Opus Bank's (OPB) CEO Stephen Gordon on Q2 2016 Results - Earnings Call Transcript

| About: Opus Bank (OPB)

Opus Bank (NASDAQ:OPB)

Q2 2016 Earnings Conference Call

July 25, 2016 11:00 a.m. ET

Executives

Stephen Gordon - CEO

Nicole Carrillo – CFO

Michael Allison - President of Commercial Bank

Brett Villaume – IR

Analysts

Brian Zabora - Hovde Group

Ben Lurio - JPMorgan

Matthew Clark - Piper Jaffray

Jill Shea - Credit Suisse

Jacque Chimera - Keefe, Bruyette & Woods

Tim O'Brien - Sandler O'Neill & Partners

Operator

Good morning, my name is Kacey and I will be your conference operator today. At this time, I would like to welcome everyone to the Opus Bank's second-quarter earnings call conference. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]

Thank you. Brett Villaume, Director of Investor Relations, you may begin your conference.

Brett Villaume

Good morning and welcome to Opus Bank's investor webcast and conference call. Today I'm joined by Stephen Gordon, Opus Bank's founding Chairman and CEO and President; Michael Allison, Co-President and President of the Commercial Bank; and Nicole Carrillo, Chief Financial Officer. Our discussion today will cover the Company's performance during the second quarter of 2016 and information contained in the earnings press release issued earlier this morning. A slide show presentation that accompanies today's call is available on the Opus Bank investor web page at investor.OpusBank.com.

Today's discussion may entail forward-looking statements which are intended to be covered by the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. You'll find a discussion of these forward-looking statements in our recent FDIC filings and on page 8 of this morning's release. Today's call will include a question-and-answer session following the discussion. For listeners who are participating via WebEx, should you have any questions, you may submit those using the Q&A feature located on the right-hand side of your WebEx window, the white triangle just to the left of the question mark and letters Q&A should be pointing down. Clicking on that triangle opens and closes the Q&A dialogue box.

Now I will turn the call over to Stephen Gordon, Chairman and CEO.

Stephen Gordon

Thank, you Brett. I'll now provide an overview of the results for the second quarter of 2016 and then call on Michael Allison, Co-President and President of the Commercial Bank; and Nicole Carrillo, Chief Financial Officer to go into more detail on our financial performance. We will address questions at the end of our prepared remarks.

The second quarter of 2016 continues to demonstrate Opus's strong underlying core performance as we execute on our mission of building a highly profitable high-growth super-regional bank that is entrepreneurial, solution based and client centric in major metro markets up and down the West Coast. Our second-quarter results were marked by record second-quarter loan fundings and record second-quarter new loan commitments which were significantly higher than any previous second-quarter levels in Opus's history.

We also saw continued strong growth in both loans and deposits but lower cost of deposits and lower loan-to-deposit ratio, record levels of net-interest income, total revenues and pretax pre-provision earnings during the quarter, as well as record fee income contributions from each of the merchant bank, our escrow and exchange division and our PENSCO Trust Company's subsidiary, which we acquired during the second quarter.

For the second quarter of 2016, we reported net income of $16.1 million and diluted earnings per share of $0.46. This quarter's earnings included $3.4 million of non-core acquisition and strategic initiative-related expenses including expenses related to the acquisition of PENSCO. Reported net income was further reduced by an additional provision for loan losses totaling $7.6 million related to four loan relationships, including two loans in our technology banking portfolio that required additional specific reserves. Finally, we had negative net-equity warrant valuations tranche changes during the quarter, mostly associated with two of our tech banking division loans that reduced total non-interest income by $942,000.

To repeat the exact same message I provided in our earnings press release issued earlier this morning, given the recent volatility in the tech markets, this quarter's resultant low-risk adjusted returns experienced in our tech lending division and that Opus's second-quarter earnings were masked in part by provisions due to downgrade-related movements in this portfolio, we've determined here at the start of the current third quarter to deemphasize our technology banking niche-lending focus for the foreseeable future and thereby unleash Opus's true earnings potential.

Strong growth within Opus's other commercial and specialty banking divisions and its income property banking division continue to drive strong risk-adjusted returns and result in no change to Opus's previously established and guided growth goals. Total assets reached $7.5 billion as of June 30, 2016, up 8% from the prior quarter and up 28% from the year-ago period.

During the second quarter of 2016, we funded $661 million in new loans, up 20% versus the prior quarter and up 21% versus the second quarter of last year; and we also originated total new loan commitments of $767 million, up 22% from the prior quarter and up 28% versus the prior year. Both our new loan fundings and new loan commitments originated were record levels of any previous second quarter in Opus's history. Loan fundings were seasonally slower during the prior linked first quarter and, as expected and guided, we experienced the ramping of loan originations during the second quarter that typically occurs as the year progresses.

Total loans held for investment, which includes the runoff we experienced from our shrinking acquired loan portfolio, grew by $363 million, or 6% from the prior quarter, and 32% from the year-ago period. We continued to see strong performance from our commercial and specialty banking divisions during the second quarter, which represented 58% of our new loan fundings and 64% of loan commitments originated. Our total portfolio of commercial and specialty banking division loans has increased by over 50% during the past year, measuring $2.7 billion as of June 30, 2016.

Meanwhile our industry-leading income property banking division also continues to provide strong loan origination growth as the dominant multifamily financing force in major West Coast metro markets. In addition to new loan funding, we continue to work the acquired loan portfolio to generate accelerated outsized returns. Our current loan pipeline remains robust entering the third quarter with 68% contributed from our commercial and specialty banking divisions as of July 1, 2016.

Total deposits increased 18% from the prior quarter to $6.2 billion. Our strong deposit growth during the second quarter included strong contribution from the transition of approximately $800 million of PENSCO's ancillary custodial-client cash balances since the close of the acquisition on April 13. These PENSCO balances are stable, core, non-interest-sensitive demand deposits with a weighted average rate, as of June 30, of only two basis points. Other divisions seeing deposit growth in the quarter included commercial Banking, municipal banking and the retail bank. The percentage of our total deposit base that is comprised of both non-interest bearing and interest-bearing demand deposits increased to 48% from 40% at March 31, 2016, and our loan-to-deposit ratio measured 99% as of June 30, 2016.

