Bank of Marin Bancorp (BMRC) Q1 2019 Earnings Report, Transcript and Summary

Good morning and thank you for joining Bank of Marin Bancorp's Earnings Call for the First Quarter ended March 31, 2019. I'm Andrea Henderson, Director of Marketing for Bank of Marin. [Operator Instructions] As a reminder, this conference is being recorded on April 22, 2019. Joining us on the call today are Russ Colombo, President and CEO; and Tani Girton, Executive Vice President and Chief Financial Officer. Our earnings press release, which we issued this morning, can be found on our website at bankofmarin.com, where this call is also being webcast. Before we get started, I want to emphasize that the discussion on this call is based on information we know as of today, April 22, 2019, 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 our earnings press release as well as our SEC filings. Following our prepared remarks, Russ and Tani will be available to answer your questions. And now, I'd like to turn the call over to Russ Colombo.

Thank you, Andrea. Good morning and welcome to the call. We're off to a solid start for 2019 and are exceptionally well positioned for the year. Our markets continue to demonstrate economic strength with steady business growth and unemployment rate that hovered near historic lows. That strength breeds intense competition, but our business model resonates strongly in a highly competitive environment. We've proven through multiple cycles and our focus on customers and relationship banking will not waver in 2019. In the first quarter, we once again generated solid balance sheet expansion, growing both deposits and loans. Looking forward, we see healthy loan demand and strong underlying fundamentals and our growth outlook for 2019 remains positive. Now, let me walk you through some of the financial highlights for the first quarter. We reported net income of $7.5 million for the first quarter, down from $9.7 million in the previous quarter, but up from $6.4 million in the same quarter last year. This quarter-over-quarter decline reflects the increases in non-interest expenses that we typically see early each year due to seasonal personnel costs, including an annual reset of payroll taxes and 401 contribution matching as well as stock-based compensation grants. Diluted earnings per share were $0.54 in the first quarter of 2019 compared to $0.69 last quarter and $0.46 in the same quarter a year ago. Loans increased to $1.77 billion at March 31, 2019 from $1.76 billion at December 31, 2018, and we're up 6% from $1.67 billion in the first quarter of 2018. Total deposits increased by $3.8 million in the first quarter to $2.18 billion. Non-interest bearing deposits increased $10.3 million from December 31, 2018 and represented 49% of total deposits at March 31, on par with our 2018 level. Strong credit quality remains one of the cornerstones of our consistent performance. Non-accrual loans represented 0.04% of the Bank loan portfolio at March 31 and there were no provision for loan losses in the quarter. We are investing in organic growth initiatives adding talent and building our presence in key markets. We expanded in the East Bay by opening a loan production office in Walnut Creek that will serve businesses across Diablo Valley. We also made key strategic hires in Napa and Santa Rosa and named Robert Holden, Senior Vice President, Commercial Banking Regional Manager in the San Francisco market. Our Board of Directors declared a cash dividend of $0.19 per share payable on May 10, 2019. This represents the 56th consecutive quarterly dividend paid by Bank of Marin Bancorp. In addition, Bancorp is considering an extension of our $25 million share repurchase program. Now, let me turn it over to Tani for additional insight on our financial results.

