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Edited Transcript of OPB earnings conference call or presentation 24-Apr-17 3:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Opus Bank Earnings Call

Irvine Apr 25, 2017 (Thomson StreetEvents) -- Edited Transcript of Opus Bank earnings conference call or presentation Monday, April 24, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brett Villaume

Opus Bank - SVP & Director of IR

* Stephen Gordon

Opus Bank - Founding Chairman, CEO & President

* Brian Fitzmaurice

Opus Bank - Senior EVP & Senior Chief Credit Officer

* Nicole Carrillo

Opus Bank - EVP & CFO

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Conference Call Participants

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* Matthew Clark

Piper Jaffray - Analyst

* Chris York

JMP Securities - Analyst

* Brian Zabora

Hovde Group - Analyst

* Tim O'Brien

Sandler O'Neill & Partners - Analyst

* Jacque Bohlen

Keefe, Bruyette & Woods - Analyst

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Presentation

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Operator [1]

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Good morning, my name is Heidi and I will be your conference operator today. At this time I would like to welcome everyone to the Opus Bank Q1 2017 earnings conference call.

(Operator Instructions)

It is now my pleasure to turn the call over to Mr. Brett Villaume, Director of Investor Relations. You may begin your conference.

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Brett Villaume, Opus Bank - SVP & Director of IR [2]

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Good morning and welcome to Opus Bank's investor webcast and conference call. Today I am joined by Stephen Gordon, Opus Bank's Founding Chairman, CEO and President; Brian Fitzmaurice, Senior Executive Vice President and Senior Chief Credit Officer; and Nicole Carrillo, Chief Financial Officer.

Our discussion today will cover the Company's performance during the first quarter of 2017 and information contained in the earnings press release issued earlier this morning. A slideshow presentation that accompanies today's call is available on the Opus Bank investor webpage at investor.opusnbank.com.

Today's discussion may entail forward-looking statements which are intended to be covered by the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. You will find the discussion of these forward-looking statements in our recent FDIC filings and on page 9 of this morning's release.

Today's call will include a question-and-answer session following the discussion. For listeners who are participating via WebEx should you have any questions you may submit those using the Q&A feature located on the right-hand side of your WebEx window.

The white triangle just to the left of the question mark and letters Q&A should be pointing down. Clicking on that triangle opens and closes the Q&A dialog box.

Now I will turn the call over to Stephen Gordon, Founding Chairman, CEO, and President.

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [3]

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Thank you, Brett. I will now provide an overview of the results for the first quarter of 2017 and then call on Brian Fitzmaurice, Senior Chief Credit Officer, and Nicole Carrillo, Chief Financial Officer, to go into more detail on our credit metrics and financial performance. We will address questions at the end of our prepared remarks.

We are proud to announce our results for the first quarter as they are a significant achievement that represents the culmination of the collaborative and proactive efforts by the talented and committed team here at Opus and is another step forward in the process of restoring the type of consistently strong financial performance that we are accustomed to achieving and which shareholders have historically expected from us. For the first quarter of 2017 we reported net income of $7.7 million or $0.21 per diluted share. Excluding strategic initiative-related expenses and the adoption of the new accounting standard, our net income was $9 million or $0.24 per share for the first quarter compared to a net loss of $19 million of $0.55 per share in the fourth quarter of 2016.

During the fourth quarter of 2016 we took decisive action to bolster our credit infrastructure and to assess our loan portfolios. As 2017 is progressing we have already begun to realize positive results from these efforts, including a reduction of the portfolio loan balances we previously announced as targeted for planned exit.

During the first quarter we reduced Technology and Healthcare Practice loans by over one-third each while total enterprise value loans were reduced by 15% to $778 million, down from $915 million in the prior quarter. Technology loans now total $122 million, down from their peak of $280 million, and Healthcare Practice loans now total $44 million down from their peak of $137 million.

Our provision for loan losses was $6 million, down from $69 million in the prior quarter. And net charge-offs were significantly reduced from the prior quarter, measuring $5 million in Q1 compared to $19 million in the fourth quarter of 2016. During the fourth quarter of 2016 we articulated, and our bankers embraced, our credit culture going forward and we began rebuilding the new loan funding pipeline.

We entered the first quarter having completed the Freddie Mac multifamily loan transaction in the fourth quarter of 2016 and increased cash through continued strong core deposit growth and loan payoffs during the quarter, resulting in a balance sheet with a tremendous amount of liquidity and flexibility. We ended the quarter with over $1 billion in cash and nearly $900 million in investment securities and entered the second quarter with a larger loan pipeline than at the start of the year. We are proactively managing our balance sheet and prudently making loans with appropriate risk-adjusted return metrics, which we anticipate will benefit net interest margin and earnings in coming quarters as cash and investment securities transition into high-quality loans.

We are also beginning to realize the benefits of rising interest rates on our asset sensitive balance sheet. And we expect that the full benefit of the Fed's rate increase in March will generate higher interest income on our largely floating-rate loan portfolio in future quarters.