As previously guided, during the second quarter we paid down $615 million of federal home loan bank advances out of the $750 million outstanding at March 31, 2016, which served to reduce Opus's overall cost of funds during the quarter. While the quarter saw a contractual NIM, net interest margin slightly compressed primarily due to lower net benefits from prepayments, and while the industry seems to be struggling with the current interest rate environment, Opus's contractual net-interest margin has increased by 10 basis points for the six months year to date. Additionally, we completed a public offering of $135 million of 5.5% fixed-to-floating subordinated debt at the end of the second quarter, taking advantage of the current interest rate environment to bolster our regulatory capital.

Non-interest income increased to 13.2% in the second quarter of 2016, nearly tripling as compared to $5.3 million during the first quarter of 2016, with $6.3 million of income from PENSCO in the form of trust administrative fees for the partial quarter performance, since the close of the acquisition didn't occur until April 13. We also recognized $2 million of fee income contributed by our escrow and exchange division during the second quarter, which is a new record for this division and well above our original guidance of $1.4 million per quarter.

Finally our merchant bank completed three transactions during the second quarter and recorded $1.8 million of advisory fee income, while also enabling $46 million of C&I loan commitments and $37 million of loans funded by Opus's commercial bank. While we continue to expect the timing of transactions in our merchant bank will be lumpy, the executed and engagement agreement deal pipeline of transactions has never been stronger and gives us confidence that future quarters will see continued strong contributions from our merchant banking division.

Our efficiency ratio for the quarter was 46.3%, adjusted for merger and strategic-initiative related expenses during the quarter compared to an adjusted efficiency ratio of 43.5% for the first quarter of 2016. Our adjusted efficiency ratio remains well below the average of our West Coast regional peers, who are at 51% and our high-growth national peers, who are also at 51% as of June 30, 2016.

Our expense reduction and efficiency improvement strategy announced in January has resulted in material successes affecting our bottom line. To date, we have realized over $7.4 million of annualized non-interest expense reduction under this initiative compared to the total $7 million we originally anticipated. The net benefit of our focus on waste avoidance and our initiatives to improve efficiency has been the reallocation of inefficient resources to more productive efficient revenue-generating and revenue-enabling investments.

Return on assets measured 89 basis points for the second quarter of 2016 and return-on-average tangible equity was 11.1%. Adjusted for the non-core PENSCO acquisitions strategic initiative, return-on-average assets measured 1.01% and return-on-average tangible equity was 12.56%. As we continue to execute on our strategy, we anticipate further improvements in our efficiency ratio on overall return metrics. We believe our scalable infrastructure will allow us to continue leveraging our operating platform and support our growth trajectory going forward.

As we continue to successfully grow and improve efficiency, we are pleased to announce that the Board of Directors of Opus has approved increasing the quarterly cash dividend payable in the second quarter by 11% to $0.20 per share, which reflects the strength and maturation of our business, strong capital position and liquidity.

At this point I'll turn it over to Nicole Carrillo to go into more detail on the financial results

Nicole Carrillo

Thank you, Stephen. Our second quarter performance resulted in net income of $16.1 million or $0.46 per diluted share, compared to $17.3 million or $0.51 for the first quarter of ‘16 and $17.5 million or $0.52 for the second quarter of 2016. Net income during the first half of 2016 was $33.4 million or $0.97 per diluted share, compared to $28.6 million or $0.86 per diluted share for the comparable period last year.

Earnings during the second quarter were impacted by $3.4 million of merger and strategic initiative related expenses that Stephen previously mentioned, as well as a larger than expected provision for loan losses of $10.9 million. By comparison, during the first quarter of 2016, we had $1.2 million of merger and strategic initiative related expenses, also primarily due to our acquisition of PENSCO and provision expense totaled $4.9 million.

Also impacting EPS this quarter was a higher share count as we issued approximately 1.7 million shares of Opus of common stock at the close of the acquisition of PENSCO on April 13th as part of the total consideration paid in addition to the $46.4 million in cash. As a result, weighted average diluted shares outstanding used to calculate EPS increased 5% from the prior quarter, to approximately 35.5 million shares.

Interest income from originated loans was $60 million for the second quarter of 2016, an increase of 4% from the first quarter, driven by higher average balances. Average originated loans increased 6% from the prior quarter, driven by quarterly new loan fundings of $661 million. The yield on originated loans decreased by 9 basis points to 4.28% during the second quarter, primarily due to a decrease in the net benefit from prepayments and interest reversals on loans that were placed on non-accrual status during the quarter. Interest income from the acquired loan portfolio, which include accretion income, increased to $8 million for the second quarter of 2016 from $7.3 million in the prior quarter, due to higher accretion income from loan sales and closed loans during the quarter.

During the second quarter of 2016, we sold 22.9 million of acquired loans which accelerated $3.3 million of accretion income, compared to the sale of 13.2 million of acquired loans in the prior quarter that accelerated $1.2 million of accretion income. We currently have a remaining discount of $6.1 million on the acquired loan portfolio and we will continue to opportunistically work the acquired loan portfolio to maximize returns and expect continued, but volatile income contribution to our total revenue. Accretion income increased our net interest margin by 31 basis points during the second quarter, as compared to 25 basis points in the prior quarter.

Interest expense on deposits increased slightly to $6.5 million during the second quarter of 2016 from $6.3 million in the prior quarter, driven by quarterly growth of $682 million in the average balance of interest bearing deposits. As a result of the increase in low cost demand deposits relative to our total deposit base, our total cost of deposits decreased by four basis points to 44 basis points during the second quarter of 2016.

