Banc of California Inc (BANC) 2020 Q2 法說會逐字稿

Hello, and welcome to Banc of California's Second Quarter Earnings Conference Call. (Operator Instructions) Today's call is being recorded, and a copy of the recording will be available later today on the company's Investor Relations website.

Today's presentation will also include non-GAAP measures. The reconciliation for these and additional required information is available in the earnings press release. The reference presentation is available on the company's Investor Relations website.

Before we begin, we would like to direct everyone to the company's safe harbor statement on forward-looking statements, including -- included in both the earnings release and the earnings presentation.

I would like to now turn the conference call over to Mr. Jared Wolff, Banc of California's President and Chief Executive Officer.

Good morning and welcome to Banc of California's second quarter earnings call. Joining me on today's call are Lynn Hopkins, Chief Financial Officer, who will talk in more detail about our quarterly results; as well as Mike Smith, our Chief Accounting Officer; and Bob Dyck, our Chief Credit Officer, who will all be available during Q&A.

Our second quarter performance reflects both the conservative, well-capitalized bank we have built that is well positioned to manage through the impact of COVID-19 pandemic as well as a bank that has reached an inflection point in its transformation from restructuring to growth.

We continue to benefit from the inherent advantages we had entering the crisis. Most notably, high levels of capital and a well-underwritten credit portfolio, predominantly secured by Southern California real estate with relatively low loan to values. Approximately 66% of our loan portfolio is secured by properties that serve as primary residences, including the SFR, multifamily and warehouse portfolios. And we have very limited exposure to stressed industries such as hotels, restaurants, energy, airlines and other hospitality.

Through our hard work over the past year, we have substantially enhanced the long-term earnings power of the bank by improving our deposit base, lowering our cost of funds, increasing our net interest margin and reducing operating expenses. These efforts have enhanced our operating leverage and brought us to an inflection point, where we believe we are positioned to deliver profitable growth and generate higher levels of returns, subject to, of course, economic recovery from the effects of the pandemic.

Despite the challenges created by the coronavirus, we continue to execute on our strategic initiatives and the transformation of our balance sheet. The runoff in our SFR portfolio continues with the low-interest rate environment, while the Paycheck Protection Program enabled us to fund the type of relationship-based commercial loans that we are targeting. As a result, at June 30, loans to commercial customers increased to 75% of our total loans up from 73% at the end of the prior quarter and 70% at this time a year ago.

In other key areas, we made substantial progress in the second quarter. Our noninterest-bearing deposits increased by $135 million or 11% from the end of the prior quarter, with a portion of this growth attributable to PPP loan proceeds received by our commercial customers. Over the past year, our noninterest-bearing deposits have increased 40%. This has resulted in significant improvement in our mix of deposits. Noninterest-bearing deposits comprise 23% of our total deposits at June 30, up from 16% at this time a year ago. The improvement in our deposit mix, along with the lower interest rate environment, contributed to a further decline in our average cost of deposits this quarter, which dropped to 71 basis points from 111 basis points in the prior quarter and reached a spot rate of 59 basis points at the end of the second quarter. And largely as a result of this substantial reduction in our cost of deposits, our net interest margin expanded by 12 basis points compared to the prior quarter, reaching 3.09%.

We believe the progress we are making reflects the clarity of our vision and the consistency of our execution. Our organization devotes considerable resources to providing high-quality deposit products and high-touch services that enable us to gather low-cost deposits and to deploy them profitably into relationship-based loans to small and mid-sized business. While the value of these deposits may not be as obvious in a time like this, over the long term, this focus and execution will provide a stable funding base that will protect both margin and earnings and translate into true franchise value.

The investments we have made in personnel and technology reflect our commitment to developing multiple channels for bringing in low-cost deposits. We are seeing strong deposit gathering contributions from all areas of the company, from our specialty deposits and private banking team to our relationship managers in both community and business banking as well as the commercial and real estate banking teams who are successfully increasing our deposit share of existing clients and adding the operating accounts of new clients each quarter.

On top of our core business strategies, we have some additional opportunities to accelerate our progress as market conditions and timing permit. One of these opportunities was terminating our naming rights agreement with LAFC, which we were able to complete in the second quarter. Under the terms of our new agreement, we have been released from over $89 million in future expense, while still retaining our position as LAFC's primary banking partner and remaining as a partner in a number of other collaborations. Our restructured relationship will save the company approximately $7 million for the next 12.5 years. While the one-time charge associated with terminating our naming rights agreements impacted our second quarter results, this is a significant step forward in our continued efforts to reduce expenses and improve our future operating leverage.

Let me address our near-term focus of managing the impact of COVID-19. We accommodated a significant number of deferral and forbearance requests for our clients early in the quarter, and the pace of our loan deferral activity declined dramatically as we moved through the quarter. After approving a total of 205 loan deferrals in March and April, we approved 87 deferrals in May and just 6 deferrals in June. We ended the quarter with 298 active deferments on $604 million of loans or approximately 11% of the loan portfolio, and this includes both SFR, where deferments are actually forbearances, and non-SFR loans. A chart in our presentation lays out deferrals by asset class.

Many of our borrowers with deferred loans are now coming up on the expiration of their 90-day deferral periods, and we are reviewing their current financials as we evaluate extensions of the deferral periods. For those commercial borrowers that demonstrate a continuing need for a deferral, we generally expect to obtain some additional credit enhancements, such as additional collateral, personal guarantees or putting in a reserve in order for an additional deferral period to be granted. We expect the legacy SFR loans to run with a higher percentage of deferrals or forbearances due to the consumer rules, but that portfolio is well underwritten with an average loan-to-value below 60%.

As the Paycheck Protection Program has been extended, we continue to offer these loans as a means for helping clients manage through the crisis. We ended the second quarter with $262 million in PPP loan approvals for businesses that represent an aggregate workforce of more than 25,000 jobs. We viewed PPP loans as an opportunity to reinforce the high-touch client experience that we offer at the bank. So rather than opening up an online portal to take applications, we had our relationship managers guide our clients through the entire process to ensure a successful application and timely funding. Additionally, we believe this approach will provide administrative efficiencies to facilitate the loan forgiveness process with our clients.

