PacWest Bancorp (PACW) 2022 Q2 法說會逐字稿

Good day, and welcome to the PacWest Bancorp Second Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Bill Black. Please go ahead, sir.

Thank you. Good morning, and welcome to PacWest Second Quarter 2022 Earnings Conference Call. Investors have been eager for us to do a call for some time, and we're excited to add this to our ongoing Investor Relations activities. With me in speaking today will be CEO, Matt Wagner, CFO, Bart Olson; COO and leader of our venture banking business, Mark Yung, and our newly appointed President, Paul Taylor.

Before I hand the call over to Matt, please note that we may make forward-looking statements during today's call that are subject to risks, uncertainties and assumptions. For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements, see our company's SEC filings, including the 8-K filed yesterday afternoon, which is available on the company's website. I'd now like to turn the call over to Matt.

Thank you, Bill, and good morning, everybody. I just wanted to make one comment before we get into the results for the second quarter. I'd like to welcome Paul Taylor to the PacWest team. Of course, Paul has been on the Board since May of 2021, so he's not new to the PacWest story. As announced on June 13, Paul joined PacWest as President and will succeed me as CEO upon my previously announced planned retirement at the end of 2023.

Paul and I have known each other for many years and many of you probably know Paul from his days as CEO of Guaranty Bancorp here in Denver from 2011 to 2018 and then Opus Bank from 2019 to 2020. We're very excited to have completed the search for my successor earlier than planned, and I look forward to working closely with Paul during the transition over the next 18 months. Paul, would you like to say a few words?

Thanks, Matt, and good morning, everyone. Like Matt, I'm very excited about the new opportunity. My time on the Board has provided me with the opportunity to get to know both the Board and the management team, which has allowed me to hit the ground running. I'm looking forward to building on the success of the company and leading it into the future.

Thanks, Paul. With that, let me turn it back over to Bill for a summary of the key highlights for the second quarter.

Thanks, Matt. And we continue to focus on 2 strategic priorities: optimizing the balance sheet through remixing earning assets and rebuilding our capital ratios. The second quarter was marked by exceptional loan growth, which has been the culmination of our colleagues' hard work over the last 12 to 18 months. That growth has had 4 material impacts on our second quarter. First and foremost, the loan growth helped drive the $15 million of net interest income growth quarter-to-quarter. Second, the $2 billion increase in unfunded commitments led to a loan loss provision for the first time since the fourth quarter of 2020.

Third, expenses were elevated due to higher bonus accruals and commissions as well as higher loan-related expenses. These items accounted for about $7 million of the Q-to-Q increase. Finally, the strong loan growth was a factor in upsizing our preferred capital raise.

The second quarter saw an incredibly volatile rate environment and significantly more economic uncertainty, which has caused us to tap the brakes with the expectation of slower loan growth in the second half of the year. We expect the higher interest rates to benefit our earnings over time and will start to show up in the second half of 2022.

We saw continued deposit headwinds in our venture business, with deposit outflows of $1.9 billion in the quarter which was offset by increases in wholesale deposits. Our credit quality metrics remain near historic lows with net recoveries in the second quarter. We added to the ACL to be prepared for whatever the economic environment and greater uncertainty deliver. We strengthened our capital position with the $513 million preferred equity raise advancing our capital plan.

We will continue to grow our capital ratios from here with increasing profitability and slower balance sheet growth. And with that, I'd like to hand it over to Bart for some specific commentary on the financial results before we go into Q&A.

Thanks, Bill, and good morning, everyone. Hopefully, you've all had a chance to review the press release and the earnings release deck. So I thought I'd just touch on a couple of items before we go into the Q&A portion of the call. As Bill mentioned, we booked a provision for credit losses of $11.5 million in the second quarter, $10 million related to loans and $1.5 million related to our held-to-maturity investment portfolio, which I'll talk about in a few minutes. The loan loss provision was due primarily to the significant increase in unfunded commitments of $2 billion. The ACL remains a robust 1.07%, down slightly from the 1.12% as of the end of the first quarter and above our CECL adoption date ACL of 97 basis points.

Looking at noninterest income, there was really nothing unusual here in the second quarter. Warrant income was $1.6 million, in line with the historical quarterly averages when excluding the significant record gain from the fourth quarter of 2020 to the fourth quarter of 2021.