As Stephen mentioned earlier, deposits associated with PENSCO’s ancillary custodial client cash balances transitioned to Opus early during the second quarter, resulting in a benefit to our overall cost of deposits for the partial quarter. These trends in interest income and interest expense resulted in net interest income of $62.5million for the second quarter of ’16, compared to $59.1 million in the first quarter of 2016.

Our GAAP net interest margin for the second quarter decreased four basis points to 3.8%, largely due to the lower net benefit from prepayments, compared to the first quarter, interest reversal on non-accrual loan balances and lower balances of acquired loans compared to the prior quarter. This was all offset by the increased accretion income from acquired loans that were sold during the quarter.

Our contractual net interest margin, excluding accretion income, decreased by 10 basis points to 3.49 during the second quarter, also due to the lower net benefit from prepayments compared to the first quarter, interest reversals on non-accrual loans and the lower loan balances of acquired loans, compared to the prior quarter. Both GAAP and contractual net interest margin benefited from the four basis point decrease in our cost of deposits during the quarter. Contractual NIM has increased by 10 basis points for the six month period ended June 30, ’16, compared to the full year 2015.

I'll now turn to non-interest income and non-interest expenses. During the second quarter, non-interest income was $13.2 million compared to $5.3 million during the first quarter of 2016 and $8.1 million during the second quarter of 2015. Non-interest income during the second quarter included $6.3 million of trust administrative fee income, which represents the partial quarter contribution from our PENSCO subsidiary, since the close of the acquisition on April 13.

Additionally, our escrow and exchange division experienced record levels of account openings and closings during the quarter and contributed $2 million in non-interest income, which is a record quarterly income level for this division. Our merchant bank completed three deals during the quarter that resulted in $1.8 million in advisory fee income. We also recognize the $313,000 gain on the sale of four originated multi-family loans during the quarter. Finally, the net change in valuation of our equity warrant portfolio decreased non-income by $942,000.

Non-interest expense for the second quarter totaled $38.4 million, which was an increase from $30.9 million in the prior quarter. The quarterly increase was primarily due to $3.4 million of merger and strategic initiative related expenses, as previously discussed, of which $1.2 million were compensation and benefit related and $2 million were professional services expenses.

Total non-interest expense also increased due to the additional operating expenses associated with PENSCO, which during the second quarter totaled $6.2 million, excluding the strategic cost that I previously mentioned. Opus’s amortization of intangibles increased to $1.2 million in the second quarter due to the addition of the intangible assets associated with the acquisition of PENSCO. Finally, we recorded a $1.2 million recapture of previously expense professional services fees due to a legal settlement during the quarter.

Our stated efficiency ratio was 50.7% for the second quarter, an increase from 47.9% for the first quarter and an increase from 45.3% for the second quarter of ’15. Excluding the above mentioned $3.4 million of merger and strategic initiative related expenses, our efficiency ratio was 46.3% for the second quarter, compared to a similarly adjusted ratio of 43.5% in the first quarter.

Finally, tangible book value per as-converted share decreased to $16.60 at the quarter end from $18.73 as of March 31st, 2016 and decreased from $17.48 as of June 30th, 2015. The decrease to tangible book value was due to the dilutive effect of the common stock issued to acquire PENSCO during the second quarter. We remain comfortable with our original estimate for tangible book value dilution earn back of three years.

Our return on average assets was 89 basis points for the second quarter of 216, a decrease from 1.03% in the prior quarter and a decrease from 1.23% percent in the second quarter of ’15. And return on average tangible equity was 11.14 for the second quarter, compared to 11.46 for the first quarter of 2016 and 12.54 in the second quarter of ’15.

On June 29th, 2016, we completed a public offering and sale of 135 million in aggregate principal amount of 5.5% fixed to floating sub-debt due in 2026. The notes were sold at par and resulted in net proceeds to Opus of $132.3 million, which will be used for general corporate purposes, including supporting Opus's growth and capital adequacy and is recognized as tier two capital by the regulators. As a result, our total risk-based capital ratio increase from 11.70 as of March 31st, ’16 to 12.93 as of June 30th, 2016. All our capital ratios continue to remain in excess of regulatory requirements under the Basel III requirements at quarter end.

I'd now like to turn the call over to Michael Allison for discussion of our origination trends and credit metrics.

Michael Allison

Thank you, Nicole. As Stephen highlighted, we accomplished $661 million in new loan fundings during the second quarter, which is a record for Opus's second quarter loan funding volume. Furthermore, we originated new loan commitments of $767 million, which is also a record second quarter commitment level achieved. We view our second quarter loan fundings and loan commitments, each more than 20% above the prior year second quarter, as evidence of the continuation of our strong growth rates overall, as well as proof of the seasonal pattern of loan growth ramping over the course of the calendar year that we typically experience, as second quarter loan fundings and commitments rebounded from the seasonally slower first quarter.

Our loan pipeline has also rebounded from the first remains robust as we enter the second half of the year. We continue to be pleased with the successes in our commercial and specialty banking divisions as we build commercial volumes to complement the ongoing success in our commercial real estate banking group. In fact commercial and specialty banking divisions contributed 64% of the $767 million in total new loan commitments during the second quarter.

New loan fundings during the quarter were partially driven by our income property banking division, which contributed $280.4 million of the total, that were primarily the result of strong contributions from our commercial and specialty banking division which made up 58% of the total new loan fundings, including $133.2 million from the commercial banking group, $78.3 million from structured finance, $75.1 million from healthcare banking and $64.1 million from our corporate finance team.

We also originated $27.3 million of technology banking division loans, which were primarily funded at the beginning of the second quarter and represent the bulk of all technology banking division loans made during 2016. As Stephen previously explained, based on the low risk adjusted returns we have experienced in our technology banking division, we made the decision to deemphasize this [indiscernible] lending focus for the foreseeable future as we thoroughly assess the space. As of June 30, 2016, technology banking division loans outstanding total $279.5 million and total loan commitments were $316.4 million or approximately 4.5% and 4.7% of total loans outstanding in total loan commitments respectively.

