Q2 2023 Bank of Marin Bancorp Earnings Call
Participants
Andrea S. Henderson; Senior VP & Director of Marketing; Bank of Marin
Misako Stewart; Executive VP & Chief Credit Officer of Bank of Marin; Bank of Marin Bancorp
Tani Girton; Executive VP & CFO; Bank of Marin Bancorp
Timothy D. Myers; President, CEO & Director; Bank of Marin Bancorp
David Pipkin Feaster; VP & Research Analyst; Raymond James & Associates, Inc., Research Division
Jeffrey Allen Rulis; MD & Senior Research Analyst; D.A. Davidson & Co., Research Division
Matthew Timothy Clark; MD & Senior Research Analyst; Piper Sandler & Co., Research Division
Robert Andrew Terrell; Analyst; Stephens Inc., Research Division
Wood Neblett Lay; Associate; Keefe, Bruyette, & Woods, Inc., Research Division
Presentation
Andrea S. Henderson
Thank you for joining Bank of Marin Bancorp's earnings call for the second quarter ended June 30, 2023. I am Andrea Henderson, Director of Marketing for Bank of Marin.
(Operator Instructions)
This conference call is being recorded on July 24, 2023.
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, July 21, 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 of these risks and uncertainties, please review the forward-looking statements disclosure in our earnings press release as well as our SEC filings. Following our prepared remarks, Tim, Tani and 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.
Timothy D. Myers
Thank you, Andrea. Good morning, everyone, and welcome to our second quarter earnings call.
Our second quarter reflected the full impact of the late Q1 bank failures resulting in meaningful net interest margin compression due largely to the higher cost of funds on FHLB borrowings and deposits compared with slower lending activity. We believe that this impact is temporary in nature and will not be an indicator of future performance as we have continued to make significant progress by focusing on our balance sheet. In fact, we substantially strengthened the balance sheet by attracting customers, raising deposits and improving liquidity to position the bank for efficient growth and stronger profitability.
There are a few key highlights of note. After regional bank failures triggered significant industry deposit outflows and price sensitivity, our deposits quickly stabilized late in the first quarter. During the second quarter, we raised $152 million in new balances at below capital market rates. Additionally, we opened over 1,400 accounts for both new and existing customers. New balances net of normal customer activity and some continued outflow largely to money market accounts drove deposit growth of $75 million in the second quarter. Importantly, those new deposits and investment cash flows enabled us to review our short-term borrowings as the FHLB by $113 million or 28% during the second quarter.
Deposit growth has continued post quarter end and included seasonal DDA growth we had anticipated. From quarter end to July 18, we added $116 million of total deposits, which are now within $50 million of pre-bank failure levels in early March 2023.
Our percentage of demand deposits has also increased to a level higher than the pre-pandemic percentage at the end of 2019. At the same time, the rate of increase in the cost of deposits has slowed and FHLB borrowings have fallen another $126 million. Our deposit growth strategy was and continues to be driven by proactive customer outreach and relationship-based pricing discussions. We have not offered CD specials or tapped into brokered CD markets. In the quarter, we saw a natural shift from noninterest-bearing to interest-bearing deposits as customers sought higher yields on excess cash as well as increased FDIC insurance coverage through our reciprocal deposit network offerings.
Second quarter deposit costs increased 49 basis points sequentially due to deliberate pricing adjustments that we made. We expect that funding cost increases will level off in the second half of 2023, as Fed rate hikes and customer reallocation of funds between operating accounts and interest-bearing accounts slow.
Our deposit mix at June 30 consisted of 48% noninterest-bearing deposits down from 50% last quarter. However, the percentage of noninterest-bearing deposits was back up to 50% by July '18. Going forward, we will continue to carefully manage deposit pricing on a customer-specific basis and as we have throughout our history, we'll remain in close contact with our customers to understand opportunities and risks.
In alignment with our stringent liquidity standards, we continue to maintain a high level of liquidity that covers all of our uninsured deposits by over 200%. Notably, our uninsured deposits declined to 29% from 33% of our total deposits at quarter end. In addition, our average balance per deposit account declined slightly by $2,000 to $62,000 from the prior quarter, with our largest depositor representing only 1.3% of total deposits.
