Banc of California, Inc. (BANC) Q2 2013 Earnings Report, Transcript and Summary

Good morning. My name is Melinda, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Banc of California Second Quarter Earnings Call. [Operator Instructions] Thank you. Mr. John Grosvenor, you may begin your conference.

Thank you, Operator. Good morning, everyone, and thank you for joining us for our earnings conference call covering financial results for the second quarter of 2013. With me on the call today is Banc of California’s Chief Executive Officer, Steven Sugarman; our Chief Financial Officer, Ronald Nicolas; President, Robert Franko; and our Managing Director of Residential Lending, Jeffrey Seabold. Today’s conference call is being recorded and a copy of that recording will be available starting later today on the company’s Investor Relations website. Before I turn it over to Steve, I want to remind everyone that, as always, elements of this presentation contain forward-looking statements, which are based on our best view of the world and our businesses as we see them today. Those elements can change as the world changes. So please interpret those statements in that light. In addition, the limitations on our forward-looking statements described in today’s 8-K filing also apply to our comments today. A copy of today’s 8-K filing is available on our Investor Relations website, as are other filings we have made with the SEC. We will have time for questions-and-answers at the end of the presentation. And now with those formalities concluded, I’d like to introduce our Chief Executive Officer, Steven Sugarman.

Good morning. Welcome to the first earnings call for our newly named company, Banc of California. As you know, the second quarter was another active quarter for our company and that activity has not slowed during the beginning of the third quarter. We had several key accomplishments during the quarter, including the following. First, we announced the sale of 8 of our legacy trust branches located in non-core markets. This transaction was very important, strategically, operationally and financially. Upon the closing of the branch sale we will materially reduce the operating cost associated with our deposit gathering and complete the transition of our deposit franchise to that of a commercial bank, while realizing substantial profits associated with those transactions. As of yesterday, it is our understanding that all regulatory approvals necessary for the completion of the transaction have been received. Second, we completed 2 capital raises to fund our strong organic growth during the second quarter. This included a $40 million offering of perpetual non-cumulative preferred stock and a $51 million offering of common stock. These capital raises have fortified our balance sheet and funded our ability to continue our growth-oriented business plan, following the closing of our acquisitions of the Private Banc of California that occurred on July 1. Third, we have continued to build our Residential Lending division. During the second quarter we have seen our loan originations increase each month to new record levels and we launched several new product teams, including warehouse lending and correspondent lending. We have continued to see further growth through July in our originations, both in our Mortgage Banking business and our Portfolio Lending business. Importantly and unfortunately, with the dramatic rise in interest rates during the second quarter, we did see leakage in our profits for Mortgage Banking division due to the inability to hedge all exposures related to interest rate increases. We estimate that our pre-tax profits were reduced by approximately $2 million as a consequence of the interest rate fluctuation. We continue to review ways to improve the effectiveness of our hedges and have implemented several enhancements to our business to improve our sensitivity to rate. We expect these actions to reduce future leakage. With respect to our current run rate volumes we are seeing continued strength and growth through the first part of the third quarter. Notwithstanding the moving rates and declines generally experienced by other originators, our -- especially originations focused on refinancing call center business, our mortgage banking volumes for loans held for sale have moved to above $200 million a month and portfolio lending volumes are now exceeding $50 million a month. With that, I'll turn it over to Ron Nicolas to review our second quarter financial performance.