Technology banking division deposits were $84.2 million. Other divisions within Opus are continuing to deliver strong growth, providing attractive risk-adjusted returns which gives us confidence in reiterating our previously established growth goals and guidance of $2.5 billion in new loan fundings for the year 2016. We continue to deliver on our strategy to shift the mix within our loan portfolio towards a greater percentage of higher-yielding non-multi-family loans and our efforts have seen results as our total loan portfolio has transitioned to 45% originated multifamily loans, down from 51% at the end of the second quarter of 2015 and 56% at the end of the second quarter 2014. The increasing percentage of commercial or C&I loans in our total portfolio, which now measures 28% compared to 19% in the prior year's second quarter and only 9% in the second quarter of 2014, is a key reason we have confidence in our ability to sustain our strong growth rates while improving our net interest margin over time.

The recent discussions surrounding commercial and multi-family real estate concentrations across the industry and across the nation, seem to have intensified during the second quarter. In spite of the industry chatter, at Opus we remain extremely confident in our ability to successfully grow our leading multi-family lending platform, which continues to originate loans at attractive rates and has experienced zero charge-offs and de minimis delinquencies since inception. And Opus’s multi-family loan rates remain in the high 3% range, a favorable rate compared to the rate experienced on the East Coast.

Additionally, credit metrics on our multi-family and CRE portfolios include attractive loan-to-value and debt coverage levels that have sustained during the first half of 2016 aided by our markets that have rent control regulations, including the San Francisco Bay Area and certain submarkets of the Los Angeles metro area.

During the second quarter, we saw our ratio of non-performing assets to total assets increase to 1.06% as compared to 62 basis points last quarter. The linked quarter increase in nonperforming assets was attributable to three long relationships, two of which were in our tech portfolio and one in our Healthcare banking portfolio that were placed on non-accrual due to developments during the quarter. Excluding the technology banking division’s credit issues, our credit quality continues to perform consistent with expectations as our portfolio of multi-family CRE and C&I loans continue to season.

To put some figures around that statement, if you exclude technology banking division loans from the calculation, our NPA ratio would have been 43 basis points for the second quarter compared to 32 basis points in the first quarter, again excluding tech. We believe our proactive and timely decision to de-emphasize our tech lending niche focus will result in a return to the credit profile that we have expected over the course of Opus’s evolution. That is to say we continue to maintain our focus on a disciplined approach to credit that includes active portfolio Management and may include quarter to quarter changes in risk ratings or accrual status based on our stringent proactive underwriting standards.

The Management of credit risk in the specialty banking portfolios that we originate is ongoing and consistent with expectations. We continue to anticipate changes in risk ratings as our entire portfolio seasons. While the credit issues within our technology banking division are receiving attention this quarter, it bears noting that our income property banking portfolio continues to reflect stellar credit metrics, including zero losses in the originated portfolio and zero delinquencies as of June 30, 2016.

Our provision for loan losses on the originated portfolio during the quarter included $3.2 million for quarterly loan growth and $7.9 million for changes in specific reserves, individual risk ratings identified through our proactive credit management process and loss factors, compared to $1.9 million for quarterly growth and $3.2 million for changes in specific reserves, risk ratings and loss factors during the first quarter of 2016. Two large technology banking division credits contributed to our elevated provision expense this quarter as we continue to position these relationships for optimal resolution.

Our ratio of the allowance to total loans increased to 97 basis points as of June 30, 2016 from 85 basis points as of March 31, 2016, and 66 basis points in the year ago period. The linked quarter increase in the allowance ratio was primarily driven by the net additions to specific reserves I just discussed, as well as the quarterly growth in our C&I portfolio, which has occurred more quickly than our multi-family portfolio and has therefore resulted in the need to allocate a greater percentage to our reserves.

Net charge-offs during the quarter were only $24,000. We recorded a provision recapture of $144,000 on the acquired loan portfolio, with the corresponding allowance for loan losses on the acquired loan portfolio decreasing to $785,000 at the end of the second quarter. The remaining discount on the acquired loan portfolio was $6.1 million as of June 30, 2016. Our total coverage ratio, which includes the remaining discount on acquired loans, was 1.07% at the end of the second quarter, an increase from one an increase from 1.03% last quarter. The impact on our total coverage ratio from the runoff on the acquired loan portfolio, which continues to comprise a smaller percent of our total portfolio each quarter, was partially offset by the larger than expected increase in provision expense.

As discussed earlier, deposit growth during the second quarter was driven by various divisions within Opus Bank, but was primarily due to the transition of PENSCO's ancillary custodial cash balances following the close of the acquisition on April 13. PENSCO deposits totaled $863 million at June 30, 2016 and had a weighted average cost of only two basis points. An additional $319 million of PENSCO's ancillary custodial client cash balances remain on deposit at other banks and are expected to transition to Opus over the remainder of 2016.

Other divisions within Opus also contributed to the growth in total deposits, including our commercial banking division which added $78 million and our municipal banking division which added $95 million and now has over $400 million in total deposits. Additionally, our retail bank continues to be a source of client deposits, contributing $38 million during the second quarter and continues to effectively serve as a distribution network for our commercial banking efforts up and down the West Coast.

I'll now turn the discussion back over to Stephen.

Stephen Gordon

Thank you, Michael. Thank you for joining our conference call and we're now going to open it up for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Brian Zabora from Hovde Group. Your line is now open.

Brian Zabora

Good morning. Just a question on those two technology credits. Do have the dollar amount of the individual credits?

Michael Allison

The principal or the reserve? I didn't hear the first part of your question

Brian Zabora

The principals off of those two loans.

Michael Allison

So one is 24 and the other is 15.

Brian Zabora

Okay. And in light of the deterioration, did you do a review of the entire technology portfolio or how do you think about the rest of the portfolio?

Michael Allison

Yes, actually we've done and continue to do a pretty deep dive across the entire portfolio. Recognize we do have quality relationships within the portfolio, but we definitely want to some confidence the niche profile that we want to propose going forward.