While we focused on serving existing clients with our high-touch model, we also used our framework to attract new clients and used the PPP to differentiate ourselves, showing how true service can make a difference. As a result, we were able to add many new clients who are consistent with the type of commercial customers that we are targeting in our traditional business development efforts, substantially all of whom brought over their primary deposit relationship. New clients accounted for approximately 25% of our total PPP originations.

We saw an increase in delinquencies and nonperforming assets due mostly to one $11.5 million relationship that is well secured by both commercial and single-family properties. Additionally, we took a specific reserve of $5 million related to the legacy shared national credit that has been on nonaccrual for several quarters. Lynn will address the components of the provision build under CECL for the quarter.

Before I turn the call over to her, I want to briefly address our CLO portfolio as we received a number of questions about it following a piece on the CLO market that appeared in The Atlantic last month. While it isn't our place to be defenders of the overall CLO market, and many investment banking analysts and firms did an excellent job of rebutting some of the assertions made The Atlantic piece, and I would highlight Wells Fargo's analysis in particular, we do want to provide as much information about our particular CLO holdings as possible, so that our shareholders are comfortable that we have minimal loss exposure in our portfolio. As with last quarter, in our slide deck, we have included some detailed information that should be helpful in understanding the level of risk in the portfolio.

Without getting too much into the weeds on this, the key takeaways from our CLO portfolio are as follows. One, it consists entirely of AA and AAA-rated securities; two, our portfolio is broadly diversified with minimal exposure to severely stressed industries; three, our analysis indicates that the underlying securities would need to experience approximately 25% of losses before we would take our first dollar of loss, and our analysis was also supported by the conclusions reached by 2 other brokerage firms; and lastly, and perhaps most importantly, Moody's data shows that no U.S. AA or AAA-rated CLO has ever had a principal impairment. All that being said, we still consider the CLO portfolio to be noncore, legacy assets that we want to diversify away from as market conditions permit.

Following the dislocation that occurred in the CLO pricing at the end of the first quarter, we saw tighter spreads at the end of the second quarter that reduced our unrealized loss in the portfolio by $44.8 million or approximately $0.63 per share on an after-tax basis. Given the level of credit enhancement we have in the portfolio, we continue to believe that at this point in time, we are best served by holding the securities until there is a more attractive opportunity to trade out of them. When the timing is appropriate, we would view this as another one of our larger opportunities to accelerate the progress of our franchise by removing the volatility that this portfolio experiences and diversifying and amplifying our investment returns.

Now I'll hand the call over to Lynn, who'll provide more color on our operational performance. Then I'll have some closing remarks before opening up the line for questions.

Thank you, Jared. First, as mentioned, please refer to our investor deck, which can be found on our Investor Relations website, as I review our second quarter performance.

The net loss available to common stockholders for the second quarter was $21.9 million or negative $0.44 per share. Our net loss and net loss per share were impacted by our decision to exit the long-term naming rights agreement with LAFC, which resulted in a onetime pretax charge of $26.8 million and a provision for credit losses of $11.8 million. In addition, during the quarter, we recognized a $2.5 million debt extinguishment fee for the early termination of $100 million in FHLB term advances and a $2 million gain on the sale of $21 million in corporate securities.

The core operating performance of the company is more accurately reflected in our adjusted pretax pre-provision income of $16 million for the quarter, which compares to $12.2 million in adjusted pretax pre-provision income for the prior quarter. We continue to build momentum in our core underlying earnings power, and we think we can continue that progress in the second half of the year and into the future. I will start by reviewing some of the highlights of our income statement before moving on to our balance sheet trends.

We saw strong growth in our total revenues compared to the prior quarter, driven primarily by a 6.7% increase in net interest income. The increase in net interest income resulted from a combination of higher average rate assets of $165 million and an increase in our net interest margin. Our net interest margin reached 3.09%, an increase of 12 basis points from the prior quarter, as our cost of funds fell by more than the yield on our average earning assets. As Jared highlighted earlier, our average cost of deposits fell 40 basis points to 71 basis points during the second quarter and illustrates the progress we have made in improving our deposit franchise.

Also as mentioned, the spot rate for our cost of deposits at the end of the quarter was 59 basis points. This is 12 basis points below the second quarter average, and it will provide us additional opportunities for NIM expansion in the third quarter. In addition, we have $497 million of CDs maturing over the next 6 months with a weighted average rate of about 1.7%, which will further reduce our cost of deposits.

In late June, we restructured $111 million of FHLB term advances, lowering the rate of such advances by 79 basis points while extending their duration about 2.5 years. And we prepaid $100 million of FHLB term advances, which had a November 2021 maturity date and a 2.07% interest rate. As a result, the aggregate cost of our FHLB advances are expected to further reduce our overall cost of funds going forward.

Turning to our earning assets, our average loan yield declined 8 basis points from the prior quarter, reflecting both the challenging interest rate backdrop and the relatively limited exposure to repricing within our existing portfolio, given that a large portion of our fixed rate and hybrid loans are not scheduled to mature or reprice for at least 3 years.

During the quarter, we collected $7.5 million or approximately 3% in fees on PPP loans, which we recognized through interest income over estimated life of 9 months. Funded PPP loans added 3 basis points to our second quarter NIM. While our loan yield only decreased 8 basis points, our earning asset yield decreased to 21 basis points due primarily to our CLO portfolio repricing down into the current market as well as temporary excess liquidity being held in lower yielding assets.

Briefly, noninterest income increased $3.5 million to $5.5 million. The second quarter included a gain on sale of securities of $2 million and the prior quarter included an unrealized loss of $1.6 million to record loans held for sale at their fair value. These accounted for the majority of the linked quarter increase. I would also like to mention the 3-year earnout from the sale of the bank's mortgage banking division, which contributed average quarterly fee income of approximately $800,000, concluded in the second quarter.

