Banc of California, Inc. (BANC) Earnings Call Transcript & Summary

Thanks, everybody. Good afternoon. We're happy to continue the Mid-Cap Bank schedule with Banc of California. We're joined by Jared Wolff, the Chairman and CEO. Thanks a lot for coming. And Karen Hon is in the audience as well with us as Deputy CFO. Thanks very much for coming, and look forward to having the conversation.

Thank you, Jared. Thank you to Barclays. Really happy to be here.

Great. Maybe kicking it off, you took several significant balance sheet actions in the second quarter, including the securities repositioning and CRE loan sales. What were you trying to accomplish? And I guess, what evidence are you seeing that those actions are producing the intended results?

The second quarter actions that we took were among the most significant we've taken since we merged Banc of California and PacWest in November of '23. We had over $2 billion of securities that were locked at a -- suboptimally priced at around 2% with a fairly long duration of 6 years plus. We were able to sell those securities and reinvest them at a 285 basis point pickup. And so it was a big lift to earnings. We have been fully reinvested since the beginning of this quarter. And so it's been really -- I think it will show up well this quarter. One of the ways that's going to show up is we gave guidance that our margin by the fourth quarter would be 3.30% to 3.40%. We're ahead of schedule. And so I think that's one reflection that it's working.

Why was this the right time to do that?

We've been looking for the right time to break HTM and move these securities. And I think since then, we've seen some others follow. We had to thread the needle. We had to find the right time. First of all, you had to have the right amount of capital. We did this without raising any capital. And I would mention that the earn back because of the reinvestment rate and the relatively low AOCI is only 1.4 years. So we feel good about that. But we have to have the right level of capital. And then you have the right environment where you want to be reinvesting in a higher rate environment, but that's going to work against you in terms of the AOCI. We're able to do so at a loss that was lower than we projected and reinvest higher than we projected. So our team did a great job of threading the needle. I would also mention that until about 12 or 18 months ago, no bank had really done this for quite some time. And then a couple of banks did it in 2025. They had to raise capital when they did it. And so we found the right time was 2026 when we had the right amount of capital and the conditions were right.

Sticking with the capital, capital moved lower following the actions. What's the path from here? And how are you balancing capital build with opportunities to grow the balance sheet?

Yes. So we have plenty of capital. We ended the second quarter in the low 9s. We are picking up capital pretty quickly. And so we will be returning close to 10% by the end of the year. And then if the risk-weighted adjustments take hold, if the Fed rules take hold, we will expect to pick up 50 to 60 basis points of additional CET1 when those rules take effect. So we're building up capital pretty quickly. I think we should be at 10% or have 10% clearly in sight to start buying back stock. We have a repurchase authorization that's out there. If we're in the fourth quarter, everything is moving along, our capital levels are on target, and we have confirmation that the new risk weightings will take effect. I don't think we would hesitate to buy back stock if the conditions were right. If we haven't heard about those regulatory capital rules, and we don't know with certainty, then I think we'll wait until we get above 10% to start buying back stock.

As part of the actions, you took some steps to address select credits and reduce CRE concentration. How would you characterize the underlying credit portfolio and the provision outlook from here?

So the actions that we took in the second quarter were designed to derisk the balance sheet and improve the earnings profile on a consistent and reliable basis. We obviously did that through the securities repositioning. It was about a $200 million loss on the securities, and we said, if we're going to do this, maybe the $200 million loss should be larger if we find some opportunities for things that could pose risk to earnings in the future. So we looked at select groups of credits. We identified $825 million of credits. $300 million were in a construction relationship that had gotten into -- it was a business divorce. We thought it was money good, but it was going to create noise for a while. And then we found $525 million of performing CRE loans that had repricing characteristics that we didn't like. We found buyers for these 2 pools of loans, discounted roughly. We sold them for roughly 90%, so not a very significant discount. The first pool of $525 million is under contract at the price that we marked it to that will close -- should close this quarter. The second pool for $300 million is now being documented at the price we marked it to. It should close very early next quarter, certainly well before earnings.

With that now addressed, how should investors think about loan growth going forward? And what matters most about the evolution of the portfolio from here?

Well, we feel really good about credit, and we think it's going to be relatively stable going forward. On the provision, which you asked about, we expect to provision at normal levels, $9 million to $11 million has been our historical run rate, and we expect that to return in Q3 and hopefully for Q4 as well. So far this quarter, loan growth has been very, very strong. It's been good. We've had continued strong production for several quarters, but we expect net loan growth this quarter. Deposit growth has also been strong. And as I mentioned, both on noninterest-bearing deposits and on interest-bearing deposits, and we expect those to support the margin going forward. Loans have been steady, fairly broad-based this quarter. We'll see where we end the quarter, but the averages should be good on both fronts, loans and deposits.

On the deposit side, you've had some good trends in noninterest-bearing DDA. What's been driving that momentum? And I guess, with that backdrop, how are you thinking about the margin outlook?