Our available contingent liquidity was approximately $2 billion and consisted of cash, unencumbered securities and borrowing availability from the FHLB and Federal Reserve Bank. Post quarter end, we have taken additional steps to bolster on balance sheet liquidity by selling AFS securities and Visa B Class shares at a net breakeven and retaining proceeds in cash. In addition, we entered into fixed pay interest rate swaps to protect our other available-for-sale securities from changes in market value.
We also continue to actively engage with and support our borrowers, and we are optimistic about identifying compelling lending opportunities in the second half of this year. While lending activity has slowed, the new loans that we are bringing on to our books are high-quality credits coming on at notably higher yields than those being paid off. This is providing a boost to our interest income and moving forward, we believe should help us protect our NIM as we continue to fund our pipeline. Additionally, approximately 29% of our loan portfolio will reprice in the next 12 months. If those repricings occurred at today's rates, we estimate it will provide an incremental lift of roughly 30 basis points for the loan portfolio.
While loan demand is eased, our teams continue to focus on achieving attractive risk-adjusted returns while maintaining solid credit quality. We are sticking to the prudent lending policies and standards that we have always had, carefully monitoring our loan portfolio and proactively adjusting risk rating. While there has been some risk rate migrations, largely in special mention loans, there were no meaningful surprises in the quarter. During the second quarter, nonaccrual loans held steady at just 10 basis points of total loans.
Classified loans comprised only 1.81% of total loans at quarter end. Classified loans did increase during the quarter centered primarily around the non-office CRE loan, the C&I term loan and increased usage on a previously downgraded line of credit.
I'll take a moment to provide added color to our commercial real estate portfolio as it is the largest concentration in our loan book, representing 73% of our total loan balances at the end of the second quarter. Of our total CRE loans, 22% are owner-occupied, which we believe carry a different risk profile than nonowner-occupied loans in this environment. Our $366 million of nonowner-occupied office portfolio consists of 142 loans with an average loan size of $2.6 million, the largest loan being $17 million. The average LTV was 55% and the average debt service coverage was 1.67x based on our most recent annual review process.
Lastly, we are actively recruiting proven talent as recent industry disruption has made available a considerable number of seasoned bankers. We have taken advantage of the recent market changes and expect to announce a meaningful recruiting new sum that we believe will help boost lending activity and deposit growth and deliver greater value to our customers and our shareholders.
Now I'll pass it over to Tani to discuss our financial results in greater detail.
Tani Girton
Thanks, Tim. Good morning, everyone.
Now that Tim has provided a picture of how our balance sheet is evolving, I will walk through earnings. Bank of Marin generated net income of $4.6 million or $0.28 per diluted share in the second quarter. As Tim said, the decline from the first quarter was largely due to a higher interest expense, both from the rising cost of deposits and higher average borrowing balances.
Our second quarter tax equivalent net interest margin of 2.45% was down 59 basis points from the prior quarter as rapid deposit pricing adjustments and higher borrowing balances far outweigh gradually increasing loan yields. While lagging deposit rate increases delayed NIM compression and contributed to 2022 earnings, it also resulted in more change concentrated in the second quarter of 2023. We expect pressure on our net interest margin to continue in the second half of 2023, but to abate somewhat as deposit rates have caught up with market rate changes and loan yields are expected to continue improving.
Additionally, we have taken steps early in the third quarter to mitigate the impact of further rate hikes by paying down another $126 million in borrowings, selling $83 million in securities to retain proceeds in cash and entering into $102 million fixed pay interest rate swaps. We made a $500,000 provision for credit losses in the second quarter based on increases in qualitative factors related to our multifamily and nonowner-occupied commercial real estate office portfolios impacted by trends in criticized and classified loans and collateral value.
Subsequent to quarter end, we sold our only other real estate owned properties at a slight gain. Noninterest income of $2.7 million was down modestly from the first quarter, primarily related to the recognition of policy payments on bank-owned life insurance in the first quarter somewhat offset by higher debit card interchange fees and wealth management and trust services income in the second quarter. Noninterest expenses remained well controlled at $20.7 million for this quarter, up from $19.8 million in the first quarter.
