CVB Financial - Q2 2023

Transcript

Operator (participant)

Good morning, ladies and gentlemen, welcome to the second quarter 2023 CVB Financial Corporation and its subsidiary, Citizens Business Bank and earnings conference call. My name is Cherie, I am your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. To ask a question during the session, please press star one one on your telephone. You will hear an automated message advising that your hand is raised. To withdraw your question, press star one one again. Please be advised that today's call is being recorded. I would now like to turn the presentation over to your host for today's call, Christina Carrabino. You may proceed.

Christina Carrabino (President)

Thank you, Cherie, and good morning, everyone. Thank you for joining us today to review our financial results for the second quarter of 2023. Joining me this morning are Dave Brager, President, Chief Executive Officer, and Allen Nicholson, Executive Vice President and Chief Financial Officer. Our comments today will refer to the financial information that was included in the earnings announcement released yesterday. To obtain a copy, please visit our website at www.cbbank.com and click on the Investors tab. The speakers on this call claim the protection of the Safe Harbor Provisions contained in the Private Securities Litigation Reform Act of 1995.

For a more complete discussion of the risks and uncertainties that may cause actual results to differ materially from our forward-looking statements, please see the company's annual report on Form 10-K for the year ended December 31st, 2022, and in particular, the information set forth in Item 1A, Risk Factors therein. For a more complete version of the company's Safe Harbor disclosure, please see the company's earnings release issued in connection with this call. Now I will turn the call over to Dave Brager. Dave?

Dave Brager (President and CEO)

Thank you, Christina. Good morning, everyone. For the second quarter of 2023, we reported net earnings of $55.8 million or $0.40 per share, representing our 185th consecutive quarter of profitability. We previously declared a $0.20 per share dividend for the second quarter of 2023, representing our 135th consecutive quarter of paying a cash dividend to our shareholders. Our net earnings of $55.8 million or $0.40 per share compares to $59.3 million for the first quarter of 2023, or $0.42 a share, and $59.1 million for the year-ago quarter or $0.42 per share. The second quarter demonstrated the bank's financial strength at a time where the industry is seeing disruption.

Although our net interest margin contracted by 23 basis points compared to the first quarter of 2023, our efficiency ratio was below 41% in the second quarter of 2023. We generated strong returns, reflected by a return on average tangible common equity of 18.39% and a return on average assets of 1.36%. Our pre-tax, pre-provision return on average assets was 1.91% for the second quarter. For the second quarter, our pre-tax, pre-provision income was $78 million, compared with $84 million for the prior quarter and $85.7 million earned in the year-ago quarter. Total deposits increased by approximately $126 million from the end of the first quarter of 2023 to June 30th, without the benefit of broker deposits.

Our non-interest-bearing deposits continued to be greater than 63% of our total deposits. At June 30th, 2023, our total deposits and customer repos were $12.8 billion, an $88 million increase from March 31st, 2023. Deposits and customer repos were lower than the same period a year ago by approximately $1.7 billion, for an approximate 12% decline year-over-year. We've experienced $552 million decline in deposits in customer repos from the end of 2022, which includes $550 million that was moved into CitizensTrust, where these funds were invested in higher-yielding liquid assets such as Treasury notes.

The velocity of deposits moving to CitizensTrust declined in the second quarter, with approximately $180 million transferred off balance sheet in the quarter, compared to $370 million in the first quarter of 2023. The bank continues to acquire new deposit customers, and the deposit pipeline has strengthened over the last three months. New accounts opened during the first half of 2023 total approximately $650 million of new average deposits. We have historically maintained one of the lowest cost of deposits in the industry based on the customers we target and our business model. Our cost of deposits was 35 basis points on average for the second quarter of 2023, which compares to 17 basis points for the first quarter of 2023 and 3 basis points for the second quarter of 2022.

