Banc of California Inc (BANC) 2018 Q2 法說會逐字稿

Hello, and welcome to Banc of California second quarter earnings conference call. (Operator Instructions) Today's conference call is being recorded, and a copy of today's recording will be available later today on the company's Investor Relations website. A presentation that management will reference on today's call is also available on the company's Investor Relations website.

I would now like to turn the conference over to Mr. Doug Bowers, Banc of California's President and Chief Executive Officer. Mr. Bowers, please go ahead.

Thank you, and good morning, everyone. I appreciate your joining us for today's Second Quarter 2018 Earnings Conference Call. Joining me on the call today is John Bogler, Banc of California's Chief Financial Officer.

Before we begin discussing the quarterly results, I would like to refer you to our safe harbor statement included in both the earnings release and the earnings presentation.

With that, I will start by saying I'm pleased with the progress we are making in executing on our 3-year strategic road map. While we are only 2 quarters into our journey, we continue to see positive signs. To remind everyone, that road map includes 4 primary points of focus that we expect to achieve over the ensuing 12 quarters.

Before John speaks to the detailed financial results for the quarter, I want to spend some time updating you on our progress and work-to-date on these strategic goals.

In short, we are happy with the early accomplishments and remain confident in our ability to execute on the full strategic plan. That said, we well recognize we have plenty of work ahead us.

As a reminder, the 4 focus points on the BANC road map, B A N C, are: B, build core deposits; A, amplify lending; N, normalize expenses; and C, create stockholder value.

First, and most importantly, build core deposits. On this front, we have fully exited the high-rate, high-volatility institutional deposits and have accelerated our efforts to grow core deposits.

For the quarter, core deposits grew by $357 million, allowing for the reduction of wholesale funding sources, mainly brokered deposits and FHLB advances. Quarter-over-quarter, brokered deposits declined by $332 million, while FHLB advances declined by $100 million.

While we saw a strong growth in core deposits, it should be noted that this growth was mostly in higher costing deposits. As we have noted in the past, we envision our overall funding transformation occurring in 3 phases: the first phase was to transition out of high-rate, high-volatile institutional bank deposits into a more traditional wholesale funding. This has been accomplished.

The second phase is to transition out of wholesale funding into core deposits, and the results this quarter are strong indication of our capabilities.

Overlapping with the second phase, the third phase is to begin to convert the higher costing core deposit pursuits into lower cost relationship-based deposits. This third phase is receiving growing emphasis but will take time.

As for key insights, we continue to gain traction in all our deposit gathering efforts. Commercial real estate, while a relatively modest contributor, continues to add low costing deposits through the direct borrower channel we initiated late last year.

The community bank, or retail and small business channel, is redefining their approach to deposit gathering and is demonstrating their ability to deliver on growth plans.

The specialty and treasury management groups are also gaining traction and continue to build an impressive pipeline. I, particularly want to commend the private bank team for their success in both gathering deposits as well as bringing in low cost core deposits and offering first-class service to our clients.

It is worth noting that this is the first quarter in which all our new leaders have worked together, and I must say it's already paying dividends. The teamwork, collaboration, consistent messaging and training across all our front line business units has been impressive.

Jason Pendergist and Rita Dailey have each been in their respective chairs less than a year and are changing the way we think about commercial deposits and treasury management services.

Leticia Aguilar has been onboard for 5 months and has upped our game considerably with respect to how we engage with our customers.

Jay Sanders is our seasoned veteran of over 18 months in the role, and he continues to lead a talented team in our private banking business.

For the first half of the year, the private bank well exceeded their goals for loans, deposits and managing the cost of deposits. With these leaders and their teams firmly in place, coupled with having a fuller product set, we expect to see meaningful progress in growing core deposits over the coming quarters.

On a related note, over the next 2 quarters, we will also plan to relaunch our small business banking product set with a coordinated effort across all of our front line commercial banking units. Lines of credit, term loan products and cash management services will be offered with a primary focus, as you would guess, on gathering deposits.

Our second strategic initiative is to amplify lending. While our gross loan production for the quarter was below expectations, we remain very encouraged by our pipelines across the franchise. The real estate banking teams are now largely established, while we continue to seek additional talent to join both our private banking and commercial banking teams.

As noted earlier, we will soon relaunch the small business banking platform. And while it will not provide meaningful loan volume in the short term, it further enhances our ability to sell treasury management services and gathered deposits.

