Bank of Marin Bancorp (NASDAQ:BMRC) Q3 2023 Earnings Call Transcript

Bank of Marin Bancorp (NASDAQ:BMRC) Q3 2023 Earnings Call Transcript October 23, 2023

Bank of Marin Bancorp reports earnings inline with expectations. Reported EPS is $0.33 EPS, expectations were $0.33.

Operator: Good morning, everyone. Welcome to the Bank of Marin Bancorp's Q3 2023 Earnings Call. [Operator Instructions] I will now turn the call over to Yahaira Garcia-Perea.

Yahaira Garcia-Perea: Good morning, and thank you for joining Bank of Marin Bancorp's earnings call for the third quarter ended September 30, 2023. I'm Yahaira Garcia-Perea, Marketing and Corporate Communications Manager for Bank of Marin. During the presentation, all participants will be in a listen-only mode. After the call, we will conduct a question-and-answer session. Joining us on the call today are Tim Myers, President and CEO; and Tani Girton, Executive Vice President and Chief Financial Officer. Our earnings press release and supplementary presentation which we issued this morning can be found in the Investor Relations portion of our website at bankofmarin.com where this call is also being webcast. Closed captioning is available during the live webcast as well as on the webcast replay.

Before we get started, I want to note that we will be discussing some non-GAAP financial measures. Please refer to the reconciliation table in our earnings press release for both GAAP and non-GAAP measures. Additionally, the discussion on this call is based on information we know as of Friday, October 20, 2023, and may contain forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those set forth in such statements. For a discussion on these risks and uncertainties, please review the forward-looking statements disclosures in our earnings press release as well as our SEC filings. Following our prepared remarks, Tim, Tani and our Chief Credit Officer, Misako Stewart will be available to answer your questions.

And now, I'd like to turn the call over to Tim Myers.

Tim Myers: Thank you, Yahaira. Good morning, everyone, and welcome to our third quarter earnings call. Our improved third quarter results reflect meaningful progress that we made to reposition our balance sheet out of borrowings and securities and into deposits and cash to expand our net interest margin, increase our liquidity diversification and improve our interest-free risk position. We generated 16% sequential growth in net income while maintaining comparable loan balances, strong credit quality and well-managed expenses. We further strengthened our core deposit franchise during the quarter by engaging new customers and deepening ties with existing clients through exceptional service and our local market expertise. These efforts led to strong deposit growth for the second consecutive quarter, including growth and non-interest-bearing deposits which continue to represent 48% of our total deposits.

Notably, during the quarter, we added more than 1,200 new accounts, 38% of which were with new clients. While deposit costs increased in the quarter, the pace of increase slowed dramatically from the second quarter as we continued to effectively manage our deposit costs in an ongoing competitive environment. Interest-bearing deposit costs increased 31 basis points between June and September compared to 77 basis points between March and June. Historically, our overall cost of funds has trended well below pure averages, reflecting our long-term approach to customer engagement, which emphasizes building connections with a full suite of products and services rather than competing on price alone. We continue to work hard at improving our net interest margin by executing on our balance sheet initiatives, which not only include raising deposits and building our loan pipeline, but also reallocating part of our investment portfolio to cash and applying fair value hedges to other securities.

Those actions enabled us to expand net interest margin by 3 basis points from the second quarter. We also substantially paid down our short-term borrowings during the quarter with cash flows from our securities and loan portfolios, as well as deposit growth as part of an ongoing strategy to reduce interest costs and support our net interest margin. While borrowings and cash fluctuate with day-to-day changes in deposits, the borrowing balance net of cash fell to 0 earlier this month. We expect our funding cost increases to remain moderate in coming quarters, given expectations that Fed rate hikes and customer migration of funds from operating accounts to interest bearing accounts will continue to slow. Our loan portfolio and loan production was relatively stable in the third quarter as we remain disciplined in our underwriting.

