opposed to growth? I'm just trying to get a handle on where the loan portfolio can shake out size wise.

Speaker 1

Sure. So I think that we're going to, at this point, continue to take this generally the similar posture that we have On adding new credits, but we think there's some areas to incrementally add as long as they meet our risk adjusted thresholds. 2, as Ron mentioned, we are seeing what appears to be a pretty good slowdown in prepays and payoffs. I think that's probably owing to some of the other Lenders out there finally beginning to tighten up a bit around their own extensions of credit and naturally Just less demand. So I think those factors I would hard to forecast, But I would certainly expect you would not see that level of compression in the second half of the year.

Speaker 1

What level and whether or not we get net loan growth really depends upon a number of factors here. We're just not going to fund new loan growth as I've told the team with wholesale funding. It just doesn't add any value to the institution. But we've got plenty of room to bring on good quality Full banking relationships to the organization and we're going to continue to stay focused in that area.

Speaker 5

Yes. Understood. I appreciate the color there. And then one more on the wholesale or broker deposits. I think you $450,000,000 that comes up for maturity at the end of the 3rd quarter.

Speaker 5

Is that $450,000,000 is that a pretty even amount over the next, Call it several quarters?

Operator

Approximately,

Speaker 1

it varies a little bit from quarter to quarter, but yes, You could use that number for your model.

Speaker 5

Okay. Very good. Well, thank you for taking the questions.

Speaker 1

Certainly.

Operator

Thank you. This concludes today's question and answer session. I'd like to turn the conference back over to Mr. Gardner for any closing remarks.

Speaker 1

Great. Thank you, Rocco, and we appreciate everyone joining us. Have a good day.

Operator

Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.

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Earnings Conference Call
Pacific Premier Bancorp Q2 2023
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