Thanks, Steve, and good morning, everyone. I will be directing my comments to the financial statements included with the release, focusing primarily on the comparison to the first quarter, starting with the income statement. The foregoing figures through June 30, of course do not include the effects of the July 1 PBOC merger nor the over allotments exercised early in July related to our common and preferred raises in June. During the second quarter of 2013, the company reported net income of $4.4 million or $0.36 per share on just over 12 million average shares outstanding, compared to net income of $929,000 or $0.05 a share for the first quarter and a net loss of $739,000, a $0.09 loss per share for the second quarter of 2012, as highlighted in our release. This included the benefit of the slightly lower effective tax rate of 29.5% for the quarter, as the company continued to realize the benefit of unwinding its valuation allowance recorded against its deferred tax asset. This also includes a small benefit of 0 preferred dividends as the company had previously overpaid which is now -- has now been corrected. Total revenues before loan loss provision increased $14.4 million to $47.7 million for the quarter, compared to $33.3 million for the first quarter, a 43% increase. Net interest income of $21.6 increased $6.2 million on a linked quarter basis or 40%, reflecting a full quarter’s benefit of our purchase season SFR mortgage pools in March, also benefiting our consolidated net interest margin, which grew to 3.93% compared to 3.7% in the first quarter of 2013. Our combined bank net interest margin was approximately 4.8% for the quarter. Our seasoned SFR mortgage pools added $9 million of interest income for the quarter, contributing to the $7 million linked quarter increase in interest income. Interest expense also increased $1.3 million from the prior quarter to $5.1 million, in part to fund the incremental loan growth and in connection with our previously announced branch sale expected to close in early October. Our preferred and one-account saw continued excellent growth during the quarter. For the quarter, the company added $1.9 million in loan loss provision with approximately $950,000 in net charge-offs, while maintaining its ALLL loans to attributable, excuse me, to loans attributable to the allowance at approximately 1.5%. Loan loss provision was $2.2 million in the first quarter and included $600,000 in net charge-offs, more on asset quality in a few minutes. Non-interest income of $26.1 million compared favorably to $17.9 million in the prior quarter, a 46% increase reflecting both stronger mortgage banking revenues and the continued success of our mortgage platform and the sale of $100 million of our loan -- mortgage loan portfolio. The company realized mortgage banking revenues of $20.3 million including $2.7 million in origination fees and $535 million in originations from Mission Hills Mortgage Bank, compared with $16.4 million in the first quarter of 2013 on $333 million of origination from Mission Hills. Origination fees were $1.8 million in the first quarter. Gain on sale came down slightly or remained solid at 3% on approximately $400 million in loans sold during the quarter versus 3.4% on $332 million sold in the first quarter. As mentioned, the company continued to opportunistically acquire and sell mortgage portfolio loans, which also gave rise to higher non-interest income. Turning now to non-interest expense. Non-interest expense was $39.6 million, reflecting the higher impact of our mortgage loan originations, the continued expansion -- and the continued expansion of that business. Higher staffing, commission, loan operations and processing expense all increased as a result of increased business volumes and the continued growth of our key strategic initiatives. Company headcount grew to 1,003 as of June 30, compared to 792 as of March 31, 2013. Of that 211 headcount increase, the expanding residential lending division headcount grew by 194 to 684 with the remaining company, including the bank, growing only 17. Included in the salary and benefit costs were commission expense of $6.3 million related to the $535 million in originations, compared to $3.8 million related to the $333 million originations for the first quarter. The increase of $2.5 million was solely driven by the volume increases as the cost per loan remained consistent with first quarter. Other notable operating expense items include higher salary and benefit costs supporting the growth initiatives outside of mortgage banking, higher marketing costs for the rebranding of Banc of California and the continuing preferred and one-account deposit advertising campaign. In addition, the company incurred merger and acquisition costs related to the PBOC acquisition, such as legal accounting and other consulting fees. Lastly, the company incurred just over $700,000 of repurchase expense, commensurate with the quarter’s loan origination in sales and the assessment of our current reserves for this liability. As mortgage originations continue to grow the company will continue to see its related operating expense increase with the increase in volumes. As previously mentioned, the company incurred a tax provision of $1.8 million for the quarter with an effective tax rate of 29.5%. This reflects a year-to-date adjustment of the company's anticipated full year effective tax rate, taking under consideration the company's previously identified tax planning income. As the company continues on its path of increasing profitability, the effect of the company potentially reversing its remaining $8 million deferred tax asset valuation allowance will continue to be realized through a reduction of its effective tax rate. However, please keep in mind this can fluctuate materially based upon the level and timing of several of our key initiatives. Turning to the balance sheet. The company finished the quarter at just over $2.5 billion in total assets, prior to the acquisition of The Private Bank of California. Total loans including loans held for sale were up 8% on a linked quarter basis and up approximately 125% from 1 year ago, as organic loan growth and the acquired SFR mortgage pools gave rise to the increase. During the quarter, the company sold approximately $100 million of its mortgage loan portfolio loans and acquired approximately $40 million of additional seasoned SFR in June. The company now has over just over $300 million in seasoned SFR purchase mortgage pools and will continue to look for opportunities to potentially buy or sell these loans to shape its portfolio in terms of risks and economic returns. On the liability side, deposits grew by 24% or $411 million from the first quarter as preferred and one-account continued their success. Additionally, equity was up during the quarter at $268.5 million, compared with first quarter at $188.3 million, in connection with the previously disclosed capital raises, including the perpetual preferred and common equity raises closed in June 2013. Although not yet included in our capital base, both capital raised over allotment were exercised, adding approximately $10 million more in equity in early June, excuse me, July. Despite the increase in common shares outstanding, the company's tangible book value grew to $12.28 per share from $12.05 at the first quarter. This includes a reduction of approximately 52% from the impact of our deferred tax asset valuation allowance of $8 million. Turning now to asset quality. During the second quarter, our non-accrual loans fell 45% to $9.2 million, down from $16.5 from the prior quarter. 90 day delinquencies increased $3 million during the quarter in connection with our seasoned SFR mortgage pools acquired in March. Not unexpected, we saw a slight uptick in the delinquency with these pools related to the transfer of servicing. However, early indications in July point to these loans normalizing to lower levels. With that, I will turn it back over to Steve.