However, our loan pipelines have expanded meaningfully and fourth-quarter loan production is shaping up to be strong, particularly in the area of commercial and industrial where we are seeing a nice diversity of attractive opportunities. We generate a momentum in the third quarter that has continued into the fourth quarter and since quarter end have funded or approved for funding amounts exceeding Q3 total originations. In most cases, our new loans are coming onto our books at meaningfully higher rates than those being paid off, and we expect this will provide further support for our NIM. David Bloom, who joined us as Executive Vice President and Head of Commercial Banking in July, is emblematic of our ongoing recruiting efforts and the results that follow.

A commercial banking veteran with more than 25 years of experience, David is responsible for the vision and growth of the Bank's commercial banking division comprised of eight regional offices located throughout Northern California, including our wine practice. We believe his growing team is well positioned to drive further momentum late this year and moving into the new year. Importantly, with new commercial-client relationships comes the potential for fee-based opportunities and new deposits. We believe that this will help the bank generate improved profitability, continue robust earnings-generated capital and strong returns on behalf of our shareholders. Critically, as we pursue growth, we remain focused on prudent risk management and strong credit quality that reflects our consistent underwriting standards and customer selection across cycles.

We also continue to proactively manage our credit and support our borrowers, building momentum with high quality credits while carefully monitoring our loan portfolio and rating risk appropriately. Non-accrual loans totaled 0.27% of the loan portfolio at September 30 compared to 0.1% at June 30. We moved two loans totaling $4 million to non-accrual status in the third quarter. The increase was driven by a legacy acquired bank loan and we are working with that bar to ensure the best possible outcome. All of our non-accrual loans are collateralized by real estate with no expected credit loss as of quarter end. Classified loans comprised only 1.9% of total loans at quarter end, up only slightly from the prior quarter. Looking closer at our commercial real estate portfolio which accounted for 74% of our total loan balances of September 30, 23% were owner occupied which we believe carry a different risk profile than non-owner-occupied loans in this environment.

Our $364 million non-owner-occupied office portfolio is granular and consists of 142 loans with an average loan size of $2.6 million, the largest loan being $17 million. The weighted average loan to value was 56%, and the weighted average debt service coverage was 1.68 times based on our most recent data. Earlier this quarter, we conducted a review of the refinance risk in our non-owner occupied commercial real estate portfolio, the results of which can be seen on Slide 13 of the earnings presentation. We evaluated 36 loans totaling $97 million with total commitments over $1 million each that mature or reprice in 2023 or 2024. We determined that the refinance risk on these loans is manageable with weighted average debt service coverage ratios ranging from 1.28x to 2.01x across the four cohorts based on current rates.

A woman signing papers with her banker for her first home mortgage. Editorial photo for a financial news article. 8k. --ar 16:9

In summary, we made important progress on both sides of our balance sheet in the third quarter and continue to make headway as we position the bank for improved profitability in the quarters ahead. Finally, the bank is pleased to welcome Cigdem Gencer to its Board of Directors, as announced in our recent 8-K. Cigdem brings extensive leadership and financial services experience to the board, including the development and execution of transformative growth, expansion, and investment strategies for organizations. In 2021, she established an executive coaching and organizational consulting firm, and which she also serves as an executive coach. With that, I'll turn the call over to Tani to discuss our financial results in more detail.

Tani Girton: Thanks, Tim. Good morning, everyone. First, I'll start with some key highlights for the quarter. We generated net income of $5.3 million in the third quarter or $0.33 per diluted share up from $4.6 million or $0.28 in the second quarter. As Tim noted, the increase was driven by a 3 basis point increase in our tax equivalent net interest margin to 2.48% from 2.45% in the prior quarter due primarily to higher rates on interest-bearing cash balances generated from security sales and the addition of $102 million fair value hedges in the form of interest rate swaps. We recorded a $425,000 provision for credit losses on loans in the quarter compared to $500,000 in the prior quarter. The provision was due primarily to increases in qualitative factors related to trends in adversely graded nonowner-occupied commercial real estate loans and the potential impact of higher interest rates and other external factors on both our nonowner-occupied commercial real estate and construction portfolios.