Opus' leading Income Property Banking division, which includes our $2.3 billion multifamily loan portfolio and our banker presence in all of the major West Coast metro markets, remains a consistent source of attractive risk-adjusted returns while our relationship-based core deposit franchise continues to grow and prove to be strong and stable in the now rising rate environment. While we remain laser focused on remediating our credit issues, including reducing the balances of criticized loans and continuing our progress on planned loan relationship exits, we have also remained dedicated to constantly evaluating our operating expenses and always looking for ways to avoid waste in every aspect of our business. As a result, we initiated an expense reduction strategy during the first quarter to reduce our overhead expense forward run rate and the actions we have taken so far are already reducing our expense base in this second quarter.

While we are always looking to be more efficient, we continue to make investments in our credit infrastructure, enterprise risk management and new business development. We are encouraged by the significant accomplishments we have already made in credit administration and ongoing portfolio management, enterprise risk management and our banking operation which we believe have set us on a path to improving shareholder value.

We are more focused than ever on the tasks at hand of successfully deploying our commercial banking strategy, working through our challenged credit, optimizing our balance sheet structure and executing our expense reduction initiative. I will now turn it over to Brian Fitzmaurice to go into more detail on our loan portfolio and credit metrics.

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Brian Fitzmaurice, Opus Bank - Senior EVP & Senior Chief Credit Officer [4]

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Thank you, Stephen. During the fourth quarter we announced significant steps to improve our credit infrastructure including changes to credit administration, underwriting and ongoing portfolio management processes. Management changes were made including the hiring of two new senior credit administrators focused on C&I, the promotion of a highly qualified and talented Opus team member to lead portfolio management as well as several support staff hires within credit administration, portfolio management and enterprise risk management.

As part of the process we identified the deterioration was largely seen in loans that had been underwritten based on projected cash flow or enterprise value of the underlying business which we have since been referring to as enterprise value loans. In the fourth quarter we suspended new originations of these types of loans and began the process of identifying and working through potential planned exits from the relationships we identified as not fitting within our refined credit risk appetite. This was in addition to exiting the Technology and Healthcare Practice sectors.

As a result of the steps we took in the fourth quarter to strengthen our credit administration, portfolio management and underwriting these teams were able to hit the ground running in the first quarter and made significant progress. Our new credit administration personnel are now actively reviewing and approving new loan production that appropriately fits within our commercial banking strategy. During the quarter we reduced the balance of our Technology Banking and Healthcare Practice loan portfolios by $68 million and $24 million respectively, which is an approximate 35% reduction in each of these portfolios from their balances at year-end.

Additionally, we reduced the balance of total enterprise value loans to $778 million, down from $915 million at year-end or a 15% linked quarter decline. Together, Technology Banking and Healthcare Practice loans drove $7 million of the decrease in total enterprise value loans from the prior quarter.

Of the $778 million balance of total enterprise value loans as of March 31, $43 million was Technology loans and $13 million was Healthcare Practice loans. We expect our exposure to enterprise value loans to moderate as we are actively managing this portfolio.

While we experienced positive steps forward in the workout of our targeted portfolios during the first quarter, it is important to acknowledge that this quarter's accomplishments are just that: steps within a process. And this is ongoing and will take time to complete.

We remain optimistic that many of our problem loans will be resolved positively. However, since the primary resolution of many of these loans and a majority of the non-accrual loans is the sales of borrowers as a going concern there is the potential for a high severity of loss if the sales are not completed. This could result in elevated provisions as we work through the portfolio if they are not offset by positive credit events in the rest of the portfolio.

We recorded a provision for loan losses of $6 million in the first quarter of 2017 compared to $69 million in the prior quarter. Risk rating changes during the quarter resulted in $12 million of additions to reserves, but this was offset by a $13 million decline in reserves as a result of the quarterly shrinkage in the loan portfolio, including planned exits of both past and criticized loan relationships. As we continue to work through exiting the portfolios of Technology and Healthcare Practice and reduce our exposure to enterprise value loans, we are likely to see additional reserve recaptures that will lessen the impact of potential adds to reserves as a result of future migration, impairments or charge-offs within the total loan portfolio.

Net charge-offs drove $5.1 million of the provision which included $5.7 million of total gross charge-offs primarily related to Technology Banking loan charge-offs totaling $4.4 million. This compares to net charge-offs of $19.2 million in the fourth quarter.

Additions to specific reserves during the quarter totaled $812,000 and total loss factors drove $1.2 million of the provision expense. This compares to $22.1 million of adds to specific reserves in the fourth quarter and $5.3 million for increased loss factors.

As of March 31, 2017 the remaining balance of Opus-originated loans, which previously had charge-offs recorded, was $16.2 million. Specific reserves totaled $24.6 million at the end of the first quarter on a remaining balance of $57.3 million of loans compared to specific reserves of $23.8 million at year-end on a remaining balance of $60.5 million. Loans with specific reserves at the end of the first quarter included seven relationships including one in Technology Banking, two in Corporate Finance and four in Commercial Banking.

