Pacific Premier Bancorp Inc (PPBI) 2016 Q3 法說會逐字稿

Good afternoon and welcome to the Pacific Premier Bancorp Q3 2016 conference call.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Steve Gardner please go ahead.

Thank you, Angie. Good morning, everyone. I appreciate you joining us today.

As you are all aware earlier this morning we released our earnings report for the third quarter of 2016. I'm going to walk through some of the notable items. Ron Nicholas is going to review a few of the financial details and then we will open up the call to questions.

I will also note that in our early earnings release this morning, we have the Safe Harbor statement relative to the forward-looking comments. And I would encourage all of you to take a look and read through those.

Clearly this was a disappointing quarter for us from a bottom-line perspective. As we generated $9.2 million in net income or $0.33 per diluted share. We understand that we have set high expectations for the Company, both internally and externally, and we did not meet them this quarter. At least in terms of our level of profitability.

However, we had a solid quarter from the perspective of new client acquisition activity and balance sheet growth. And we're confident that this quarter wasn't indicative of the earnings power of the Company. Our fundamentals are strong and we are well positioned to deliver improved performance going forward.

I'm going to start by discussing the major items that impacted our earnings this quarter. First, we had an unusually high level of credit costs, which was primarily related to one commercial credit.

Those of you who have followed the Company for awhile know that we have always taken a great deal of pride in our credit quality, underwriting, and loan monitoring practices. So it is unusual for us to see a credit go this route. But sometimes no matter how robust your credit risk management practices are these things occur.

The loan was an in-market C&I credit, wherein the borrower was a local engineering and construction company that had performed well for years. One of the partners experienced a serious medical issue and the company lost their largest customer. The firm ultimately was not able to continue operations.

It was a rapid deterioration and we determined that we needed to fully reserve for the total amount outstanding on this credit. This drove approximately $2 million of the $4 million provision for credit losses that we recorded this quarter. Aside from this one issue, we continued to see positive trends in the loan portfolio as nonperforming assets to total assets was 17 basis points and delinquency as a percent of total loans was just 18 basis points.

The other notable item impacting our earnings this quarter was certain one-time noninterest expenses totaling about $1.4 million. Primarily in our compensation, marketing, and data processing categories. Ron will discuss these more at length later in the call.

When you back out these one-time costs our noninterest expense in the third quarter was in the $24 million to $25 million range. Which is what we expect will be our quarterly run rate for noninterest expense for the foreseeable future. As we talked about on our last call, over the past few quarters we have been making investments in the organization with a focus on building an infrastructure that will support our long-term growth and ensuring that we always stay ahead of the higher regulatory expectations for larger, high-growth banks.

We have seen banks across the country and in our immediate markets run into regulatory issues. Ranging from the Bank Secrecy Act and Anti-Money Laundering regulations to CRE concentrations, compliance CRA, or any host of other issues. By being proactive and managing the bank to a high standard, our shareholders have benefited from our ability to effectively execute on our organic and acquisitive growth strategies, without running afoul of the regulatory agencies. And we intend to continue that approach.

We've both added to our headcount and made upgrades at existing positions, ranging from bankers to operations to risk management and compliance as well as to our senior management team. The $24 million to $25 million range for noninterest expense reflects the full quarter impact of these investments in personnel. As well as the incentive compensation commensurate with the level of loan and deposit growth our team is generating.

As a growing institution, we will always have some growth in headcount. But 2016 has clearly been a year of outsized investment and we don't expect our expense levels to grow at the same pace going forward.

As far as the core performance of the bank this quarter, we continued to have a great deal of success in attracting new clients to the bank and expanding our existing relationships. We generated $322 million in new loan commitments, which is a record level for the bank and our loan portfolio increased at an annualized rate of 23%.

The addition of the security bank team is having a positive impact on commercial loan production that we expected. During the quarter, we originated $64 million in new C&I loan commitments and our franchise lending group contributed another $48 million in new commitments.