Thank you, Russ. Good morning. I'll begin with net interest income, which totaled $23.8 million in the first quarter of 2019 compared to $23.3 million in the prior quarter and $21.9 million in the same quarter a year ago. Despite two fewer days in the quarter, net interest income exceeded the fourth quarter due to lower interest expense related to the early redemption of subordinated debt. Year-over-year, quarterly net interest income is up almost $2 million, thanks to a higher earning asset base, increased yields and controlled funding cost. The tax equivalent net interest margin was 4.02% in the first quarter compared to 3.85% in both the prior quarter and the year ago quarter. The 17 basis point increase from the previous quarter was primarily due to accelerated discount appreciation on the - accretion on the October 2018 sub-debt redemption. The improvement over Q1 2018 is related to the Bank's asset sensitivity to higher interest rate. Non-interest income of $1.8 million in the first quarter of 2019 declined $1.7 million from $3.4 million in the prior quarter due to a $956,000 pre-tax gain on the sale of 6,500 shares of Visa Inc. Class B restricted common stock and a $180,000 Federal Home Loan Bank special dividend in the fourth quarter. Additionally, the Bank incurred a $283,000 cost to underwrite new bank-owned life insurance policies in the first quarter and income from the sale of excess deposits to deposit network fell $163,000. Likewise, the decline in non-interest income from Q1 2018 is attributable to the new BOLI policy expense and lower deposit network income. As Russ mentioned, the first quarter of the year typically includes some seasonal expenses and this year is no exception. Non-interest expense was $15.5 million, included the typical New Year reset of payroll taxes and 401K matching. Additionally, 401K matching spikes in the first quarter when bonuses are paid. First quarter also included accelerated stock-based compensation expense for retirement eligible employees, new grants and performance share payout. The net increase in all of these first quarter expenses between 2018 and 2019 was just $68,000, primarily attributable to five more retirement eligible employees in 2019. Other increases included eight additional full-time employees, annual merit increases, a $136,000 one-time pay cycle adjustment and a $129,000 provision for off balance sheet commitments in the first quarter of 2019. The more significant differences accounting for the net decline in expenses between the first quarters of 2018 and 2019 were $713,000 in professional services mostly related to core processor contract renegotiations and $366,000 in data processing primarily due to the Napa acquisition. The $1.8 million increase in expenses between Q4 2018 and Q1 2019 was primarily attributable to $498,000 in retirement eligible stock-based compensation expense, $64,000 in performance share vesting, $339,000 more in 401K match, six additional employees, the one-time pay cycle adjustment and the off balance sheet commitment provisions. In the first quarter, the Bank delivered a return on assets of 1.19% and a return on equity of 9.54%. While several moving parts affected our comparative results this quarter, we are pleased with the Bank's continuing profitability and the long-term prospects that derive from strong customer relationships and consistent credit and expense management. Now, Russ would like to share some closing comments.

Thank you, Tani. I'm pleased with our first quarter results. We are successfully executing on our long-term strategic plan for organic growth, which is reflected in our performance. I'm also pleased that we were able to declare our 56th consecutive annual - quarterly dividend. Our ability to consistently deliver this level of value to our shareholders is a testament to our relationship banking model. We build strong and lasting ties with our customers that are based on virtualized service. This allows us to focus on both sound underwriting and our customers' needs, while consistently growing loans and deposits. We maintain a low cost and stable deposit base with close to 50% of those funds in demand deposit accounts. While the competition for high-quality borrowers is strong, our lending activity continues to grow across our commercial banking market in Marin, Sonoma, Napa, San Francisco and the East Bay. One of the biggest challenges that all companies face is access to talent. We continue to attract and retain great people. Our commercial banking teams in Santa Rosa and Napa are creating solid opportunities for loan growth. Along with our long production office in Walnut Creek, we have made a number of key personnel moves, including Rob Holden in San Francisco. Our investment in people is helping to build an even stronger foundation for future growth. Our primary focus for the second quarter and beyond is to leverage the talent and expertise of all of our local teams to drive organic growth. Together, I am confident we will deliver great results and value to our shareholders. Thank you for your time this morning. And now, we'll open it up to answer your questions.

[Operator Instructions] Our first question comes from the line of Jeff Rulis, D.A. Davidson. Please go ahead.

Wanted to get into the expenses just a little bit on detail. Clearly, some seasonality occurring. I don't know if you consider some of those items almost non-recurring, if we could talk about kind of what occurred in the quarter, but also the - you got the LPO kind of coming on. Maybe the question is for Tani. Just see where expenses sort of settle in that, not exactly specifics, but what would you expect to recur and what would maybe fall off?