Total criticized loans, which include both special mention and classified loans, increased to $359 million as of March 31, 2017, from $317 million in the prior quarter. This was a result of gross downward migration of $91 million that was partially offset by reductions of $49 million. This included commercial business loan downgrades into criticized categories consisting primarily of five relationships totaling $57 million and that had an average loan balance outstanding of a $11 million.

These were partially offset by $45 million of loan exits including full loan payoffs, strategic loan sales, charge-offs and normal amortization. As a result, commercial business loans contributed $12 million of the increase this quarter.

Real estate secured loan downgrades into criticized totaled $34 million during the first quarter and were partially offset by loan exits of $4 million. Real estate secured loans is a broad category of loans.

The downgrades during the quarter consisted of $17 million in CRE, $9 million in multifamily and $7 million in construction loans. We note that the total multifamily criticized loans were $19 million at quarter end or 0.8% of total multifamily loans compared to $11 million or 0.5% of total multifamily loans as of December 31, 2016.

The common theme for downgrades in the multifamily pool of loans was diminished cash flow as a result of the borrowers executing a strategy of vacating units to perform improvements on the properties with the goal of increasing net operating income and improving property values. Therefore, we believe these loans will be resolved without loss.

Our ratio of nonperforming assets to total assets decreased to 1.09% as of March 31, 2017 compared to 1.21% in the prior quarter. Commercial business loans on non-accrual totaled $74 million as of March 31, 2016, or 85% of the total non-accrual loans and were comprised of three technology relationships totaling $27 million, two corporate finance totaling $25 million and four commercial banking totaling $16 million.

Commercial real estate made up $12 million of total non-accrual loans at quarter end or 14% and consisted of two loan relationships. There were no multifamily loans on non-accrual at quarter end.

Our allowance for loan losses totaled $112 million, or 2.07% of total loans as of March 31, 2017 compared to $111 million or 1.97% of total loans at year-end 2016. This quarter increase in our coverage ratio was primarily driven by the 4% decline in total loans outstanding during the first quarter compared to a 0.7% increase in the dollar amount of reserves.

We remain highly focused on a remediation of problem loans and working through the process of rationalizing our previously identified portfolio of enterprise value loan relationships. We are encouraged by the progress we have made reducing the balances of enterprise value loans, Technology loans and Healthcare Practice loans in the first quarter.

I will now turn the discussion over to Nicole to cover our financial results for the first quarter.

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Nicole Carrillo, Opus Bank - EVP & CFO [5]

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Thank you, Brian. Our first-quarter performance resulted in net income of $7.7 million or $0.21 per diluted share. As Brian mentioned, net income in the first quarter of 2016 included a provision for loan losses of $6 million, which was a significant decrease from the $69.5 million provision we recorded in the fourth quarter.

Net income in the first quarter also included $1.8 million of strategic initiative related expenses and $248,000 of additional tax expense as a result of the adoption of the new accounting standard impacting share-based compensation. Excluding these two items our diluted EPS for the first quarter was $0.24.

Total loans decreased by $237 million during the first quarter to $5.4 billion and the average balance of loans decreased by $664 million which resulted in lower net interest income and lower net interest margin for the quarter. The decrease in average loans was mainly the result of the Freddie Mac multifamily loan transaction completed near the end of the fourth quarter of 2016 combined with payoffs outpacing loan fundings during the first quarter of 2017.

New loan fundings during the quarter were $219 million compared to $430 million in the prior quarter. The linked quarter decline was the result of normal seasonality in the first quarter as well as the continued impact of our commercial banking strategy shift to target relationships that are not considered enterprise value loans which began in the fourth quarter of 2016. New loan fundings during the quarter were offset by loan payoffs of $333 million, loan sales of $40 million and net loan charge-offs of $5.1 million.

As Stephen mentioned, we successfully reduced the balance of loans within targeted portfolios including Technology, Healthcare Practice and enterprise value loan relationships which included both loan sales, full loan payoffs and charge-offs during the quarter. These targeted reductions comprised $126 million of the total payoff during the first quarter.

The yield on originated loans increased by 9 basis points to 4.31% in the first quarter, driven primarily by lower lost interest on loans placed on non-accrual and day count during the quarter. Interest income from originated loans decreased $7 million from the prior quarter largely due to the decline in the average balance of loans. This was partially offset by an increase of $3 million in interest income earned on cash and investment securities due to the shift from loans into securities from the Freddie Mac multifamily loan transaction as well as purchases of investment securities of approximately $300 million during the first quarter of 2017.