Noninterest expenses were higher than the prior quarter, but keep in mind that the first quarter included $3.4 million in OREO gain and a lower commission expense of $2.4 million related to the significant valuation write-downs of equity investments during Q1.

So adjusting for these items, the first quarter noninterest expenses would have been about $173 million compared to the $183 million in the second quarter or an increase of $10 million. This increase was primarily driven by an increase in compensation expense, including commissions by about $2.5 million, bonus accruals by about [$2.5] million, both due to the strong loan growth. The remainder was largely due to a full quarter of annual merit increases, along with an increase in FTEs 95. The FTE increase was primarily related to Civic, the Community Bank and our digital and innovation strategy.

I now want to turn to the balance sheet for a couple of comments and actions taken during the quarter. On June 1, we moved $2.3 billion of available for sale securities held to maturity to mitigate the impact on accumulated other comprehensive income for future increases in interest rates. As previously mentioned, at quarter end, we booked $1.5 million provision for credit losses on this HTM portfolio. The OCI related to this portfolio at the time of transfer was about $217 million.

During the quarter, we also sold approximately $393 million of investments out of our bond portfolio at a loss of $1.2 million. We used those proceeds on the normal cash from the portfolio to fund loan growth while not making any significant new bond purchases.

As mentioned, venture banking deposits declined $1.9 billion during the quarter for many of the same reasons as they declined in the first quarter. As a reminder, most of our venture banking deposits are related to late-stage companies, which are highly impacted by the capital markets, which again saw virtually no IPO activity during the quarter and the lowest level of venture investments in 3 years. This lack of capital market activity is a key driver in the decline in deposit balances.

Other contributors to the decline included normal cash burn of the underlying clients, cash used for acquisitions and cash management activities, which could be a transfer to a money center bank or a transfer to our off-balance sheet entity, Pacific Western Asset Management, or PWAM. In the second quarter, transfers to PWAM were about $500 million.

From a capital perspective, the preferred stock offering drove an increase in capital despite the strong growth in both loans and unfunded commitments which increased risk-weighted assets by $2.7 billion. At quarter end, just put our Tier 1 capital at 10.15, up from 9.07 and put our total risk-based capital at 13.12, up from 12.27.

This increase in capital aligns with our strategy to increase capital and operate at levels more similar to those in the first half of 2021. This concludes our prepared remarks.

Operator, could you please open the line for questions.

(Operator Instructions)

And we'll take our first question from Jared Shaw with Wells Fargo Securities.

Can you just spend a little time on the outlook for funding growth in deposits? I hear the headwinds on the venture side and it seems like that's likely be there for a little while. What other sources, could you tap to start to see growth there? And would you look to growing -- continuing to grow brokered to fund loans here?

Yes, Jared, this is Bart. Yes, we saw during the quarter. We some wholesale deposits to fund some of the loan growth. Wholesale deposits were up about $2.9 billion. As we look into the second half of the year, we talked about the lower loan growth that we anticipate. But with the positive outlook, I expect we'll have some further increases in wholesale deposits during the quarter looking ahead.

Okay. And then when we look at the deposit base, what's the expectation for beta as we -- if we assume sort of a 350 fed funds and some of these changes, should we expect to see an accelerating beta as we go into the end of the year here.

Yes. Our second quarter beta on total deposits was 15%. And I think looking forward, we'd expect that to increase. So roughly within the first year, probably north of 22%. And then probably move towards 30% as you look out over a 2-year horizon.

Jared, just to keep in mind, the absolute level of interest costs that are there. So a beta of x on a very low cost of deposits is not as impactful. It's just the overall thing as we're looking at it, we're ready to grow net interest income -- and if the beta is x, but your overall cost of deposits is still low, actually the foundation of the business, right.

Yes. Yes. Great. Okay. I'll step back. And actually, what's the rate that you're paying right now in brokered and new CDs.

Yes. The brokered ranges probably during the quarter range anything from 50 basis points to about 185 and it's up slightly, obviously, more recently.

We'll now take our next question from Andrew Terrell with Stephens.

Maybe just sticking on the kind of core deposit growth outlook. I'm curious if we don't see any kind of improvement in capital markets and kind of private fundraising heading into third quarter versus the second quarter, do you think we can see a similar level of core deposit declines as what you saw in 2Q or should it moderate them here.

You want to take it up?

Yes. I think we're starting to see it moderating -- it's pretty hard to predict, Andrew.

