Bank of Marin Bancorp's (BMRC) CEO Russell Colombo on Q3 2016 Results - Earnings Call Transcript

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Bank of Marin Bancorp (NASDAQ:BMRC)

Q3 2016 Earnings Conference Call

October 24, 2016 11:30 AM ET

Executives

Jarrod Gerhardt - SVP and Director of Marketing

Russ Colombo - President and CEO

Tani Girton - Chief Financial Officer

Analysts

Tim Coffey - FIG Partners

Tim O’Brien - Sandler O’Neill & Partners

Jacquelynne Bohlen - KBW

Don Worthington - Raymond James & Associates

Operator

Good morning, and thank you for joining us for Bank of Marin Bancorp’s Earnings Call for the Third Quarter Ended September 30, 2016. My name is Jarrod Gerhardt. I’m the Senior Vice President, Director of Marketing for Bank of Marin. During the presentation, all participants will be in listen-only mode. After the call, we will conduct a question-and-answer session [Operator Instructions]. As a reminder, this conference is being recorded on October 24, 2016.

Presenting this morning will be Russ Colombo, President and CEO; and Tani Girton, Chief Financial Officer. You may access the information discussed from the press release, which went over the wire at 5:00 AM Pacific Time this morning and on our Web site at bankofmarin.com, where this call is also being webcast.

Before we get started, I want to emphasize that the discussion you hear on this call is based on information we know as of today, October 24, 2016, and may contain forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those set-forth in such statements. For a discussion of these risks and uncertainties, please review the forward-looking statements disclosure in the earnings press release we issued earlier this morning, as well as Bank of Marin Bancorp's SEC filings. Following the prepared remarks, our team will be available for questions.

And now, I'd like to turn the call over to Russ Colombo.

Russ Colombo

Thank you, Jarrod. Good morning, and welcome to the call. We are pleased to discuss the results for the third quarter of 2016. Let’s start with some highlights. Our earnings for the third quarter of 2016 was $7 million compared to $4.8 million in both the second quarter of 2016 and third quarter of 2015. On top of solid organic growth, the Bank posted additional net income of $2.1 million associated with the recovery on a problem credit and higher accretion on acquired loans.

Deposits grew $96 million in the third quarter as compared to $24 million in the second quarter, and $5 million in the corresponding period last year. At quarter-end, deposits were $1.8 billion, and we continue to have success adding low cost relationship deposits. Some of this growth is seasonal due to our customers and will likely decline to more normalized levels in the fourth quarter.

Non-interest bearing deposits grew by $56 million, and comprised 48% of total deposits, and increased from 47% last quarter and 46% in the third quarter of 2015. As a result, the total cost to deposits remained stable at 8 basis-points. Third quarter loan originations were $56 million, an increase of $12 million or 27% compared to the second quarter of 2016, and roughly the same as this period last year. Total loans increased to $1.47 billion for the third quarter from $1.45 billion at the second quarter and $1.36 billion for the same period last year. This is a positive year-to-date trajectory for loan origination and a continuation of our solid organic loan growth.

Loan payouts for the third quarter were $39 million, and down from $40 million last quarter and up from $37 million in the same period last year. Payouts were again largely the result of property sales and the successful completion of construction projects that occur in normal course of business. Diluted earnings per share were $1.14 in the third quarter, an increase of $0.35 from $0.79 per share for both last quarter and the third quarter of 2015. This was due to strong underlying production, the recovery and acquired loan accretion. Diluted earnings per share were $2.86 in the first nine months of 2016, an increase from $2.23 for the same period in 2015.

Our credit quality continues to be exceptional. Non-accrual loans, as a percent of total loans, declined to 0.04% at September 30, 2016, including resolution of a non-performing credit due to the sale of the underlying collateral by the borrower. This resulted in a reversal of a loan loss provision and new capture of interest income.

We remain committed to our disciplined underwriting and relationship banking focus. This enables us to work with our borrowers to ensure the optimal results for both our clients and for the Bank. Over its 27 year history, Bank of Marin has incurred only $306,000 in net losses on commercial real-estate loans that we have underwritten. We continue to closely watch loan-to-value. There are indications that the rapid rate of appreciation in commercial property values has slowed and rental rates are beginning to stabilize.

Now, let me turn the call over to Tani for additional insights on our financial results.