Non-interest income totaled $2.6 million for the third quarter down $141,000 from the second quarter. The modest decline was primarily due to a decrease in debit card interchange income. The sale of $82.7 million investment securities generated a loss of $2.8 million and that loss was offset by a gain on the sale of our remaining 10,439 vis-à-vis shares, which had a zero carrying value. Non-interest expenses of $19.7 million in the quarter were down $918,000 from $20.7 million last quarter. Contributing to the reduction was a $675,000 decrease in salaries and benefits related to decreases in accrued incentive and profit-sharing expenses and 401(k) contributions. Additionally, our annual charitable contributions grant program normally occurs in the second quarter, resulting in another $618,000 reduction quarter-over-quarter.

Finally, FDIC insurance costs declined $197,000 due to a second quarter catch-up adjustment for the statutory rate increase to bolster the deposit insurance fund. These decreases were partially offset by a $533,000 net increase, other expense primarily resulting from a $688,000 increase in expenses and fees associated with our customers' participation in reciprocal deposit networks to bolster their FDIC-insured balances. Our third quarter earnings translated into a return on assets of 0.52% and return on equity of 4.94% up from 0.44% and 4.25% in the prior quarter. The efficiency ratio improved to 72.96% from 76.91% in the prior quarter due to both higher net interest income and lower non-interest expenses. We continue to maintain a high level of capital and liquidity as well as an allowance for credit losses equal to 1.16% of total loans.

All capital levels remain strong and meaningfully above well-capitalized regulatory requirements. Our total risk-based capital improved to 16.6% and 16.1% for Bancorp and the Bank respectively during the quarter. Our TCE ratio was comparable with prior quarter, despite pressure from AOCI resulting from resulting - rising interest rates in the quarter. Bancorp's quarter end tangible common equity was down 1 basis point to 8.63%. The $7.2 million decline in AOCI resulting from after-tax marks on our AFS portfolio, net of fair value hedges was mostly offset by earnings and a reduction in tangible assets. After adjusting for $107 million in after-tax unrealized losses in our HTM securities portfolio, our TCE ratio would be 6.1% for Bancorp. Importantly, our liquidity covers all of our uninsured deposits by over 200%.

Liquidity and contingent liquidity of approximately $2.1 billion at quarter-end consisted of cash, unencumbered securities and total borrowing capacity and does not include our ability to tap the brokered deposit market. Uninsured deposits remained at 29% of our total deposits as of September 30. Our largest depositor represented just 0.8% of total deposits and our combined four largest depositors represented 3% of total deposits. Our Board of Directors declared a cash dividend of $0.25 per share on October 20, 2023 which represents the 74th consecutive quarterly dividend paid by Bancorp. As we noted on last quarter's call, the Board of Directors renewed the share repurchase program for $25 million effective through July 2025. There have been no repurchases in 2023 as we have focused on continuing to build upon our already strong capital position.

We continue to believe that our emphasis on the fundamentals of relationship banking and risk management, combined with our strong liquidity and capital will continue to serve our customers and shareholders well across all interest rate and economic cycles. At Bank of Marin, we are committed to fostering a culture of excellence, effort and engagement as our teams work together on the execution of our strategies to increase operational efficiencies and improve long-term profitability. With that, I'll turn it back to Tim to share some final comments.

Tim Myers: Thank you, Tani. In conclusion, we continue to build upon our valuable core deposit franchise in the third quarter. Emphasizing our relationship-based banking model to increase deposits while maintaining an attractive deposit mix and healthy liquidity levels. We also proactively managed our balance sheet enabling us to expand our net interest margin in the quarter. We bolstered our commercial banking team and are attracting new clients that are seeking financing to pursue new opportunities and expansion plans and we are deepening our relationships with existing clients. This is enabling our lending teams to build a strong pipeline that we believe will lead to loan growth, increased interest income and ongoing margin and earnings improvement. Finally, I want to thank everyone on today's call for your interest and your support. We will now open the call to your questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Jeffrey Rulis from D.A. Davidson. Your line is open. Please go ahead.

Jeff Rulis: Good morning.

Tim Myers: Good morning, Jeff.

Tani Girton: Good morning, Jeff.

Jeff Rulis: Hoping to get an update on - I think you've identified a couple of months ago, that the percent of loans that we're repricing in the next 12 months, I think it was around 30%. Has that meaningfully changed as of today?