Purchases of securities were weighted towards the end of the quarter, resulting in higher period end balances than the quarterly average and as a result the benefit to interest income will be fully realized in the second quarter. Our NIM during the first quarter was affected by lower yields on investment securities of 1.73% compared to 2.34% in the fourth quarter driven primarily by higher premium amortization on the Freddie Mac multifamily securities as a result of higher prepayments in the underlying loans.

Interest expense on deposits increased slightly to $7.2 million during the first quarter of 2017 compared to $7.1 million in the prior quarter driven by an $82 million increase in average interest-bearing deposits. Average noninterest-bearing demand deposits increased $11 million in the prior quarter. Our cost of deposits increased 1 basis point to 44 basis points for the first quarter while our cost of funds was unchanged at 54 basis points.

Our GAAP net interest margin for the first quarter decreased 22 basis points to 3.14%, largely due to lower contribution from our originated loan portfolio as a result of the change in the mix of earning assets I described previously, offset by higher contribution from investment securities and due from banks. Prepayments remained elevated during the quarter resulting in a 1 basis point decline in our NIM compared to the prior quarter. Accretion income contributed 4 basis points to the NIM this quarter, unchanged from the prior quarter.

I will now turn to noninterest income and noninterest expense. During the first quarter, noninterest income was $12.5 million compared to $27.1 million during the fourth quarter of 2016. Noninterest income during the fourth quarter included $14 million of gain associated with the Freddie Mac multifamily loan transaction.

Noninterest income during the first quarter included $6.4 million in trust administrative fees generated from our alternative asset IRA custodian subsidiary. This was a slight decline from $6.6 million in the fourth quarter of 2016 as $279 million of ancillary custodial cash balances were transferred to Opus in the fourth quarter of 2016, which lowers total fee income generated but benefits Opus' cost of deposits.

Additionally, our escrow and exchange divisions contributed $1.5 million and our Merchant Banking division contributed $829,000 of fee income. During the first quarter of 2017, we also recorded losses on the sale of loans and an REO assets which were offset by gains on sale of securities.

Noninterest expense for the first quarter totaled $50.1 million compared to $51.2 million in the prior quarter. During the first quarter of 2017 we experienced the normal seasonality in compensation and benefits expense due to employer taxes as well as had $1.6 million of compensation related to charges for our cost-saving initiatives.

Lower loan originations in the first quarter resulted in a $1.4 million increase to compensation and benefits due to lower deferred expenses. Our efficiency ratio was 73% for the first quarter, an increase from 58.6% for the fourth quarter of 2016. While noninterest expenses decreased 2% from the prior quarter, total revenues decreased 21% as the loan sale gain on the Freddie Mac multifamily loan transaction was not repeated in the first quarter.

The expense reduction strategy that we implemented during the first quarter is already benefiting our core expense run rate in the second quarter and we expect to see the full benefit by year end. We are targeting a quarterly efficiency ratio in the mid-50s as we head into 2018.

Return on average assets improved to 39 basis points for the first quarter of 2016 and return on average tangible equity was 5.35%. Tangible book value per as converted share increased to $16.23 at quarter end from $15.84 at year-end.

On February 15 we issued 2.9 million shares of common stock at a price of $18.50 through a private placement transaction that resulted in net proceeds of $50.5 million. The impact to our weighted average diluted share count in the first quarter impacted EPS by $0.01.

As a result of our net income in the first quarter as well as the additional equity raised through the private placement, our Tier 1 leverage ratio increased from 7.54% as of December 31 to 8.19% as of March 31 and our total risk-based capital ratio increased from 12.11% to 13.26%. Our capital ratios continue to exceed bank regulatory requirements for well-capitalized institutions.

I will now turn the discussion back over to Stephen.

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [6]

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Thank you, Nicole. Thank you again for joining our conference call today and we will now take questions. Operator, if you would please open the call for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Matthew Clark, Piper Jaffray.

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Matthew Clark, Piper Jaffray - Analyst [2]

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Hey, good morning everyone. Maybe just first on the cost-cutting plan, just wanted to get a better sense of the magnitude of that plan. And I appreciate the efficiency ratio guide as we get into next year, but just trying to size up, again, the potential cost-cutting plan and what that might mean for the run rate either next quarter or later this year.

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Nicole Carrillo, Opus Bank - EVP & CFO [3]

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Hi, Matt, it's Nicole. So as we said, we are targeting efficiency ratio in the mid-50% range, which essentially equates to about a 10% cut in our core run rate from the first quarter by year-end.

Obviously, that efficiency ratio will also depend on revenue. So that's going to be kind of a circular reference there. But that's essentially what we are targeting is that 10% from Q1 normalized run rate and mid-50% efficiency ratio.

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Matthew Clark, Piper Jaffray - Analyst [4]

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Got it, okay great. And then thinking about loan growth, obviously you have a few portfolios that are in runoff mode between the enterprise, the Tech and the Healthcare Practice. Aggregating to about 17% of loans just trying to get a sense of whether or not the production that you put on here can really keep that portfolio stable if not grow slightly from here.

