Q3 2022 Pacific Premier Bancorp Inc Earnings Call
Good day and welcome to the Pacific Premier third quarter, 2022 earnings conference call.
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Please note. This event is being recorded I would now like to turn the conference over to Steve Gardner Chairman and CEO . Please go ahead.
Great. Thank you Sara good morning, everyone. I appreciate you joining us today as you're all aware earlier. This morning, we released our earnings report for the third quarter of 2022.
We have also published an updated investor presentation that has additional information and disclosures on our financial performance.
If you have not done so already we encourage you to visit our Investor relations website to download a copy of the presentation.
In terms of our call today I'll walk through some of the notable items related to our performance Ron Nicolas Our CFO will also review a few of the details on our financial results and then we will open up the call to questions.
I note that our earnings release and Investor presentation include a safe Harbor statement relative to look forward looking comments.
I encourage each of you to read through that statement carefully.
Over the past several quarters, we have taken a number of balance sheet management actions with respect to interest rate sensitivity designed to preserve our ability to deliver solid financial performance in an increasingly challenging and uncertain environment.
These actions along with the ongoing business development efforts of our talented commercial banking teams served us well during the third quarter.
Our earnings per share and pre provision net revenue both increased from the prior quarter.
Our net income was $73 $4 million or 77 cents per share in the third quarter and our P. P and our return on average assets increased eight basis points to 185% of.
Our regulatory capital ratios further strengthened over the prior quarter.
Increased profitability was driven largely by net interest margin expansion from the prior quarter.
During the third quarter, our net interest margin increased 12 basis points as we effectively managed our deposit costs, while realizing higher yields on earning assets.
We highlight in our Investor presentation, our core deposit base, which remains the foundation of our franchise.
Our cost of core deposits remained relatively low at 11 basis points in the third quarter, which reflects our relationship focused business model that has resulted in more than 38% of our deposits comprised of noninterest bearing deposits.
Given the expectations for further rate increases over the coming months. It is likely we will see some acceleration in deposit costs going forward as we are not immune to market dynamics.
In addition to deposit pricing impacts the higher interest rate environment has led to recent deposit fluctuations in our commercial escrow and exchange business.
Due to lower commercial real estate refinance and sales activities in the third quarter.
A dynamic that may persist as we work through the economic cycle.
Though we are taking steps to mitigate the potential impact, which I'll comment on a bit later.
We held our loan to deposit ratio relatively flat at 84% as we added $400 million of brokered time deposits have varying maturities during the quarter.
While incorporating time deposits into our funding mix, we will increase our deposit costs in the near term we.
We believe that locking in this longer term funding ahead of additional rate increases will provide more funding flexibility and help us control our overall funding costs going forward.
In terms of loan production, we saw decreased demand in the quarter, while remaining disciplined in our pricing underwriting and overall credit risk management.
This has been our approach router management's tenure and has contributed to our strong asset quality throughout various cycles.
Market conditions and implementation of our strategic pricing actions had the most pronounced effect on our new production of Investor owned CRE multifamily and construction loans as we methodically decided to pull back the volume of new originations in these areas.
The lower production of real estate related loans, along with a decrease in utilization rates on lines of credit resulted in a slight decline in total loans from the end of the prior quarter.
Our teams are actively engaged with existing clients and are focused on developing new commercial banking relationships with attractive businesses that will drive future organic growth.
As a result, our production of C&I loans was up from the prior quarter.
The new banking relationships, we are generating today continue to be attractive.
As the average yield on our new loan commitments increased 144 basis points from the prior quarter.
Asset quality remains solid with low levels of problem loans, and net charge offs totaling $1 $1 million in the quarter.
Overall, we are not seeing a degradation in our borrowers cash flows or their ability to service their obligations.
We have provided additional details on our loan portfolio segments and the investor presentation.
Our loan to values and Doug coverage ratios remained strong within each of our loan segments.
Proactive monitoring of the loan portfolios, including ongoing analysis of the financial performance of our borrowers and the collateral supporting our loans are fundamental tenants of our credit administration process.
This active management of the portfolio together with our conservative underwriting standards has been and we expect will continue to be important to our ability to effectively manage asset quality throughout the cycle.