Tani Girton

Thank you, Russ and good morning. This quarter illustrates once again Bank of Marin’s ability to originate and leverage quality banking relationships for bottom-line results. Let’s take a closer look. Net interest income grew to $19.4 million in the third quarter, up from $17.2 million last quarter, and $16.9 million for the third quarter a year ago. There were several contributors to the increase, which were minimally offset by a lower average loan portfolio rate; one, a $1.4 million interest recovery; two, accelerated accretion from the pay-offs of an acquired loan; three, growth in loans and other earning assets; and four, lower interest expense as a result of an FHLB advanced repayment.

Net interest margin are 4.05% was elevated in the third quarter for the same reasons with additional downward pressure from higher cash balances. Net interest income was down in Q3, primarily due to gains on sales of securities recorded in the second quarter and the same period last year. We successfully maintained our expense discipline in the third quarter with non-interest expenses at $11.9 million, down slightly from $12 million last quarter, and up slightly from $11.6 million a year ago. We continue to look for ways to be more efficient. As a result, 2016 year-to-date return on assets of 1.17% is up 10 basis-points from last quarter, and return on equity increased to 10.4% from 9.52% last quarter, and 8.75% for the same period last year.

Our loan to deposit ratio was 81.5% and we continue to have ample liquidity and capital to support growth in the coming years. All of our capital ratios are well above regulatory requirements for a well-capitalized institution. The total risk-based capital ratio for Bancorp was 14.3% at September 30th compared to 14.1% at June 30th. Tangible common equity to tangible assets decreased slightly to 10.9% due to the growth in our balance sheet. The Board of Directors declared our 46th consecutive quarterly dividend and raised it $0.02 to $0.27 per share on October 21st. This implies a forward dividend yield of 2.17% based on the September 30th closing price, similar to the S&P average and a move toward higher payout ratios in the future. The cash dividend is payable on November 14th to shareholders of record at the close of business on November 4th.

And with that, I would like to turn it back over to you, Russ, for some additional comments about where we are headed from here.

Russ Colombo

Thank you, Tani. On past calls, I’ve talked about our business model and what type of Bank we are. In this last quarter, we have truly experienced how our commitment to relationship banking impacts the bottom-line. While many banks [indiscernible] relationship oriented, let me illustrate how Bank of Marin does it better.

First, much of the success stem from our ability to build and maintain strong client relationships, which enables us to attract non-interest bearing deposits from our business customers. Our ability to fund loan growth with the cost of deposits at only 8 basis-points is a significant competitive advantage for us. This allows us to perform well even in the face of some of the fiercest net-interest margin compression the banking industry has ever seen. It's our commitment to creating strong client relationships that allows us to earn and maintain those inexpensive deposits in this low margin environment.

Second, as we reported in both our earnings release and on this call, we had a major recovery on a problem credit. While the resolution of this credit was a long process, our relationship models allowed us to work with the client, over the past few years, to achieve the best possible outcome for everyone.

Third, we have built strong relationships with many highly experienced developers over the years. Recently, we had a number of construction loans pay-off. As this business has moved on to new projects, Bank of Marin is there to work with them again. It’s that joint track record of success and discipline that allows us to backfill our construction loan portfolio with a robust pipeline of new opportunity, a sign of success for both the borrowers and the Bank. These are just a few tangible examples of how we operate as a Bank. This approach, which is unique to Bank of Marin, pays-off for our shareholder, clients and employees.

With a solid pipeline of new opportunities, we are well positioned for a strong close to 2016. We remain committed to our strategy of delivering consistent shareholder return. This will be achieved through a combination of organic growth, acquisitions, and returning capital to our shareholders through rising dividends. Thank you all for your time this morning. We will now open it up for questions.

Question-and-Answer Session

Operator

Thank you [Operator Instruction]. Our first question comes from the line of Tim Coffey with FIG Partners. Please proceed.

Tim Coffey

I want to follow up on one of the last comments you made in your prepared remarks about the loan to value, and how that’s starting to change with depreciation slowing and the rental rate starting to stabilize. How does that affect Bank of Marin’s approach to underwriting new credits?

Russ Colombo

It's good question, because it's time when you don’t want to get too aggressive in terms of the loan to values when you are advancing for customers. Because with these high and possibly inflated values, if you’re lending at a high loan to value on loans, if we have a correction, you could be under water. So we’re being very careful and very conservative when it comes to loan to value that we will advance for our clients. And we’re being very cautious and watching the market to make sure we don’t get into a position where we have loans that are underwater, so when it comes to collateral of value.

Tim Coffey

And do you think that your competitors are willing to perhaps fudge on quality or structure right now?