Brian Zabora

Just lastly, I thought I heard that the expenses associated with PENSCO, the operating expenses were $6.2 million. I just want to double check that. You’re anticipating a cost save going forward from that business.

Nicole Carrillo

Yes, the quarterly expenses for the partial quarter were $6.2 million, excluding the one-time associated expenses. We are working to aggressively implement the cost saves that we had previously discussed with the anticipation that that will be completed within the 12 month after acquisitions. So we should be reaching that normalized run rate that we are anticipating by Q1 2017.

Brian Zabora

Thank you for taking my questions.

Operator

Your next question comes from the line of Ben Lurio from JPMorgan. Your line is open.

Ben Lurio

Hey guys. Thanks for taking my questions.

Stephen Gordon

Hey Ben, how are you doing?

Ben Lurio

Doing well, thanks. First of all, I think last quarter you mentioned, you criticized the total loans ratio, it was about 2%. Do you have an update on where that stands today?

Michael Allison

Yes. Total …

Nicole Carrillo

2.4

Michael Allison

Yes. Total of 2.4 now, Ben 2.39.

Ben Lurio

Okay, got it and was the growth pretty much primarily tech or was that more broad?

Michael Allison

It's primarily tech, but there’s a little bit in the C&I book as well, but primarily tech.

Ben Lurio

Okay, got it. And then lastly, just do you have a number of kind of the specific reserve for the tech portfolio, where that stands available?

Michael Allison

Let's see here. I do know that we added about 2.3 to that this quarter, but I have to go back and look across the whole portfolio to tell you what that is. We can do that though.

Ben Lurio

Okay, great. Thanks. Appreciate it. That's all for me for now.

Operator

[Operator Instructions] Your next question comes from the line of Matthew Clark from Piper Jaffray. Your line is open.

Matthew Clark

Good morning guys. Can you give us the contribution of prepayment penalty income this quarter and last in dollars?

Nicole Carrillo

Yes. So the net contribution for this quarter was actually a net negative of about $700,000 as opposed to a net positive about $300,000 last quarter.

Matthew Clark

Okay. And then the impact of the interest income reversal this quarter?

Nicole Carrillo

Was about $250,000.

Matthew Clark

Okay, got it. And then I guess just thinking about your provisioning going forward, it looks like the amount you provided for growth was about 88 basis points on the net loan growth this quarter. Your reserve is obviously above that. How should we think about the coverage ratios going forward, assuming migration settles down here? Is it fair to assume we will stay around this 1% on loans or not?

Michael Allison

I think given where our mix is, Matt, that's probably a safe way to think about it. Again the volatility of origination has a meaningful impact given that we reserve obviously a fair amount in addition for the C&I book relative to the multi-family.

Stephen Gordon

So you get the effect of both growth and mix.

Matthew Clark

Okay and then just back on -- I forgot to ask you one on the core margin. Can you give us the new money the new money, the weighted average yield on production this quarter?

Nicole Carrillo

Yes. The wear on our quarterly funding for Q2 was 440, which was 14 basis points higher than the 426 for Q1.

Matthew Clark

Okay. Good.

Stephen Gordon

And then you can see the indication we gave as far as what the mix is in the new loan funding pipeline, that it's gone even more heavily towards a C&I mix. So I think the, what did we say? The 68% is the mix of C&I loans in the new pipeline. So we are getting that gravitational trend towards the higher yielding stronger risk-adjusted return type events that’s coming on in the balance sheet.

Matthew Clark

Okay. And I guess going forward and based on what the curve has done and multi-family pricing of late, I guess how do you think about that targeted range where you think that core margin could eventually settle out? And I think we talked about 360 or 375 in the past. Just curious what you're all thinking about that.

Michael Allison

You are seeing that the mix, the weighted average mix and the increased rate that we get, increased yield that we get on the C&I related specialty banking related assets, is more than offsetting any compression that the industry is seeing in multi-family related rates.

Nicole Carrillo

The wildcard here is the prepay impact, which doesn't impact contractual NIM like we saw the swing of almost $1 million from quarter to quarter …

Michael Allison

That’s as far as on an absolute yield basis. On absolute yield, we’re seeing the benefit from the shift in the mix offsetting any compression that the industry is seeing on multi-family, but then we are also managing the NIM interest margin I think extremely effectively off of the liability side of our balance sheet where the overall cost of deposits on a much larger base has come down. If you look at where it was it started the year versus where it is today, we've seen a meaningful move over the course of that six months in terms of downward success on the deposit side of the balance sheet. Not to mention the benefit of eliminating almost all of those federal home loan bank borrowings that we put on the balance sheet as we readied for the PENSCO acquisition.

Matthew Clark

Okay. And then just on the non-performers, you isolated I think the tech piece for us, but there was another $10 million I think outside of tech. Just it sounds like it was healthcare, but can you just drill down into that incremental increase, that $10 million increase ex-tech? And maybe also just talk about these three new non-accruals kind of the situation that emerged in each case?

Michael Allison

So you’re correct. The one outside of tech came from the healthcare practice group that we've also isolated just like we have the tech portfolio to make sure that we are focused on the right niche there. General commentary I guess around the transition to the non-accrual status has mostly to do with how we've modified the relationship to try to optimize the outcome. And so as a restructure, we've gone into this non-accrual, status but in essence it's a progression towards a better outcome expected this way.

Matthew Clark

Okay, but the underlying situation I guess in each case is just typical multiple large customer, that type of stuff or what?

Michael Allison

Yes. Again I guess I would suggest there's no pattern that we are seeing that makes us feel like there was an incorrect strategy in place. These are again lumpy loans that have their own characteristics that have moved the wrong way for different reasons and we think we see an outcome and we're progressing towards that with an amount of confidence.