The increase included $589,000 in annual giving program charitable contributions, $486,000 in salaries and related benefits, which included annual merit increases. $393,000 in deposit network expenses and a $377,000 FDIC assessment base rate adjustment. These increases were partially offset by reductions of $482,000 in depreciation and amortization expense and $434,000 in occupancy and equipment expense related to first quarter branch closures.
In addition, professional services decreased by $326,000 related to the timing of audit work performed. Our second quarter earnings translated into a return on assets of 0.44% and return on equity of 4.25%, down from 0.92% and 9.12% in the prior quarter. The efficiency ratio increased to 76.91% from 60.24% in the prior quarter due to both higher interest and noninterest expenses. Our capital ratios were above well-capitalized regulatory requirements at June 30. The total risk-based capital ratios for Bancorp and the bank increased to 16.4% and 16%, respectively.
Quarter end tangible common equity was 8.6% for Bancorp and 8.4% for Bank of Marin as compared to 8.7% and 8.3% in the previous quarter, respectively. After adjusting for $85 million after-tax unrealized losses in our HTM securities portfolio, our TCE ratio would be 6.7% for Bancorp. Our board of directors declared a quarterly cash dividend of $0.25 per share payable on August 11, 2023. This represents the 73rd consecutive quarterly dividend paid by Bank of Marin Bancorp. The board also approved a new share repurchase program for $25 million effective through July 2025.
Our ample capital position and high-quality investment portfolio provides strength and liquidity for the ongoing operations and investments in the future of Bank of Marin. We evaluate the bank's interest rate, liquidity, economic value and market price risk under various scenarios regularly, and we stress test underlying assumptions. We believe that our unwavering emphasis on the fundamentals of relationship banking and credit, liquidity and capital management will continue to position Bank of Marin to navigate challenging cycles profitably.
Now, I'll turn it back to Tim to share some final comments.
Timothy D. Myers
Thank you, Tani.
In conclusion, while the current rate environment and the effects of the recent bank failures caused a significant impact on our net interest margin and earnings in the second quarter, we continue to believe those effects to be temporary. Due to our intense focus on the balance sheet, we considerably enhance our prospects for NIM and EPS improvement going forward while doing nothing outside our normal business model, and we have seen material improvement post quarter end.
With that, I want to thank everyone on today's call for your interest and support. We will now open the call to your questions.
Question and Answer Session
Operator
(Operator Instructions)
Our first question is from the line of David Feaster with Raymond James.
David Pipkin Feaster
Maybe just starting out on the deposit side and the flows. Look, it's great to hear the commentary that you had about what you guys -- been very active this far in the third quarter already. But I'm just curious if you could characterize some of the NIB flows. It sounds like it's a lot of it's seasonality. Curious how much is continued account growth? And then just how you think about continued deposit growth going forward and your efforts there, your strategy to continue to drive growth? And then is the kind of the plan to continue to have deposit growth outpace loans and pay down the borrowings hopefully, by the end of the year?
Timothy D. Myers
So good question. So the movement in demand deposit accounts in the quarter and after quarter end were reflective of our normal seasonality. You had payroll and taxes in there on the outflow side, and we have some seasonal increases that we mentioned on the call last quarter, where they start to go up, maybe $10 million or so of that deposit raising effort was in checking accounts. Most of that was in interest-bearing, as you can imagine because we're going out and soliciting funds. So the bulk of the money we mentioned we raised through our deposit initiative was interest-bearing, but what was nice is the weighted average rate on that was 3.20% for the whole pool. So still well below our cost of borrowing.
So the goal is to continue to raise deposits. Our goal is not to shrink loans, our goals to grow loans. We continue to build a pipeline. We did have some closings we expected to happen get pushed in the next quarter. When you talk about issues with office real estate tenancy issues or vacancy, we're seeing that affect us kind of more in the pipeline than we are in the portfolio. Our portfolio has maintained very steady. What we have had to do in our pipeline activities weed out where there's a lot of lease turnover risk, et cetera, valuation risk. So we continue to build a pipeline. We're looking to make some hires in the near future to help drive that growth.