In addition, before the end of the third quarter, we expect to relaunch a business banking platform with a narrower focus that is more tightly integrated with our other divisions. Coupled with our existing middle market banking team, we will soon have the ability to offer robust credit products and treasury management services to key client segments from $500,000 to $250 million in revenue. All of this, alongside our maturing private bank services for high net worth individuals.

For the first half of the year, the annualized loan growth was 11%, and we fully expect to achieve our mid-teens target rate for the full year.

As mentioned earlier, the loan pipelines we are seeing today support that expectation. In the early part of the quarter, a new loan origination system was implemented and other efforts are underway to further improve on the time it takes to originate and fund a loan.

We believe the increasing use of technology, combined with streamlining the onboarding process, will ultimately lead to an improved customer experience and a reputation in the market as a preferred bank.

Third, normalize expenses. Late in the quarter, we announced reduction in force that resulted from the simplification of our operating structure and in recognition of the process improvements being implemented throughout the bank.

Over the past 12-plus months, the conforming mortgage platform was sold, nontraditional investment securities have been sold, the majority of the bank's MSR asset portfolio was sold, the institutional banking business was rightsized and we exited the trust business, to name just a few of the operating changes that have occurred here. While friends and colleagues were impacted by the staffing actions, it was a necessary step in furthering our commitment to create an efficient and focused bank.

This quarter included several other transactions and nonrecurring items. However, the core outcome was operating expenses were reduced to $54.3 million. The result was better than we had expected. And while we believe the recently announced expense reduction initiative will produce incremental benefits, efforts will also be focused on further building out the front line businesses.

Fourth, creating stockholder value. Second quarter reported ROAA and ROATCE were 58 basis points and 6.03%, respectively. We recognized these results are well below our long-term targets of 1%-plus and 12%-plus, respectively. We are confident in our plan and initiatives underway. And by continuing to focus on growing core deposits and accelerating core lending efforts, while leveraging our expense base, we strongly believe we can drive returns toward these targets.

As part of our commitment to aligning our interest with our stockholders, you saw earlier this year that we published the metrics for our 2018 annual incentive plan, which apply to myself, the other named executives in our proxy and other portions of which apply to the senior management team.

These metrics are aligned with the plan we shared with you and the metrics we are focused on. Those metrics include: core deposit growth, ROAA, loan growth and adjusted efficiency ratio, in addition to minimum gaining thresholds around capital and credit quality.

Our goal here is to be good stewards of your capital, and the board and I take that task very seriously and want to ensure all of our interests are aligned. As I have noted before, the incentive approach and goal-setting efforts are aligned, not only with me and my leadership team but just as importantly, are aligned throughout the organization.

With those opening remarks, I would now like to turn it over to John to provide more detail around our second quarter financial results.

Thank you, Doug. During the second quarter, we continued on our plan to remix the balance sheet toward more traditional core assets and liabilities with the overall size of the balance sheet remaining flat at $10.3 billion.

On the asset side, we continued to reduce our securities portfolio, which declined by $127.5 million, and securities as a percentage of total assets declined to 22% and continue to trend to the target range of 15% to 20% of assets.

Included in the ending securities balances are $130 million of CLOs that have been purchased but not [sold] under our trade date accounting practice. Further based on feedback from various sources, an estimated $150 million of CLOs will be called in the third quarter.

The net impact is that the CLO portfolio will continue to decline, with the net proceeds expected to be redeployed to loans. Also during the quarter, we completed the sale of an additional $3 million of mortgage-servicing rights or MSRs. The bank will continue to provide services related to the remaining MSR balance, which is now immaterial to the core business platform.

The asset remix was supported by continued growth of core held-for-investment loan balances, which increased by $105 million for the quarter. During the quarter, we elected to sell $132 million of single-family loans, along with $71 million of multifamily loans. These sales were focused on performing long-duration, low-coupon loans with the sale executed primarily for interest rate risk management purposes.

Going forward, we may continue to selectively sell portions of the loan portfolio to manage interest rate risk, reduce concentrations in selective borrowers or to manage overall loan portfolio growth.

For the first half 2018, the annualized rate of loan growth is 11%, and we remain confident that the full year growth rate will meet or exceed the long-run target of mid-teens annual loan growth.

Gross loan production totaled $765 million for the second quarter, and new production yields on average were 5.05%, substantially above the blended portfolio loan yield of 4.63%. The higher loan production yields we saw in the second quarter were largely reflective of a higher macro rate environment, and the spread above existing portfolio yield should give us a degree of tailwind as new production balances continue to grow.