Tim Myers: No. There's a slide in the deck on Page 17 on - in the investor presentation on the total, but that's - I'll let Tani go into some of the details on that.

Tani Girton: Yes. So Jeff, the 29% in - when we discuss that in the context of our interest rate risk and where our net interest margin is headed, that includes prepayment projections, whereas what you can see on Page 17 in the deck or the presentation, if you add up the first two columns in the loan repricing schedule, that 17% there are no prepayment rates applied to that.

Jeff Rulis: Got it. Okay. And as you both kind of talked about the puts and takes of the bigger picture on margin, it sounds more positive than not. High-level margin conversation, the outlook here is to continue to scratch out some expansion or kind of how do you see it as those deposit costs kind of held it big?

Tani Girton: Yes, exactly. So we had talked about that on the last call. And I think for some of the factors, what we expected was what actually transpired. But again, that was absent any loan growth and also any change in deposits. Obviously, we had more growth in deposits and also the rates on the deposits went up. So that's where you would have gotten the differential. So as we look forward from today with a static balance sheet. So similar expectations, obviously not quite as much lift, if we don't make any changes associated, you know, last time we worked in the changes associated with the security sales, excuse me, and the interest rate swaps. This time, we have not done any of those as of yet this quarter. So, if you just look at a straight static balance sheet, with no changes in market rates, no changes in deposit rates, you know, that ranges from two to five basis points in lift on average margin in a quarter.

Tim Myers: Yes. I would say, Jeff, from a, less sterile standpoint, analytically and Tani's right as we are seeing that pace of deposit cost decelerate. When you look at the deposit campaign we did, this last quarter versus the prior quarter, the weighted average cost on that was very, very similar, almost identical. And the yield on new loans coming on was 769 in the quarter. So, I think we mentioned in the script there that we have had an acceleration of loan closings. We had expected some last quarter, but those are materializing now. And so, if we get that loan growth on top of what Tani mentioned, we're optimistic we can continue to show that expansion barring any unforeseen circumstances there.

Jeff Rulis: Great. I appreciate the color. If I could ask about the deposit side, and you talked about, I think you said 1,200 new accounts added and a large portion of those were new clients. What - if you could kind of range-bound, what the newer clients, where are they coming from? Is it from some of the struggles - or failed banks in your region? Or is it community banks? Is it larger banks? Do you get a sense for where those clients are coming from?

Tim Myers: Yes, it's all the above. We are continuing to benefit from what happened with some of the banks that were taken over, but we're also getting accounts from just other large banks. I think the pros and the market drove people that direction, but fundamentally there's still a strong desire and love of the community banking model, or appreciation of that. And so, we continue to benefit from that. The bulk of it that we brought in, meaning not current account fluctuations, it was about $80 million or $81 million of that was interest bearing, but again that weighted average cost was 3.63% just for interest-bearing. So, we continue to get DDA. None of that was broker deposit activity and very little CD activity. So, it's just blocking and tackling deposit gathering. But it is across the board in terms of sources.

Tani Girton: And I'd say you can see in the deck on Page 16, what the cost of deposits was in September versus June, but in general, the deceleration in the increase in cost of deposits is significant. It was about half this quarter versus what it was last quarter.

Jeff Rulis: That's great. Thank you.

Tim Myers: Thank you, Jeff.

Operator: Our next question comes from the line of David Feaster from Raymond James. David, your line is open. Please go ahead.

David Feaster: All right. Good morning, everybody.

Tim Myers: Good morning, David.

Tani Girton: Good morning, David.

David Feaster: Maybe just following up on the margin discussion, you guys, that's assuming a static balance sheet, if I heard you correctly. And you guys have been, you've done a great job managing the balance sheet. I'm just curious, how you think about it going forward? We built cash balances this quarter. Are there any expectations to continue pruning the security book, pay down borrowing? You know, that would only be additive to the discussion, I would think, but I'm just curious, kind of how you think about managing the balance sheet going forward?