With that I'm going to turn the call over to Ron to provide a few more details on our third quarter financial results.
Thanks, Steve and good morning.
For comparison purposes. The majority of my remarks are on a linked quarter basis.
Let's start with the quarters financial highlights.
Third quarter EPS increased to 77 per share a 5% increase on a linked quarter basis, driven by a total revenue increase of $6 3 million to $201 $3 million.
Although fee income was slightly lower operating costs were well controlled as noninterest expense for the third quarter came in at $109 million.
As a result, our pre provision net revenue increased $4 million to $100 4 million or $1, 85% of average assets and our efficiency ratio improved to 48, 3%.
Taking a closer look at the income statement.
Net interest income increased $8 3 million to $181 million driven primarily by a 26 basis point increase in our asset yields.
And slightly higher average loan balances.
Additionally, our swap income added $4 $2 million incrementally compared to the prior quarter.
On the deposit front total deposit costs came in at 22 basis points.
And our cost of core deposits, which excludes brokered and time deposits increased to 11 basis points for the quarter.
As a result, our reported net interest margin expanded by 12 basis points to 361%.
And our core net interest margin expanded 11 basis points to 344% as core loan yields increased 19 basis points to 440%.
Noninterest income decreased $2 million from the prior quarter.
Driven mostly by a $679000 decrease in net gain from the sale of loans and a $403000 decrease in trust custodial fees.
Lower trust fees were driven primarily by lower asset market asset values, while the SBA business has slowed recently in connection with the higher interest rates.
Going forward, we expect our noninterest income for the fourth quarter to be in the range of $20 million to $21 million, excluding any security sales.
Noninterest expense came in at $109 million, an increase of $1 9 million, primarily due to a $2 $5 million increase in other expense, which included a onetime $1 9 million dollar expense for a client loss, where our investigation concluded.
That our client system was compromised.
These items were partially offset by a $1 $2 million decrease in compensation and benefits.
As overall staffing decreased to 481 employees.
We anticipate our noninterest expense to be approximate $101 million to $102 million in the fourth quarter.
Our provision for credit loss of $1 $1 million increased slightly compared to the prior quarter's $469000.
And our credit quality was largely unchanged in the quarter.
While we have not seen a meaningful deterioration in credit quality, we are closely monitoring the macro economic environment.
Turning to the balance sheet.
We saw a slight decline in gross loans of $122 million from the prior quarter.
Driven by lower loan fundings in commercial line utilization rates.
Which declined slightly to a quarterly average of 44% and a spot rate of 39, 9% as of quarter end.
Not surprising given the interest rate environment. We also saw slower pay offs in the third quarter somewhat offsetting the lower loan production.
Period end deposits were $17 7 billion a decrease of 338 million from June 30, primarily driven by a $532 million decrease in deposits from the bank's escrow and exchange business due to lower transaction volumes and $127 million.
Decrease in municipal deposits.
To help offset the escrow and exchange deposit flows in early September we added another $400 million in term broker deposits, which provided additional liquidity and enhanced our interest rate risk asset sensitivity.
Notable on a year over year basis, our HOA deposit business grew 16% to $2 $3 billion. The trust business deposits grew 5% to $1 $7 billion.
And escrow deposits grew 4% to $1 billion.
Our securities portfolio remained flat compared with the second quarter at $4 billion, while our portfolio yield is currently at two 1% 2%.
The available for sale portfolio also remained flat at $2 7 billion and our mark to market unrealized loss for the quarter as of 930 was $95 million.
Our tangible common equity ratio ended the quarter at $8, 59%, an increase of seven basis points from June 30.
And our tangible book value per share decreased slightly to $18 68.
From $18 86 at June 30th.
The decrease was primarily driven by the other comprehensive loss of $65 million from the impact of higher interest rates on our securities portfolio compared to a $71 million loss in the second quarter.
Along with the higher TCE ratio, we further strengthened our capital position this quarter.
With common equity tier one tier one risk base and total risk based capital ratios all increasing from June 30.
And finally from an asset quality standpoint.
Asset quality remained solid as nonperforming loans and delinquency increased slightly at <unk>, four 1% and two 8% of loans held for investment, respectively, but well below industry historical averages.