Stephen Gordon

Matt, I think it's important to note that as it relates to the de-emphasizing stuff, that I think the way I'm viewing it is that if you look at pretax pre-provision earnings for Opus, as much as they have been steadily meaningfully increasing quarter to quarter year over year, there's still, while we are at 7.5 billion in assets, they’re still not large enough to be able to absorb the movement that you get in terms of rating as it relates to tech more specifically. So those movements that might be normal movements in a tech portfolio and that I'm sure other tech lenders are probably seeing in their portfolio, it's just those movements are too big to be absorbed without it having a meaningful impact on our earnings. So we made the decision to no longer have those earnings being masked by a portfolio or by a niche that typically characteristically is known for these type of movements, but we just can't -- our pre-tax pre-provision earnings aren’t high enough to be able to absorb those typical movements.

Matthew Clark

Okay and can you just talk about kind of what your plans are for the tech group going forward? It sounds like you're going to kind of drill down into that space and decide what piece of it you want to continue to grow, but just curious what your plans are for that group. And then I guess just the incremental --

Stephen Gordon

Before you go to the next question, so you saw the announcement last week that we took our phenomenal banker that we have in that group, Raed Alfayoumi and we've now brought him over to the merchant bank and he's going to be running or heading up our new, basically it’s our FSG group within merchant banking, so our financial sponsor group. And we've got phenomenal relationships with private equity firms and funds and he's got amazing history of dealing with financial sponsors. And we are bringing him over into the merchant bank and that's going to be his focus within there.

So we've got a phenomenal banker we've added and we anticipate seeing growth out of that effort within the merchant bank. And it as I said in my remarks that we are seeing great increased activity within the merchant bank and engagements that are turning into business getting done, so we anticipate that to be further. The bankers’ portfolio managers within the tech group are going to be very focused on maintaining relationships with those very strong tech clients that we have and making sure that those assets perform as planned. And then there are some assets in there that we are going to want to have go to other banks and we're going to enable that and encourage that and make that happen.

And that will stabilize the -- we believe that will have a great stabilizing effect on the earnings and if you looked at -- if you really dig into what the earnings would have been for this quarter, we would have actually had a strong beat with contributions coming from all sorts of areas within Opus and instead we ended up having the drag on earnings predominantly coming out of this division. And we are going to make all efforts to put that behind us and move forward and continue with the unleashing the core strengths that exists within our business that's really seeing contribution from all sorts of divisions in all sorts of ways and great maturations going on. But the tolerance for having something drag those earnings at Opus, we are not going to make that what happened.

Matthew Clark

Okay, I'll step back. Thanks.

Operator

Your next question comes from the line of Jill Shea from Credit Suisse. Your line is open.

Jill Shea

Good morning guys. Can you just talk about the loan pipeline heading into 3Q and perhaps just provide some color around the ramp in loan fundings you expect over the course of the year?

Stephen Gordon

Sure. As we said in the release, we have a strong loan pipeline built very nicely going into the start of the third quarter. And I think we indicated that it’s roughly 68% from commercial and specialty banking division, so generic C&I, corporate finance, healthcare, income property banking, structured finance, media entertainment, et cetera. And we are seeing the weighted average rate on that portfolio hold up its score on the pipeline, hold up extremely well. And we anticipate that the ramp will continue through the year as we originally always indicated, as we indicate every year. And we are still guiding for the same $2.5 billion of new loan fundings for 2016 as we had earlier guided and that includes the assumption of no contribution from tech through the balance of the year. So our guidance hasn't changed at all for the $2.5 billion of new loan funding, and again it includes no loans, no rate contribution from technology banking, but just simply strong growth in all our other divisions.

Jill Shea

Okay and then perhaps just on the deposit side, can you just talk about your expectations for deposit growth and the balances that may come over from PENSCO and perhaps the timing of the remaining balances coming over?

Stephen Gordon

Sure. So there's 300 plus million that is sitting over at -- it's really a combination of two other financial institutions. $50 million we're going to be bringing over very shortly. I would anticipate that we will bring it over during this quarter and we’ll make a decision how much of the 300 we want to bring over. And right now we are simply thinking that that's going to be in the fourth quarter, but we can always accelerate that at any point that we so choose, but the larger amount of the 300 and change million, let's call it a little under $300 million of that, we're earning quite a nice yield on it and close to three times what we'd be earning at the Fed.

So we're just going to kind of time it carefully in terms of bringing that over. But again when that comes over, it's only going to cost us two basis points on our balance sheet on those ancillary PENSCO related balances. So we are seeing very good growth from there. We are also seeing very good growth from our municipal banking division, which focuses on banking those small local municipalities in and around where our banking offices are located up and down the West Coast. It's not an institutional focus. It's very much a relationship-based community focus and we are seeing really good growth there and those balances have now increased to $400 million at Opus and that has a very robust pipeline as well.

We are seeing very good contribution that includes the income from our fiduciary banking divisions as well as growth in our commercial depository services division and commercial depository services brings in deposits from all of our commercial clients income property banking clients everywhere to the Company and partners up very well and completes the task, the agreement to bring in those deposits from the client and be very relationship focused. And then lastly, our correspondent banking division is sitting at around $175 million and continues to just kind of slowly contribute to growth into the Company and we will continue to do so.

Jill Shea

And then just quickly on the fee income side, can you provide some color in terms of the quarterly run rate that we should expect their given that it wasn't quite a full quarter of PENSCO? How do we think about that trust and administrative fee line? Should we just gross it out for the extra two weeks or how should we think about that line?

Nicole Carrillo

Yes. So just to give you some insight, the PENSCO fee income that you see is $6.3 million for the second quarter. There's two components to that right now. There’s what we call the maintenance fees, which is the fees earned on the assets under custody, which was about $5.5 million of that and then there is $700,000 of what we call administrative fees, which is what Stephen was referring to as the interest earned on the cash, ancillary custodial cash balances held at other banks. Because that's not on balance sheet cash for us, the interest earned is actually included in non-interest income. So that's what comprises that total of $6.3 million for the partial quarter. Going forward, you can pretty much just kind of base weight that to see the increase for the third quarter and the maintenance fees. Administrative fees, the kind of interest portion of that is really going to depend on how we move those balances.