Tim Myers: I'll talk high level, but Tani jump in, but we continue to look at that all the time. If we can sell securities, particularly fund into loan growth, obviously have a more definable earn back period that way. There's more clarity into that. We've been successful in paying down those borrowings. In fact, for a number of days during the quarter, we were, if you net from the cash, the $83 million from the prior security sales. If you net that from borrowings, we were negative $10 million for a while. We were sitting at zero. So, we've seen the ability to work that down. But your question is a great one we will continue to look at that. We're being sensitive to managing all the stakeholders here, shareholders, regulators, and want to maintain liquidity on the balance sheet. But we definitely want to look at what we can do, to fund loan growth and continue to reposition that NIM.

Tani Girton: Yes, I would just add, - I think it's an exciting time if you see what the originations were at the beginning of Q4. You know, that's a time where we can really take some more action and do some redeployment on the balance sheet. So, I think there's possibly some opportunities coming up for us here.

David Feaster: That's terrific. And maybe just following up on that point, could you talk about some of the dynamics that you're seeing on the loans side of the equation? Maybe just, first of all, I guess a pulse of your markets and how demand is trending, but just given some of the hires that you talked about and the commentary on, originations already exceeding the third quarter level. I'm just curious, where you're having success, where you're seeing opportunity to gain clients and new lending opportunities and how good risk, where are good risk adjusted returns at this point?

Tim Myers: Sure, so we are seeing a mix with a higher weighting towards C&I right now. Certainly that comes with new hiring and focus. But we're also starting to see opportunities within CRE, meaning as prices have come down and rationalized and panic has abated, buyers, customers, prospects, looking to make purchases at those lower values, with those number all pencil out, we're seeing a mix of all of that. And it's also a good mix between new and existing customers. And you always want to see that kind of mix across all those things, type, borrower type, et cetera. So, it's been very encouraging. Some of it is stuff that was stuck in the pipeline for some time as, these things worked their way through the system. We are being very cautious. There's other factors out there that slowed our process down. A lot of it is just brand new customer referrals from some of the hiring we've done. So, I'm encouraged by the diversity of that.

David Feaster: That's terrific. And the last one from me, you guys have done a great job managing expenses in a challenging revenue environment, still investing for growth. I'm just curious, how do you think about the expense trajectory going forward, some of the push and takes there, and how new hires, are you seeing more opportunity to invest and add new hires at this point? Where are they coming from? And just again, maybe some higher level commentary on the expense trajectory more broadly?

Tim Myers: I'll start on the hiring and then let Tani talk about the expense front. We are seeing opportunities. We're in the process of trying to fill some open positions on the production lending side. We've benefited across the bank and the different divisions from some of the disruption in the market and been able to hire some really good people. But we continue to be reluctant to throw a lot of money at people that we can't really map out a road to return on that, meaning big team hires, et cetera. But we are trying to be very selective and the people we have hired are making a difference. So, we'll continue to look at that, but it will be in a pragmatic incremental approach.

Tani Girton: And on the general expense side, I'd say that this quarter continues to be indicative. Fourth quarter is typically when all the true ups happen. But, the team has been really persistent about trying to make sure that we're doing our true ups as we go throughout the year. So you saw a few happen in the third quarter. The one thing that, could bounce around a little bit, the reciprocal deposit costs, did go up as the balances went up. Those balances went up at quarter end, they came down a little bit after quarter end. So, those deposit fees could fluctuate somewhat, but those have become a larger component of our other expense category.

David Feaster: Okay that's helpful. Thanks everybody.

Tim Myers: Thank you, David.

Operator: The next question comes from the line of Woody Lay from KVW. Your line is now open. Please go ahead.

Woody Lay: Hi, good morning, guys.

Tim Myers: Good morning, Woody. How are you?

Woody Lay: I'm good. I wanted to start on the deposit side. I mean, it was another good quarter of deposit growth. Excluding the normal seasonality, do you think that these trends can continue sort of in the near to medium term, or would you say most of the heavy lifting has been done at this point?