At June 30th, 2023, our non-interest-bearing deposits were $7.9 billion, compared with $7.8 billion for the prior quarter and $8.9 billion from the year-ago quarter. Non-interest-bearing deposits were greater than 63% of total deposits, as they have been for the last five quarters. The bank has no brokered deposits. Our deposits are 100% core customer relationships across diversified industries. More than 75% of our deposits represent customer relationships that have banked with Citizens Business Bank for three or more years. 76% of our deposits are business deposits, and our customers typically have operating accounts that, by the nature of each of their businesses, exceeds the FDIC insurance coverage level of $250,000.

52% of total deposits and customer repos were uninsured and uncollateralized at June 30th, 2023. As of the end of the second quarter, the Federal Reserve had increased the Fed funds rate by 500 basis points since April of 2022. The bank's cost of deposits over the same period of time have increased from 3 basis points to 41 basis points for the month of June 2023. The bank failures in March of 2023 brought greater attention to the Fed's increases in short-term rates, and of the 38 basis point increase in our cost of deposits from the start of the Fed's rate increase, more than 50% of the increase has been experienced since March of 2023.

Although the pace of the increase in deposit costs slowed in June, we cannot be certain about the pace of increases in the future, especially as the Fed continues to raise rates as they did yesterday. Total loans at June 30th, 2023, were $8.9 billion, a $172 million or 1.9% decrease from the end of 2022. From December 31st, 2022, loans declined by $31.9 million after excluding the seasonal increase in dairy and livestock loans and PPP loan forgiveness at year-end. Dairy and livestock loans decreased by $136 million from December 31st, 2022, as we experienced paydowns in the first quarter of each calendar year.

Excuse me, as paydowns the first quarter of each year as a result of the temporary increase we experienced in the fourth quarter of each year. Commercial real estate loans increased by $19 million from the end of 2022 to June 30th, while C&I loans increased by approximately $8 million over the same period. Declines in construction, SBA, and consumer loans totaled $59 million from December 21st, 2022 to June 30th, 2023. Let's discuss loans in more detail. Loan growth during the second quarter was impacted by a slowdown in loan demand. Total loans declined by $35 million from the end of the first quarter of 2023 to the end of the second quarter.

Commercial real estate, construction, and consumer loans declined from the prior quarter, while C&I loans increased as utilization rates improved from 28% at the end of the first quarter to 31% at the end of June. Year-over-year core loan growth was $277 million, or approximately 3%. This core loan growth was led by growth in commercial real estate loans, which grew by $260 million or 3.9% year-over-year. Our new loan production weakened in the second quarter. New loan commitments were approximately $240 million in the first quarter of 2023 and approximately $288 million in the second quarter of 2023. In comparison, we originated $604 million of new loans in the second quarter of 2022.

New loan production at the end of the second quarter was generated at average yields exceeding 7%. Although we continue to strive to grow loans, our current loan pipeline is at its lowest level in the last three years. Although loans declined at quarter end from the end of the first quarter, we recorded a provision for credit losses of $500,000 for the second quarter of 2023 to reflect a further deterioration in our economic forecast. Asset quality continues to be strong, and the trends remain stable. At quarter end, non-performing assets, defined as nonaccrual loans plus other real estate owned, were $6.5 million, or 4 basis points of total assets. The $6.5 million in non-performing loans compares with $6.2 million for the prior quarter and $13 million from the year-ago quarter.

During the second quarter, we experienced credit charge-offs of $88,000 and total recoveries of $15,000, resulting in net charge-offs of $73,000, compared with net charge-offs of $77,000 for the first quarter of 2023. Classified loans for the second quarter were $78 million, compared with $67 million for the prior quarter and $76 million for the year-ago quarter. Classified loans as a percentage of total loans over the last five quarters has been consistently less than 90 basis points.

The $10.9 million increase in classified loans quarter-over-quarter was primarily due to a $9.7 million increase in classified commercial real estate loans and a $6.1 million increase in classified dairy and livestock and agribusiness loans, partially offset by a $4.4 million decrease in classified commercial and industrial loans. The increase in classified loans for the dairy and commercial real estate categories were primarily due to one dairy relationship, in which $11 million of dairy and livestock loans and $6 million of owner-occupied commercial real estate loans were downgraded during the second quarter. Commercial real estate loans secured by office buildings has been an area of much attention recently across the banking industry. We've included additional information related to our office exposure in our July 2023 investor presentation.