Net held-for-investment loan growth was primarily driven by C&I growth of $104 million, while multifamily growth of $16 million was muted by the previously mentioned $71 million pool sale, along with a number of deals that moved into July.

The commercial real estate portfolio grew by $21 million, and the single-family portfolio declined by $27 million due to the previously mentioned $132 million pool sale.

Commercial loans collectively increased by $150 million or 3% from the prior quarter and are up $728 million or 18% from a year ago. At quarter-end, commercial loan balances totaled $4.8 billion and represented 68% on the loan book.

Over the past year, the gross loan portfolio has increased nearly $1.1 billion or 18%, further supporting our belief that attaining our loan growth target is achievable.

On the deposit side, we saw a strong core deposit growth of $357 million, alongside lowered brokered deposit balances of $332 million and lower FHLB advances of $100 million.

The deposit growth was largely centered on savings accounts, which increased by $124 million over the prior quarter and CDs, which increased by $309 million.

As Doug noted, we are in a multiphase transition of the deposit portfolio. With the passage of time, we expect to migrate the core deposit portfolio to an overall lower cost on a relative basis.

Core deposits, or non-brokered deposits, now account for 75% of total deposits, up from 72% at the end of the fourth quarter.

FHLB advances decreased by $100 million during the quarter, as growth in core deposits allowed for the repayment of overnight advances.

During the quarter, one term advance was secured for a 7-year term, which totaled $200 million and as part of our overall balance sheet and asset liability management activities.

Transitioning to the income statement, net income available to common stockholders for the second quarter was $9.7 million or $0.18 per diluted common share.

For continuing operations, earnings per diluted common share were $0.16. These results include a number of items that we want to call to your attention.

The company's second quarter reported financial results included $6.4 million of net nonrecurring expenses. This included $4 million of severance-related costs associated with the reduction in force, $6.9 million of legal and professional fees and a $900,000 charge for various other items.

These costs were offset by a $5.4 million insurance recovery related to ongoing director indemnification expenses. After adjusting for these nonrecurring expense items, our operating expenses for the second quarter were $54.3 million, for which we have provided a reconciliation on Page 8 of our slide deck.

In the June 28 published 8-K regarding our expense reduction initiative, it was indicated that we expect to reduce go-forward expenses by approximately $15 million annually due to the reduction in staff along with the reduced use of third-party advisers.

Our expectation is that the go-forward expense savings will be phased in over the third and fourth quarter, with approximately half of the savings starting to be realized by the middle of the third quarter and the balance of the expense savings starting to be realized by the middle part of the fourth quarter.

We also plan to continue investing in our front line business units, which will offset some of the current and expected expense savings.

The result of excluding the nonrecurring items for the second quarter and normalizing our tax rate at 20% puts us closer to our core earnings figure from continuing operations of $0.23 per diluted common share, which we have detailed on Page 9 of today's slide deck.

Average interest-earning assets for the quarter were unchanged from the prior quarter at $9.7 billion. Both remix of assets and securities in the loans and the growth in earning assets are key to our plan to drive revenues higher over time.

Net interest margin increased by 3 basis points for the quarter at 3.01%, which was above our expectations. The yield on interest-earning assets increased 23 basis points for the quarter, driven by a 15 basis point increase in loan yields to 4.63%.

The securities portfolio yield increased by 31 basis points from the prior quarter to 3.78%, largely driven by the quarterly rate reset on CLO investments.

The cost of interest-bearing liabilities increased 22 basis points to 1.60%, primarily due to a 21 basis point increase in interest-bearing deposit costs and a 34 basis point increase in FHLB borrowing costs.

The increased FHLB borrowing costs were driven by both higher short-term rates and overnight advances, which totaled $775 million at the end of second quarter as well as increased interest expense as a result of the longer-term FHLB advances mentioned earlier.

While we benefited in the second quarter from various rate resets on the asset side, we remain in very early stages of our deposit growth initiatives and the transformation of our overall liability funding structure.

Despite the increase in net interest margin for the second quarter, we believe the margin could come under a bit of pressure for another quarter or 2, at which point incremental deposit traction and higher loan yields should prospectively drive the margin back above 3% and slowly expand thereafter.

Net interest income increased by $1.3 million from the prior quarter to $72.8 million, which is the first quarterly increase in net interest income over the past 5 quarters.