Tim Myers: No. I think - sorry, can continue or should continue I think like a lot of these trends will decelerate. So if you looked at our new deposit gathering activity, that was $152 million, call it, in the prior quarter, $90 million this quarter. But we intend to continue that effort, and we want to continue the deposit mix. It's really the seasonality, I think, that's going to - that we see in the large depositor operating account fluctuations where we might see upward or downward trends affecting the results. But I think - the behavioral attributes that have allowed us to be successful should continue, and that ultimately leads to treasury management fee income growth that adds to lending opportunities, its behavior we want to continue I just think it will continue to decelerate. I just don't know at what pace.

Tani Girton: Yes. And I would just add that those large depositor fluctuations, that's part and parcel of our business model and has been forever. But also the third quarter, what we did observe was sort of during the months of late July and August, we saw the activity go down a bit, because of vacations, not only people here but customers being on vacation. And we did see that activity start to pick up again towards the end - of the quarter. So as long as we stay engaged, I think we stand to continue the trend. But as Tim said, maybe not quite as heavy as in the second quarter.

Woody Lay: Got it. That's great color. I wanted to get over to credit. And when I look at your office slide, it looks like the average occupancy rate ticked up for the - San Fran office portfolio. Do you think that sort of represents a positive trend? Or is that just sort of a quarter-over-quarter fluctuation that's not really representative of much?

Tim Myers: I wouldn't read too much into that. We're actually seeing some - there is weakness in the market. What we are starting to see, what's interesting is activity per borrowers' landlords is increasing in terms of tenant investigation of taking down space. But right now, what you're seeing is a rationalization of the market, meaning our landlord is willing to accept what tenants can pay per market rents today. And so, we're seeing that ongoing negotiation. And so, I really unload to predict a run rate Woody based on that trend, because we are seeing a softening, people not renewing leases. And as the landlords look for new tenants, again, can they live with five, 10-year or seven, 10-year leases at today's current market rate.

And there's a bit of a standoff there, and that will play itself out. But all those deals got good sponsorship and decent loan to values in some cases, excellent loan to values, which gives us flexibility for time. But as San Francisco is still a weak market right now for leasing up newer empty space.

Woody Lay: Right. Thanks for that. And then last, I just wanted to follow-up on the special mention loan bucket. Were there any trends there in the third quarter? Any color there would be helpful?

Tim Myers: We did exactly what I was just saying. So that's two of the properties we moved into there were properties in San Francisco, where tenants have chosen not to renew. We're pretty aggressive when we downgrade. So watch credits, for example, is a very transitory bucket for us. So, we're pretty aggressive in downgrading the special mention, if we think there's a threat to the primary source of repayment. But those are properties where one in particular, where the lease isn't up yet, tenant has said they're leaving, landlords looking for a new tenant. And again, you get back to that rationalization of accepting longer-term leases at current market rates. So, the increase in special mention or classified as similar - I'm sorry, credit side, is very similar to the amount that moved in the prior quarter.

We just have a lot of transitory activity there. So, we'll aggressively downgrade when we see a threat to that primary source. But oftentimes, we can work out. But that goes back to the softness in San Francisco.

Woody Lay: All right. Thanks for taking my questions.

Tim Myers: Yes.

Operator: The next question comes from the line of Andrew Terrell from Stephens. Your line is now open. Please go ahead.

Andrew Terrell: Hi, good morning.

Tim Myers: Good morning, Andrew.

Tani Girton: Good morning.

Andrew Terrell: If I could just follow-up on credit for a moment. The $3.8 million loan that you called out that went nonaccrual this quarter, it looks like it was acquired. Do you have just what the specific reserve or the mark is against that credit? And was this one that you had marked as PCB in the transaction originally or originally identified as being a potential problem loan?

Tim Myers: I'm going to let Misako Stewart, our Chief Credit Officer, answer this question. So go ahead.

Misako Stewart: Yes. There is no specific reserve for that particular loan, because we do still have adequate or sufficient loan-to-value coverage on that. And the loan did go into non-accrual, but since quarter end, they did bring the payment current. So actually, as of this date, the loan is current on payments. And - we're continuing to work with the borrower. The deal happens to be in an industry that we normally are not in. So it's kind of an isolated situation, and we're continuing to work with the borrower.