Moving on to noninterest expense. While there's been a fair amount of volatility in noncore expenses, which I'm happy to address in Q&A, core expenses declined 13% from last year's second quarter to $42.8 million and decreased by $558,000 from the first quarter. We received some benefit from reduced regulatory assessment costs for being below $10 billion in assets for 4 consecutive quarters. The second quarter regulatory assessment costs are reflective of our current run rate and higher than first quarter, which benefited from an FDIC assessment credit. While the core expense to average assets ratio increased 16 basis points year-over-year to 2.22%, it's important to keep in mind that our total assets declined by 17% year-over-year as we work to reduce noncore assets and transform into a relationship-focused business bank.

Turning to our balance sheet, our total assets increased by $108 million in the second quarter to $7.77 billion as we continued our repositioning efforts. We remain focused on increasing relationship-based lending. As of the end of the second quarter, we had $262 million in PPP loan approvals, of which $250 million had been funded. The PPP production offset the expected runoff of our legacy single-family residential portfolio, which declined by $97 million, and declines in most other loan portfolio segments. We continue to expect a relatively flat balance sheet for the year, but also expect our operating leverage to continue to expand.

The investor presentation includes updated details on the disclosures we provided last quarter around our loan portfolio in addition to details on deferments by loan segments. The portfolio continues to be largely weighted towards real estate loans, which are supported by high-quality collateral and underwritten by low loan-to-values. We also continue to have limited exposure to sectors that are most at risk from the pandemic: energy, hotels, restaurants, airlines and other hospitality.

Deposits increased $475 million to $6.04 billion at the end of the quarter, with noninterest-bearing deposits reaching $1.39 billion and representing 23% of total deposits. Demand deposits, noninterest-bearing plus interest checking, increased from 41% to 54% of total deposits from the end of the second quarter of 2019 to the second quarter of 2020. This increase, combined with the rate environment and our proactive efforts to reduce deposit costs and bring in new relationships, drove our all-in average cost of deposits down from 162 basis points to 71 basis points over the same time period. As previously mentioned, we believe building a strong, truly low-cost deposit base is one of the most valuable things we can do to create franchise value.

While we recognize a portion of our noninterest-bearing deposit growth relates to the PPP loan program, overall, our progress is generally ahead of plan due to our investment in products and systems and the tremendous dedication of our team. We have posted 6 consecutive quarters of growth in average noninterest-bearing deposits. And our mix of noninterest-bearing deposits and interest-bearing checking to total deposits continues to grow, even on a growing deposit base. With deposit growth exceeding loan growth, our loan-to-deposit ratio declined from 102% at the end of the prior quarter to 94%.

Our securities portfolio increased $207 million to $1.18 billion, driven mostly by net additions of $94 million of corporate securities and $61 million of agency CMOs and the $54.7 million reduction in the net unrealized loss of our portfolio. We ended the quarter with 88% of the portfolio in AAA or AA-rated securities and the remaining 12% in BBB corporate securities. The majority of the BBB-rated securities are subordinated bank debt investments.

As Jared discussed, tighter spreads reduced the unrealized loss in our $668 million CLO portfolio. However, the CLO portfolio continues to weigh on our tangible book value with an unrealized pretax loss of $35.3 million at the end of the quarter.

Turning to asset quality. Credit quality overall is showing resiliency given the challenges created by the pandemic. Nonetheless, delinquent loans increased to $95.2 million or 169 basis points of total loans and nonperforming loans increased to $72.7 million or 129 basis points of total loans. The increases in delinquent loans and NPLs of $10.2 million and $16.2 million are due mostly to one $11.5 million lending relationship that is well secured by both commercial and single-family residential properties.

At quarter end, nonperforming loans included 3 relationships totaling $37 million or 51% of total nonperforming loans. These are the $11.5 million relationship added this quarter and the legacy $16.4 million shared national credit and $9.1 million SFR with a 58% loan-to-value, which have both been discussed in prior quarters. We believe the risk of loss on the single-family portfolio is low, given the weighted average loan-to-value is below 60%. However, due to consumer lending regulations, single-family loans tend to take longer to work through and can temporarily elevate our total delinquent and nonperforming loans. As a result, we show our asset quality metrics for both the entire portfolio and for the portfolio excluding SFR in our investor deck.

Let me turn to CECL and our provision for the quarter. As we've discussed in the past, our ACL methodology uses a nationally recognized third-party model that includes many assumptions based on our historical and peer loss data, our current loan portfolio and economic forecast. Economic forecasts published by our model provider have deteriorated since the first quarter, with June baseline unemployment rate forecasts for 2020 and 2021 increasing and real GDP growth rate declining.

Using current economic forecasts and the estimated impact of the pandemic on our portfolio's lifetime credit losses, we recognized a second quarter provision for credit losses of $11.8 million. The provision included $5 million in general reserves, reflecting a deterioration in the macroeconomic variables and the updated forecasts and other qualitative factors, offset by a decrease in total loans; and $6.8 million in specific reserves, including the $5 million related to the previously disclosed legacy nonaccrual shared national credit. We also had a nominal amount of net recoveries with no charge-offs in the quarter. As a result, our total allowance for credit losses increased to $94.6 million, which is an allowance coverage ratio to total loans of 1.68%. Excluding the PPP loans, which have a 100% government guarantee, the ACL coverage ratio totaled 1.76%.

Our capital position remains strong with a common equity Tier 1 ratio of 11.7% and has benefited from the strategic actions completed over the past several quarters. We will continue to be prudent and strategic with the use of our capital to maximize benefits to shareholders and to build franchise value, while protecting our very well capitalized position at a time when the outlook remains uncertain.

While we are currently operating in a capital preservation environment, we plan to deploy our excess capital over time through organic growth, preferred stock redemption, resumption of share repurchase activity and other opportunities in the market.

At this time, I will turn the presentation back over to Jared.

Thank you, Lynn. Since implementing our strategic plan to enhance the value of our franchise, our goal has been to show progress each quarter. Some quarters, we will have more progress than others, but every quarter, we want to keep moving the ball down the field, improving franchise value and profitability.