For the second quarter, loan interest income increased by $6.4 million due to a $250 million increase in the average balances and a 15 basis point increase in the average yield.

Interest income on securities is relatively flat as the average balances declined by $246 million, offsetting a 31 basis point improvement in the average yield.

On the liability side, interest expense on deposits increased by $3.5 million, as the average balance increased by $79 million, and the average rate increased by 21 basis points.

Interest expense on FHLB advances increased by $2.1 million due to $116 million higher average balances and 34 basis points of average higher rate. The growth in net interest income is an important step, as we continue to remix and reposition both assets and liabilities.

The composition of interest income continues to improve as commercial loan interest income now represents 54% of total interest income.

Loan interest income now comprises 77% of total interest income, up from 73% a year ago. For the recorder, we recorded a $2.7 million provision for loan losses, which included $372,000 of charge-offs related to the sale of performing loan pools. Under our accounting policy, we attribute a portion of the loan sale as a credit charge against the ALLL balance, with an offsetting amount included in the gain on sale line item.

Net of this accounting treatment, the provision for the second quarter was $2.3 million as mostly reflected with slight deterioration in loan portfolio, along with further enhancements to our ALLL model. The slight deterioration in the loan portfolio was attributable to borrower performance and not necessarily risk of loss.

The ALLL balance coverage ratio of nonperforming loans is 254%, while the overall ALLL ratio was 81 basis points. Total noninterest expenses for the quarter were $62.5 million, which included $6.4 million of onetime expenses and $1.8 million of expenses from solar investments.

Our current solar tax investment commitment is largely completed. For the third quarter, we now expect to see the solar expense moderate with a similar level of tax benefit.

For the fourth quarter, we would expect to see a small amount of expense on solar investments, largely offset by a small amount of solar tax credits with our tax rate returning to a more normalized level of 20% to 25%.

As noted, noninterest expenses include a number of items that we do not consider to be core operating expenses. These items totaled $6.4 million, and adjusted for these items, core operating expenses came in at $54.3 million.

Our adjusted efficiency ratio came in at 74% for the quarter and continues to reflect more of a revenue opportunity for us to the extent we can improve on our net interest margin, grow the earning asset base and begin to generate fee income from our expanded deposit and treasury management initiatives.

Noninterest expenses to average assets came in at 2.12% from continuing operations for the second quarter after adjusting for the nonrecurring expense items.

Over time, we expect to leverage our expense base through asset growth, coupled with infrastructure investments that we believe will improve operational efficiency and manage this number closer to 2%.

Our capital position remained strong as the common equity Tier 1 capital ratio was 9.90% and a Tier 1 risk-based capital ratio totaled 13.83%.

As many of you know, we have a $40 million preferred issuance, with an 8% coupon that becomes callable starting September 15 of this year.

At this time, we have not made a decision on whether to call the preferred or defer action for another quarter or more. We expect to make a decision on this tranche of preferred prior to August 15. And if the decision is to call the preferred, we will make an announcement at that time.

Moving on to credit and asset quality metrics for the second quarter. Our nonperforming asset ratio for the quarter was 22 basis points, consistent with the prior quarter. This absolute low level of nonperformance reflects the disciplined credit culture of the bank and remains very strong compared to peers and the industry broadly. Nonperforming assets to equity continued to remain strong at 2.3%. Delinquent loan metrics are strong and declined to 38 basis points compared to 63 basis points at the end of the prior quarter.

Net charge-offs for the quarter were $738,000 and include $372,000 related to the accounting treatment of the performing loan sale discussed earlier.

Adjusting for the charge-off related to performing loan sale, the annualized charge-off rate for the quarter would have been 2 basis points.

With that summary of our second quarter financials, I would now like to turn the call back over to Doug.

Thank you, John. As mentioned in my opening remarks, we are beginning to see the potential for Banc of California. Earlier this month, we held a full-day off-site meeting with over 100 of the top leaders in the bank, along with all of our client-facing teammates.

The energy, optimism, desire to succeed and work as one was all very inspiring. Coupling that kind of tenaciousness with the most robust market in the United States and maybe the world, Southern California, gives me plenty of optimism and determination that we are indeed on the road to building something special at Banc of California. That concludes my prepared remarks.

Operator, now let's open it up for questions.

(Operator Instructions) The first question today comes from Timur Brazil (sic) [Timur Braziler] with Wells Fargo Securities.