A couple of data points regarding our $1.1 billion of office CRE includes the granular nature of the portfolio, which is highlighted by the average loan size of less than $1.7 million. 87% of the office CRE loan balances are below $10 million, and we only have one loan greater than $20 million. Additionally, 25% of this portfolio is owner-occupied, and on average, these loans were originated with loan-to-values of 55%. Approximately 13% of the office portfolio will mature over the next 24 months, while an additional 13% of the portfolio will have their interest rates reset during those same 24 months.

To visualize where our office portfolio is positioned geographically, we have maps on pages 33 through 36 of our investor presentation that show the dispersion of our loans and the minimal exposure in the city centers of Los Angeles, San Diego and San Francisco. In summary, we believe our office CRE portfolio was conservatively underwritten, very granular, and not exposed to central business district areas. I will now turn the call over to Allen to discuss the allowance for credit losses, liquidity and capital. Allen?

Allen Nicholson (EVP and CFO)

Thanks, Dave. Good morning, everyone. At June 30th, 2023, our ending allowance for credit losses was $87 million or 0.98% of total loans, which compares to $86.5 million or 0.97% of total loans at March 31st, 2023, and $85.1 million or 0.94% total loans at December 31st, 2022. The allowance for credit losses as a percentage of classified loans was 112% as of June 30th, 2023, compared to 108% as of December 31st, 2022.

For the quarter ended June 30th, 2023, we recorded a provision for credit losses of $500,000, compared to $1.5 million for the quarter ended March 31st, 2023, and $3.6 million for the second quarter of 2022. The provision for credit losses in the second quarter was driven by the change in our economic forecast, which resulted in lower projected GDP growth, lower commercial real estate values, and higher unemployment when compared to our forecast at both March 31st and the end of 2022. Our economic forecast also resulted in a $400,000 increase in our off-balance sheet reserve at June 30th, compared to an increase of $500,000 in the first quarter of 2023.

Our economic forecast continues to be a blend of multiple forecasts produced by Moody's. These U.S. economic forecasts include a baseline forecast, a more optimistic forecast, as well as numerous downside forecasts. We continue to have the largest individual scenario weighting on the baseline forecast, with downside risk weighted among multiple forecasts represent approximately 40% of our overall forecast. As of June 30th, 2023, the resulting weighted average forecast assumes GDP will increase by 1.5% in 2023, including a decline in GDP in the second half of this year, followed by modest growth of 0.8% for 2024, and then GDP growth in at 2% for 2025.

The unemployment rate is forecasted to be 3.8% in 2023, followed by 5% in both 2024 and 2025. Borrowings as of June 30th, 2023, consisted of $695 million from the Bank Term Funding Program that we borrowed during the second quarter of 2023 at a rate of 4.7%. These borrowings replaced at higher cost borrowings from the Federal Home Loan Bank. Our FHLB borrowings consist of short-term advances that declined from $1.4 billion as of March 31st, 2023, to $800 million at June 30th, 2023. As of June 30th, their cost was approximately 5%.

These FHLB advances will mature over the next two quarters, with the final maturity at the end of November. The modest growth in borrowings from the end of the first quarter of 2023 to the end of the second quarter coincided with a $322 million increase in funds on deposit at the Federal Reserve, which earn a rate of more than 5%. In addition to having more than $600 million of cash on the balance sheet as of June 30th, 2023, we had substantial sources of off-balance sheet liquidity.

These sources of liquidity include $4.1 billion of secured and unused capacity with the Federal Home Loan Bank, $1.3 billion of secured borrowing capacity at the Fed's discount window or Bank Term Funding Program, more than $550 million of unpledged AFS securities that could be pledged at the discount window or the Fed's Bank Term Funding Program, and $300 million of unsecured lines of credit. In addition to these borrowing sources, the bank has not utilized any broker deposits as of June 30th. We continue to shrink our investment portfolio by not reinvesting approximately $120 million of cash flows generated by our investments during the second quarter.