We think about our strategic plan in 3 phases. The first phase consisted of reorganizing the bank, realigning our personnel and business lines appropriately for the type of relationship-oriented bank that we want to be and building the foundation of a deposit focused institution. Second phase builds on that foundation, enters the period of generating profitable growth and operating leverage. And the third phase is when the profitable growth and improved operating leverage have fully stabilized, as a mature organization with the opportunity to be consistently a high-performing financial institution.

While we didn't put a time line around these phases, given that market conditions put some of the timing outside of our control, we feel comfortable in saying that we are now entering Phase 2 of our strategic plan. We will continue to focus and execute on all of the initiatives that help build the foundation in Phase I, improving our deposit mix, managing expenses, et cetera. But now we feel optimistic about our ability to generate greater operating leverage and better profitability.

While we see loan demand, we are being selective in the credits that we pursue. There are attractive opportunities, particularly as stronger borrowers look to capitalize on current conditions in the marketplace. There is still a lot of uncertainty about the pace and the strength of the reopening in the economies in our markets, however. We serve clients from Santa Barbara to San Diego, and there are a lot of differences in how each market in Southern California is opening back up. But we are seeing enough activity in loan demand for us to continue to believe that in the back half of the year, loan production should outpace runoff and our balance sheet should remain relatively flat for the year as we continue to remix our loan portfolio as planned. And with the heavy lifting of cleaning up some of the legacy issues largely completed, we believe there will be less noise in our quarterly results going forward.

We also continue to have a lot of additional levers that we can pull at some point in the future to further accelerate our performance. One of which is around our expense levels as we make decisions about how we operate in the future based on what we have learned and are learning during this crisis. We have been very successful in delivering our services digitally to clients. And the commercial customers that we have added are now accustomed to conducting business digitally. All of our experience will inform how we think about our real estate and what's appropriate for the type of commercial bank we are building. It's certainly a potential opportunity that will further enhance efficiencies without impacting our business development capabilities.

As we look ahead to the end of 2020, we're very excited about what our bank will look like after 2 years of transformation. A bank that was well positioned defensively for the pandemic, while having the foundation in place to substantially improve its earnings power in the years ahead.

I think it is important to highlight the fact that from an operating standpoint, in just a year and a quarter, we have a vastly improved deposit base, an expanding net interest margin and improving operating leverage in core earnings, with significant excess capital and a healthy reserve. To boot, our loan portfolio is 66% residential related, as mentioned, with very limited exposure to stressed industries. We have radically transformed our franchise, particularly on the deposit side, and we are well positioned to drive a higher level of earnings and returns.

We have a strong credit culture that has made it a priority to exit and move beyond the few remaining legacy loans that represent the past. And most importantly, we have a truly incredible team: talented, experienced and dedicated colleagues that make a difference every day on behalf of our clients and in our communities.

We have created a unique and powerful culture at Banc of California. And as a result, we are achieving our goals, continuing to attract high-quality talent and supporting existing and new clients with our special brand of relationship banking. As a nearly $8 billion franchise in one of the top markets in the country, our continued execution should ensure significant value for shareholders going forward.

Thank you for listening today. I hope that you and your families are safe and healthy, and I look forward to sharing more about Banc of California's progress in the coming quarters.

With that, operator, let's go ahead now and open up the line for questions.

(Operator Instructions) Our first question comes from Matthew Clark from Piper Sandler.

Maybe just first on deferrals. As you speak with all your customers during the quarter, I guess, what percent of that deferral amount do you think might resume normal payments in the third quarter?

That's a good question. I don't have an exact number for you. A lot of it is going to be wait and see, and it's pretty fluid. I think we're obviously very encouraged by the trend, and we're not seeing an uptick in requests. We're on top of it, but I'm nervous that at the last minute, people could just say, look, we're not ready yet, we need another deferral. And of course, if they did that, we'd want to see the financials that support that. And as we mentioned, we would ask for some sort of credit enhancement to support that.

Overall, our portfolio is performing very strongly. I went through our top retail credits. And as you know, we have limited exposure to retail. It's a small percentage. It's 5% of our total loan portfolio. But I went through our top retail credits, and I was encouraged to see really high debt service coverage ratios, very low loan-to-values and a lot of rent collection. And so we just -- it didn't raise any flags for me.

So as of right now, I think we're optimistic that we're not going to see an uptick, but there will be some. There will be some for sure. And we just don't know. The SFR portfolio is being serviced by a third party. They're doing okay. They're not doing great, which is why there's so much noise in the portfolio. It'd be a terrible time to change servicers. And we've been very vocal with them about the changes that we want to see. For example, at the end of the quarter, delinquencies went down by $28 million and a huge percentage of that was SFR.

And so we keep mentioning it's running with a lot of noise, but we don't think there's loss exposure in the portfolio because of the loan-to-values and just knowing what we have, it's fundamentally a white color portfolio. So we think we're going to be good there.

Okay. Great. And then on the $11 million new problem relationship, what's the resolution process there?

Yes. I'll let Bob Dyck, our Chief Credit Officer, address it, but it's basically a business divorce. It's 2 families that -- it's a family that is split on 2 sides that disagrees on the portfolio with tons of SFRs with some commercial property as well. Bob, you want to talk about what our process is right now?

Yes. We're going to continue to monitor and work closely with the borrower. The relationship, as Jared said, is split about 50-50, that $11 -- just over $11 million, between the commercial CRE piece and the SFR piece. Both of them -- both of those pieces have very low loan-to-values. The single fam or the commercial real estate piece has a family-related business in it as the primary anchor. So there's lots of motivation there. We'll just continue to monitor for payments. And the SFR piece, as Jared had mentioned, there are consumer protection issues that relate to that piece. So we'll just -- we have to move very slowly there.

Yes. And Matthew, it actually -- I believe, Bob, correct me if I'm wrong, but I believe they brought it current after the end of the quarter, but we have to leave it on nonaccrual for quite a long time because that doesn't show that it's going to come off nonaccrual. But they actually brought it current. And it's a family, it's a business divorce basically. And so we're monitoring it very closely. We're getting more aggressive. They went quiet on us, and now they're starting to talk to us. So we're well secured, but it's just -- we'll get out of it.