Thanks, Ron. As previously mentioned, we closed our acquisition of The Private Bank of California on July 1. Now this was a key event for our company. With a brief update about the transaction and our progress integrating The Private Bank of California with Beach Business Bank, I’ll turn it over to Bob Franko.

Thanks, Steve. Our team has been hard at work, closing and integrating the acquisition of The Private Bank of California, which was merged into Beach Business Bank. Our team has performed with distinction and I'm particularly proud of how we've been able to take the best athletes from each organization without ego and to build a much stronger bank. In particular, one person deserves mention, that’s Suzanne Dondanville. She performed with distinction as our new bank Chief Administrative Officer, and she helped to complete the successful conversion and integration of our technology platforms on the week of July -- weekend of July 28. The conversion went smoothly, although as anticipated, not seamlessly. The colleagues at Beach Business Bank and The Private Bank of California put in many hours to assure that customer impacts from the conversion were minimal. Additionally, we've already started to realize about half of the anticipated synergies from the transaction. With that, let me turn it back over to Steve.

Thanks, Bob. As we look forward to the second half of the year, I thought it would be worthwhile to provide a summary of the key projects we are focused on to enable investors to better track our progress and our success in growing enterprise value. There are 3 main initiatives that we expect to achieve for our subsidiary banks over the next several months: First, to complete our brand sale; second, to consolidate our banks under a single National Bank Charter; and third, to acquire CS Financial. These initiatives will increase the profitability and efficiency of our company overall. Importantly, we still believe we are on track to reduce our run rate efficiency ratio at our commercial bank to 65% or less by the end of the year. At our holding company, we have 2 main initiatives. One is to close the previously announced acquisition of The Palisades Group, and number two is to complete what we call our platform initiative. Our platform initiative will be the most important focus of our executives over the next 6 to 12 months. The initiative is designed to enable our company and our banks to continue to prudently grow their businesses with the technology, analytics, risk systems and financial systems necessary for our transition to a larger and more profitable and efficient organization. We expect this initiative to result in the expenditure of approximately $5 million over the next several months. We believe the efficiencies we will realize from these investments will pay for themselves over time. For instance, our data warehouse project will enable us to reduce costs, increase profitability and manage risk in a more integrated manner. The costs associated with this initiative will be committed or spent predominantly in the third and fourth quarter of this year, alongside the consolidation of our charters. And we expect to see improved profitability from these investments beginning in the first quarter of 2014. With that, operator, we’re ready to open the call up for some questions.

[Operator Instructions] Your first question comes from Andrew Liesch with Sandler O'Neill.

Could you talk a little bit about the, Steve, the organic growth that came in the quarter, like what portfolios on the commercial side may have risen from one quarter to the next?