Our allowance for credit loss was effectively flat in terms of dollars and our coverage ratio at 131%.
And our total loss absorption, which includes the fair value discount on loans acquired through bank acquisitions finished the quarter at 170%.
With that I will hand, it back to Steve.
Great. Thanks, Ron.
Wrap up with a few comments about our outlook.
With the increasing likelihood of a material economic slowdown we will continue to place a priority on maintaining high levels of capital liquidity and reserves. So that we can meet the needs of our clients and to be in a position to react to what could be unpredictable market dynamics.
This foundational approach to risk management has served us well historically and has been critical to our track record of creating franchise value.
Our relationship managers are providing exceptional service to our clients. While our teams are collaborating well and are highly focused on developing new long term relationships with high quality businesses and their owners.
We continue to invest in technology and people and that is benefiting us as we seek to expand and add new relationships throughout the bank.
The current environment for the escrow and exchange business is not as favorable we believe we have good opportunities to add clients expand market share and grow over the longer term.
We have recently added additional personnel, who we believe will be valuable in helping to grow the business and gain share during a time of market disruption.
Following the considerable work we have done to optimize the operations of the trust business. We have started to accelerate our business development efforts in the area and continue to see attractive opportunities to add clients.
In future periods, we expect both commercial escrow and trust businesses to steadily increase their contribution to our fee income and expand our base of low cost deposits.
It is likely that our level of loan production will be lower than what we have seen earlier this year.
Mix will continue to be more heavily weighted towards high quality commercial businesses as market dynamics limit the production of investor owned CRE and multifamily loans.
Ultimately, we will leverage the strength and talent of our leadership and bankers to deliver results for our shareholders, while effectively managing risk in a rapidly evolving and uncertain environment.
That concludes our prepared remarks, and we would be happy to answer any calls Sarah could you. Please open up the call for questions.
Thank you.
I'll now begin the question and answer session.
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Okay.
Our first question comes from David Feaster with Raymond James. Please go ahead.
Hey, good morning, everybody.
Good morning, David Good morning.
Maybe just.
Just touching on the deposit flows.
And looking exclusive of the escrow impacts that's not that surprising.
But you know just exclusive of that could you just talk about the flows that youre seeing in there and maybe how migration within the portfolio is trending and whether.
Whether youre seeing.
More cash burn at existing clients that might be driving some outflows within the existing book or is it more rate sensitive customers that are looking to deploy our liquidity into higher yielding assets and then just overall thoughts on how you think about deposit flows, especially as there might be some more migration within the escrow.
Sure.
So theres a lot of questions wrapped up fair, David I would tell you that.
At this point, we're not seeing a cash burn on on our borrowers.
Although I think that.
Business is individuals' investors are all being pressured by.
The high inflationary environment.
Still continued impacts from supply chain disruptions and the like.
Overall.
What we're seeing I think it is generally I don't even know that.
Qualify most of our customers as rate sensitive they are generally not it's not like people have ever banked with us.
Oh boy.
In this environment, where we've seen fed funds.
Raised by 300 basis points and in six months and likely to at to be at somewhere north of 4% by year end.
In a nine month period of time, that's just simply unprecedented and the returns that one can get risk free rate.
On treasuries.
For some investors become become attractive.
So I think those are the various dynamics our teams are doing a great job.
We have certainly increased the level of communication and meeting with our clients and talking to them.
And then working directly with them.
And many of these areas.
As far as the mix of flows we've seen a little change.
But nothing really material from any of our.
The business is we bank or some of the other specialty areas the HOA the trust.
Escrow and exchange.
And at the same time, we do see some.
Attractive opportunities to gain market share because there is clearly been disruption in the escrow and exchange business, where smaller firms are really being negatively impacted.
In the trust business seeing very attractive opportunities to add clients and as I said, we've accelerated our our business development and in that area and our.
Seen some preliminary nice results.
And then lastly in the HOA side that team is.
Function very well and we offer some market leading technology. There that has allowed us to grow that business. So throughout the organization I think we see some.
Pretty good opportunities at the same time.
This is <unk>.
Unprecedented.
Environment.
That.
We will see how things develop here in the coming months.
Okay. That's helpful and it was a couple of quarters ago that you started talking about using higher rates to strategically slow production and we've seen it it's been effective in origination yields looking at looking at the table were up huge.