So the goal is to continue to build deposits, pay down the borrowings and continue to drive a pipeline that will result in loan growth. So long-winded answer, we're trying to do both. But we did have a very concerted effort on the fundamentals in the quarter of raising deposits at the lowest rates we could because those will retain as customers when all this goes away and those rates will eventually subside, and we are trying to maintain that mix of noninterest-bearing and interest-bearing as close to that level as we are today as we can.
David Pipkin Feaster
Okay. That's helpful. And I want to touch on the growth side in just a second. But before we get there, there's a lot of moving parts for all the things that we've talked about as it relates to the margin. And just hearing Tani, kind of your commentary, it sounds like expect a bit more pressure in the back half of the year, but it sounds like we're getting close to the trough. I was hoping just given all the moving parts in there between the borrowings, pay-downs, the deposit growth you've seen in your quarter, if you could just help us think about the timing of a trough and kind of the NIM trajectory as we look forward?
Tani Girton
Yes, I can help you with that.
So short answer, I believe we have hit the trough, but if not, soon. And a lot of that is just dependent on as we continue to go out and try to bring in more deposits, which we would like to do to pay down some more of those Federal Home Loan Bank borrowings at what rate those end up coming in at. But if you think about it, we sold about $83 million in securities that gave us proceeds of about $80 million. We're going to keep that on the balance sheet, and we'll get a NIM pick up on that piece of about -- or interest rate pickup of about 150 basis points.
Then when we did the $102 million in swaps, in the base case no rate change scenario, and assuming a Fed funds rate increase just one in next -- this week, we probably -- we'll probably pick up 70 basis points there and also the 150 basis points that I gave you on the securities that also assumes a 25 basis point increase in the Fed this week.
So let's see the other thing is on deposits. If you look at where we were July 18, we got another 20 basis points in cost. So cost of deposits was up to 89%. That's the wild card where that one is going. But then you've got borrowings coming down by $175 million, and those had yielded about 5.18% during the quarter. But offsetting that, you have $200 million remaining in Federal Home Loan Bank borrowings, and that's because we're retaining the $80 million on the balance sheet, that portion would go up 25 basis points.
So you put it all together, I think assuming no growth to the balance sheet, and again, not taking into account where deposits are going to go beyond where they went as of July 18, I'd say we'd be looking at roughly 10 basis points to pick up in margin.
David Pipkin Feaster
Okay. And so when you say you think the margin has troughed, is that relative to the full second quarter or maybe the June figure?
Tani Girton
I was thinking about the second quarter.
David Pipkin Feaster
Okay. So you think margin starts expanding here in the third quarter?
Tani Girton
Yes, that's what I'm thinking, with all those assumptions and caveats I gave you.
David Pipkin Feaster
Yes, of course, of course. And then, Tim, back to your point on the growth side, I mean it's encouraging to hear about the opportunity to understand some delays. I'm just curious -- things getting pushed back. I'm just curious maybe if you could talk about what you're hearing from your clients, what's the pulse of your market? How much of the slowdown is truly demand versus your appetite for growth? It sounds like you still have a pretty big appetite for growth. Where are you still seeing good risk-adjusted returns? And then just kind of where these new hires are coming from? Is it infill? Is it market expansion? Just any color on all that? I know it's a broad category, but just curious what you're seeing.
Timothy D. Myers
Sure. So there's no question that with rates where they are and a lot of our client base being real estate investors, the demand is muted. We actively are pushing on a C&I calling program to try to benefit that or grow that portion of the business and continue diversification and get more benefit from variable rate lending, but certainly, that is -- there's no question, demand is muted. For the opportunities that are coming, where people have to refi, that's where we're parsing through as the rollover risk, are we sacrificing some of our credit standards, meaning if there's 1/3 of that tenant list that's going to roll over in the next year or 2, and they want a 5- or 7-year loan, those conversations a little more protracted because we're just not going to stretch right now.