Okay. Great. And then just shifting gears to the margin, maybe for Lynn. Do you happen to have the spot rate on your borrowing costs at the end of June, just to give some visibility into the third quarter?

Sure. Actually, I didn't pull that. Yes, Matt, let me pull my support for you, and I'll share it with the group. I apologize. I don't have it right here at my fingertips.

That's okay. And then maybe lastly, on the pipeline of new loan and deposit business. You deposit growth this quarter exceeded your PPP loans that were funded. I guess can you just speak to the -- to both pipelines and how much of that deposit growth might have been there for taxes on July 15? And how much of that might stick?

Yes. Lynn and I were talking about this the other day. We think that about 50% of the deposit growth was non-PPP. And so we still have an engine that's working, and we see a really, really good deposit pipeline right now. And so we're going to keep doing what we're doing. We have the right incentives in place, the right technology, the right tools. Everybody is really aligned around this and which is why we're showing 5 consecutive quarters of very strong DDA growth. And we want noninterest-bearing, but we also are getting low-cost checking, which is just as valuable at all times because it's true low-cost relationships -- deposits. And so I feel very, very good about that.

We had said that we thought that runoff would outpace production in the first half of the year and production would outpace payoffs -- would outpace runoff in the second half of the year. I think that's still the case. Whether we put on production in terms of earning assets either through the investment portfolio or loans, we think the balance sheet will be relatively flat at the end of the year. But it will be a better mix of assets, and we're going to continue to expand our margin.

We'll get the earning asset, the loan yield for you.

The next question comes from David Feaster from Raymond James.

I just wanted to follow-up on Matt's question on deferrals and maybe the thoughts on reserve builds going forward. I mean you had larger-than-expected build this quarter, only some modest credit migration. I guess I would estimate the heavy lifting seems like it's probably been done, but as we start getting some more redeferrals and maybe some risk rating downgrades, would you expect some modest builds in the second half of the year? Or just how you think about reserve here?

I'll let Lynn address that. Go ahead, Lynn.

Sure. So as of the end of June, I think we were appropriately reserved. I think it's important to note that the second quarter provision had $5 million of general reserves. We did have some nominal recoveries. The majority was related to some specific credits that we call out: $5 million related to the shared national credit that's been nonaccrual. So looking forward in the absence of significant loan growth, we'd expect the provision to stay relatively the same. I mean we do have to look at updated economic factors and how that impacts it. But we think we've considered the risk in our portfolio appropriately now, and I don't see significant reserve builds.

Yes. I think -- David, I think your note this morning, got it right. We have -- our top 3 NPLs, nonperforming loans, are 50% -- over 50% of our nonperformers. So we've got that shared national credit that we now have specific reserved against, and I think we're well reserved against it. We've got a $9 million SFR -- and this is all legacy stuff. We got a $9 million SFR that's being sold, right, that's like got a $16 million value. And we have this new $11.5 million relationship that's on nonaccrual, that's well secured. So those 3 loans alone.

So if I expect some migration out of those credits as well, I don't -- that's going to offset any sort of loan growth in terms of kind of reserve build. And we also have -- we're 66% residential. I mean look at our peers who have that concentration, they're nowhere near reserved the way that we are. And so I think that we are very healthily reserved right now, maybe in some ways, conservative. And in addition to that, as Lynn points out frequently, we've got a huge amount of capital, too. And so whether it's in the reserve or whether it's just sitting in capital, all those are buffers. So I feel good about where we are, and it would take a lot, I think, for us to reserve more.

Okay. That's terrific color. I appreciate that. And then just on the PPP program, just had a couple maybe minor ones. Do you have an estimate for the overall level of forgiveness, the timing of fees? I guess that 9-month expected life, is that the rate that you're going to amortize those fees versus what we're seeing for most, it's like 24 months? And then how many of those loans were under $150,000? Just curious there.

Go ahead, Lynn.

Yes, sure. So we did take a view that the estimated life is 9 months. So that is the period of time that we'd be amortizing our deferred fees related to it. We collected about $7.5 million by the end of the second quarter. The second quarter included about $1.7 million. Given how we approached the PPP program and that we have about $250 million of PPP loans at the end of the second quarter and that the clients are known to us, for the most part, we do expect to move through the process, obviously, subject to government and how they're able to work with the PPP program. So we think we'd have a high level of success in helping our clients through the process and see it -- the majority of it conclude by the end of the first quarter in 2021.

And then as far as the percent of the portfolio that's below $150,000, there is a large percentage of the deferral amounts from a dollar -- easy for me to say -- from a dollar perspective. A high amount, the majority are under $150,000. And then from a numbers perspective, I can get those ratios for you, I have them on another piece of paper.

We have about -- that $260 million -- I just pulled it, that $260 million is about 1,100 loans. So you can do the average there.

Okay. And then that $7.5 million fee estimate, is that net of expenses? Or is that gross?

That's gross. And we do not have a material level of costs being deferred. We used our standard SBA deferral amount, but yes, that's the gross fee.

(multiple speakers) I don't know. It's an interesting thing about it; I saw that a lot of banks are using 2 years. I'm not sure I get why that is because this stuff is -- we're not going to have a life of -- it's only the percent of the funds that weren't being used for an approved purpose that get termed out over a period of time. Otherwise, it was supposed to be 2.5 months of average monthly payroll, which means the funds are almost expired and -- they're expired in August for the most part and then they're going to be applying for forgiveness. So I didn't understand why people were doing 2 years, but we just took the approach of 9 months.

Yes. I hear you. That makes sense. And then just maybe more of a bit of a strategic question. You talked a bit about seeing good customer acquisition. I guess just what's your thoughts on maybe hiring or your growth trajectory going forward? And maybe just being a bit more aggressive when some others are fearful?

Yes. Well, so 2 different questions there. One is our kind of hiring and second is kind of where we're being aggressive. So on the hiring side, we're hiring production people. We've got a good formula, but folks have to pay for themselves, and you want to see a quick return. Otherwise, your expenses are growing and then you've got a delay before you start showing production and it kind of goes the opposite way for operating leverage. So we've got to be really thoughtful about bringing on people and make sure that production can support it. You kind of want to hire ahead of the curve, but then don't. So we're trying to balance that and really want to continue to capitalize on the positive operating leverage that we're getting right now. We did -- the core earnings, $16 million versus $12 million prior quarter, we want to keep building on that. And that's not nearly enough. I mean it's just got to be higher and higher and higher as far as I'm concerned.