Andrew Terrell: Okay. Great. I appreciate the color. And then a lot of banks have been giving some color this quarter around the reserve against their office portfolio. Is that something you guys have offhand that you could share?

Tani Girton: A specific reserve, are you - is that what you're asking…

Andrew Terrell: Yes, specific reserve against the office portfolio?

Tani Girton: Yes. We don't have a specific reserve. However, we did make some adjustments in our Q factors and our qualitative factors under CECL to kind of increase the risk factor for our non-owner occupied real estate, which would include office. So that's kind of where the reserves would be coming from. But no individual reserve.

Andrew Terrell: Okay. Understood. And then just I wanted to make sure I understood that the Page 13 of the presentation, the refinance slide correctly. And I appreciate the data. It's very helpful. For the four loans that are $11.6 million out maturing in the fourth quarter. I just want to make sure that the 128 debt service coverage is based on a 3.80 weighted average current rate, correct?

Tani Girton: No, it's not. It's actually stressed to current market rate.

Andrew Terrell: Okay. Understood. Okay. I appreciate it.

Tim Myers: We may not - for everyone's benefit, we may not have done a good job selling that out, but those are the current rates we took current lease rates, current rent rules, current tenancy and said, could these loans or sensitize those to repricing at current market rates to see what our exposure was on that. And so, we did it in two buckets, loans coming due by way of maturity or loans that reprice because those are somewhat different risk buckets. But similar underlying risk factors is commuting cash flow when you reprice them at market rates. We wanted to demonstrate - for ourselves do that analysis and demonstrate that they have adequate debt coverage.

Tani Girton: So that rate - there is indicative of how far those would have to move between their and the stressed rates to get to those debt service coverages. Right, right, right. It means that based on the current rate that they're paying on the debt coverage, would be much higher than what was indicated here, because the weighted average debt service ratio that you see on this page is stressed.

Andrew Terrell: Understood. Okay. Yes, definitely still really strong, especially understanding that you've already stressed that debt service right there. Okay. Very good. And then just one last one from me. I wanted to get maybe updated thoughts. You've obviously got a really strong capital position maybe updated thoughts on the buyback, I think about $25 million outstanding. Just how you're thinking about that given where the stock is trading at right now?

Tim Myers: Well, we continue to believe we'd love to do that based on the valuation. We think it's a great deal, obviously. Similar to my I answered, I think, David, on security sales and having ongoing conversations with different stakeholders, including the regulators about their appetite, given fears around potential credit losses. What that might mean, but it's something we remain keenly interested in. It's probably a matter of timing.

Andrew Terrell: Okay. Thank you for taking all the questions.

Tim Myers: Thank you, Andrew.

Operator: The next question comes from the line of Matthew Clark from Piper Sandler. Your line is now open. Please go ahead.

Matthew Clark: Thanks and good morning.

Tim Myers: Good morning, Matthew.

Matthew Clark: Just a few more all around the margin, just trying to fine-tune the forecast here. Loan yields were basically flat this quarter. Was there anything unusual there? And we see the repricing slide and we know about, new loan production coming on a lot higher. But maybe just any commentary around this latest quarter and then kind of the lift you might expect going forward?

Tim Myers: I think some of the yields of loans paying off are a little bit higher, depending on the loan category. So the average yield of loans paying off of $6.2 million, that's a little bit high. And so there wasn't a huge rate differential. You had overall loan compression, albeit marginal. And I think that all affected an average yield. But that average yield of loans coming on at $769. If we can continue that trend, again that $620 million as high for loans coming off, that should expand or more differentiated.

Tani Girton: Yes. And if you look at the yield on the quarter before loan fees, we had lift of 5 basis points there. And I think what happened in the loan fees and cost amortization is that if memory is serving correctly, we had some payoffs last quarter. So we had some fees that were associated with those that lifted the yield a bit.

Matthew Clark: Got it. Okay. And then the trend in interest-bearing deposits you show on Slide 16, call it, 10, 11 basis points per month in terms of the rate of increase. And it sounds like you expect things to moderate. Do you happen to have, I guess you - yes, do you happen to have the spot rate at the end of September. I'm just trying to get a sense for - does that 10 basis point increase get cut in half going forward or not?