Our commercial real estate and construction groups each contributed more than $50 million in loan commitments this quarter. Our overall loan production was well-balanced and we continue to build what we think is a high quality, well diversified loan portfolio that also generates favorable risk adjusted yields. Additionally, we had a strong quarter of SBA loan production, originating more than $43 million in loans, which is contributing to solid fee income.

Lastly on loans, we bought an $83 million multi-family portfolio during the quarter, which enabled us to redeploy the strong inflows in core deposits and the early payoffs within our portfolio that we saw during the quarter. Our overall deposits were up $129 million, with all of the growth coming in core deposits. Our non-maturity deposits increased by $176 million, with $117 million of that coming in non-interest-bearing deposits.

As a result of these strong inflows, we ran off some of our higher cost time deposit's. The growth in deposits is coming from both new and existing commercial clients as well as from solid growth in our HOA division. Our focus on building a highly productive deposit gathering institution, has resulted in non-maturity deposits comprising 81% of our total deposits and reflects our focus on enhancing franchise value.

Looking ahead, we view the fundamentals of the business and our markets as being healthy and we expect our fourth-quarter performance to be more in line with the core earnings power of the Company. We are well-positioned to manage our future growth, both organically and through additional M&A activity. We remain actively engaged in conversations with boards and management teams that we believe would be attractive partners for our franchise.

Our loan pipeline continues to be healthy and we should see quality loan growth in future periods. As we grow our balance sheet we expect to see improved efficiencies, increased operating leverage, and a higher level of profitability.

With that, I will turn the call over to Ron to provide a little bit more detail on our third-quarter results.

Thanks Steve and good morning everyone. As is customary, we have provided a fair amount of detail in our earnings release today. So I will review some of the more significant items in the quarter focusing primarily on the link quarter comparison starting with the income statement.

As highlighted in our earnings release, net income was $9.2 million and we earned $0.33 per diluted share on 27.9 million average shares outstanding in the quarter compared to net income of $10.2 million and $0.37 per diluted share on 27.8 million average shares outstanding in the second quarter. Our pre-provision total revenues came in at $45 million compared to $42 million in the prior quarter, an 8% increase quarter over quarter. As Steve mentioned, we provisioned $4 million during the quarter of which $2.4 million was for specific reserves on two commercial credits and the remaining $1.6 million for loan growth and non-interest expense came in at a disappointing $25.9 million, but as Steve mentioned it included a few one-time items totaling roughly $1.4 million.

Our core expenses included higher production related expenses resulting from the aforementioned record loan and deposit growth during the quarter. Despite the higher NIE, our efficiency ratio remains among the industry leaders at 57% and our non-interest expense to total assets was 2.74%.

Net interest income increased by $1.4 million driven principally by our on-balance sheet loan growth. Excluding accretion income, net interest income grew $1.8 million over the prior quarter. However, the majority of our loan originations occurred in the back half of the quarter, which should lead to further expansion of our net interest income in the fourth quarter.

Average earning assets increased by $146 million for the quarter fully by record months -- record production and the purchase of $83 million multifamily loan portfolio in mud August. Our core net interest margin excluding the impact of accretion was 4.18% in the third quarter compared to 4.19% in the second quarter. Accretion contributed 23 basis points to the net interest margin compared to 29 basis points in the second quarter.

Our overall cost of deposits remained flat at 28 basis points, which included the acquired CD mark to market accretion benefit. Excluding that accretion benefit, our cost of deposits fell from 31 basis points to 29 basis points, as average non-interest-bearing checking deposits grew by almost $75 million during the quarter.

We believe our core net interest margin should continue to hold up as we move into the fourth quarter. We have taken actions to lower our dependency on higher cost time deposits, as illustrated by our $47 million decrease in CDs from the second quarter and expanded our investment portfolio, which should favorably impacted the net interest margin. Lastly we lowered our cash requirements by almost 50% effectively redeploying those funds into new loans and securities.

The bank recorded a loan loss provision of $4 million during the quarter compared to $1.6 million in the prior quarter. As stated, in addition to loan growth we recorded $2.4 million in specific reserves for two credits. One of which was $2 million commercial credit Steve spoke about earlier.