We're a very focused business bank, and we focus on serving businesses and bring in relationships where we can serve the business. But primarily, we want to help them with their operating accounts. They are business accounts that need services from banks but aren't necessarily focused on yield. They're focused on the services that we can offer to make their lives better, their business lives better. And that's been our consistent focus for many, many years in driving higher NIB. When we merged with PacWest, on a collective basis, we were about 25% NIB. We're now close to 30%. Once we hit 30% on a reliable basis, we'll set a new target of 35%. As many of you know, before the merger, Banc of California on a stand-alone basis improved its noninterest-bearing deposit percentage from below 15% to 40% in 4 years by focusing on the steady focus on business clients. That's something that I did when I was early in my career at PacWest and also at City National. So we have a track record of doing this, and we know how to do it well. Our margin, of course, will be protected by the higher percentage of noninterest-bearing balances that we're able to continue to drive through the bank. As I think about the margin, we're seeing a good contribution from the asset side now on our margin. Previously, we were getting most contribution on the margin from the liability side when rates were relatively flat, but we were driving down deposit costs. Today, as rates have kind of moved up, we're seeing better contribution from the asset side of the balance sheet, particularly on the securities portfolio, but also on loan yields, which are holding up and less contribution from the liability side. The more we can drive noninterest-bearing deposits, and we've been successful at that, the more contribution that we'll have going forward. I mentioned one other thing, Jared, in terms of contribution to the margin. We have 2 levers that we intend to pull or that will be self-effectuating going forward that will be significant drivers of earnings growth and also the margin. We have $5.4 billion of performing multifamily loans, mostly broker-funded. Half of that $5.4 billion matures or reprices over the next 2 years. Those loans today are priced at around 4%. So they're going to be -- you take $2.5 billion roughly of a pickup of at least 200 basis points over the next 2 years. And those loans reprice or mature on a fairly even schedule over the next 2 years with a little bit of lumpiness. That's a pretty big pickup. That's $50 million of pretax income that will come just through the portfolio repricing itself and maturing over time. In addition to that, as you and I have talked about, we have our preferred stock that matures -- we have the right to redeem it in September of 2027. That's a $40 million dividend after tax that we pay to the preferred shareholders. We expect to redeem it all, but we might have to finance some of it with FHLB or -- but we'll use mostly our liquidity. So at a minimum, we expect $20 million of after-tax income to come back to the common stockholders. Between those 2 things, that's roughly $70 million of pretax income that will come back to the common just through normal pricing and maturity.

With all of that, I guess, how should investors think about the path from today's earnings profile towards the longer-term targets you've outlined for PPNR and ROTCE?

I think it will be very evident this quarter where our earnings are going and certainly through the end of the year through the fourth quarter as we show the power of having repositioned $2 billion of securities that went from 2% to nearly 5%. Similarly, the multifamily that's repricing will start to take hold. And then our new production yield is about 6.4%, similar to what it was last quarter. So I think the earnings profile is accelerating, and our returns are accelerating due to the strategic positioning -- repositioning that we've done on the balance sheet. Our aspiration is to be a very reliable relationship lender with a very boring earnings profile. We want to have consistent, reliable, steady earnings that come from very transparent sources without a lot of noise. And I think we've done a really good job moving the balance sheet in that direction. If you look at what happened when we closed the merger in November of '23, we said '24, we'd spend restructuring. The fourth quarter of '24 was kind of business as usual. So we've been at this about 7 quarters. Earnings have gone up and to the right on an adjusted basis pretty much every quarter. And now it's going to be with less and less noise going forward.

The company generated about $2.8 billion of production in the second quarter and still delivered strong underlying growth despite the loan sale. What does the growth outlook look like from here? And how do you expect the mix of loans to evolve over the next few years?

We think that mid- to upper single-digit loan growth is a steady place to play when the economy is working normally. In any one quarter, any couple of quarters, you can outpace that, have low double-digit growth because you had a strong quarter. But banks are generally participants in the economy. And if you're growing too fast, at least at our bank, I wonder if we're stretching for yield. So we feel very comfortable. You also have to fund it and you have to bring in deposits to fund it. We want to be core-funded as much as we can. And if you're growing too fast, you're going to have to find the funding elsewhere. It might be fine in any given quarter, but on a sustainable basis, you're going to want to have to have core funding. So we think about living within our means and growing responsibly. One of the great things today is that there are many alternatives for our capital. For the last 2, 3 years, you had to find yield in loans. Today, you can find yield in securities as well. So when we're making loans, we're looking at, is this the best risk-adjusted return for our shareholders' capital. One area of loan growth that we expect to see grow is our single-family portfolio. We have about $3.5 billion plus of single-family loans. Originally, we were replacing those loans to keep the balance sheet flat. But we have a mortgage warehouse portfolio. And so we're able to buy those loans off our mortgage warehouse portfolio from the borrowers that we lend to. We're already secured by those loans. And we have other sources. So we've been finding that today, we can get pretty good risk-adjusted yields in single-family. We don't have any compliance infrastructure because we don't originate the mortgages. We also don't service them. So it's like a bond portfolio, and we're netting about 6.25% for 30-year fixed rate mortgages. And we put a hedge on the portfolio to make sure that it doesn't prepay. So we're locking in that against that risk of prepayment speed. So that's another avenue that we have. But we think that overall, we're going to be a fairly down-the-middle C&I and real estate lender, our real estate exposure has gone below 300%. We think averaged 250% to 285% capital for CRE exposure. We continue to grow our fund finance business, our lender finance business, middle market and regular C&I is doing very well, and we think construction will pick up.

From your conversations with clients, what are the C&I clients sort of saying about demand and business conditions and navigating through all this macro noise that's out there?

So business conditions today remain generally benign. The interest rate environment is comfortable enough for businesses to borrow. It's not getting in the way of lending. We'll see what happens this week, whether the Fed raises rates. And I don't think 25 basis points will impact the lending environment very much. I would say that the environment feels okay. It doesn't feel like anything is particularly great, but it doesn't feel bad either. So it's just benign. And we hope to have a more positive overall economic environment. But as we all know, we're all living and feeling it, there's a lot of excess noise out there. The cost of diesel fuel is very high, and diesel fuel runs through the economy and power is increasing costs for all sorts of industries. There's still spillover effects from tariffs and other things. So hopefully, that noise calms down and the economy is able to run with the power that I think it should.

From the outside, we often hear the narrative around businesses and individuals leaving California for lower-tax states yet your loans and deposits continue to grow. What are you actually seeing on the ground? And why do you remain constructive on California as a strong banking market?