First question relates to loan growth and the loan sales that occurred this quarter. I'm just wondering as you look out for the remainder of the year, how should we think about the loan sales strategy and how much of that is going to be driven by the ability to generate core deposits?

Well, let's kind of break that apart. I'll talk a little bit about the loan growth on the deposit side and ask John to comment more on the loans sale side. Loan commitment is a little bit -- in the second quarter, a little bit below what we had planned. Outlook, however, given pipelines and how we were seeing the rest of the year unfold, makes us pretty optimistic both on the top line as well as loan growth overall, so both outstanding to end commitments. With respect to deposits, obviously, that's in many respects a comes with. And the quarter was quite good on the deposit side. We're obviously very pleased. That is, as we stated, more of the higher rate, the Phase 2 of this process. And we're doing a lot of work. We started the small business banking program -- restarted it rather. We've commenced with much more rigor our business banking and middle market capabilities, particularly now under Jason Pendergist's leadership, and then all the work that Rita Dailey's team is doing on treasury management side and the specialty deposit side. Put all that together with Leticia's retail banking, community banking efforts and the great success that Jay Sanders has had on the private bank, we're pretty upbeat. We've got a lot of work to do on the deposit side, but we're pretty upbeat there. John, can you comment on the loan sales side?

Yes. Certainly, on the loan sales, what we did during the second quarter was primarily for interest rate risk management purposes. And so the sales were in longer duration, lower-coupon type instruments and things like 10/1, 7/1 Hybrid type instruments. A number of them were I-O in nature. So it was primarily intended just to simply shorten the duration and help us out to the extent that we have a rising interest rate environment. So it wasn't necessarily about balancing the rate of growth in the loan portfolio. So as we continue to move through the second half of the year, we will continue to look at those opportunities from an interest rate risk management purposes and less from an overall managing the rate of growth in the loan portfolio. We'd still expect to target something in the mid-teens in terms of the overall loan growth for the year.

Okay. So it sounds like loan growth is going to accelerate and the sales were more from an interest rate perspective than a growth perspective. So with that being the backdrop, should we expect the growth in deposits and the runoff in securities to help fund that loan balance for the remainder of the year? Or should we see some sort of expansion in the wholesale markets as well?

No. I think for the most part, you'll see the securities continue to decline, we continue to make progress and balancing out on the asset side with securities coming down and loans going up. I would expect that to continue through the second half of the year. And I would expect that we'd see kind of similar events occurring on the liability side, where we have a declining concentration of wholesale funding sources and increasing level of core deposits.

Yes. You put all that together, the rate of balance sheet growth will remain muted here for a while longer as we continue to run down the securities portfolio to a more normalized level and have the continued success in growth on the loan side. Same is true on the deposit side as we run down the FHLB and brokered and run up the more traditional deposit side. So again, the balance sheet growth will be -- will remain a little bit muted here for a few more quarters.

Okay. And then maybe just switching gears to the securities side, I guess pretty surprised to see the magnitude of yield increase, given the linked-quarter reduction in balances and the linked-quarter reduction in CLOs. I guess, what was the total net new purchase of securities during the quarter? What's that composition? And what's the new securities yield being brought on?

Yes. I don't have the balances here in front of me. But for the most part, that CLO book of business resets on a quarterly basis. It's tied to LIBOR. We saw a significant increase in LIBOR during the first quarter and a little bit in the second quarter. LIBOR has been relatively flat throughout the second -- latter part of the second quarter. So I would not expect to see the same degree of repricing effect as we go into the third quarter reset. So I just don't -- I think in the securities book of business, most of those instruments as they are called and we enter back into new ones to the extent that we do enter back into new ones, the pricing has been relatively stable. So we don't really see much difference in terms of what's being called because it's a current rate coupon versus what we're purchasing.

Okay. That's helpful. And then maybe one last one, if I can, on the expense base. I'm just wondering of the restructuring that was announced about a month ago now, what portion of that employee base has already been notified? And then, similarly, on the vendor side, how many of those relationships have already been terminated?

Yes. Well, we'll not go into the deep detail there other than to say the majority on both fronts.

The next question comes from Jackie Bohlen with KBW.

I wonder if you could provide a little more color just on what you're thinking in terms of the small business banking platform. And I know you mentioned treasury management and deposit growth from them, but just how you see that playing out over time?