Non-interest income increased $1.5 million to $6 million from the second quarter, primarily as a result of higher SBA loan sales. During the quarter, the bank sold $36 million of SBA loans achieving a net gain of $2.7 million, compared with $23 million and a gain of $2.1 million in the second quarter. The gain rate was a little lower this quarter than historical, as a result of tighter pricing on certain loans.

Our average loan size jumped this quarter to $1.6 million compared to $1 million in prior quarters, which contributed to the quarters higher production. We also had a one-time smaller loan sale which achieved a $450,000 gain, this was a one-off sale opportunity the Company took advantage of. Also impacting net interest income favorably was $700,000 of one-time gains related to recoveries on loans previously charged-off prior to acquisition. From time to time the bank realizes these gains.

Similarly we recorded $100,000 in the prior quarter and almost $800,000 in the first quarter. Lastly, we sold $17 million of securities this quarter achieving approximately a $500,000 gain compared to $21 million sold in the prior quarter.

Turning now to non-interest expense, overall as Steve discussed our net interest expense came in at $25.9 million and included certain one-time items totaling $1.4 million. As I highlight primary specific expense lines, I will note the impact of these items. Without these additional nonrecurring costs we believe our net interest expense would've come in at $24 million to $25 million.

Higher compensation costs included higher bonus and incentive compensation of approximately $800,000 during the quarter, in part due to the higher loan and deposit production for the quarter and the additional new hires in the first quarter and first half of 2016, as well as a $200,000 one-time item. Higher data processing reflects a one-time termination fee for a service provider for $100,000 as well as a post merger run-rate expense for the combined organizations.

Professional fees were driven principally by stocks and audit costs related to both the newly merged company and our new auditor. Marketing expense includes a one-time expenditure of $800,000.

And lastly, other expense includes a $300,000 charge to our off-balance-sheet commitment reserve for the outstanding letter of credit for the aforementioned commercial credit. This charge represents a 50% reserve level for the letter of credit. Combined with the specific reserve provision for this credit, this was a $2.3 million charge to pretax income. Our effective tax rate during the quarter was 39% and we anticipate the 39% will be the full year tax rate for 2016 and beyond.

Taking a look now at the balance sheet, total loans as highlighted in our release increased by $169 million or 23% on an annualized basis and was driven principally by record organic originations for the quarter of $322 million and to a lesser extent the mid-August purchase of the $83 million of multifamily loans. We believe this production level highlights the additive traction of the SBOC acquisition.

We saw strong loan originations across the business spectrum growing by 8% on a linked quarter basis and over 30% annualized. In particular, the strongest growth occurred in the relationship lending areas of the portfolio, such as C&I, owner-occupied, CRE, and franchise loans. Portfolio repayments slowed somewhat this quarter compared with the second quarter, as the rate of annual repayment fell to the low 20% levels compared with the mid-20%s in the second quarter.

The primary or largest repayment driver remained construction loans although they came down from the prior quarter. We anticipate some potential slowing of payoffs in the fourth quarter.

We also initiated a couple of actions to make our balance sheets more efficient. First we were able to lower our reserve requirements this quarter through the adoption of new technology which enabled us to lower our cash position by almost half. Effectively we were able to deploy some of our loan growth out of cash.

We grew our investment portfolio as we purchased $97 million during the quarter and sold $16 million. We continue to target a portfolio size equal to 10% of our total assets. Additionally, we expanded our investment portfolio to include a small amount of investment grade corporate securities.

Turning now to deposits. As a result of both the lower cash requirements as well as our strong deposit growth, we were able to lower our higher cost-time deposits on both the wholesale and retail front. This helped to give rise to slightly lower deposit costs. Our non-interest-bearing deposits rose to 38% of total deposits from 36% in the second quarter and our non-maturity deposits grew to 81% from an overall of 78% in the second quarter.

Deposit growth was primarily from both our existing customer relationships as well as new customer relationships and our deposit growth also in our HOA business grew $60 million in core deposits also from both existing customer relationships as well as new. The Company and the Bank both remain well-capitalized across all regulatory measures with our tangible common equity at 9.28% and our tangible book value increased $0.35 to $12.22.