And you also mentioned in the prepared remarks talking about having less of an appetite for some of these real estate bank loans.
Back to loans, but I'm just curious how you think about gross loan growth going forward, how the pipeline's looking I mean would you expect balances may be to continue to decline near term or Ken slower payoffs and Paydowns help offset some of these slower originations and we could actually see balances grow.
Curious how you think about that yeah, I think that it's the latter part there that given the fact that.
Prepayments and Paydowns have in fact slowed and we would expect them to continue that trend here in the fourth quarter.
We're just going to need.
Less production to whether its hold the portfolio flat grow it a little.
The like I think for US always has been the regulator has always been around loan growth as how quickly we can bring in low cost core deposits true.
Client banking relationships, that's always been the governor not certainly following the <unk> acquisition.
And with the.
Of fiscal and monetary stimulus that was shoved into the economy liquidity.
It all financial institutions.
Increased and so we deployed some of that.
Into really strong credit quality loans, such as as multifamily.
But as we've seen these dynamic shift.
We as we tell our teams we operate in a dynamic environment things are not static.
With the way that we manage the business.
And the way that we think about the future and the potential risks and so we have slowed down.
As I said some of the commercial real estate multifamily construction loans.
Okay that helps and then obviously just touching on the multifamily again I mean, obviously, that's a core competency for you all and you talked about decreased appetite and for this segment in production clearly declined in the quarter.
Historically I've always looked at the West coast multifamily is providing really good risk adjusted returns in a defensive asset class. Just curious you know obviously there is a lot of.
The dynamics changing in the housing market. These days, but just curious how you think about multifamily.
More broadly and any other trends that youre seeing within that segment on the west coast.
Sure I think that part of it multifamily remains one of the most attractive asset classes at least for.
This segment that we concentrate on which is you could characterize it as workforce housing we don't do.
Hi, and call. It if you will class a type multifamily properties is just not what we've ever done.
The occupancy levels remain very high cash flows are are strong we are stressing the portfolio to look at the impact on higher rates and debt coverage.
And we're in a.
Very good position I think that the.
The West coast from a housing and certainly multifamily benefits from this is under built significantly and although there are there are projects that will come on line in future periods. It just not has not been able to fill that that.
GAAP, if you will that exists for affordable reasonable housing so with that our expectation is is that that asset class.
We will continue to perform well, but as Ron said, we're closely monitoring all of our portfolios and the overall macro economic environment.
Alright, thanks, everybody.
Certainly.
Our next question comes from Matthew Clark of Piper Sandler.
Hey, good morning.
First one just for Ron I may have missed it in the prepared comments, but did you provide your near term guide on the core NIM for the upcoming quarter.
Go ahead, Ron Yes, we did not Matt.
We expect obviously on the asset side, if the current what's what's baked into the market. If you will for November December .
In terms of the fed rate hikes, we do expect the asset side of that to move consistent with what we see here in the third quarter.
But that said.
The whole question, Mark around where deposit cost and deposit betas and all of that.
Is really.
Up in the air right at this point in time.
Yes, I'd just add that you look at market dynamics that are going on.
We're seeing a number of institutions out there that are putting some pretty aggressive pricing.
And that's just not what we wanted to compete on but as I said.
We're not immune to market dynamics either show.
Why we haven't provided any guidance on it and don't intend to I think that the the modeling as subject to.
So many deferring.
Variables and variance.
What the outputs are we didn't think it was appropriate to provide guidance on it.
Okay, and then when you're working through your budgeting process or just.
Looking out at your kind of internal forecast around deposit betas, I mean, 18% last cycle you were at 6%.
To date.
You're expecting slower growth so there should be less.
Need for funding incrementally.
I mean do you feel like you can kind of match.
Match, what you did last last cycle.
Very fluid situation, but just any any additional thoughts around deposit betas.
Sure I have no idea.
I mean.
Yes.
All you have to do is take a step back and say, let's compare.
That period of time in December of 2015 to 2018, and what we went up by 225 to 250 basis points and then the fed and the fed began instituting quantitative tightening at half the level that they're doing today.
And that was over it took them two five years roughly to get to that level.