Yes, Mark, I don't know if you want to add to that?

Yes. I mean, again, what we've seen here in Q2 even versus Q1 is a continued reduction in fundraising activity. I mean, I think we've all seen the data at this point coming on as the venture capital community. We are in the low of the summer months as well that we get part of it here through Q3. So that probably should continue in terms of transaction levels that -- but we are seeing some deal activity in our portfolio that is encouraging. Some larger round sizes for companies that still had plenty of cash on hand. So I think that's an encouraging sign. But to Matt's point, I mean, I do think as opposed to Q1, there's a little bit more sensitivity, obviously, around yields. We saw a larger movement towards PWAM an example Bart spelled it out $500 million block in the quarter.

Obviously, that's something that we're working very closely with our portfolio companies to make sure that they see all of our liquidity product opportunities to obviously keep those moneys on balance sheet.

Okay. And then if I can move over. I know when you first closed the Civic deal, we talked about how you were comfortable with the credit quality there. I guess just given what we've seen kind of in the real estate market, has the comfort level changed at all? And what gives you kind of confidence in the underwriting of the business.

Well, we've got a track record of performance that we've been buying a loan since 2017. And I mean since inception, we originated a significant amount of assets and had de minimis levels of any real issues. We feel good in the underwriting, and we've been able to prove that out and you just from the ins and outs of loans that we've had. So we feel really good about that.

Yes, Andrew, we've always been aggressive at downgraded loans where there might be an issue here or there, but it doesn't mean that there's necessarily a charge-off implications to that. And I think if you look at the track record over the past 2.5 years, you'll see that. And I don't see that changing. The underwriting is very strong. Even our venture business, which, as you know, lots of those portfolio company loans could be sort of air balls, we've had 0 charge-offs literally for the last 2.5 years -- net charge-offs, I should say.

We will now take our next question from Brandon King with Truist Securities.

Just wanted to touch on the loan growth guidance, anticipating smaller loan growth in the back half of the year. And I was kind of surprising expectation as far as your production levels. I just want to know what the question takes are for loan growth in the back half of the year. What categories you're seeing slowing more than others? And kind of where you see [Civic] running gas in back half of the year.

Yes, Brandon, I think you're going to see slowing overall higher rates, more economic uncertainty I think you're going to see a natural slowdown at a real high level. But obviously, we will continue to monitor and really try to optimize the balance sheet. So I think you're going to see slowdowns in general. And I think from here, we will be clearly more selective.

And I think when you look at putting that together, you'll see that slow down from the peaks we saw in the second quarter. Now what does that mean business by business? I mean what there's not a prescribed limit, but I think you would imagine that it would be -- if you're looking to optimize the balance sheet, you could probably figure out where that is.

I mean we're hearing that from our customers too, Brandon. Projects that may be penciled out at 4.5% interest rates don't really pencil out of rates or whatever you might be anticipating rates going to that in terms of how it relates to construction projects and then also your supply chain issues and just cost of materials. Rarely have we seen a project that's been completed in the last 12 months that didn't have some cost overruns in 1 line item or another.

I wanted to touch on taking classified loan. I was wondering if you could provide some color there about what the source of that was. If there's anything to note.

Yes. Yes, no problem. So yes, you did see a tick up in some of the credit metrics. There was a few credits where we had some administrative type issues. I think these are things where we feel really good about them. We're very well secured, and we expect those credits to be either remediated or resolved in the coming months or months -- month on months. I would tell you that the risk rating downgrades here, I think are more of an indication of our conservative credit culture more than anything else. As you saw in 2020, we certainly were aggressive in downgrading things, but that didn't lead to losses. It's certainly not a sign of any form of credit deterioration. We feel really good about where credit is by now.

I was trying to say, those are kind of just some one-off issues and not sort of a deteriorating macro environment.

Yes. Yes. Yes. And you're going to get a little extra activity from Civic, as you can imagine, as those loans become near completion or whatever, one of the customers could opt not to make payments, make these last couple of payments because the properties under contract or whatever, we're going to put that loan on special mention for sure and you can get a handful of those. Again, they're granular. They do get resolved, and we've seen -- we haven't had a charge-off yet, I don't think every $1 billion now.

We'll now take our next question from Matthew Clark with Piper Sandler.

First one for me, just on the expense outlook. Understand what contributed to the increase in comp this quarter. But can you give us a better sense of where you think the run rate will be in the second half.