Lastly, taking a look at asset quality, as discussed earlier we recorded a provision for loan losses of $4 million, including the $2.4 million of specific reserves, these credits are now fully reserved for our balance sheet exposure. We also believe these are isolated credits and do not reflect any worsening trend in the loan portfolio.

Net charge-offs for the quarter were $1.1 million or 4 basis points of total loans, compared to $1.1 million in the prior quarter. Our total allowance for loan loss increased to $21.8 million and we finished the quarter with an allowance to total loans of 70 basis points, an increase of 5 basis points from the prior quarter. When we factor in the fair market value discounts related to our acquired loans, our allowance to total loans was 89 basis points, unchanged from the prior quarter.

Nonperforming loans were 18 basis points of total loans and NPA's were 17 basis points. Total delinquency was 18 basis points compared to 19 basis points in the prior quarter. Lastly, we continue to have very strong coverage of our nonaccrual loans with an allowance that represents 351% of our total nonaccruals at the end of the quarter.

We would be happy to answer any questions you may have. Operator, please open up the call for questions.

(Operator Instructions)

Our first question comes from Bob Ramsey from FBR.

Maybe you could provide a little bit more detail around some of the unusual costs that made up that $1.4 million that gets you back into a normalized range. I'm curious if you could elaborate on what that was, how it fell into this quarter and how it goes away next quarter.

As Ron eluded to, it included about $800,000 in bonus and incentive compensation, as well as some of the new hires, roughly about $200,000 in one-time nature. The data processing costs were approximately $100,000.

We had -- I'm sorry let me just go back and deal just strictly with the one-time cost, which the incentive compensation and overall compensation had increased by $800,000. There is about $200,000 in the compensation that is really a one-time cost.

The data processing as I said was about $100,000. Some increase in professional fees related to [SoCs] and then the audit costs. Marketing expense, we had a one-time expense of $800,000 during the quarter. And then the $300,000 reserve for off-balance-sheet reserve on a letter of credit that we have associated with that loan that we placed on nonaccrual doubtful status.

Okay. Shifting gears, you mentioned a purchase of a multifamily loan portfolio, could you give us a little more detail around that book, geography, loan-to-value, debt service coverage, et cetera.

It is predominantly all loans in the West. It's from an institution that we have bought and/or sold loans to over the years. We are very familiar with their platform.

Loan to value, DCR, I do not have off the top of my head but we could get that number back to you. As with any portfolios that we buy, which hasn't changed over the last decade, we fully analyze, underwrite, and inspect the properties. And we have not changed our approach at all in any of the products -- that loans that we end up purchasing.

Okay. I am going to circle back to the cost and then I will pass it on to someone else but with some of these unusual items, obviously incentive comp is going to depend on performance for like SoCs and audit, it some of that seasonal, is it something that we should think about having certainly not every quarter but maybe in this quarter in future years?

Bob that is a very good point. Certainly on the SoCs side of things it is seasonal. There is a step up in SoCs related activity that comes about starting I would say sometime in the mid to later part of the second quarter and then starts to really gain momentum in the third and fourth quarter.

No question about that as it relates to SoCs, we also have, as I think everyone is aware we hired Crowe, they are our new auditors. They initiated with the second quarter review and now are fully mobilize on-site, so there was a step up in cost related to their hiring as well.

And then some of the other things that have come about. We have grown our department, we have grown, as Steve indicated, other areas in the Company and with those hires albeit, it is all, -- it all does relate back to the performance, ultimately the performance of the Company, but there are also bonus opportunities for those folks albeit on a partial basis because they are mid-year hires but we have to constantly adjust the numbers and that.

It will continue to adjust as we go forward based on the performance of the Company. And obviously with any further change in personnel. But as Steve indicated, we don't anticipate any more significant increases in personnel or in staffing then where we are at today.

Okay. Great, thank you.

Our next question comes from Gary Tenner from D.A. Davidson.