Well, first of all, it's very, very early innings. And with Leticia coming onboard, her teaming with Jason Pendergist, it's a matter of wanting to take advantage of our branch network and ensure that we are focused as much, if not more, on the small business community which, as you know, is richer and lower cost deposits. And we have had a degree of that capability and focus here relatively modest. And we've worked to amp that, both in terms of creating the right credit metrics, right credit box and ensuring that our teams are well trained to deal with that client base. So early innings, but that's the intent. And it's much more a deposit play than it is a loan play, but the loan is usually how you start the relationship.

Okay. That's helpful. And then just in terms of -- you've obviously done a wonderful job of building out your senior management and helping to transition the company. Approximately where are you in that process? It's kind of a 2-part question. And of that $15 million in annualized cost savings that you anticipate, how much of that do you expect to generally reinvest in the company?

Well, I'll deal with the first portion. In terms of my leadership team, the team that reports directly to me, we are set. So with Jim Hazboun coming onboard as our Head of HR and with the earlier announcements that we had in the first quarter, Kris Gagnon, our new Chief Credit Officer, now well in the chair; Leticia, as I mentioned earlier, now well in the chair with respect to running all of our branch operations and capabilities, all of that front line leadership team for me across those originations and the support areas is in place. And I'm really satisfied, really pleased with the degree of teaming and just the degree of adult leadership that we have in place here. So very, very good. And those teams now have -- those leaders have also gotten themselves in a very, very good spot in terms of their chosen senior leaders. So it's something, I suppose, you're never quite done with, but we're a long way down the path with respect to the teams. On the expense side and John, I want you to comment more but first of all, we're much more geared towards the expense-to-asset ratio and driving that to the 2% and lower number. So obviously, we're pleased with the expense levels that came in, in the second quarter. There will be some add backs. We do want to continue to add to our teams on the origination side and where we need to throughout the rest of the company. But obviously, we're quite focused on the sales front office side. Any other?

Yes. I guess, what I would add is we will continue to focus on back office and creating efficiencies. And as we make those gains, that will certainly be a benefit toward expenses but as Doug mentioned, we will continue to invest in the front line units and so that will put some upward pressure. But the way I'd think about expenses, again, is over the long term, we'll drive that expense ratio down to something that's at 2% or lower of average assets.

Okay. That's helpful. And then, just one last one. This is regarding footnote 4 on Slide 9. The $2.1 million legal settlement with -- that was just captured as a benefit to other income in the quarter?

That's correct. That is correct, yes.

The next question comes from Matthew Clark with Piper Jaffray.

Can you give us a sense for the rates on the brokered CDs that you ran off relative to the pricing on the new CDs that you're offering? Just trying to get a sense for that differential.

The -- typically, the way we take out the brokered CDs is going to be in 3- and 6-month terms. And so you'd look back at what the rates were at that time, which was a rate increase or 2 ago, versus the new CDs that are coming on. So I don't have the exact numbers, but it's relatively short duration on the brokered deposit side. So they're continuing to reset at market and then we're bringing on, obviously, the new CDs at what we believe are market rates. But all-in, we generally believe -- on a comparable basis, we're able to generate deposits at a lower cost than brokered deposits.

Okay. Great. And then can you quantify the pay-off activity in the quarter? Just wondering what the pay-offs were in the first relative to the second quarter on net loan growth?

No. I don't -- we typically don't kind of break that out. We're just more focused on what it looks like in terms of the overall net loan growth. What I can say is that the yield on the gross WAC, I guess on the new production was 5.05%, which is up slightly from the prior quarter, and certainly well above the overall loan portfolio yield.

Okay. And then, just on the income statement, the loan servicing income, I guess how should we think about that line item going forward? I think with the MSR asset largely going away, I guess, what else is left there?

What's left is primarily the SBA loans that we service. And so there will continue to be a little bit of servicing fee income, but it's a relatively small component of the overall income statement. And the MSR is a small component of the balance sheet. So it will be relatively small on a go-forward basis.

The next question comes from Andrew Liesch with Sandler O'Neill.

Can you hear me?

Yes, Andrew.

Okay. Great. Just some questions on the yield side here just looked, noticed that the C&I, SBA and lease financing yield was up pretty substantially. Was it just a function of the variable rate loans repricing? Or was there anything else driving that to that increase?

No. That's primarily the variable rate loans repricing. They are substantially tied to LIBOR. And again, we saw some pretty significant increases in the LIBOR curve in the early part of the year. So that resulted in the higher rates in the second quarter.