And so we are -- I think it's pretty even throughout our footprint about the opportunities we're seeing. A lot of that is in some form of commercial real estate. And within that, we're being cautious. On the hiring side, we've had opportunities ranging from credit administration, to infill, to opportunistic hires. And there are people that fit our model. So when you think about the different banks that have failed, we're looking to bring in people that already understand how we do things that can benefit growth within our model, but also bring us new things, but on the edges, meaning not changing dramatically our lending appetite for our strategic push around that.
Does that answer your question, David?
David Pipkin Feaster
Yes. No, that's terrific.
Tani Girton
Dave, can I go back to -- I think I left out loans on my last description. That 10 basis points also includes an assumption of an increase of roughly 7 basis points on the loan portfolio with the embedded repricing and also assuming a 25 basis point increase at the Fed.
Operator
Our next question is from Andrew Terrell with Stephens.
Robert Andrew Terrell
Tani, just to go back to that last point on the 10 basis point pickup of the margin. Can you just talk about the underlying assumptions that might be in that commentary in terms of incremental deposit cost pressure?
Tani Girton
So what that includes is the lift to 89 basis points that we disclosed in earnings in the release and the presentation as of July 18. It doesn't include anything else because, like I said, that's the big wildcard. It's really tough to assess right now because while we think that the repricing on the deposit portfolio is going to slow down because we had so much catch-up to do during the quarter, they're still -- we're still having those conversations, and we're still pricing kind of at levels where we've been pricing. There hasn't been a lot of pressure to take it up higher than that, but then you get another 25 basis points.
My initial thought is the next 25 basis points will be as impactful as all of that catch up. And since we've caught up to where Fed funds are today, it might not come in as strong, but it's really, really hard to gauge.
Robert Andrew Terrell
Yes. Understood. No, I appreciate that. If I could drill down the deposit front, specifically. I appreciate the disclosure for the 89 basis points quarter-to-date in the third quarter. I guess can you give us a sense on how that compares to where total deposit costs ended the quarter or what the June deposit cost was on average? Just trying to get a sense of really whether or not the cost pressure is leveling off throughout the third quarter or not?
Tani Girton
Yes. So the second quarter total cost of deposits was 69 basis points. If we just look at the month of June, that was 82 basis points. And if we look at July 1 through July 18, that was 89 basis points.
Robert Andrew Terrell
Understood. Okay. So only a 7 basis point lift so far throughout the month of July versus the spot at the end of June.
Timothy D. Myers
We do think the pace of requests has moderated, it hasn't stopped. But as a number of you and your peers noted on our last call, Andrew, we had a lot of catch-up to do. We talked about the fourth quarter where, given the loan-to-deposit ratio, not being -- not full transparency into where rates were going to go. We're slower to adjust our rates than the events of early March happened. We'd already started that process, but there was a lot of catch-up to do in the quarter. So the quarter had a lot of that impact of that rapid catch-up. There's certainly more requests coming in, but the process has moderated in terms of people's requests.
Robert Andrew Terrell
Yes. Totally understood. Really appreciate the color there. And if I could ask a question on just the presentation mentions the interest rate risk modeling assumption using a 35% interest-bearing beta. I think if I recall correctly from the last quarter call, we've discussed kind of a 45% beta on interest-bearing for the prior kind of rate risk modeling assumption, but expectations to outperform that. I get a lot of moving pieces right now, but what drove the moderation to 35% in this presentation from, I think, the previous discussion of 45%. Is that kind of where you'd -- I guess, now that we've seen a lot of the catch up, is that kind of firmly where you think you're going to shake out from a beta perspective?
Tani Girton
So that's a little bit of apples and oranges. The 45% beta was on money market deposits only and the 35% is on all interest-bearing deposits. So we have not -- we're not changing our betas. We're definitely not taking the betas down. In fact, what we're doing is we're eliminating the lag in our modeling.
Robert Andrew Terrell
Okay. Understood. Understood. And then it sounds like maybe getting close on some team hires. Just hoping to maybe get a sense on the noninterest expense kind of run rate moving forward. I don't know how much you can share about the team hires or individual hires you might expect and how that influences the expense run rate? But just any help there, any potential levers or give back on expense we should be thinking about going forward?
Timothy D. Myers
Well, I don't want to jinx it or overpromise on the timing of the hires, but we are looking at ways to moderate those costs and the cost impact of that. I'll just leave that one there just because I don't want to -- for disclosure reasons.