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [5]

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So Matt, it's Stephen. So I would assume for your purposes that we are targeting around $1.4 billion of new loan fundings over the course of the year. And historically that has always ramped as the year progresses.

I would expect no different in terms of how that would ramp over the course of this year with the fourth quarter being our highest quarter and first quarter being our lightest quarter. And we've got a balance sheet that we are working through in terms of the challenged credits, and you should assume that we are going to continue having or making progress on decreasing the Tech portfolio, the Healthcare Practice portfolio and Enterprise Value loans.

And then you've got that other piece that we don't really completely control which is loan prepayments. And loan prepayments overall still remain relatively high, but that's giving us a lot of flexibility on the balance sheet and a lot of cash flow. So you should assume that the thing that we also called out was the increase in cash and securities on the balance sheet and all that liquidity that that gives us and flexibility.

So you should assume that we are also going to be transitioning cash and low yielding related assets into better risk-adjusted returns related loan assets as well as we have some inefficient leverage that's on the balance sheet. And you should assume that we are going to address that as well, meaning that there is a component of the balance sheet that basically has a zero net interest margin. And we've got some higher cost deposits that were more rate sensitive that were there in order to support a higher growth rate.

At the same time, you can see that there's a good amount of that that's obviously sitting in Fed funds not earning anything. So there may be a little bit of delevering of inefficient [path] on the balance sheet that may occur, as well. So you've got a lot of moving parts to address.

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Matthew Clark, Piper Jaffray - Analyst [6]

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Got it. Okay, and then how much of the enterprise value portfolio was in criticized and non-accrual on a dollar basis?

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Brian Fitzmaurice, Opus Bank - Senior EVP & Senior Chief Credit Officer [7]

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So non-accrual dollars would be special mention $11.4 million, classified $192.1 million and non-accrual $62.3 million.

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Matthew Clark, Piper Jaffray - Analyst [8]

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Okay, thank you. And then last one for me for now is on the margin outlook. Obviously, it was way down this quarter.

With the mix shift to the excess liquidity, the premium AM, obviously, expect some relief going forward. But just trying to get a better sense for that incremental margin on new business, thinking about that $1.4 billion of production as well and the mix of that and how much of that is coming from multifamily and so forth.

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [9]

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Yes, so you have got two sides to the equation or maybe three. So the liability side of the balance sheet, the deposit base has proven to be very strong and very relationship based. And our cost of deposits has been very stable to potentially declining when I talk about that deleverage component of the higher cost deposits.

Then on the asset side assume that you are going to see transition, also cash and low yielding assets into loans. And that would be accretive to the asset side of the balance sheet in terms of yield on earning assets.

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Matthew Clark, Piper Jaffray - Analyst [10]

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Okay, so you are not expecting --

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [11]

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And then as far as the mix of what we are originating, on any given day the mix moves around. But we've got a very strong new loan funding pipeline, significantly larger than it was as we entered the year. And there's a very good, healthy mix of those assets and the yield is holding up very nicely.

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Matthew Clark, Piper Jaffray - Analyst [12]

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So your plan is not to hold necessarily that excess liquidity or build it from here. The plan is to reduce it from here?

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [13]

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Well, we are going to have, I said this during the fourth quarter, we have a lot of flexibility on this balance sheet and a lot of room to be able to originate a loan and have it go on to the balance sheet and be funded by cash that's already on the balance sheet or by low yielding securities that are already on the balance sheet or by prepayment activity that's occurring elsewhere in the balance sheet. So we've got a lot of flexibility, and I think we are going to have still remaining a decent amount of liquidity as well through both cash and securities. But we are seeing a ramp up in our new loan funding pipeline, and I think we are going to continue seeing that strength as the year progresses based on line of sight that we have into pipeline, money up real live pipeline as well as what we are seeing coming through the system in prescreened.

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Matthew Clark, Piper Jaffray - Analyst [14]

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And on that $1.4 billion of production this year, how much of that is going to come from multifamily and what is the current rate on that?

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [15]

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We will give guidance on that as we progress. But the overall rate on average has been holding up around the 4% level.

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Matthew Clark, Piper Jaffray - Analyst [16]

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Thanks.

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Operator [17]

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Chris York, JMP Securities.

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Chris York, JMP Securities - Analyst [18]

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Good morning, guys, and thanks for taking my questions. So Stephen, you stated that the loan pipeline is up from the start of the year and this is maybe a follow-up to the last question. So is there any loan type that is receiving more demand than others?

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [19]

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Well, I think we are seeing good mix across the board. We are seeing less in the way intentionally in Corporate Finance and we are seeing across the board, though, between our various commercial and specialty banking divisions as well as Income Property Banking and predominantly within the multifamily we are seeing very healthy demand and our bankers are very much back to being very active in the markets.

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Chris York, JMP Securities - Analyst [20]

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Okay. And then maybe, forgive me here if I missed this, but what was the weighted average rate on new fundings and then maybe what was the weighted average yield on payouts and loans?