In terms of where we're growing, we don't want to make any credit missteps here, as much as we want to grow. We're trying to be the bank for the smartest real estate entrepreneurs in our markets. And people that I've lent to before that I wasn't comfortable lending to because I didn't think we had the infrastructure to support them, not because I didn't like them. Now that we have the infrastructure, we have the right people. We have this -- we had the talent on the credit and the relationship side, and our whole organization is aligned, we're doing our best to lend to people in the market who are going to take advantage of dislocation. And these are institutional real estate borrowers who are to be buying properties that are underperforming, that might be not collecting rents the way that they should. They know how to perform, they know how to operate, and we're going to lend to them, let them turn around the property, and then we'll be there for -- on a bridge basis and we'll be there for a take-out loan too, if they like it. That's where I think we can really play.

And then also, we're grabbing relationships by providing really high-touch service. So I got a story this morning of a new $9 million relationship that we just brought over on the deposit side. We've been working it for quite a while. We finally got them to come over to us. And they agree to do it, and they were very concerned because they thought they were one of the largest customers at the bank they were at and that they were they could never be treated as well. The bank that they're leaving didn't even protect them on the way out. No counterproposals, no phone calls, no anything. And so it says if they got a wake-up call that they weren't as important as they thought.

And we are focusing on being a high-touch relationship bank. The way that we did the PPP program, it was kind of like an HMO versus a PPO. We were -- you didn't have to wait in a line, you picked up the phone, you got somebody on the phone. We walked you through, we understood your business. That is going to translate to really high-quality client base. And so -- and we need -- the people that we're hiring need to understand how we're going about things. It's not about throwing rate against the wall. It's about bringing over real relationships, not selling on rate. And so we're working hard to find those types of people.

We're being as aggressive as we can. I mean I just had a conference with my team this morning about not turning down any good credits. I don't want them turned down based on rate yet. I want to have a conversation about it. As our deposit costs drop, it gives us more flexibility to be a little bit less price sensitive on the loan side. And because our deposit costs still have a long way to go in terms of -- we still have a lot of levers to pull. We have so many securities -- excuse me, CDs that are maturing that are near 200 basis points. So we can still drop our deposit costs quite a ways, which gives us some flexibility on the rate side, on the loan side. And so we're going to be as aggressive as we can, but we don't want any credit missteps here because those are headlines we don't need.

The next question comes from Timur Braziler from Wells Fargo.

Yes. So I appreciate the Wells Fargo shout out. And I guess it would only be fitting to start with a CLO question. We saw another bank exit their CLO portfolio earlier in the quarter. I guess how close are we getting on price to seeing additional divestitures out of that portfolio? And how do you weigh the pace of that with the expectation for a flat balance sheet?

Lynn or Mike? Lynn, you want to start?

Sure. So as far as progress on it, as we've mentioned, we do still have a $35 million unrealized loss from the CLO portfolio. I think, as it stands today, we're close to $3 million, $4 million. Given our stress testing, our analysis says that we believe the CLOs are still money good. They -- none of them were downgraded during the quarter. They're still AA and AAA rated. For now, I think we're still looking to hold on to them and not divest at a loss. They are, as I look forward for the remainder of 2020, in the earning asset mix in the absence of significant better opportunities. So that's where we stand now, but we are evaluating and looking at it, and as opportunities arise, we will strategically exit them into alternative earning assets.

Yes. Given how low -- I mean, it used to be that at least they had a good yield on them, even though they had some volatility. Now they even have a crappy yield. So it's like how quickly can we get out of them? But we don't want to do it at a loss. And we also don't want to taint the rest of e portfolio by selling 1 piece and then having to permanent the loss that's remaining. And so we have to be careful about it. And I don't think it's going to be much of a problem to replace them in terms of your earning asset question because the yields are so low. We'll be able to find something. So that, I think, is less of an issue than just not wanting to take a loss just to take a loss.

Okay. That's good color. And keeping on that topic, the opportunities for investments, we saw other investments increase during the quarter. I guess, what's the plan to put incremental liquidity into the securities portfolio at this point? And how much of I guess the PPP deposit stickiness is going to play into how fast or aggressive you are into investing further liquidity?

On the PPP --

Sure.

I'll let Lynn go, but on the PPP question, our deposit engine is just -- we're continuing to go. I mean it was just a portion of the deposits were PPP, and I don't think that's going to influence us much as long as we see our general deposit flows continue e way they are.

So we did take the opportunity during the quarter to put some of the additional liquidity into the securities portfolio. Our investments were in corporate securities and some other CMOs, so we did see the security portfolio grow during e quarter. And then as we look forward, I'd expect there's a portion of additional liquidity that will be deployed to the securities portfolio. But we would be looking for the net loan growth that we've talked about to achieve a flattish balance sheet growth year-over-year.

Okay. And then what was -- do you have the investment yield for the quarter on new purchases?

The investment yield for new purchases during the quarter was probably -- about $100 million of it was about 5%. And on the other portion, it was around 2%. So -- yes, so about $60 million of them was in the 2% and $100 million was at 5%, kind of broad brush strokes.

Okay. That's great color. And last for me, there was a statement in the release that part of the decline in C&I was in response to strategically reducing certain facilities due to the change in economic bet. Can you just provide a little bit more color on that statement?

Sure. Yes. So in our warehouse group, the market backed up, and we lend to non-bank lenders who are originating mortgages. And the duration is very short, 30 to 45 days, and they lend and then they securitize and they clean up the line and then they lend out again. And so we saw the markets easing up on the securitization side for non-QM mortgages, and we wanted to make sure that we weren't going to get left holding long duration, so we cut back our lines.