Yes. There was -- David Feaster, I did fail to answer, I think, part of your question around the growth in the loan yield. So if you look at the quarter, the loans that came on were had a yield -- a weighted average yield of about 6.6%, which was considerably higher than the average of those paying off. Unfortunately, the ones that paid off were still high compared to our overall portfolio yield at around 5.95%. But that gives you a sense of the pickup as originations as we hope will improve.
Operator
Our next question is from Woody Lay with KBW.
Wood Neblett Lay
Just had a follow up on that expense question. I know hiring can sort of move it around. But excluding any additional hires I know there was some -- a little bit of noise in the 2Q expenses with the charitable contributions. But if you adjust for that, I mean, does 2Q seem like a reasonable run rate going forward?
Tani Girton
I think on depreciate -- sorry. What was the last thing you said there?
Wood Neblett Lay
Sorry, I just said excluding any potential hires?
Tani Girton
Okay. So depreciation and amortization, occupancy and equipment, those 2 lines, those reflect the branch closures now and are indicative of the go-forward levels. So most of the acceleration was in the first quarter. So you'll see that continue. The FDIC base rate went up from 3 to 5 basis points. So that's about a 67% lift versus where it was. So what I would say is look at the first quarter FDIC and adjust for the change in deposits and then raise that by 67% because the second quarter included an adjustment for the first quarter because we incorporated that later than we should and we should have accrued for it in the first quarter. And then it also included a higher accrual for the go forward. So that's going to -- it's going to be lower than Q2, but higher than Q1.
You are absolutely right on charitable contributions. So it mostly go out in Q2. The rest of them seem pretty indicative of other expense is higher because we do have more recyclical deposits. So that's also indicative.
Wood Neblett Lay
Yes. That's helpful. Maybe shifting over to the new client disclosure. I mean it looks like it was a really successful quarter on that front. How sticky do you view these clients? And how optimistic are you that you can sort of get the full suite of business over time with these clients?
Timothy D. Myers
That's a good question. I do tend to think it's sticky. A lot of that was going back and getting money that had left. So you look at the number of accounts that were opened just over half of new accounts for existing customers or reallocating the architecture of their account structure, putting some money that was in a DDA into an interest-bearing account or a reciprocal account, but over 500 of those were new clients. And so we are already talking to them. There has been some pushes around some of the municipalities and then what other things can we do for them. So we're starting here, yes, but we always look to see how we can grow that relationship in their totality.
Wood Neblett Lay
Got it. And then last for me, I saw the renewed buyback announcement. Just with the volatility in the market, seeming that settled down a little bit. Are there any updated thoughts on how you are thinking about the buybacks?
Timothy D. Myers
They're very similar to how we have described it in the past. We think our stock is a tremendous value. We think the impact that we've had on earnings as a result of what happened in Q1 remains temporary and we want to have the ability to take advantage of that value depression and purchase the stock.
All that being said, we are being very cautious about capital preservation. So we're not rushing out to do that, but we want to retain the ability to do so.
Tani Girton
And I think I'll just add, Woody, our top priority in the capital management is to maintain the dividend and reinvest in the company if we've got the strategic initiatives and our plates are full on both of those fronts, but maintaining that dividend is really important to us.
Operator
Our next question is from Jeff Rulis with D.A. Davidson.
Jeffrey Allen Rulis
Tani, I appreciate all the color on the deposit trends in cost. Did you have a month of June net interest margin average?
Tani Girton
Yes. Let me pull that. I should already have that at my fingertips because -- not every time. I'll pull it, just a second.
Jeffrey Allen Rulis
Okay. Then maybe during that. I wanted to hop the classified loan increase of the loans there, I think you've outlined in the loan segments, C&I, CRE, line of credit. But do you have within industries and geography of those additions on classifieds?
Timothy D. Myers
Yes, I'm going to ask Misako Stewart, our Chief Credit Officer, to talk about the classifieds.
Misako Stewart
Yes. First, there's not really a concentration in geography, if that's the question, and it's kind of across the board in terms of both the migration that we saw from watch to the criticized and criticized to classify where it kind of covers all different collateral category, multifamily, retail, C&I. We only had one small office loan that was downgraded from watch to special mention.