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Nicole Carrillo, Opus Bank - EVP & CFO [21]

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Okay, the weighted average rate on new fundings was 4.08 during the quarter. And the weighted average rate on payoffs, including the planned exits, was 4.89.

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Chris York, JMP Securities - Analyst [22]

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Great. And then maybe Nicole, so looking for clarity on the efficiency ratio. So the mid-50% guide heading into 2018, meaning that the Q4 2017 efficiency ratio should be in the mid-50%?

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Nicole Carrillo, Opus Bank - EVP & CFO [23]

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That's where we are hoping to bring it down to. And it may be weighted towards the end of the quarter but that's our target.

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Chris York, JMP Securities - Analyst [24]

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Okay, and then another clarification. Is your view of core salaries and expenses in the first quarter here $27.4 million?

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Nicole Carrillo, Opus Bank - EVP & CFO [25]

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It is the $29.2 million, minus the $1.6 million of severance related expenses. The $1.6 million is part of the $1.8 million we disclosed.

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Chris York, JMP Securities - Analyst [26]

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Okay, the $1.6 million. And then maybe Stephen, with your balance sheet flexibility here and then maybe the $1.4 billion loan funding that you just guided to, have you given any consideration to loan purchases or portfolio purchases that would drive the loan growth in addition to the fundings?

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [27]

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No, we haven't given thought -- well, we've given thought. The answer is no as far as whether we are strategically focused on that. We have a very talented group of bankers who have very much embraced the credit culture going forward.

They are active in the market. They are succeeding in terms of ramping up loan pipelines, and we have a good degree of confidence that based on what the loan pipeline has grown to today and based on the line of sight of activity that we are seeing a amongst all of our bankers that that activity, that core relationship-based franchise activity, meaning that franchise of Opus around its bankers, around its relationships with its clients, that is very much intact and alive and functioning well and that the wholesale aspect of going out and buying loans is not necessarily appropriate for the institution.

And we are keenly focused on the credit quality of what we are originating as well as working through assets, legacy assets on the balance sheet, challenged assets. So at the moment we'd rather be focused on our core business activities and not focused on doing the wholesale-related activities of acquiring loans from other institutions.

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Chris York, JMP Securities - Analyst [28]

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Sure. Makes a lot of sense.

Can you talk a little bit about the strengthening relationships? And then this shows up here, so non-interest-bearing deposits was up nicely both quarter over quarter and year over year, so is there any color you could provide for the drivers of this growth?

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [29]

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Well, I'd say that we've built a great depository franchise over the years. And it continues to prove and it's been tested in this rising rate environment numerous times as well as with the business that we had in the past two quarters that we've got a very, very strong depository franchise of clients that want to bank here at Opus and bank with our bankers and bank with the product services and solutions that we bring to our clients. So it really is a very good strong core depository franchise, and we've actually been able to lower the cost of deposits in a rising rate environment.

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Chris York, JMP Securities - Analyst [30]

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And then the last one here for me, so last quarter you stated that the dividend would be commensurate with earnings. So given the bump up here in capital, this quarter's earnings and then maybe the expected trajectory of earnings throughout the year, how should investors think about the return on this stream of income?

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [31]

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Well, we are going to continue evaluating our balance sheet and our progress and we are going to continue evaluating our earnings and sustainability of them and we will just keep on evaluating where we are. This is our first quarter of turn off of the past two quarters and we increased capital ratios, we had decent retained earnings and we made a lot of progress in terms of the challenged assets on the balance sheet.

But clearly we've got a lot of work ahead of us and everybody is extraordinarily focused on the task at hand. And so we are going to continue to evaluate as we go forward. But my statement doesn't change we will evaluate as we go and continue to do what we've got to do here.

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Chris York, JMP Securities - Analyst [32]

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Sounds good. Thanks, guys.

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Operator [33]

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Brian Zabora, Hovde Group.

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Brian Zabora, Hovde Group - Analyst [34]

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Thanks, good morning. I have a question on the Freddie Mac securities. How much was the amortization this quarter as far as the dollar amount or maybe impact to the margin?

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [35]

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I think we had roughly, bear with me, the security balance -- prepaid roughly about, correct me if I'm wrong, Nicole, the Freddie Mac securities I'd say about $42 million, I'm sorry, about $50 million in overall balance. You're not asking about premium amortization, you are talking about the principal balance of the security?

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Brian Zabora, Hovde Group - Analyst [36]

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Both I guess.

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [37]

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Well, principal balance is down about $50 million.

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Brian Zabora, Hovde Group - Analyst [38]

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And did you have the amortization number?

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Nicole Carrillo, Opus Bank - EVP & CFO [39]

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The total premium amortization on the portfolio was $2.3 million with $2 million of that coming from the Freddie Mac securities.