This is Bob, Andrew. I’ll take that. We saw some growth in C&I and we saw some decent growth in CRE. But at the same time we continued it, each time that we’re adding volume and those two areas, we’re still seeing payoffs. So net-net that's not a -- has not been a lot of growth in that area. Most of the originations have been through Beach and the private Bank of California. We are seeing pickup in the month of August and we think that there is some organic increase in the market. In other words, not just where we're taking a credit away from another bank while somebody is paying off one of our credits, but where there’s actually increasing demand. Although to be honest, we've been saying that quarter-to-quarter. And each quarter, while we put on good quality new business, we’re still seeing some payoffs. So that’s the best I can tell you anecdotally right now.

Okay. And then just looking at the compensation cost line here. So it seems like that the commissions were up few million. I’m just, kind of, curious, like how much of the mortgage banking would you say like the fixed -- fixed salaries and benefit cost, just a sort of breakout, what’s at the banking, what’s at the commercial bank and what’s at the mortgage bank?

Look, the predominant amount of the fluctuations in a compensation expense are the variable cost from the commission for our employees, our loan officers, within mortgage banking. So those are purely variable. As we talked about on last quarter's call, the vast preponderance of our loan officers are on a purely commissioned based salaries and compensation. So to the extent that volumes go up, you’ll see kind of on a basis-point-basis, we’re pretty close to right in line with where we were in the first quarter, what the commission expenses for volume. And if volumes were to decline, it would decline similarly. That said, there are also some expenditures on the fixed bases with our compliance and back office staff. Those expenditures are not kind of material, part of the increases you are seeing here. And then lastly, we do continue to open new locations and loan production offices within the mortgage banking group. However, we focus on pretty short-term leases and in pretty low, fixed cost for those offices. So our fixed cost base is not growing very rapidly.

Your next question comes from Gary Tenner with D.A. Davidson.

Just a few questions on the merger charge that was mentioned, could you quantify what are the merger costs, how would you qualify with that amount loss?

Sure, I’ll quantify it in one second. But as the merger closed in July 1, so you should expect that the cost directly associated with the closing will be also kind of third quarter event. But there were costs in the second quarter, which Ron can layout for you.

Hey, Gary, it was approximately $1 million dollars of additional professional fees that we saw associated with the merger and a couple of other of our initiatives over and above our first quarter number.

Okay. And then were there within the other income, item reserve that seems to be quite a bit higher this quarter. Was there anything unusual in their terms of gains?

Yes. Look, we are and have been for a while now active in both the acquisition and disposition of loan portfolios, primarily single family. But it’s also been multifamily and other, and that’s reflected in two different places within our portfolio, one’s within the mortgage banking non-interest income and then the other’s within the non-interest income in the other bucket. And our portfolio of purchases that are directly from mortgage banking and sales will often be reflected in our other bucket. One example of that activity is some of the season’s single family loans that we purchased in the first quarter, we actually disposed of in the second quarter, a portion of those for a realized gain of several million dollars. So this is part of our activities, this is kind of where the portfolio loans look at, which we’ll opportunistically evaluate whether there are good times to sell them if there are positive events that occur.

Okay. And then just one last question, I wondered if you could comment on the first initial property purchase that was in the 8-K filed week, what the intention is for that property over time?

Sure. We currently occupy about 100,000 square feet and in other lines, we do so in multiple buildings. And with the growth that we’re seeing and the opportunity we’re seeing, we continue to add some office space and that can be operationally challenging from having a split organization, because our buildings are running out of space. So if you look at the cost that we’re spending on the current lease portfolio and kind of the occupancy cost for our current space and here in Irvine, we believe that it could be more efficient and profitable to consolidate all of our employees over time into a single locations that would improve our operations from risk and also efficiency standpoint. And given the tradeoffs and kind of the lease expenses and storage expenses that we’re already incurring, and then parking and things of this nature, we actually think that there is a nice opportunity to consolidate into that new space. Now long term, the question of whether it will stay on our balance sheet or be subject to a sale lease back or something to that effect is still an open question. But from an operational standpoint and efficiency standpoint, it will be something that will be helpful to us and it won’t become relevant though for another year. And the 8-K will require filing, the agreement is still subject to certain conditions and has not been acted upon or closed at this point, and is still subject to diligence period.