Russ Colombo

Well, I don’t really make specific comments about whether they are or not. I think that sometimes you will see banks going [indiscernible] and will go for whatever reason they have, whether it’d be for loan to value or maybe credit structure. But as a organization, we’re very disciplined and we just consistently underwrite the same way we always have and stick to our guidelines because over the long term as you start doing the recession, that will play very well for us. And those that don’t stick to that discipline, that’s when we have problems.

But then I’ll point to our record in the commercial real-estate. We’ve had in the loans that we’ve underwritten and that doesn’t include acquired portfolios from the two acquisitions that we make. And the loans we’ve underwritten, we’ve only had over 27 years, just below the $300,000 in net losses on commercial real-estate. And obviously there’s lots of concern about commercial real-estate in the market these days from the regulator whatever. But you can point to that and say we’re doing something right in terms of the way we underwrite.

Tim Coffey

Absolutely. And kudos to your ability to recapture some of the interest on previous charge-off loan this quarter. And then the other question was, has the Board expressed a desired range for the dividend?

Russ Colombo

Desired range, you mean in terms of payout ratio?

Tim Coffey

Yes, payout ratio. One thing you did mention towards the end there was that, one of the goals was to go to return capital to shareholders. So I was wondering if there was kind of range in mind.

Russ Colombo

As Tani mentioned, she mentioned that our payout ratio -- I mean, our dividend yield is pretty much in line with the S&P, and that’s important. If you strip away the non-recurring items, we’re at about 34% payout ratio from ongoing earnings. And that’s likely to be, as we look forward, we’re trying to maintain that yield and potentially that payout, because even at a 34% payout, we’re still accumulating capital.

Operator

Our next question comes from the line of Tim O’Brien with Sandler O’Neill & Partners. Please proceed.

Tim O’Brien

Tani, could you -- what are your regulatory concentration ratios for construction and commercial real-estate right now?

Tani Girton

Hang on one second. We’re going to pull those.

Tim O’Brien

Thanks Tani.

Tani Girton

For construction and land loans, it's 37%. And for total commercial loans, it's 337% -- commercial real-estate, sorry.

Tim O’Brien

But you guys don’t feel like you are constrained at all by having a ratio in excess of the guidance numbers that they gave. You’re good to go. You’re unfettered as far as that’s concerned. The only thing that’s going to regulate you is quality and rate term structures, all those usual competitive points for making those loans. It’s not regulatory.

Russ Colombo

Tim, I’ll answer that. The regulatory guideline obviously is 300, and we’re in excess of that. But we have conversations with the FDIC all the time about that. There, I’m not speaking for them. But we’ve been fine because of the way we underwrite, because of our performance in commercial real-estate. It's not to say that that’s not going to change in the future. But we’re obviously very cognizant of and the fact that we’re at a high level in commercial real estate. That’s why we’re still -- we maintained such discipline in the way we underwrite. And we’ll continue to maintain that discipline, which conversations with the regulators that’s what they find most important. It’s not necessarily what percentage it is, but what’s the make-up of that percentage? How -- are you making loans at 80% loan to value? Are you doing non-recourse loans? Or are you being conservative with the loan to values and you have direct guarantors with liquidity. And while underwrite, we always try to have guarantors, liquidity and low loan to values. So that makes a huge difference when you’re having a conversation with the regulators.

Tim O’Brien

And then another question for you is the full-time equivalent employee number is 263 and 255 at the end of the second quarter. Is that correct, Tani?

Tani Girton

So those are [indiscernible] numbers. If you look at the average, the average is only up about 3 as opposed to the larger number.

Tim O’Brien

And yet your comp cost, I think they were down in the quarter. So can you give a little color on why that was?

Tani Girton

Well, I think that has to do a lot with the timing of when people leave and when new hires come on, and when we, if we have any recruiting costs associated with new hires, when those are paid, and that sort of things. So, there are a lot of moving parts on that, Tim.

Tim O’Brien

Was there some recruiting costs that hit in the second quarter then in that $6.724 million number that are won and done in the second quarter, and now we’re in the third quarter.

A – Russ Colombo

Tim, interestingly, [indiscernible] we brought on it. So, I think we mentioned last quarter in our call, we have brought on a number of new people in [Ontario] [ph] and also in Oakland. And so we’ve hired people that the numbers are sometimes deceiving, because you’ve got to look at the mix. And so while the numbers haven’t changed that much, the mix of the employees have changed in terms of, in our commercial banking offices, we’re fully staffed, well not fully, but close to being fully staffed-up. Yet, we have a number of vacancies at the branch level at the teller position in new accounts and things like that, which are much lower cost people. So while the numbers haven’t changed, your mix of people and salaries has changed a bit. And so that will drive a little bit higher numbers especially in the second quarter when we have recruiting costs and things.