You will see, if we keep all of those balances there during the third quarter and only move a small amount, you’re going to see a pretty steady run rate of that administrative fee, but if we end up moving them a little bit more quickly to put them into loans to get that higher yield, you’ll see that go down in the non-interest income line, but you are going to see the benefit in the spread income line. So there will be a little bit of fluctuation in that component. And then you will see the impact of UBS coming in during the end of August in the third quarter. So that will be about a couple hundred thousand dollars bump in the maintenance fees line. So you will see that total fee income from PENSCO bump around a little bit as we move the deposits over, but that maintenance fee component that I walked you through is what will stay steady and continue to increase as we grow the assets under custody.

Stephen Gordon

As well as getting the full quarter as opposed to a partial quarter. Then as far as other items that contribute, you have the activity, the velocity and volumes that exist over on our escrow and exchange division which contributed, we had originally guided $1.4 million a quarter, that then worked its way up to around $1.7 million a quarter and we got $2 million of contribution this quarter. So you might want to model something around $1.8 million, $1.9 million a quarter and we will see what we contribute there. Then the merchant bank contributed $1.8 million during this quarter and we're feeling very good about how the engaged pipeline, so signed engagement pipeline has been building and we’d anticipate continued strong contribution and continued ramping actually of that division as we go forward through the rest of the year and clearly into 2017.

We've been hiring additional bankers. The success is ramping and they have deals that are in process right now that we anticipate will be closing during this third quarter and we have very good line of sight into what the fourth quarter and into the first quarter of 2017 would look like and we are going to continue expanding that and we’ll keep you apprised as that develops. And then you've got the continued deposit-related fee income contribution. And then keep in mind that non-interest income was actually held back during this quarter by $942,000 in warrant-related adjustment and that flowed through non-interest income. So we would have had even stronger non-interest income, fee income than we had during the quarter which nearly tripled from the previous linked quarter. So we are seeing really good strong momentum there. And again, like I said, we are starting to see it from all sources, all sorts of contributing divisions within the Company.

Jill Shea

Okay very helpful. Thank you.

Operator

Your next question comes from the line of Jackie Chimera from Keefe, Bruyette & Woods. Your line is open.

Jacque Chimera

Good morning, everyone. Similar to the treatment with the full quarter of PENSCO income and that was excellent color. Thank you on all that. Can we assume the same for expenses that you'll have -- that that's a pretty normalized rate, that 6.2% and then just add on the additional two weeks for that?

Nicole Carrillo

Except that we are going to be aggressively pursuing the cost saves that we had given guidance on previously to bring that down to what we believe is a more normalized run rate by Q1 of 2017.

Jacque Chimera

Do you have an estimate on the timing of some of that, when it could flow in? Are you already in process? Is there still a lot more to go? Was anything already realized within the quarter?

Nicole Carrillo

I would say that there was really none realized in the quarter, that it’s all really going to be weighted into the third and fourth quarter with some smaller amount trickling into the first quarter, but really weighted in the second half of the year.

Jacque Chimera

Okay. And then, all of the other expenses related to branch consolidations, were those all completely realized by the end of the quarter?

Nicole Carrillo

They were and that was included in that $3.4 million of strategic-initiatives related expenses that we disclosed.

Jacque Chimera

Okay. What did the run rate on that look like for the quarter? Was it a pretty clean quarter? Are we going to see a future benefit in 3Q with a new revised run rate?

Nicole Carrillo

I'm sorry, of the branches or?

Jacque Chimera

Yes. All of the savings, was that a good run rate for the quarter or are you anticipating a little further benefit in 3Q from those?

Stephen Gordon

We're trying to figure out what exactly you're asking. I don't want to guess.

Jacque Chimera

I can follow up afterwards. That's okay. And then just one last quick one. Most of what I had was already answered. I just wanted to re-verify that the tech lending that you do do, those are later-stage companies, correct? You are not doing early stage?

Michael Allison

That is correct, yes.

Jacque Chimera

And are all of those 100% Opus funded or are there any participations that you have in there?

Michael Allison

Of the whole book, I think we have two that we've participated out.

Jacque Chimera

And is it a large portion? Obviously it's a large portion if there's only two, but do you have the approximate dollar amount or percentage of what that would be?

Stephen Gordon

And again, I want to clarify and reiterate what Michael said, participated out as opposed to participated in. So where we led and enabled another bank to come in as part of us.

Michael Allison

Right. So I think the total on our book is maybe 20, 25. I'd have to look to be candid with you because it's not something we -- we don't participate in that part of the market frequently.

Jacque Chimera

Okay, so just a smaller piece and definitely understood that you were the original originator of the loan.

Michael Allison

Yes and it is certainly a smaller piece.

Jacque Chimera

Okay. All right. Thanks guys.

Operator

Your next question comes from the line of Tim O'Brien from Sandler O'Neill & Partners. Your line is open.

Tim O’Brien

Good morning. Can you remind us what the cost-saving expectations are out of PENSCO at this point?

Nicole Carrillo

What we had previously disclosed was about $9 million of annualized cost-save expense base.

Tim O’Brien

And what's the base that you are working off of that $9 million with, Nicole?

Nicole Carrillo

That current base that we've got.

Tim O’Brien

Okay great. So that's all fully reflected in there? I don't have to day-count that or anything? $6.2 million is a good baseline?

Nicole Carrillo

That is a partial-quarter expense. You do need to day-weight that to get kind of their current run rate.

Tim O’Brien

Perfect. Done. Thanks. And then another question is, do you have the -- all of the employees at PENSCO effectively are now employees of Opus, right, the employees that came over with the deal, right?

Stephen Gordon

Yes, but I'm going to get technical on you. So yes, but as a subsidiary of Opus.

Tim O’Brien

Thanks Stephen for the clarification. So you guys are going to report an FTE number on your call report I guess. Can you give us that number?

Stephen Gordon

I don't want to be wrong.

Nicole Carrillo

I don't have it in front of me, but I could get it to you.