But on the substandard of the classified, again, as Tim noted, it was an increased usage on an already existing classified loan and then 2 loans that downgraded, one a C&I term loan and the other a CRE secured term loan as well.
Jeffrey Allen Rulis
Got it. So yes, not so much geographic concentration just kind of where they were. So it sounds like it was spread throughout the footprint?
Timothy D. Myers
Yes, both geographically and asset class diversified. If you look at the largest migration we had, which was in the special mention within criticized, it's all over the place. There's nothing alike there. There was C&I on the wine industry side, a motel or retail, a commercial real estate space and in multifamily space, not in the same geography, not in the same asset class. So we have not seen meaningful deterioration in any one particular class.
The problems we have on the substandard side remain the same ones we've been talking about for multiple quarters. And again, the increase in that, as Misako noted, was outstanding usage on a C&I revolving credit that we're negotiating full real estate collateral for. So we've been able to focus on those properties.
Misako Stewart
Right. And that line has since paid down. And I also wanted to note to the migration from watch to special mention isn't necessarily indicative of deterioration. We just haven't seen any meaningful improvement. And we kind of treat the watch category as a transitory. So we don't see any meaningful improvement or deterioration for that matter. We do move it to special mention. In this case, it was a matter of not seeing any improvement.
Jeffrey Allen Rulis
Okay. And maybe, Tim, to go back to the capital and I appreciate the buyback, a prudent, cautious approach. I just -- a philosophy kind of question, I guess, on the TCE, I think you got, I think, at 8.6% current and I think 6.7% with AOCI baked in. What do you value more? I mean do you -- is that a guiding kind of thought? I mean the regulatory capital is very robust. I don't know if you look at that, is that part of the cautiousness of with AOCI, do you value that metric? Or do you look at 8.6%, I guess I'm trying to get to what's the capital target that you value most that we could -- we should look at?
Timothy D. Myers
It's a good question, Jeff. And I'm not sure I have a solid answer, meaning we look at all those factors all the time, and those are the conversations we have amongst ourselves and with the board. Meaning, yes, we have high regulatory capital, but right now, TEC ratio is important. It's important to the investment community. It's important to us, and we do have to look at that adjusted for AOCI or the impact of unrealized losses in the HTM book.
And so -- and certainly, we'll look at that within the context of our deposit trends and our asset growth and our earnings generation. So it's -- we look at all of that. And yes, we want to take advantage of the stock value and we'd love to buy back more shares. We just look at all those factors and say, okay, what's the right thing to do at this time?
So there is no one clear answer for you, and I'm not saying that to be evasive. But if we continue along the balance sheet cleanup path that we're on, our earnings start to improve, and we don't feel like we're going to have any other marginal -- I'm sorry, meaningful impacts to capital then we'll certainly take a lot closer look at that.
Tani Girton
Jeff, back to your month of June net interest margin question, that was 2.4%. And just to give a little bit of color to that. Our Fed funds or -- sorry, our funds purchased or borrow balance peaked at the end of April, a little over $400 million. And for the month of June, that had come down to a little over $300 million. And now if you net out the excess cash that we're holding because we are keeping the $83 million -- or this -- the proceeds from the $83 million sold on the balance sheet, the borrowing level is now closer to $125 million. So that's going to have a significant impact on the margin improvement.
Jeffrey Allen Rulis
And Tani, that's -- the 2.40% is relative to the fully tax equivalent, 2.45%?
Tani Girton
That is correct.
Operator
(Operator Instructions)
Our next question is from Matt Clark with Piper Sandler.
Matthew Timothy Clark
Just on the restructuring within the securities portfolio, it looks like you're taking advantage of the Visa gain here. I guess what's your appetite for restructuring more of that portfolio in the back half here?
Tani Girton
So that's a tough question. I mean we impacted $180 million if you include the swaps in terms of our interest rate risk position. So in terms of selling securities, I think we want to remain opportunistic. It's really a matter of once you start taking losses, what's the earn-back period, and we'd be looking at a very short earn-back period, and that's frankly hard to achieve right now. But as -- if rates go down and we do have that opportunity, then we will take it.