Tani Girton: Yes. So we don't have the spot rate for September 30, but what we gave you was the month for the rate for the month of September, which was 100 basis points on the total cost versus 82% in the month of June. So a 28 basis point lift over the three months.

Matthew Clark: Okay. Great. And then just any additional commentary around expenses for next year? How should we be thinking about growth? Is it - are we shooting for expenses to be flat on an operating basis? Or do you think there might be some modest growth?

Tim Myers: Well, we have some investments we want to continue to make around efficiencies and digitalization. That being said, that investment has been slower this year. The branch closures we announced the savings this year because of accelerating TI costs was more minimal. But next year, that's a $1.4 million annualized savings. So we're doing our best to cover investments or any further increases in expenses with offsetting that with savings like that and we'll continue to do that. So we don't have any large expense things planned that would deviate too far from that. But we also caveat that, we want to be opportunistic with hiring and other things. And I say that with nothing in mind, but I think that's the general picture.

Tani Girton: And we normally will plan for merit increases. And so that's going to give you an upward trend just in general.

Matthew Clark: Yes, okay. Got it. Thank you.

Tim Myers: Thank you.

Operator: The next question comes from the line of Tim Coffey. Your line is open. Please go ahead.

Tim Coffey: Great. Thank you, Morning, everybody.

Tani Girton: Good morning, Tim.

Tim Coffey: Tim, if we can circle back to the San Francisco office book. How much of that is criticized or classified at this point?

Tani Girton: We'll see here, let me do the math. So about of the $71 million, there's about 25% that's in the classified bucket. And then yes.

Tim Myers: And that continues and has been skewed, Tim, by that large substandard that we downgraded two Decembers ago. So we've had the movement in there. We just mentioned into criticized, but that one large $17 million loan really contributes the bulk of that it has for some time.

Tani Girton: It's one borrower. We're not seeing any deterioration, not any notable improvement, but no deterioration. There's good sponsorship behind it. So loan payments are being made as agreed, and we're continuing to work with the borrower.

Tim Coffey: Okay. Okay. That's great. And then, Tim, as you talk to some of the commercial real estate investors and your bank. What's their temperature like right now? Are they still waiting for things to get worse and pick up better deals? Or do you see them getting more interested in being back in the market?

Tim Myers: We're seeing interest pick up. I don't want to - we don't have a large enough portfolio to be statistically relevant there with my opinion, but we are seeing activity pick up, whether it's a North Face Sacramento, but we are seeing people interested at acquiring properties at what look like depressed or degraded prices, and that's creating opportunities. So and that rightsizes the credit risk, right, as we're doing those at higher returns. We're also funding loans that are rationalized appraised value in this environment. So I don't want to - I don't know if that's a trend yet, but it's becoming more visible.

Tim Coffey: Okay. Well, that's positive relative to where we were earlier in this year. And then as you kind of go forward with your deposit for gathering strategies, do you have a target loan-to-deposit ratio you'd like to get to?

Tim Myers: Well, I mean, we'd love it to be higher than it is, right? So we want to lend into this with the higher yields. And so we'd love to continue to raise deposits at manageable costs at a relationship deposits that will come down in cost over time and pay off the borrowings, et cetera. But we really want to grow the loans. And so if we can get back to a historical trend line for us on that, that's really where we'd like to be. But no one set number target.

Tani Girton: Yes. We have a lot of headroom to go where - I mean, we used to talk about what would the cap be on that? And unlike a lot of the larger banks, we don't really have an appetite or haven't historically for getting loan-to-deposit ratios over even not only 100, but even 90 to 95. So.

Tim Coffey: Great. Okay. Well, thank you very much for your time. Those were my questions.

Tim Myers: Thank you very much.

Operator: There are no further questions in the queue. I will now pass the call over to Tim Myers for closing remarks.

Tim Myers: Thank you again, everyone, for your interest in joining us and the outstanding questions, and we look forward to talking to you again next quarter.