Yes. Sure, Matthew. This is Bart. I think it's going to be in that upper 170s, low 180s. I think if you kind of normalize, like I mentioned in my opening comments, Q1 and Q2. (inaudible) talked about during the year thus far, which was starting in the low 1 and working its way up is about 180 and loan growth and the pace of that will affect that. But again, with the loan growth expected to recede a little in the second half of the year, I expect some of those expenses to go down. And so I'd say something around the 180-ish area.

Okay. Okay. And then just on the credit risk transfer. Any update there in terms of potential timing just overall plans there?

Yes, we're still working through that plan for at least something in the third quarter. And so that's what I would anticipate at this point.

Okay. And then last one for me. Just maybe for Paul. You've been on the board for some time now. I know it's still a little early, but it would be great to get your kind of initial thoughts on how you think the -- what might change when you formally take over in terms of the way that the banks managed.

Yes. I've known Matt for almost 20 years, and I've known John for the same period of time and -- this is a great bank. I mean this in many respects is an easy job to take over because the bank is very well run. I think that it's just -- it's more of the same and improving various products and pieces where -- yes, technology is one of the big pushes today. It's a pretty huge project. PacWest has been through a number of acquisitions. And in doing that, there's some holes in the technology, and we're working hard to get a much better technology platform for the company.

(Operator Instructions)

We'll now take a question from Gary Tenner with D. A. Davidson.

Just thinking about -- about the commentary on optimizing the balance sheet and outlook for some lighter loan growth in the back half of the year, to what degree do you think you would see a run down the securities portfolio or cash balances to kind of offset maybe some of the possible deposit headwinds that may still gather here in the back half of the year. You have optimal levels that you'd like to have in the mix look like, I guess, is the question.

Yes, Gary, I think we ended the quarter with cash around 6% of earning assets, investments around 24% of earning assets. I can see the investment portfolio running down a little bit further, but obviously cap staying around that 5%, 6%. And so a little bit on the investment portfolio, you can see.

Okay. So as we think about the back half of the year, potentially overall balance sheet growth is something lower than the amount of net loan growth on the balance sheet. Is that correct?

Yes, I think that's correct.

We'll now move to our next caller, who is Christopher Marinac with Janney Montgomery Scott.

Thanks for hosting the call, everyone. I wanted to dig into the pace of loan growth on some of the other lines, such as lender finance and equity fund loans and et cetera. Is the pace of their kind of indicative of the macro environment? And do you think that may be different in the next couple of quarters?

Mark, do you want to take that?

Yes, I can speak to that. I mean the pace of lender finance and equity, so let's start with fund finance, right? I mean there was limited growth in the quarter. But that really honestly is more indicative of just one-off funding that could happen on individual transactions, given our portfolio construction. As you see, fundraising activity has been very robust, about $120 billion raised in the venture market loan in the first half of the year. And so fund formation continues to be at a relatively healthy clip. Obviously, we're watching very closely. Fundraising is starting to become a little harder, especially for emerging managers. So that's something we're watching carefully. But given that dry powder, I would expect transaction levels to pick up here in the second half of the year and fund finance for benefit from that.

And I would say lender finance is kind of cut from the same cloth in the sense that there's still a tremendous amount of dry powder out there, $780 billion in the private equity landscape in the U.S. alone and they're all looking for to deploy that capital. And obviously, we provide lending opportunities that enhance their -- these private credit fund returns, number one.

And number two, we do provide a lot of warehousing facilities that are subject to the securitization market that has been a little kind of, I would say, intermittent in its activities. And so obviously, we're watching that very closely as for the remainder of the year. There's some securitizations that could happen that could quickly impact lender finance growth as well.

So with higher interest rates, do these become better spread businesses for you just as we're in this part of the cycle.

Yes, absolutely. I mean we're seeing opportunities here to enhance our spreads. Well, especially in the lender finance side. I say fund finance, that business is relatively commoditized. We play within a certain niche, more BC focused there so we can capture a better yield vis-a-vis our competitors. But in lender finance, yes, we're seeing opportunities here to enhance our spreads and make some better yields in our new originations.

Great. And then I guess one other question for you, Mark, just on the technology build. How much extra expense is out there for the expense run rate? Or is most of that technology build already in today's numbers.