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Brian Zabora, Hovde Group - Analyst [40]

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Okay great. That's helpful. And then the quarter-to-quarter benefit from, I guess, your lower non-accrual reversals, fourth quarter compared to first, do you happen to have that how much maybe that helped loan yields?

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Nicole Carrillo, Opus Bank - EVP & CFO [41]

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Yes, I do. Just give me one second. Actually that was 8 basis points to NIM was the lower interest true-up in the loans during the quarter.

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Brian Zabora, Hovde Group - Analyst [42]

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And then just lastly a question on PENSCO. Are those all the deposits that are, ancillary deposits that are on their balance sheets moved over to Opus at this point as of the first quarter and just the outlook for that, just maybe the fee income and thoughts on AUM growth from here?

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [43]

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Most of the balances are moved over. We still have some balances that remain in assets at outside institutions but it's a relatively small balance compared to the, let's call it, approximately $1.250 billion of balances that are on Opus' balance sheet and the cost of deposits still remains the same on those balances.

And then the fee income number off of PENSCO --

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Nicole Carrillo, Opus Bank - EVP & CFO [44]

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It's $6.4 million. We will check that, yes, it's $6.4 million.

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [45]

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$6.4 million of fee income driven from our ancillary, our alternative asset IRA custodial subsidiary.

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Brian Zabora, Hovde Group - Analyst [46]

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And how are AUMs trending there? Are you seeing opportunities, you've signed a couple of agreements, are you seeing some inflows yet or is that still maybe down the road?

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [47]

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So we still have a very solid pipeline and we have experienced growth in assets under custody during the -- from fourth quarter to first quarter we are roughly, we are sitting right now at about $13.5 billion of assets under custody.

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Nicole Carrillo, Opus Bank - EVP & CFO [48]

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And I'd like to correct one thing I said. I said there was 8 basis points impact to the NIM. That was 8 basis points impact to the loan yields, the originated loan yields.

It was actually 6 basis points to the NIM for the loan interest true-up and 8 basis points to the loan yields. Sorry about that.

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Brian Zabora, Hovde Group - Analyst [49]

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No problem. Great. Thank you for taking my questions.

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [50]

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As far as the pipeline we had expected growth in assets under custody we expect over the course of the next couple of months to see some pretty decent growth in the assets under custody.

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Brian Zabora, Hovde Group - Analyst [51]

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Great. Thank you.

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Operator [52]

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Tim O'Brien, Sandler O'Neill & Partners.

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Tim O'Brien, Sandler O'Neill & Partners - Analyst [53]

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Thanks, good morning. Just to follow up on Brian's, the color that he provided, I thought I heard you say, Brian, that the plan is still to eliminate Tech and Healthcare Practice, the remaining loans on the books but then following that you said but to reduce EV exposure. So I guess what I want to ask is do you have a sense of what the bifurcation is between EV loans that you expect to continue to maintain a balance sheet versus other loans that you would just as soon see depart the Company, depart the bank?

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Brian Fitzmaurice, Opus Bank - Senior EVP & Senior Chief Credit Officer [54]

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I don't have specific percentages, but clearly the two letter plus that sits in the problem assets we will seek to exit. And then the others I just see as organically moving off over time a portion of those assets.

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Tim O'Brien, Sandler O'Neill & Partners - Analyst [55]

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So those will still be managed relationships, you will retain them, you will service them, all of that stuff, they are decent quality assets as far as you are concerned and there is no plan to force the issue there or see those leave the bank?

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Brian Fitzmaurice, Opus Bank - Senior EVP & Senior Chief Credit Officer [56]

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You know, there's some higher risk of the balance. Risk return might be a little bit high, but generally if they are problems that have already been criticized classified. So we are still going through them and identifying those that are clearly we'd like to retain and the rest, I guess, see organically reducing as they have credit requests, etc.

Even those that we deem very attractive it's still for the very good credit it's a highly competitive environment and there is still a fair amount of stretching occurring on credit terms. For those that you want to keep it's still a highly competitive environment.

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Tim O'Brien, Sandler O'Neill & Partners - Analyst [57]

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Great, thanks. And then for Nicole or Stephen or both, so the $1.8 million in strategic expense that you guys booked this quarter, $1.6 million being related or tied to comp and severance and such, is there more strategic expense that's ostensibly non-core that you guys expect to accrue here in the second quarter or perhaps second and third quarter? Is that process done now, fall coming out of the first quarter and are we going to see more of an organic kind of run rate number here going forward certainly in the second quarter?

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [58]

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We don't have anything in mind that materially stands out that would be impactful we are just simply at this point executing on the expense reduction strategy and that's going to phase in over the course of the year with a decent amount of it already phased-in currently.

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Tim O'Brien, Sandler O'Neill & Partners - Analyst [59]

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All right, great. Thanks for answering my questions.

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Operator [60]

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Jacque Bohlen, KBW.

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Jacque Bohlen, Keefe, Bruyette & Woods - Analyst [61]

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Hi, good morning everyone. Is most of that expense reduction, is that primarily on the compensation line or are there some other line items that could benefit from that, as well?