Yes. So the LPO actually is not coming on in the expense space until the second quarter in terms of the real estate and additional employees. Of course, we had already hired the manager of that office and that's embedded in Q1. So most of the Q1 expenses that we talked about related to salary and benefit is not non-recurring. So when - I think that the big item is retirement eligible employees. When you have new - when employees become newly retirement eligible, any of their existing stock-based compensation grants, options, whatever, that were not on - had not been expensed prior to that, get expensed at that time plus any new grants for all retirement eligible employees get expensed immediately. And our - the bulk of our grants are granted in the first quarter, so - and that - you'll see that every first quarter. And over the last several years, our first quarter expenses have typically gone up about somewhere around $1 million, between $775,000 and $1.2 million depending on the year and as a result of that plus the 401(k) matching, which, as I said, goes up when bonuses are paid. Non-recurring expenses would be the $136,000 one-time pay cycle adjustment. And what happened there is that we had - we pay our employees on 15th of the month and the end of the month. And for non-exempt employees, due to payroll processing time for the last few days in the pay period, we previously estimated those hours. Now, we're not by law allowed to do that. So if we pay the - if we pay it on actual hours logged on time card, employees would have been shorted a few days because of that payroll processing period. So the Bank chose to make up that difference for the non-exempt employees and that was what that $136,000 cost was. As long as we - we continue to invest in our infrastructure and also look for revenue producing employees and we never stopped doing that. And as long as we're successful in doing that, we're going to see expenses go up. I would say that the first quarter we tend to be more successful, or the first half of the year in recruiting people because that's when a lot of those folks are getting their bonuses and are ready to move. So does that cover? Russ, do you want to add something?

Just going to add one thing and that was on the retirement benefits, that was something we instituted last year. And it - you become retirement eligible if age was - years of service exceed 75 with a minimum of 10 years of service. So it's not just anybody who decide they're going to retire, then all of a sudden invested, you have to have a certain criteria. So we always ran into the situation, where people would get to retirement, they'd have unvested equity and the Board will be forced to make a decision. And we didn't want to make it, we decided that it was important that we not make that subject to have some of it decide the time, we made a criteria which then applies to all employees, which is the appropriate thing to do in my mind. So unfortunately from the standpoint of the earnings, you have a one-time for that year, but you will have it each year as you have new retirement employees and those employees who don't retire and are eligible each year, you have to extend those options or stock that restricted stock. That's why that popped up for last couple of years.

And maybe another one to maybe Russ, just a bigger picture. Competitive landscape and you guys didn't seem like you're talking about a lot of opportunity with bringing folks on to the platform. Maybe if you could just touch on the - just the current update of what you see in the market. Obviously, we've seen the Rabo-Mechanics deal and maybe too early to see if there's any potential of their customers or personnel. Any thoughts Russ on the credit landscape and your ability to attract additional talent?

I think every time you have mergers, which are of community banks by much larger banks, it creates opportunity because people work for community banks for a reason and when a bank is acquired by a much larger bank, it often creates opportunity for us to acquire talent. And that was certainly the case with some of our people that we've acquired. That being said, it's still very, very competitive for people in the market, it's just tough. And we compete. We're competing for people when we're talking about Marin or Sonoma or East Bay, we're competing for people that typically are working in San Francisco, and that's a very competitive market not only for bankers, but for all employees because of the technologies and otherwise. So I don't think it's going to change, but it does. There are certain opportunities that do present themselves when you see much larger banks acquiring community banks. So we're certainly on that and focus on those people when that happens.

Our next question comes from the line of Jackie Bohlen, KBW. Please go ahead.

I just wanted to touch on expenses again. And thank you for all that background, that was very helpful in knowing what you expect in addition to what we would consider normal seasonality in 1Q with the retirement eligible and everything. But touching on that, Tani you had mentioned, yet you to anticipate a roughly one [indiscernible] during the first quarter of each year. How do you think about the potential decrease that might occur in 2Q as those 401(k) expenses and other eligibility and payroll taxes wind down?

So payroll taxes is not nearly as significant as the 401(k). The 401(k) kind of tapers down over the course of the year because as people hit their cap in terms of the company matching, then that sort of tapers off. But I think the difference between Q1 and Q4 is a good indicator of what that differential is, and that was about $339,000.