Matthew Timothy Clark
Okay. Great. And then in terms of the swap, what are the specific terms there in terms of what you're receiving tied to what index and what you're paying?
Tani Girton
Okay. So we did $50 million in 2.5 years, and we did $50 million in 3 years. And the underlying on those is the AFS security portfolio. Those are floating at SOFR and the fixed rates are on average in the 4.5% range -- 4.5% . And that -- yes.
Matthew Timothy Clark
Okay. I didn't mean to interrupt. And then on your interest-bearing deposit beta assumption of 35% for the cycle and in light of the spot rate on July 18, and assuming another 25 basis points this week by the Fed would imply your deposit cost meaningfully in terms of the rate of increase meaningfully slow beginning of the fourth quarter and into 1Q. And I'm assuming I'm not missing anything, but just didn't want to speak at a turn. That's a fair assumption?
Tani Girton
Matthew, you're talking about fourth quarter '22 and first quarter '23?
Matthew Timothy Clark
No, fourth quarter of this year. No, I'm just saying, it looks like given the spot rate you provided, you have a nice -- you have another step up here in the upcoming quarter. But then after that, you get to that -- the back end of the 35% deposit beta it would suggest that your deposit costs -- the rate of change meaningfully slows beginning in the fourth quarter of this year and into next year?
Tani Girton
Yes. That is -- in the numbers I gave earlier, that is the embedded assumption with a lot of caveats, but I only assumed a 25 basis point increase in the Fed funds rate. But in our modeling, it's -- in our modeling, of course, it's different. In the base case, you're assuming zero interest rate changes. And in the up scenarios, we apply the betas with no lag, and so those actually would go up faster than what was assumed in previous modeling attempts.
We're running our -- we will run our next model on -- as of July 31, and that will take into account all of the actions, balance sheet actions that have occurred in July. What will be published in the second quarter earnings will be the -- or in the second quarter 2Q -- sorry, 10-Q will be the interest rate risk results from April 30 -- as of April 30. And as I said, we were at peak Fed funds there. So we will be showing much more liability-sensitivity there. But when we run as of July 31, it will probably start looking a little bit more like what was in the first quarter 10-Q.
Matthew Timothy Clark
Okay. Got it. And then just shifting gears to the office CRE portfolio. What do you have in terms of -- what you have in that is going to be maturing or repricing through the end of this year, maybe even through next year. And whether or not you -- and whether or not you...
Timothy D. Myers
We have about 10 loans maturing the rest of this year and a little bit more than that into next year. So not a tremendous number. That's just within the investor office space.
Matthew Timothy Clark
Okay. Got it. And then housekeeping item. Tani, on the tax rate going forward? I know it's a little low this quarter.
Tani Girton
Yes. So it's particularly low this quarter because with the earnings for the quarter, what that does is it reduces the rate for the full year. So there's some adjustment going on there. So that had a big impact. That was the biggest driver.
Matthew Timothy Clark
And the rate going forward, would you 26.5% still?
Tani Girton
Yes. So that rate -- because we adjust it to reflect future -- what the future expectation is for the full year provision. I think that that's -- let me just take one quick look. I think that that's -- I don't think it's going to be 26 -- it was 26.70% last quarter. It's -- I don't think it's going to be that high going forward. Because it was down to 22.5% this quarter due to the -- all those shifts. So I think it will balance out somewhere between those.
Operator
And speakers, there are no further questions at this time. Please continue with your presentation or closing remarks.
Tani Girton
So we had one more question from the participants online. Can you talk about the duration on the swaps? Should we assume they are immediately accretive to the net interest margin?
So I gave the detail on the swaps. Yes, they are immediately accretive to the net interest margin. As of where they're priced right now not include -- and including a 25 basis point increase in the Fed, it's roughly somewhere between $500,000 to $700,000 pickup in net interest margin for the year on an annual basis, I should say.
Timothy D. Myers
With that, I want to thank everybody for your questions, your interest and support, and I look forward to talking to you all next quarter.
Tani Girton
Thank you.