So compare that to this environment, where rates have moved up 300 basis points in six months widely expected to get to four and a quarter by the end of the year nine months period of time.
And quantitative tightening that began in June and increased in September is now running at more than twice the amount that.
But the fed had implemented during that period of time.
And I can tell you we don't know, it's something that we're managing closely monitoring closely as well.
Think are our relationships.
That we have with our clients are deep.
But again, we're going to be subject to the market dynamics and they are rapidly evolving.
The effects of the economy.
It's difficult to know.
Okay, and then just on the <unk>.
Provisional credits you guys took this quarter can you just give us a sense of the likelihood and timing of getting that back.
On on that incident with those clients.
I don't know its a large good clients that we've had for a long period of time. So we went ahead and did the credit.
Something we don't do lightly.
So we'll see.
It's hard to know with these kind of things.
Okay fair enough. Thanks.
Our next question comes from Chris Mcgratty with <unk>. Please go ahead.
Hey, How's it going this is Andrew <unk> on for Chris Mcgratty.
Hi, Andrew.
Hey, How's it going.
Credit trends continue to look solid.
So I was just wondering how youre thinking about provisioning for the office and retail portfolios going forward.
And if there are any specific markets you're concerned about thank you.
Sure Joe.
When you take a look and I'd point you to the slide that's in our Investor presentation, where we do provide some additional disclosure and information around the portfolio and you look at the fact that from that.
Retail segment.
49% average loan to value and weighted average.
180 D C R.
That portfolio has seasoned by 44 months.
And you have somewhat similar metrics on the office product.
We've had historically minimal.
Charge offs losses, and those portfolios. So we'll keep that in mind, we will we'll see how the economy evolves and the dynamics impacting.
Either one of those segments just as we do.
With all of the portfolio.
So we'll continue to think about it I think I'd also point to the reserve levels that we have today at 130 on the ACL and then we also have.
The credit marks and discounts on the existing portfolio.
Really helping too.
Improve increase our total loss absorbing capacity.
Up to 170 basis points.
Okay. Thank you that's all I was really helpful.
And then just looking at.
M&A can you talk about any potential deal opportunities youre seeing within your markets and if there are any newer expansion markets you would consider for a bank deal.
Sure I mean, principally we're looking on the west coast for high quality franchises that have good solid deposit base is relationship based.
That we think would be additive.
Two to our franchise.
And at the same time, though we have always been a very disciplined acquirer and that is going to continue.
<unk>.
And then you look at the volatility that is going on in the equity market volatility and in the interest rate complex and I think it just at.
Adds to the challenge.
Of finding the finish line.
With with targets and not that there are a lot out there for.
Our institution.
But we'll continue to look and we know that these cycles always play out over time and.
The.
The fundamental reasons behind consolidation in financial services.
Those remain in place and frankly have intensified here.
As this environment as played out so that's the way we're thinking about it.
Okay. Thank you and.
I can't remember if you said this before but have you disclosed how far east you'd be looking.
You'd be willing to look.
Generally we think about it from the franchise as a west coast franchise.
Our Trust Division is headquartered in the Denver market.
So I think a long.
The mountain West the Rocky Mountains there.
We've got we've got presence in Arizona, and Nevada, Oregon, and the state of Washington, So something that is complementary.
To those geographic markets that we're in.
Okay got it great. Thank you for all the questions.
Certainly.
Our next question comes from Gary Tenner with D. A Davidson. Please go ahead.
Hey, guys good morning.
Good morning, Gary I wanted to ask about I want to ask you about the C&I <unk>.
In the quarter, you talked about broadly the last quarter or so about.
Raising your offer rates and that would reduce some demand in other portfolios, but as it relates to C&I and the sequential decline in utilization and in dollars outstanding do you have a sense that youre better C&I customers are.
Becoming.
Overly more cautious in terms of the environment.
It's driving down some lower balances or do you think that the the higher cost of those variable rate C&I loans today relative to what maybe they're getting on their on some excess deposits is driving some moderation of the balances.
I think it's a combination of those factors look every business is a little bit different in a way that they.
Manage their capital and their balance sheet in a way they think about the world.
I think that the.
Ongoing challenges around the supply chain disruption inflation.
<unk>.