Good morning. I just want to follow up on Bob's question. With regard to the characterization of some of this as one time cost. On the marketing side in particular, I understand that there will be volatility through the year, marketing and certainly the dollar amount was well above where you have been, but could you differentiate between a nonrecurring cost versus a one-time cost and what it means in the guise of marketing.

So as we have gone through our review, I have had the opportunity and my team has had the opportunity to go through a full cycle of quarterly expenses and we discovered a couple of items through that review whereby we felt that we needed to accelerate some of the expense related to those items. Or recognize the expense on a more accelerated basis and that's really what drove a couple of the items.

Okay, so more of a true-up of expense accruals? Is that -- (multiple speakers)

Yes, from that marketing side, that is true Gary. And then that is also why, as Ron said he has been here for a full quarter, we have looked at our forecast what we expect to be our run rate and that is why, we guided to that $24 million to $25 million is where we believe the non-interest expense run rate should be in Q4 and for the foreseeable future.

Okay, that is helpful color. I appreciate it. Follow-up on the deposit side, we have seen a handful of banks, so far this quarter, with similar loan deposit ratios as PPBI has, that in order to stay ahead of the loan growth have really had to increase their deposit costs and you have this quarter successfully grown deposits very nicely without doing so. Can you talk about what you are seeing in terms of competition on the deposit front?

I think that competition as it always has been, it is currently and we expected to be in the future, is very strong. We have a disciplined approach to pricing and most of the growth as we noted in the release, has come from our commercial clients.

So it is not a rather price sensitive group per se. They are really looking for that bank that is going to take care of them, that they have a banker that they can trust, and consult in when they have important decisions. So we really don't compete on pricing on the deposit side, but competition remains fierce.

Okay. Thank you very much.

Our next question comes from Matthew Clark from Piper Jaffray.

Good morning. First one, we are starting to see more one-off credit hiccups here and there and it looks like this one was an unfortunate one. But curious what you're criticized loan trends look like? I know your delinquencies and nonaccruals look good but curious what is behind the curtain here in the third quarter and if there is any areas, in terms of asset classes or types of businesses, you may be tightening standards or backing away from?

Whatever measure you want, classified to total loans, at the end of September was 81 basis points and at the end of June was 85 basis points. Or total classified assets to total risk-based capital was at 6.31% at the end of June and then 6.15% at the end of September. So the trends in classified assets are generally flat.

We have not changed any underwriting approaches or standards. As we have always done we are constantly assessing the product types and lines of business that we are in the markets but our approach to credit risk management from the products that we offer to the manner in which we underwrite and assess the credit risk, the manner in which we manage the existing loan portfolio, and our loss mitigation practices, have not changed and at this point we don't see any reason to change them.

Got it. And then shifting gears to new business, curious what the weighted average rate was on new production this quarter? I think your core portfolio ex-fees and accretion was 4.8%. Just curious what the new business was?

The new business in the third quarter came in about 4.92% and that compares to I believe it was 4.96% or 4.95% in the second quarter. So fairly consistent again and our originations profile was fairly consistent to what it was in the second quarter as well.

Let me just correct one thing, to make sure we are clear. For Q3 our originated yield was 4.87%. 4.92% in Q2.

That is right. Thank you Steve.

Got it. Okay. And thinking about the core margin going forward, it sounds like you have some flexibility or you have redeployed some liquidity here and got some relief on funding costs and again new business going on near the portfolio, it sounds like you can hold the margin but is there a chance you could even do a little bit better than that here?

I would characterize it this way, is that we have probably limited room to go down on the deposit costs simply because of given our growth rates. Two, as we have talked about competition is fierce, we are going to remain disciplined in the way we price our loans and deposits for that matter. I don't see much opportunity in increasing the yield on the loans that we are originating or naturally in the loan portfolio. So I would say that best case is probably flat going forward.

Got it. Thank you.

The next question comes from a Jacque Boling from KBW.

Good morning. I wonder if you can touch base on any charges, I'm guessing there perhaps weren't any since they were not called out before but anything that may have been associated with the branch consolidations in the quarter? And then an update on what may be in the 3Q run rate and what could potentially come in to the run rate in 4Q?