Tim O’Brien

So, as far as that comp line item is concerned on a go forward basis, Tani. Is that a good indication number, given where you are with staffing --. You guys are -- one last question on staffing. Russ, you’ve mentioned I think last quarter you guys were in the hunt maybe to add one more banker in San Francisco. Is that right?

A – Russ Colombo

Yes, haven’t done that yet....

Tim O’Brien

Were you successful?

Russ Colombo

No, we weren’t. We had -- we thought we missed a couple of opportunities that we had. So we’re still looking San Francisco to add to that team. We added, in second quarter, we added in Oakland, and we added in most of the areas.

Tim O’Brien

And so outside of still looking to add to your San Francisco team, are you guys pretty much fully staffed?

Russ Colombo

From a standpoint of the commercial banking side, pretty much, we’ve got a few openings in our business banking office, here in Nevada. And business banking is a very people intensive business, because it's a lot of small loans, multiple relationships. So, we’re still looking to add people here in Nevada on the business banking side and then commercial banking side in San Francisco we have at least one add there to go. So it's a never-ending, you never get here. If there is always opportunities to bring in people, and this is tough employment environment for the employer. Its great is your employee because it’s very competitive but it's tougher the employee side.

Operator

Our next question comes from the line of Jeff Rulis with D.A. Davidson. Please proceed.

Jeff Rulis

Russ, you’ve mentioned on the deposit side that this is normal business activity and then you expected some inflows, but pretty big. And then you followed that with expecting Q4 to be to -- to decline. Were you talking about a net decline or is a growth decline?

Russ Colombo

We’ve had some in the -- certainly in that third quarter, we had -- we have some customers that have some significant deposits that can come and go. And there is few different businesses. But I am not saying we’re going to have a net decline, but they are such significant declines in these individual accounts, and there is probably three or four of them that you never know. So it's kind of the normal course of business. And so -- and as an example we have a big construction company that has a lot of municipal work, money from business to fund the project and then it goes away as they build out. So, there is ups and downs. So it's just that there is going to be swing from time-to-time. And I don’t know that we’re going to show a net decline, but we might for the fourth quarter. It's hard to gauge these three or four clients that we have.

Jeff Rulis

And then Tani on the interest recoveries, I guess, two questions. The one, the basis point impact margin this quarter and then secondly as you have recoveries or was there a comparable basis-point in the previous quarter?

Tani Girton

So, the impact on margin this quarter from the recovery was 31 basis points. And no I don’t have the number for last quarter on total recoveries. But it was not significant.

Jeff Rulis

And then maybe last one, Russ, just on -- and not to overreact any payoff activity. I guess year-to-date you are little over than you were last year. And I guess just anecdotally what you’re seeing out there, would you expect that trend to continue or is it comes and goes type of thing?

Russ Colombo

It's kind of come and goes. We do have a really -- the good news is we have a really good pipeline of opportunities that we’re working on. It sounds interesting how this seems to be. We talk about loan volume, is not seasonal than it appears to be, particularly over year there seems to be a bit of a hockey-stick in the fourth quarter. We do have a great pipeline. We’re working on that. And pay-offs -- when billionaires told that there is not a heck a lot that you can do, we’re not losing.

The good news is we’re not losing relationships on the sales, it's because somebody with refinance has sold the property and then taken money off the table. And typically those borrowers, we do something else with them down the line. We’re going to reinvest that money elsewhere. And we’ve got a number of, as we’ve mentioned, the number of big construction projects, which are literally right in the sale process now. They’ve completed the project and they are in sales process. So they may in fact -- couple more of them, we’ve got, may in fact pay-off before the end of the year. But you don’t know for sure. It's kind of this good news, bad news. The good news is we’ve got pay-off, which is on a construction loan, which is exactly what you want. Projects work exactly the way it's mostly, the values is, where our loan volume -- I mean our loan funnel would drop a bit. But that’s the way construction business is.

Operator

[Operator Instruction] Our next question comes from the line of Jackie Bohlen with KBW. Please proceed.

Jacquelynne Bohlen

Bohlen, actually. Question on the timing of the securities purchases in the quarter. Tani, just looking at end of period balances and average balances. I am guessing there is one more towards the latter half of the quarter. Is that right?