The impacts from labor all of those are playing a factor you look at the rising rates and the concerns about.
This fed tightening cycle when that we still have a ways to go.
And that given that.
Tighter rates act on the economy with long and varied lags.
I think theres plenty of clients, who are thinking about that in the future business activity and then others.
As you mentioned, who are sitting on excess liquidity and theyre, saying the cost of their debt increase are making decisions to pay some of that down pay some of it off I think though that the one thing that we talk about with our team. The reality is as is.
Business is ongoing in different businesses see opportunity in via in environments like this and they see opportunities to expand and grow.
And that's right, where we're going to be side by side with them, providing the capital the Treasury management services to do that and we think there is plenty of opportunity.
Again to grow in these areas.
Thanks, I appreciate that.
And then as it relates to the deposit side in escrow and exchange balances down to $1 billion in the quarter.
There's obviously as you just said a moment ago, there's always going to be some level of activity do you have a sense of what maybe an ultimate floor. It could be for that business, even given just a very modest level.
Ongoing transaction activity.
Is it half again, what it is or is that.
To aggressively low do you think.
My sense would be that that is too aggressively low, but I don't I can't sit here and tell you. The one thing is as a commerce Astro.
None.
It's been well established in the La Southern California market.
A long period of time and have a great reputation with.
With investors and with some of the additional folks that we've recently brought on to expand that into some of the contiguous markets markets that we're in already coupled with the disruptions.
I'll add that we're seeing longer term, we think that there is opportunity to take market share and grow our client base. There at the same time, it's going to be dependent upon just the level of commercial real estate activity that is occurring in various.
Yes.
Market, so hard to tell from from where we sit today.
Great and then just lastly for me I apologize if I missed it but did you say what the or Ron did you say what the weighted average rate was on the 400 million of broker deposits added in September .
No we didn't we did not know.
No.
That came on in the beginning of <unk>.
September so effectively we had one months in.
Tacked on on those.
Those broker deposits. So we will have we'll have a step up there given the full quarter's impact.
Alright, Thanks, guys appreciate it.
Certainly.
Your next question comes from Zach <unk> with Stephens, Inc. Please go ahead.
Hey, this is actually Andrew Charles Steven's good morning.
Hi, Andrew Andrew.
Hey, So I wanted to ask me thanks for the expense guidance.
I wanted to ask as we think about kind of out into 2023, just given what sounds like maybe.
A little bit slower cadence of balance sheet growth.
How are you thinking about managing the expense base of the level of expense growth as we as we move into 2023.
We're thinking about managing it tightly we've.
We've always been a an efficient operator and.
And we're going to continue to do that and stay laser focused on managing expenses effectively.
At the same time, we've also believed that you do not grow any business without investing in people and technology.
And so that has always been the case for us and it will continue to be the case that we will invest in people and technology, but we'll be we'll be manner managing expenses very tightly.
Okay. Do you think from just an efficiency ratio standpoint, I mean, it was good to see the improvement. This quarter do you think you can manage to a sub 50% efficiency kind of through the rate cycle or.
Maybe some of the other pressures maybe on deposit cost side keep you at 50% or above level.
I think it's uncertain what this environment makes it very challenging to.
To forecast actually the speed and magnitude of changes in rates.
And then as the economy adjusts to those changes as well it makes it extremely difficult in forecasting.
And although we are are running forecasts and models under a variety of assumptions.
Regularly and when Ron brings it into me and although it is very detailed level.
Let them know things, but its not worth the paper, it's written on but it gives us some insight in other areas such as expenses that we have a bit more.
Troll on directly we can manage those how they play out and where that lands at from an efficiency efficiency measure.
That is dependent upon a number of other variables obviously.
Okay.
That's helpful color.
Apologize if I missed this one.
Brian could you remind us how much cash flow per month or per quarter. The bond book kicks off.
It varies.
A little bit I would say it gives off in the range of about 75 to call it $90 million a quarter.
Okay. Thanks for taking my questions.
Yes, certainly.
This concludes our question and answer session I would like to turn the conference back over to Steve Gardner for any closing remarks.
Very good thank you Sarah and thank you all for joining US today I Hope you have a good week.
The conference is now concluded. Thank you for attending today's presentation you may now disconnect.