And some of our borrowers also said, "Hey, we're going to slow down here because we want to make sure there's the take-out. And we don't want it violating any of our covenants." So it was looking at the market and just saying, okay, let's pause here and make sure that we see where things are going. We have a very experienced warehouse lending team. They're very good at what they do. It's an important business for us. It's not an outsized business for us, but it's very good. We have several hundred million of deposits that are true low-cost deposits, below 10 basis points, from institutional borrowers. We tend to lend to very well-known institutions on the warehouse side. It's not -- again, it's not a huge business for us, but it's an important business, and it's -- we have a very strong team, and they did a great job looking out for the bank.

And have those trends reversed at all post quarter end? Or is it still pretty -- or just jammed up on the security (multiple speakers)?

No. Well, actually, after quarter end, it went back -- it went down, but we see it building back up and getting back to more historical levels.

The next question comes from Steve Moss from B. Riley FBR.

Just on expenses here, kind of curious what your expectations are for the third quarter? And Jared, I think you kind of hinted a little bit about looking at rationalizing expenses a little further. Kind of wondering how to think about that. Whether we see an initiative this year or is that more of a 2021 sort of event?

Sure. I'll let Lynn start, and then I'll dovetail on it.

Sure. So I think everyone's observed that our expenses have continued to come down over the last several quarters, a portion due to a decrease in the overall balance sheet size, but also an attention to how to continue to create operating efficiencies through use of technology and our own personal resources, consultants, et cetera. So I think, based on the level that we see in the second quarter, I think there continues to be some opportunity maybe at a lower percentage or lower degree as we look forward.

As far as large initiatives, I think we all have lessons learned coming out of working remote, continuing to look at branch networks, real estate properties. So that, I think, will continue into 2021, coming down a little bit.

Yes. We obviously are going to look at branches as they come up for renewal in terms of -- are they the right location? Are they the right size? Do we need as many branches as we have now? We're always looking at that. And I think that there's some opportunity there. I think, putting aside branches, just thinking about leases overall. I mean I think every business is looking at this right now, like do we need as much office space as we historically have had.

I think -- I would -- some people are saying, well, let's just keep the same office space and just really spread people out. I don't know that that makes a lot of sense. That seems kind of silly to me. I mean we're probably going to figure out a way to have less office space. Or you keep the same size office space and you rotate people. But I don't see us getting more office space. And I think as we're lending, too, we're thinking about, okay, what's the new environment? Are we really going to lend in office right now? And if you're lending to office, what do the tenant mix looks like? And how comfortable do you feel about them re-upping if there's any issue of duration on the leases? So I think we're looking at e same thing everybody else is.

In terms of other sorts of expenses, obviously, LAFC was a big one, really, really. You guys have heard me talk about that since the day I got here. And it's a great partner, and we're still a partner with them, but we're doing it in a way that's more appropriate for our bank.

And in terms of other expenses, I mean, we listed in the presentation a couple of accelerators that we have. And CLOs are obviously one. Lynn and her team did a great job of restructuring our FHLB. We have a long way to go on the deposit cost side. We still have a whole bunch of maturing CDs, as I mentioned. So I think there's other levers we can pull.

No questions on the CLOs, Steve?

No. I'm good for now.

I joined our conversation last quarter. You had some really good insights for us. That was great.

That was a good call. I did appreciate that, too.

(Operator Instructions) The next question comes from Gary Tenner from D.A. Davidson.

Just a couple of questions on PPP. I don't know if I heard you guys put the number out there, but what was the average PPP balance for the quarter?

Well, the average balance in terms of outstandings?

Yes.

That's a good question.

Average balance for the quarter, Gary, I'm going to put it around $153 million.

Okay. Perfect. And then, Jared, based on your comments about kind of the pickup in outlook for originations back half of the year. Do you think originations -- should we be thinking about them offsetting runoff of the portfolio in the back half of the year or just runoff of the portfolio ex PPP runoff?

No. We've got to make up PPP as well. So if we had $250 million, round numbers, of PPP, we got our single-family running off at a, I don't know, $100 million more potentially and then other stuff. We've got $350 million, $400 million to make up.

Okay. But you'd be thinking of the originations sufficient to make that number up for the back half?

Yes, yes.

The next question comes from Luke Wooten from KBW.

Just wanted to get the (technical Difficulty] rolling off. Did you give -- I don't -- did you give any more clear with the (technical difficulty)? And I know (technical difficulty) think was in (technical difficulty) timing or the total dollar amount of those rolling off?

Luke, could you -- you were cutting out when you were speaking. Can you say it again?

Yes, sorry. Can you hear me better?

Hopefully.

Yes.

Sorry. Your rolling off, give a little bit more clarity on the timing and the amount (technical difficulty)? Is it quarter or is it kind of in the next 12 months?

Okay. So it sounds like -- it sounds like you're asking about -- because you were cutting out -- what the timing is for the runoff of PPP loans.

Sorry. It was about the CDs runoff.

Oh, the CDs, the CDs. Got it, got it.

Sure.

Go ahead, Lynn.

Yes. So the CDs that we referenced, the $490 million, not the $0.5 billion, those are, I'm going to say, pretty evenly spread out over the next 6 months. There's about $170 million that's in December, but the rest of it is kind of evenly spread over the third quarter. I would mention that a portion is retail. And then I think we flagged that we had some brokered CDs at the end of the second quarter. We had put on some additional liquidity end of the first quarter. So those are running their course. Also depending on how much is liquidity is in the marketplace, we'll look to let those go or roll them over. So those are about $150 million maturing this year.

Okay. Can you hear me now? Is it any better? Sorry?

Yes.

Yes, much better.

Just kind of looking at kind of the loan yields. It looked like (technical difficulty) C&I kind of had a hit from the rate drop. But it looks like the CRE category has kind of held in strong. So should we kind of model roughly flat on the yield?

So on the CRE loan, it's probably going to come down. I mean we're trying to be a bridge lender and the bridge lending is holding our yields higher. But I'm going to have to probably trade a little bit to put some volume and to put on the earning assets. And so it might come down a little bit on the commercial side and multifamily side.

Okay.

I hope it does. I'm going to try not to. I have a whole bunch of employees listening on the phone really happy that I said that, but we're going to do our best.