Stephen Gordon

We'll be able to get back to you on that.

Tim O’Brien

Or even just kind of a ballpark-ish range?

Stephen Gordon

We will get back to you on it. It's amazing how ballparks end up becoming [doubtful].

Tim O’Brien

Thanks Stephen. And another question is, how much was your gain on the sale of multi-family loans and can you give a little color on what precipitated the sale there?

Stephen Gordon

It was like $300,000.

Tim O’Brien

$300,000 or nothing. And then, why did you sell those loans?

Stephen Gordon

Because occasionally, somebody comes in and wants to buy some multi-family loans and we know a lot of people in the market that want to do that and occasionally we allow that to happen. So, we like having those relationships out there and we like periodically testing a secondary market and making sure that that secondary market for home loan exists and it's good to have that. So periodically we sell a little bit, but it's an added, it’s a rounding error. It was $300,000.

Tim O’Brien

Great. Okay. And then another question is, what were the non-recurring cost specific to the PENSCO acquisition out of that $3.4 million?

Stephen Gordon

All of that is non-recurring, right?

Nicole Carrillo

Yes, but I believe it was about -- between $2.5 million and $2.7 million of it were the PENSCO related and then the rest was related to things like the branch closures that we had announced and such.

Tim O’Brien

Great. And then another question is, what's the total dollar amount of non-accruals that are tech related? I know Michael gave us those two loans $24 million, I think it was, and $10 million or something, but what's the total dollar amount now of non-accruals in debt that are tech tied?

Nicole Carrillo

We would have to back into that. We gave the ratio, but not -- I have the dollar amount.

Michael Allison

Tim, it's about $45 million, yes.

Tim O’Brien

And what are total specific reserves against those non-accrual tech loans of $45 million?

Michael Allison

Again, we will have to get back to you on that number.

Tim O’Brien

And then, can you also talk a little bit, Michael, about the process? You talked about a review of that business and probably that loan book. How far along are you in that review? Can you characterize that I guess qualitatively or quantitatively?

Michael Allison

So I can probably do both. So quantitatively, we've done first pass of the book in entirety. That's led to a deeper dive qualitatively around the assets that we see fitting different categorizations, if I can phrase it that way. So where we have different equity support, the gestation of the firm relative to revenue and EBITDA. Those are sort of buckets that we're looking at to help us determine how deeply we want to go within specific relationship reviews. And so we're still in that latter determination, Tim. There's actually a question from the WebEx that's relative to this. The question is, have the backers of the two technology credits on non-accruals stopped providing additional funding to these entities? And the answer to that question, and relative to your question Tim, is no they've not.

And in part, that's why you are seeing the migration of these credits because we are doing it in concert with equity backers who continue to support the relationships. It’s just that their support and our support is something that we are negotiating as we try to optimize the strategies here. So no, it's not that our equity sponsors in these two have gone away. It's just the designing around their further involvement and the pace of that involvement is what we are working through.

Tim O’Brien

That's great color. By extension, obviously they are not in work-out. Clearly, you are working with the borrowers.

Michael Allison

Correct.

Tim O’Brien

And then, coming into the second quarter, last quarter you characterized qualitatively the quality of the book. You tried to give some context to that relative to a couple -- I think you said, if I get this right, that there were four loans that were troubled in that book and then you mentioned 3,000. I'm assuming that's the total, all loans at Opus, not tech loans. I guess my question is this. Coming into second quarter, was there a larger percentage of the tech book that was on watch status coming into second quarter and has that number moved now through at the end of the quarter?

Michael Allison

So the nature of that book, I think we had a higher watch content than our other portfolios, so that would be a true statement. Also though, ironically while we've seen some of this deterioration, the tech group had meaningful upgrades during this quarter as well. So I think Stephen's commentary about the size of Opus and how much we are willing to see the transitions in that book is the more relevant point around this portfolio.

Tim O’Brien

Could you quantify what the watch list dollar amount is in that book? Would you do that? And also relative to what it was at the start of the quarter, can you give us that progress report or progress number?

Michael Allison

I have to do math in my head. Math in public is never one of my favorite things to do. So we upgraded about $55 million out of watch. So Tim, let me get you some better detail. I don't want to get ahead of ourselves on that.

Tim O’Brien

The only reason I'm kind of pushing this is I think investors, it's going to give them clarity and help them with this whole process and that's why I'm belaboring it.

Michael Allison

Yes, I'm happy to get the detail. So we will see what we can put together and provide.

Tim O’Brien

Thanks for answering my questions, guys.

Operator

Your next question comes from Matthew Clark from Piper Jaffray. Your line is open.

Matthew Clark

Hey guys, just one on capital, growing into the leverage ratio here. I think it's 8.52%. Just curious what your updated thoughts are on your comfort level with the leverage ratio and how low you are willing to take it.

Stephen Gordon

We will continue evaluating. Nothing has changed on that front, Matt.

Matthew Clark

Okay.

Stephen Gordon

We just issued some debt during the quarter and took advantage of an opportunity and I think issued pretty cheaply and actually got that done the day. We closed on that what, the day before Brexit? And we're going to continue evaluating as we go along and determine what makes sense to do or not do as it relates to equity.

Matthew Clark

Okay. Is there any kind of -- I think you’ve talked about where you'd like to see that ratio over time. I'm trying to get a sense for, are you willing to take it to 7.5% or 7%?

Stephen Gordon

I'm comfortable right now and I'm comfortable with what we're seeing overall in terms of the balance sheet and our local economies and what's going on with more of a macro front. So I'm comfortable with our capital ratios and we’ll continue to guide. And where our capital ratios are, it's based on organic growth and doesn't include any impact of anything that we might look at doing in terms of potential acquisitions or anything else in front of us.

Matthew Clark

Got it. Thank you.

Operator

There are no further questions at this time. I will turn the call back over to Stephen Gordon.

Stephen Gordon

Thank you everyone and we will look forward to next quarter.

Operator

This concludes today's conference call. You may now disconnect.

Thank you. Brett

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