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Nicole Carrillo, Opus Bank - EVP & CFO [62]

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The majority of it is a compensation line item. And then the next largest will be in vendor costs, which will you will show up in professional expenses, in some of those other line items. And then the next would be occupancy saves.

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Jacque Bohlen, Keefe, Bruyette & Woods - Analyst [63]

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Okay. So that's the driver I would guess then of most of it being realized now but then having some trickle through for the rest of the year. It's just that (multiple speakers)

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Nicole Carrillo, Opus Bank - EVP & CFO [64]

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Exactly.

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Jacque Bohlen, Keefe, Bruyette & Woods - Analyst [65]

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And then a question for Brian, just touching on the enterprise value loans again and understanding what you are going to run off and what you are happy to continue to manage on the portfolio, how do you think about the duration of those loans? The healthy ones?

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Brian Fitzmaurice, Opus Bank - Senior EVP & Senior Chief Credit Officer [66]

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So they are relatively long tenor. I don't have the average but I think the enterprise value is usually backed by private equity and that's often considered [a ratio to] acquisitions.

So I think most of those will have a credit event that will make us for the ones we want to keep we will actually have to compete for. And then otherwise if they don't there's going to be, there is also a lot of credit events where it's just a miss on the covenant projection, etc., and that gives us an opportunity to reevaluate and choose to exit if there is an exit, a way out. So I think in general commercial lending there's often a lot of credit events through the year and you get a lot of looks, so again part competing and in part having opportunities to lead if we choose to.

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Jacque Bohlen, Keefe, Bruyette & Woods - Analyst [67]

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So would the majority of that portfolio have an event through the year or are there some that are longer lived?

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Brian Fitzmaurice, Opus Bank - Senior EVP & Senior Chief Credit Officer [68]

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They are probably longer. I would guess, this is just guessing, that most commercial relationships have an event at least once every 18 months in my experience.

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Jacque Bohlen, Keefe, Bruyette & Woods - Analyst [69]

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Okay, and then based on the ones that you are happy with, it sounds like if there was some sort of an even if it's a good relationship even though it's a loan that you are not originating at this time, new ones, you would look to maintain that relationship and re-up the loan that is already on the books?

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Brian Fitzmaurice, Opus Bank - Senior EVP & Senior Chief Credit Officer [70]

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We would.

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Jacque Bohlen, Keefe, Bruyette & Woods - Analyst [71]

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Okay, thank you. That's helpful. And then switching over to deposits just because it sounds like there's going to be some movements within those at some of the having some of them move off perhaps, how have, obviously, we saw what happened within the quarter but how have the March rate increase impacted some of your betas?

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Brian Fitzmaurice, Opus Bank - Senior EVP & Senior Chief Credit Officer [72]

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So we've seen no increase overall to our cost of deposits. And as I said before I think we've seen numerous times over the past year with a lot of volatility in interest rates as well as now a Fed that's being a lot more constructive on the short end of the curve, although the rest of the curve has been flattening, we've seen that the deposit base at Opus has continued to prove to be a very strong core relationship-based deposit base.

But, again, you have it correct which is we are going to be proactively looking to decrease some of that excess leverage that we have on the balance sheet that is generating a zero net interest margin. And we've got a certain amount of, let's call them, more rate sensitive, higher rate deposits that would make sense to exit if they are sitting and earning no spread on the asset side of the balance sheet.

And the result of that would be accretive to capital ratio, it would be a accretive to return on average assets and potentially that asset base would be smaller, it would be accretive to net interest margin and we would see benefit to doing that. And it would increase capital ratios.

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Jacque Bohlen, Keefe, Bruyette & Woods - Analyst [73]

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Okay. So taking all of this into consideration, is it possible then we could see the mix change just as these higher cost sources of funding come down, cash comes down, loans and maybe securities come up a little bit and the balance sheet holds fairly steady? Is that a fair assessment?

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Brian Fitzmaurice, Opus Bank - Senior EVP & Senior Chief Credit Officer [74]

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You nailed it.

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Jacque Bohlen, Keefe, Bruyette & Woods - Analyst [75]

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Okay great. Thank you very much.

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Brian Fitzmaurice, Opus Bank - Senior EVP & Senior Chief Credit Officer [76]

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But that would result in a more attractive net interest margin. It would result in accretion to return on average assets and it would be accretive to capital ratios.

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Jacque Bohlen, Keefe, Bruyette & Woods - Analyst [77]

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Yes, definitely understood. Thank you.

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Operator [78]

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There are no further questions at this time. I will turn the call back over to Mr. Stephen Gordon.

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Stephen Gordon, Opus Bank - Founding Chairman, CEO & President [79]

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I want to thank you all for joining us on the call. We look forward to the next quarter's call. Thank you.

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Operator [80]

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Thank you, ladies and gentlemen. This concludes today's conference call. You may now disconnect.