No, there's obviously some more expenses. As we indicated, Chris, early days, right, and Matt said the best. I mean, for as much as I'd love to spend more on technology today, you can't spend it overnight. So we're getting some good traction here in headcount growth and in terms of some of our milestones around technology, but there's still obviously additional investments to be made. I don't know, Bart, what we're indicating to the market here in terms of incremental vis-a-vis run rate.

Well, I mean, yes. I mean I think in the numbers I talked about earlier. And again, the real change is just the pace of that. We obviously highlighted that we hired at a growth of FTEs of 95 during the quarter. Obviously, some of that is related to the digital technology strategy.

I think about 15, if I remember.

Yes. Around 15 so...

And they're not cheap necessarily either.

Correct. So -- but that's -- certainly the plan has more than 15 to the plan, but it is not easy to hire those people. Obviously, everybody knows kind of market conditions right now is challenging for certain skill sets. And so we'll continue to work on that initiative.

And Chris, some of those expenses are going to be subject to capitalization as well, right, because we're building software with a longer shelf life here. So there's that dynamic as well.

Sure. That all makes sense. And Bart, the additional hires beyond the 15 and tech, are those mainly in production stat rolls?

Yes, yes, within Civic and the Community Bank.

(Operator Instructions)

Our next question will come from Chris McGratty with KBW.

Maybe, Bart, a question for you. I know you guys don't want to talk about margin. Given the synoptics of just balance sheet size. But you mentioned in your prepared remarks, NII was up $15 million this quarter. Just given what you're doing with the balance sheet and also what the Fed's doing. Should we think about that quarter-on-quarter growth accelerating from the second quarter levels in the back half of the year?

Yes, I think so. And if you think about the timing of the different rate hikes, I mean, the large big hike was in mid-June. So what we said all along is you're really going to see more of the real benefits from the highs and the growth in net interest income in the second half of the year and in 2023.

And in the NIM, too.

And in the NIM as well. The floors, we have about $6 billion of loans on our floor at the end of the first quarter. That dropped to $1.9 billion with the rate move during the quarter. And certainly, the next move or 2 will take the majority of the remaining [loan dropped off the floors]. So I would expect that by the end of the third quarter, the amount of loans on the core is very, very small. So I would expect that to continue to grow like to have. Net interest income is growing nicely over the last several quarters, and we expect that to accelerate.

Great. On the comment about slowing growth, you guys have made a huge effort to rebuild the growth profile in the last couple of years. Do you worry about the messaging and talent loss given how competitive it is right now?

No, I don't think so. I mean we -- did you say talent loss?

Yes.

No, I don't think that I'm concerned about that, really, Chris, people seem pretty happy. I mean people, they've done such a great job in the first half of the year. They pretty much made their bonuses, which is good, and they got to stick around to get them. I think we'll be back. I think you're going to see a -- you're going to see a change. We had this extraordinary deposit growth in 2020 and 2021, really driven by the venture business, but also the Community Bank had good, solid, high single-digit growth.

And I think you're going to see (inaudible) world that's changing, again, these companies have to raise money. It's going to come into the bank. It won't be at the level that we saw in 2020 or '21, but you're going to see that come back in, and we'll be able to -- certain businesses growth in, I think you're going to see a pullback definitely in construction lending. It's just these projects become less feasible. There's still a great need. As you know, most of our construction lending is multifamily. There's still a great need for the housing out there.

I just -- I think coupled with finance the projects, the numbers still work as well. So talking to some of our biggest clients and Paul and I are going to be meeting with some next week. They're predicting volumes at 50% of what they did in '21 and maybe down even as much as another half in 2023. So best part of it, and that's a big factor of what we do. But I think lender finance continues to grow and other businesses continue to grow. And of course, we've got this great luck with our guys at Civic.

Okay. Just the last one on the tax rate. Is 25% about right?

Yes. I mean I think we've talked about a range of 25% to 27% and so on, I would still say in that range.

(Operator Instructions)

We will now take a question from Matthew Clark with Piper Sandler.

Just wanted to ask if you had the spot rate on interest-bearing deposits at the end of June.

Spot rates deposits ended June?

Yes. Spot rate deposits ended June was 30 basis points.

And it appears there are no further telephone questions. I'd like to turn the conference back over to our presenters for any additional or closing remarks.

Thanks, everybody. We appreciate your time and effort, and we will talk to you soon. Thank you, call if you need us.

And once again, that does conclude today's conference. We thank you all for your participation. You may now disconnect.