So even with some of the new hires and understanding that there'll be some added expenses from the LPO in the second quarter, you could see the compensation line trend down in 2Q and then maybe taper just slightly as we go through the rest of the year. Is that fair? Outside of any potential new hires?

Yes. I think when I said that $339,000, that would be over the course of the year. So by the time you got to December of 2019, it would be down probably something similar to that.

But a big portion of the expense on 401(k) line is first quarter because if you look at bonuses, the 401(k) is taken off maxes out on many employees. So you do have a decline there, but some employees, it continues to go for the rest of the year and these stock-based compensation, which is from retirement benefits is not going to show up after - it's once a year because we give equity first quarter, so that's when we get. So I think you'll probably see those because both of those are pretty big impacts on the numbers first quarter.

And then if you might just provide an update on where you stand, I know that when we spoke last quarter, there were dual systems that were running and I think that plan was - so you'd be down to a single down later in the year. Can you just provide an update on that?

Yes. So right now, we are in parallel with Q2 and FIS. However, as a parallel, the jump in expenses that we expected from the parallel processing are not in the Q1 expenses yet. So we will expect a jump in the second quarter likely to - that will reflect the time period that we're running on both systems. And then after we cut over to the new system and turn off the FIS digital platform, that's when we will see a reduction expense and more to come in the next couple of quarters on that, but it's not in there right now, the parallel processing cost.

And do you have any preliminary estimations of what it would cost to run those systems in parallel?

I think we figured that it was roughly $30,000 to $40,000 in incremental expense when we have both on at the same time.

And is that quarterly or monthly?

I think that was quarterly, but - let me get back to you on that, Jackie.

Our next question comes from the line of Tim O'Brien, Sandler O'Neill and Partners. Please go ahead.

When you send Jackie that info, could you send it to us all, just so that we have it, the quarterly versus monthly?

Yes.

And then another follow on is the adjustments, could you run just through that BOLI income line item, the net $60,000 negative mark this quarter in the accounting that went into that, color behind that accounting? And is it - does that signify that BOLI assets perhaps increased this quarter and we could see higher income generated out of that line going forward?

Yes. So the policies that we put on this time were of a different structure than we usually put on. These are whole life policies, where we normally put on universal policies. So just one of the key differences between those two kinds of policies is that with the ones that we put on this time, the administrative expenses are taken upfront and - rather than spread across the life of the policy. So what that means is that we'll have a big expense - chunk of expenses upfront and then over time, over the life of these policies, they should actually produce more income, not only additional income because we have new policies, but also because we're not netting the expenses out of that income over time. So the total amount of the policies that were added was about $1.9 million and so - and then the expense associated with underwriting was $283,000. So you take out that $283,000, you'll see what the BOLI income would have been without those expenses and we can expect that to go up over time because of new policies.

And just the base of BOLI related assets at year-end, do you happen to have that number handy, I know it's probably in the K somewhere, but...?

Let me pull that number and I'll come back to this question in just a minute.

I'm going to throw another one at you, two actually though. On other income, that was down a bit in the quarter just on a sequential quarter basis, $469,000 last quarter, $257,000 this quarter. What - do you have any color on what that difference resulted from?

Yes. So when we have excess deposits, we sell them to deposit networks and we earn fee income for selling those. And we just had a lower level of those kinds of sales quarter-over-quarter.

And then regarding the LPO, do you have - happen to know what the monthly rent that kicks in here on April 1st, what that's going to be or quarterly rent or something from that? And then also, how many staff did you add? And it sounds like they're coming on here in the - at the start of the second quarter.

We've hired two people thus far, we're able to market for a third. The space I think is about 2,700 square feet. Frankly, I don't remember what the rental per foot is in Walnut Creek but it's Class A space though, but we need to get back to you on that one, Tim. Wim-Kees van Hout and we tried one other person we've got another one that will - we've been trying to get, but nothing reported yet. We're still working on that. So we'll have three people and we'll be adding maybe a potentially a fourth too.