There was immaterial expenses associated with the branch closures. We don't expect anything in Q4 related to the branch closures.

Okay so any cost savings are already in -- we're pretty good in 3Q's run rate.

Yes.

Okay. And touching base on M&A, I know you mentioned some of this in your prepared remarks and discussions remain active. Just as more time passes, without having a deal announcement, does that change your strategy at all? What I mean by that, does it cause you to look perhaps outside of the box, which you already do to a certain extent given some of the past yields you have done, but are there things that are becoming more attractive given the rate environment, given sluggish M& A activity in general, or is it kind of the same old strategy?

I would not characterize it as same old strategy. We think the strategy is appropriate and correct. We have, as you pointed out Jacque, have historically looked beyond just hold bank acquisitions within our market. We continue to look at opportunities as they come up.

I would say predominately at this point it has been hold bank within California. And that's what we are going to continue to focus on, at the same time where opportunities come up beyond those markets, we will certainly look at those, or opportunities to add products that complement the commercial banking strategy.

Okay. And I did not mean to imply your strategy was old I'm sorry that came out wrong. (laughter) When you are looking at the banks and having discussions with them, has there been any change between looking at banks that you've decided to pass on versus passing due to something you would be interested in but the pricing just is not there between the two of you? Is there any shift in that that has been happening?

I think M&A and discussions are always evolving and buyers and sellers are reacting to what is going on in the markets and what they see the future opportunities both at their own organization as well as the combined organization. So you're always assessing those.

We certainly, if there is something that we've looked at or had discussions on in the past, we are hopeful that we haven't burned any bridges if we have passed and that we are always open to re-engaging and having discussions. So those can occur as well. I would characterize it as, we remain acquisitive and interested in having conversations with any bank in California that has a business bank focus that we think combined, ultimately results in greater shareholder value for both organizations.

Okay. Thank you that is helpful. I will step back.

(Operator Instructions)

Our next question comes from Andrew Liesch from Sandler O'Neil.

You have recently covered all my questions but just looking at capital ratios and you have a good organic engine going and the desire to do deals, but has there been thoughts of instituting a dividend or is that just retaining capital for growth your plan?

The board assesses capital management every quarter. We just recently had a meeting and discussed it. At this point we think that there are opportunities to generate attractive returns by using that capital for either organic growth or acquisitions. But it's a dynamic process that the board is always considering and we take capital management very seriously.

Thank you.

Our next question comes from Don Worthington from Raymond James.

Good morning Steve and Ron. Just a couple of minor follow-ups, on the SBA side, would you expect volumes going forward to be similar in terms of sale activity and gain on sale as this quarter.

I would characterize Q3 as being very strong Don. I would think of something in between Q2's run rate and Q3 from a gain on sale standpoint.

Okay. Great. And in terms of ongoing loan purchases, what goes into the decision to whether or not and how much you might purchase any given quarter?

You know we are looking at generally speaking the amount of inflows in deposits. The amount of pay downs that we're getting in the existing portfolio. What the new production looks like and in particular from both a commitment basis, because our most of the C&I our utilization rates have not changed, they are roughly about 45% on outstanding lines of credit.

And then the actual funded balances that we get from various other lines. And so we analyze it and assess it and then at the same time, we may have a need and desire to buy more but in looking at what's available, we're just not comfortable with either the credit metrics, the underwriting, the analysis, the quality of the portfolio, or the yields on the portfolio, at what were willing to pay for them.

So there is a number of factors that we assess and that we forecast each quarter, and then make a determination whether we have a desire. And some quarters, where payouts are slower, deposit inflows are less, production is strong, we don't buy products. So it's a dynamic process.

Okay, great. Thank you.

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

We appreciate everyone joining us this morning on the call. If there are any additional questions, please feel free to reach out to either Ron or myself and we would be happy to chat with you. Thank you all. Have a great day.

The conference has now concluded. Thank you for attending today's presentation, you may now disconnect.