Okay. So you got the better rates there, generally improving rates on new production and then certainly, deposit costs are coming on higher. But what's giving you that little bit of sense that the margin is going to continue to decline? It seems like you're getting some improvement on the earning asset mix, that should help better loan yields. And while funding costs are going up, it seems like you can offset that. So what's giving you the sense though that the margin is going to slip a little bit lower?

Well, I would start by saying that it's still early innings in terms of this team and their production efforts. So I really like what we saw in virtually every category in the second quarter, but that's second quarter. So no one here is declaring victory. We've got a lot of work to do. And also, you've got a fair degree of still transitioning away from some of the more wholesale funding pieces. So we're just trying to be very cautious and thoughtful about where that NIM may turn out here over the next couple of quarters. We think it'll be in and around 3%, but it may drop below 3%.

And as we think about just the market itself, we saw a fair amount of competition, certainly, in the first quarter, entering into the second quarter. And so we still believe that the market is very competitive in terms of trying to gather deposits, so we would expect some ongoing pricing pressure in that arena.

Okay. That makes sense. And then, on the operating expense side, with the cost saves you have coming from the events announced a month ago and the good cost control this quarter, recognizing that there is going to still be some hiring, I mean, I'm looking at it. You could reach your 2% to assets ratio middle of next year. I'm just curious when -- does that make sense to you guys? Do you think you could achieve it sooner? Or is it going to take a little bit longer?

Well, I like how you're thinking. I do think the -- look, a piece of it is getting out from under the muted balance sheet growth, as we again, go through spinning down the securities and institutional funding. So as always, there's 2 sides to any ratio. But yes, now look, we're pretty optimistic in terms of getting to that 2% or below target in a timely manner.

The next question comes from Ebrahim Poonawala.

So John, thanks a lot for detailing all the initiatives you have on the deposit front. And I'm sorry if I missed this, what are the incremental deposits coming on at when you think about it on a blended basis? Is it at market rates at 2%, 2.5%, or is it much lower than that?

Well, to begin with, you're going to be closer in the 2% to 2.5% range. So higher costing deposits, the Phase 2 construct that I spoke about earlier. So this is a multiphase process here. And so this round of deposits is unsurprisingly higher rate, but -- and efforts are underway as we go pursue more and more relationship-based deposits that would be lower rate. And as we've said many times that, that portion is underway, but it will take longer to show through.

Understood. And on the other side, when you think about loan origination yields coming on, is it, I mean given the mix of the business, around 5% to 5.5%? Greater than that? I'm just trying to simplify in terms of how to think about the margin outlook.

Yes. A lot of our loan generation is all going to be done at market rates, and so it really kind of depends upon the mix. So I think, think of the general rates that are out there in the markets, you're probably in the mid-4s in the multifamily, you're probably in the low 5s for C&I and the single families, probably on a gross coupon basis, is in the high 4s.

That's helpful. And I'm not sure if you've mentioned this, with the loan-to-deposit ratio where it is due, are you okay if that goes over 100% in the near term? Or you want to kind of keep it sub-100%?

Well, yes, look, we'd love to keep it sub-100%. And we're doing a lot of work on that front. So yes, that too is a piece that will play out.

Got it. And just one follow-up question on expenses. So the operating expense on the rate was $54.3 million. I realize you like to think about it as an expense to asset ratio. But when we think about just the absolute expense on the debt in this low 50s, do you think that's kind of the right way to think about it as we look into '19, given the savings that you're getting about $3.5 million per quarter, but then reinvestments on the other end?

Yes. Look, I think that's -- yes, this is a bit of an interesting journey here and why we are so much more focused on expense to assets. So yes, we talked in terms of -- yes, we're happy with the $54 million print on the expense side for 2Q, but there will be important degrees of investment back into again, primarily, the origination side as we've said. So we're going to remain focused on the expensed asset side of things for now.

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

I have a couple of questions. First, I may have missed the $2.1 million benefit to other income? What was that driven by?

That was a legal settlement that occurred.

Okay. So that came in -- okay, separate -- but that's separate from what you called out on the press release in terms of the $5.4 million.

That's right.

Okay. All right. Great. In terms of the balance sheet, given your kind of pretty steady pace of loan growth and expected acceleration in the back half of the year, maybe some more calls of your securities portfolio. Do you think you hit a balance sheet inflection in terms of starting to see growth in first quarter of '19? Do you think you go deeper into 2019 until you spend -- until that balance sheet starts to expand again?