And Russ, I'd love to chat with you for a minute offline about these space stuff when you have a chance to just briefly, but we can do it later, it's not time sensitive at all. And then last question is Rob Holden joined the Bank of Marin to lead the San Francisco team. When did he join? And is his - is the payroll associated April 1, so that's going to be an additional for...?

Right. In Walnut Creek, I forgot about, there is actually a BDO that we have hired in addition to the two that are there, we have a business development officer who's working on a commission basis and we'll be calling in that market. So ultimately, we'll have four because we'll have an RM, we have what we call portfolio manager and then the engagement manager. So ultimately, with whole staff it will be four people, one commission based and - in that 2,700 square foot location in Walnut Creek.

Thanks a lot, appreciate all the color this quarter you guys provided on the P&L. It's really helpful.

Next question comes from the line of Matthew Clark, Piper Jaffray. Please go ahead.

First one from me just on loan pricing, given what the curve has done. If you can kind of speak to rates on new production. And I guess what I'm trying to get at is, it looks like you still have some room to run in the margin and I'm just trying to get a sense for what the incremental spreads are on new business.

We know that the spread targets are pretty similar, we look for the same kind of spread over cost, but the numbers are up a little bit. I think I was looking at the quarter-over-quarter and it's about 50 basis points that were - our actual loan yields were versus - new production versus old, which is the portfolio. So we're starting to see a little bit of improvement in that - in the yield. That being said, it continues to be very, very competitive and I don't think that's necessarily a big trend, where it's going to head even farther out, I think we're fully committed to the same, pretty much the same target that we've had historically.

And then just on - I'm sorry deposit pricing. The pace of increase is fairly consistent from last quarter. Can you speak to the pricing pressure there? With the Fed on hold, does that maybe suggest that things might start to stabilize here or do you think we're just going to continue to see some upward pressure for some period.

Our cost to deposit base, I think we're up a little bit certainly because of pressure, but I think that's going to stabilize. I don't know why we have been proactive with our big depositors to go out and make sure that we are pricing appropriately, so we don't risk moving some of that money elsewhere. We've been proactive, but less than the market to a certain extent. I mean, we're being very selective about where we're going out to big depositors to make sure we're there, they’re being treated properly and getting proper returns. But I don't - it seems like that activity has stabilized a bit and I think the Fed action and the Fed - or lack of action over the - probably over this year is going to keep our pricing on the deposit side pretty consistent from now through the end of the year. These in my opinion. And that obviously can change, but that's where I think we are right now.

And then can you speak to the tenant in common business, how that portfolio and pipeline is trending of late and competitive pressure there too?

The portfolio is very strong and we've had - I think I've said this before in calls, we had over 14 years of experience, I think we've had one to fall which got rewritten and paid as agreed. It continues that way. The San Francisco residential market is so tight that the team I think has done exceptionally well. We feel there's only a couple of other competitors in the market and it's interesting if we want more volume, we drop the rates like a quarter and we get more volume and we've done some of that and so we've gotten good volume out of TICs historically. I don't know the exact number for the year, but it's been real good and performed exceptionally well. So that's a very solid business line for us.

And then just on the tax rate. Tani, and kind of hovering around 26, is that the right rate to use going forward?

Yes, I think so. We had a little bit of an increase because of the lower BOLI expense, so that will probably come back. But in general, it is indicative of where we're headed and reflects the changes in the permanent differences. Obviously as the income fluctuates significantly then the permanent differences become smaller percentage and the tax rate does go up, the effective tax rate does go up.

Matthew, there's one thing I'll add on the space is that in the first quarter we had over $7 million of volume in TICs. Last year first quarter that number was over - little over $5 million. So we had - continue to get good volume out of that market and again as I said, it's been - credit quality has been pretty darn perfect.

[Operator Instructions] We appear to have no further questions on the phone line.

If I could add just one more, Tim, I said I will get back to you on the cash to render at the bank-owned life insurance. That was in 2018, $39 million. So that'll go up for the new purchases, but that's where it was sitting at the end of last year.

If there's no other question, I want to thank you all for joining us this morning and we look forward to talking to you again next quarter. Thank you.

Thank you.