Got you. And then to clarify, (technical Difficulty] the deposit growth in the DDA. And given that kind of (technical difficulty). Can you just talk a little bit more about the product versus a correct category that's kind of differentiated? And just give us a little kind of what the growth rate is? I mean there is tremendous growth over the past couple...

Yes. So Luke, you cut out again. It sounded like you want some color on how we're differentiating ourselves on the deposit side. And I think we have a follow-up call. So happy to -- if I didn't answer your question properly, we'll get it then too. But I think the thing that distinguishes us the most are a couple of things. Number one is everybody at our company is focused on deposits. And so we're not interested in talking to a borrower that isn't interested in moving a good portion of their relationship to us. So we are making sure that we're bringing deposits with every lending relationship.

Second of all, we're able to bring over clients because we have excellent -- I think we have excellent services on the deposit side. When I got to this bank, our technology is really good. And every bank, I've ever been at or ever acquired complains about their technology. So that's true here, too. But the reality is, it's really good. And we're able to compete by having services that some of our clients aren't getting from peer banks. And I think we punched a little bit above our weight class in terms of the technology that we have to offer there.

Third is we've got an excellent team that's dedicated to helping our front lines figure out how to bring over deposit accounts. And so we have a dedicated treasury management team that can work with clients -- work with lenders who don't need to know the nuts and bolts of every sort of deposit angle, but we have a dedicated team that can. And so when they're working on a relationship, you can bring over an expert to help figure out what's the right way to approach this client and then listen to the client and figure out how we can help them solve whatever challenges they're having where they are or maybe identify something that is -- that they didn't know was a challenge because they didn't know you could do it differently. And so those sorts of conversations are -- we're really good at them, and our teams are having great success.

I would also highlight that we have a specialty deposits team that focuses on bringing in kind of elephant hunting for large institutional deposits, whether they're bankruptcy trustee or fiduciary or otherwise. And they're doing an excellent job, a really, really superb job. So company-wide, we're all firing on the same cylinders. We have an incentive program that's attractive to reward people for what they're doing. And we have the right products, and we've got the right people. And I would just say that we do it all in a very high-touch way, and that's kind of the culture that we're building. I hope that answers your question? But if not, we'll make sure we circle back with you.

No. Great. I'll definitely kind of follow-up on the (technical difficulty).

The next question comes from Tim Coffey from Janney.

Yes. Looking at the FHLB borrowings you have and specifically, the $566 million that, I guess, have an average life of 4 years, what's your willingness to move out of those before trading out of the CLOs?

Tim, it's Lynn here. So the $566 million, yes, those are longer term FHLB advances. So the maturity is between 5 and 7 years on a big portion of those. It's pretty expensive to break those given the rate and the maturity date. So carrying that is just a small piece of our overall funding, probably not looking to do that. We did look at it very hard this quarter and based on the current interest rate environment. So we did come out of $100 million of FHLB advances that matured in November of next year based on the relative price. And then we were able to refinance $111 million that we talked about. And we're able to bring down the effective cost of those term advances about 80 basis points. But the other one is pretty expensive.

Overall, kind of circling back on, I think, a prior question, the spot rate for our FHLB advances, in particular, has come down to $247 million, a combination of when the term advances are rolling off and what's left. And then overall, our borrowing spot rates at $312 million, we do have a note payable that's at $546 million for the longer term.

Okay. That's helpful. And then just kind of -- can I get a handle on your -- where you were on expenses. If I look at your expenses from, say, a percentage of average assets, it's around 240 basis points. It seems like you could get this down that ratio closer to 2%, if not lower. What kind of near-term and longer-term targets do you have for kind of expenses as a percentage of assets?

Yes.

Near term -- yes, Go ahead.

Yes, before you jump in Lynn, Tim, we just -- Lynn and I were looking at that yesterday, and we were looking at some peer analysis. And I think 2% is pretty low, but -- so I just want to make sure we're benchmarking the right way. We looked at it as a percent of assets. It would be great to get below -- get to 2% or below. There aren't a lot of banks, I think, that are below 2%, but getting close to 2% would be great. But I don't know that we're going to get all the way there. Lynn, what do you think?

I would just add. We do believe we have the right, I think, expense base to create some operating leverage. So there's the numerator and the denominator, and I know we're spending a lot of time on kind of the numerator, if you will. Yes, I think there's some more opportunities to leverage technology, rationalize expenses, kind of sharpen our pencil on a few line items. But notwithstanding the environment and sort of our growth objectives and where we think we should be successful, I think we are looking at expanding earning assets and growing the balance sheet with the expense base we have. If we're not doing that over a longer time period, then we would have to change packed a little bit there.

So I think to Jared's point, the 2% is, I think, a great long-term goal that requires, I think, some balance sheet growth. But I think there's opportunity to bring it down to 10.

Yes. So we're going to get there by growing the denominator, I think, is...

The next question comes from a -- follow-up question from Gary Tenner from D.A. Davidson.

I had 1 quick question here. I think you used to provide this information. But in terms of the new loan origination yields in the quarter, now that kind of dust settled from the Fed rate cuts and LIBOR moving quite a bit lower over the course of the second quarter, I'm curious, what type of new business yields you're looking at?

So in terms of -- are you talking about rate-wise?

Yes.

Or volume -- okay. So I'm looking at kind of what our rates were for production in last -- in the second quarter and C&I is in the low to mid-4s, CRE is in the upper 4s and multifamily is in the mid- to upper 3s. That's probably where we are. We're going to get the best pricing on execution -- on loans that we need that borrowers need execution for on bridge stuff, where they need important -- where the structure is really important. And you're lending against something where you need to have a good understanding of how things work. And so I think I would expect our pricing to remain relatively the same for those sorts of products.

There are no more questions in the queue. This concludes our question-and-answer session. I would like to turn the conference back over to Jared Wolff for any closing remarks.

Thank you very much. I just want to thank everybody for participating on our call today. As always, if investors have any questions, they can feel free to reach out to me or Lynn. And we look forward to hearing from you and reporting quality results for the next several quarters. Thank you all.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.