Tani Girton

So, actually, we have quite a bit of run-off during the quarter, as well. So the purchases really were a little bit more towards the beginning of the quarter. But the other things about the securities portfolio is that we do have some run-off maturities anticipated for the fourth quarter, so a fair amount of the net increase in the portfolio will likely be redeployed into loans when those cash flows come in.

Jacquelynne Bohlen

How are you -- I guess, on a quarterly basis, if you could just give us some update on how you are thinking about managing between the mismatch that can occur between deposits and loans, especially in light of the three to four depositors that you’d mentioned and their fluctuations?

Tani Girton

Yes, so couple of things there. Great question. Just to talk about go back to those borrowers I want to make it really clear that some of those borrowers that have big seasonality, while they have large cash inflows and outflows. As a percent of the total portfolio, their concentrations are very small. And so the way that we manage those big changes is we look at what other cash we expect to come in, either from the portfolio or the net outflows that are expected. And we actually have frequent conversations with the branches about those large movements, so we actually know what to expect in terms of whether money is coming-in or going-out.

And then we have a short-term part of our cash deployment program, as well as a long-term part in the securities portfolio. So, any investments that we make that are related to dollars that are going be around for a long time that is more directed towards the municipal and agency securities that have a longer duration. And then we have some shorter term ways to deploy the cash that we think we’ll be needing in the upcoming quarter.

Jacquelynne Bohlen

So the purchases this quarter were all related for the longer term deposit or funding that you....

Tani Girton

We had a couple of short-term. So most of them were longer term, again because we knew we had cash flow coming off at portfolio coming up here in the fourth quarter.

Jacquelynne Bohlen

And then Russ, maybe if you could just provide an update on M&A conversations, your outlook, and how you are feeling about it in general in your region. And if you’re looking at things such -- I guess, looking outside of the box in light of just wellness that’s just being taking place in the Bay Area from M&A perspective?

Russ Colombo

Yes, that’s exactly there’s wellness in the M&A activity in the Bay Area. There’s just not a lot going on. We continue to have conversations with banks around the Bay. But there is nothing new to report. And our approach has always been, if we find something that makes sense for us, we would aggressively go after. But we’re focused on organic growth. And building our loan portfolio, building on our commercial banking offices and looking at potentially new sites for commercial banking offices loan branches to fill in, where maybe an acquisition might make sense. But if that’s not happening then we need to be looking at de novo opportunities. And we’re doing that. We’re looking dropping our Bay, that type of thing. And I think that ultimately -- I know it's great if this happens. But as an organization, we can’t be so focused on that that we forget about the organic side, which is a real driver of this Bank.

Operator

Our next question comes from the line of Don Worthington with Raymond James. Please proceed.

Don Worthington

Maybe following along a little bit discussion on liquidity management. Do you have target loan to deposit ratio that you’d like to achieve, if you smooth things out over few quarters?

Russ Colombo

We’re running in the low-80s. You’re looking at a ideal situation where you’re most profitable and you have, still have enough liquidity. Something in the high 80s to 90s is terrific. But that requires awful lot of loan growth to get there at this point. So, we’re pretty comfortable in the 80s. But I would like to be a little bit higher because I think we would drive a lot more profitability if we could get in the 85 to 90 range. But given the loan growth, you need to push loan growth beyond that, you’re going to have to be something that isn’t within our discipline. And so we stick to discipline and we’ll do what we can that will make sense for us. But we’re not going to push loan growth and do things that don’t make sense. So, that’s where we end up in the low-80s.

Don Worthington

And then any outlook on where you see the tax rate in the fourth quarter?

Tani Girton

I think the tax rate from quarter-to-quarter gets adjusted based on where we -- how things are changing in terms of accruals and that sort of thing. But in general, I think, it’s fairly stable with where we were booking last year. So, right now, no new information about significant or meaningful changes in our tax rate.

Russ Colombo

Don the only thing I would add to that is that we are -- we’ve developed somewhat of a industry’s best specialty in tax exempt financing and a number of projects. The financing of our projects for primary schools throughout the Bay Area, and that’s becoming very lucrative area for the Bank. And as we do more of that, obviously that will drive the tax rate down a bit. And because our profitability are strong, we’ve had the ability to do that, and be competitive. And it feels like solid relationship, because it's not the financing, but we’ve developed on the depository side with each one of those organizations.

Operator

[Operator Instructions] And Mr. Colombo, there are no further questions at this time. I will now turn the call back to you.

Russ Colombo

Thank you very much. I would like to thank everyone for joining us again this quarter. And we look forward to speaking with you again at the end of next quarter. Thanks.

Tani Girton

Thank you.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation, and ask that you please disconnect your lines.

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