Yes. Well, we're not going to overly comment on the when. We still have more work to do. We've said we want the securities to represent somewhere between 15% and 20%. We're in the low 20s now. So we've got important work to do there to continue to get loans up and securities down. Same is true on the institutional funding side, the wholesale funding side. We've got, certainly, more work to do there. So I don't know that I can put a precise finger on the quarter when you start to see the acceleration, but it's out there for us.

So to make it more clear for me, in terms of when that starts to happen, is it more purely driven by the asset mix? And if that happens sooner, do you not let as much of the wholesale funding runoff to support the growth? Or is it both mix and funding focused?

No. I think you've got it. Look, we want to -- this bank will have degrees of institutional funding, wholesale funding for a long, long time to come given the legacy and the work here that needs to be done. So that number will stay, probably elevated by comparison, I suppose. So -- but we don't want it to be as high as it is today. So we want to continue to work that down. And maybe less focused necessarily on the sources, what we're most focused on is the NIM and the net pricing reduction over time in the cost of funds by comparison to where we stand today.

Okay. And then, just last question in terms of the acceleration of loan growth in the back half of the year that you would need to get to your mid-teens or better target. Is that predominantly from the business banking platforms that you were talking about? Or is there other segments that you would suggest would be drivers of that acceleration?

Yes. Well, first of all, we said mid-teens, not mid-teens or better just to be crystal clear. And look, we think it's out there from across the platforms. So good -- our team

(technical difficulty)

and growth outlook in our commercial business alone.

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

Just wanted to talk about the core deposit growth and when do you think you will start getting meaningful traction on getting lower cost deposits into the bank where it's less of a CD base in terms of deposit growth?

Yes. Well, a couple of thoughts here. First of all, 2 of our units, the real estate banking business, while more modest at this stage of the game, is already having that success. And our private bank is having considerable success in that arena. So it's all about the amping of our C&I platforms from small business through business banking through middle market. And then, some of our specialty deposit initiatives and what we believe that will bring and then, if you will, slowly but surely as we work with our teams and Leticia's efforts on the branch banking side. So it's a journey on the lower cost side. We're having good degrees of success in particular units. And we're underway with pretty significant initiatives all across the board.

Okay. And then, on the -- I think I heard it that there was -- on the credit front, there were some borrower performance issues driving a little bit of an increase in the reserve. Just wondering if it was one credit? Or if there was any particular class of credits?

Nothing in particular. It was much more broad-based. And so we've just seen some downgrades into special mention and substandard. And as we continue to look at those credits though, we don't view them as having underlying loss exposure necessarily, it's just more of a borrower deterioration and classification issue.

Are they C&I credits or commercial real estate credits?

Predominantly on the C&I side.

Okay. Tied to any particular industry or...

No. No, particular industry.

Next question comes from Tim Coffey with FIG Partners.

Great. Can you provide a little bit color on the change in balances in noninterest-bearing deposits this quarter? Was it customers moving into interest-bearing products or [standard] exits from the bank or anything like that?

I don't think there is any -- necessarily any additional color to provide. We continue to see some pricing pressure out there in the market. And we continue to see people taking action with respect to how they're managing their own deposits, whether it's consumer or whether it's businesses. And so we've just seen a little bit of a migration. As we go forward and as we launch the business banking as well as the small business lending initiatives, that's where we would expect to start seeing the noninterest deposits flatten out and begin to grow, but that will take some time.

Okay. And then how should we think about the tax rate the next 2 quarters? Would it be flat in the next quarter and then a step up by 4Q, with the alternative energy investments coming down or would it be kind of a gradual rise from here going forward?

Yes. We originally expected to have completed our solar equity tax program by the middle part of the year, and we have largely done that. But it's just a timing recognition, so we'll have a little bit of a flow over into the third quarter. So our effective tax rate won't be back up into the 20% to 25% range that we had targeted. It'll be lower than that for the third quarter. And then, as we get into the fourth quarter, I would expect us to start getting back to something that looks more normalized in the 20% to 25% range.

This concludes our question-and-answer session. I would like to turn the conference back over to Doug Bowers for any closing remarks.

Well, thank you all very much for your participation. I'd close it out by saying deposits, expenses, NIM, credit quality, all making degrees of important progress. Loan growth outlook, as well. And a team that is growingly in place and settled, putting to work what we think is a special opportunity at Banc of California. So with that, we'll close it down, and thank you very much for participating.

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.