[Operator Instructions] Your next question comes from Don Worthington with Raymond James.

Could you provide a little more color in terms of the acquisition of CS Financial and kind of what that impact could be on mortgage volumes? And how many people are involved?

Sure. The CS acquisition, really the exercise of the option that we owned to acquire CS was announced a week or so ago. The most important impact that it will have, from my view, is on our commercial banking operations, and particularly the private banking division where CS Financials kind of a private mortgage bank focuses on serving mostly the fiduciaries on the west side of LA or the single family mortgage needs. They are one of what we believe is less than a handful of private mortgage banks that serve kind of those high-end fiduciaries in LA, and we believe it’s kind of the only one that’s independent and not otherwise part of banks like Union Bank or City National or other private banking divisions. So when you think about our acquisition of the private bank in California and what it takes in Southern California to be kind of a top private banking organization, this is a real estate dominated area of the country. You need to be able to serve kind of their high-end mortgage needs as well as CRE and business needs. Just the capabilities that it really adds to us that we believe will materially enhance the benefits we see from the acquisition we just closed from the private bank in California. That being said, as far as size of CS Financial and the fact that it will also provide some scale to our residential lending division, they’re originating over $100 million a month of production. We’d expect maybe a $1.5 billion this year, about half of the residential production tends to be conforming. So it’s in a loan held for sale category. And the other half tends to be jumble prime production, which have very high quality, credit characteristics and tend to be good private banking in portfolio lending products. There will be some synergies from the transaction and there will be numerous cost saves overall from kind of the ability of CS to leverage the capabilities and the balance sheet of the bank. We’ll provide more information on this as we move closer to the acquisition but it’s something that we’re very excited about. As you know, Jeff Seabold, who is part of CS Financial, joined our bank recently as the Managing Director of our residential lending division. And before that, he served to help us rebuild our strategy for the residential lending division, starting in December. Since that time, that division has become probably our most profitable division of the bank. It’s more than doubled in size and the credit quality has been exceptional to date. So we’re excited to kind of consolidate the private mortgage banking aspects of CS Financial with our bank and continue to grow the more purchase business mortgage banking operations we have under Mission Hills Mortgage and specific Trust Bank that we’ve already been doing.

Okay. Great. And then in terms of the deposit inflows in the quarter, was that primarily in that preferred account that you mentioned?

Yes. It was primarily in the preferred account. As we mentioned on prior calls and alongside the brand sale, this product that we launched in the beginning of this year has really, for us, been somewhat of a game changer as far as our deposit franchise. Our clients and our target clients in the community have really liked it and continue to grow in it. We’ve seen significant kind of growth in that product. And importantly, we’re also seeing some real traction in those high-end, high net worth depositors using either of our bank servicing relationships and getting real traction on the lending side with those depositors. And those are the guys who we really would like to lend to because they’re really good, strong credits. They’re active with small businesses and commercial real estate and personal properties. And really, they’ll form a very nice foundation for our bank. Importantly, while we have grown our deposit for the retail channel pretty significantly, I think there’s been net growth in interesting bearing demand deposits and savings accounts for the first half of the year of just shy of $1 billion dollars. But at the same time, our certificates of deposit continue to fall and we reduced our CD exposure by approximately $120 million. So what you’re seeing is a real strong transition where our total growth has actually a little bit lower than the growth into those accounts because we’re also using it to pay down some of our non-core deposits, such as CDs. And this is a trend that we’d see kind of continuing with the closing of the private Bank of California acquisition where they’re deposit base, had a high percentage of non-interesting bearing in DDA deposits and a very low percentage of CDs. So that transition to transactional and small business and high net worth family deposits away from kind of CDs, and thrift-like deposits will really continue to see good progress as we move forward here.

At this time, there are no further questions. I will now turn it back to management for closing remarks.

Well thanks everyone, for joining the second quarter earnings call for the Banc of California. We look forward to talking with you after the third quarter and hopefully updating you on more positive outcomes during the course of the next couple months. Thank you.

Thank you. This does conclude today’s conference call. You may now disconnect.