Our total investment portfolio declined by $160 million from March 31, 2023, to $5.6 billion as of June 30th. The decrease was primarily due to a $136 million decline in investment securities available for sale or AFS securities. AFS securities totaled $3.07 billion at the end of the second quarter, inclusive of a pre-tax net unrealized loss of $498 million. As the bank has ample off-balance sheet sources of liquidity, it's unlikely that we would sell any of these AFS securities. Investment securities held to maturity or HTM securities totaled approximately $2.51 billion at June 30th.

The HTM portfolio declined by approximately $23 million from March 30th, 2023, as cash flows were not reinvested during the quarter. The tax equivalent yield on the entire investment portfolio was 2.37% for the second quarter of 2023, essentially the same as the prior quarter, but grew by 44 basis points in comparison to the second quarter of 2022. Turning to our capital position. Shareholders' equity increased by $53 million to $2.0 billion at the end of the second quarter. The company's tangible common equity ratio at June 30th was 7.8%, consistent with the prior quarter, while higher than the 7.5% at June 30th, 2022.

Equity increased for the first six months of 2023 as a result of year-to-date income of $115 million, which was offset by $56 million in dividends for both the first and second quarters of this year. The resulting year-to-date dividend payout ratio was 48.5%. The 10b5-1 stock repurchase plan we initiated in 2022, expired on March 2nd, 2023. There were no shares purchased during the second quarter of 2023. During the first quarter of this year, we repurchased approximately 792,000 shares of common stock at an average price of $23.43, totaling $18.5 million in stock repurchases.

At the end of the second quarter of 2023, we entered into $1 billion in notional pay fixed rate swaps as fair value hedges to mitigate the risk of rising interest rates on our capital. These pay fixed swaps have maturities ranging from four-five years, and on average, the fixed rate is approximately 3.8%. The variable rate received by the bank is daily SOFR. At June 30th, 2023, we recorded a $7.8 million fair value adjustment associated with these swap derivatives, which increased other comprehensive income, partially mitigating the impact of a $38 million decline in fair value of our AFS portfolio.

On a net basis, the changes in fair value from our AFS portfolio and fair value hedges resulted in a $19 million decline in other comprehensive income from the end of the first quarter to June 30th. Our overall capital position continues to be very strong. Our regulatory capital ratios are well above regulatory requirements, considered well capitalized and above the majority of our peers. At June 30th, 2023, our Common Equity Tier 1 capital ratio was 14.1%, and our total risk-based capital ratio was 14.9%. I'll now turn the call back to Dave for further discussion of our second quarter earnings.

Dave Brager (President and CEO)

Thank you, Allen. Net interest income before provision for credit losses was $119.5 million for the second quarter, compared with $125.7 million for the first quarter and $121.9 million for the year-ago quarter. Our tax equivalent net interest margin was 3.22% for the first quarter of 2023, compared to, excuse me, 3.22% for the second quarter of 2023, compared with 3.45% for the first quarter of 2023. 3.16% for the second quarter of 2022.

The 23 basis point quarter-over-quarter decrease in our net interest margin was the result of a 34 basis point increase in cost of funds, compared to a 10-point increase in earning asset yields. The increase in cost of funds from the first quarter of 2023 to the second quarter was driven by a combination of a $555 million increase in short-term borrowings, which had an average cost of 4.9% in the second quarter and 49 basis point increase in the cost of interest-bearing deposits. Our 10 basis points quarter-over-quarter increase in earning asset yield was primarily the result of an 11 basis point increase in loan yields.

Second quarter average earning assets increased by $165 million from the first quarter due to an increase of $310 million in average funds on deposit at the Federal Reserve. The increase in our funds at the Fed offset decreases in both average investment securities of $73 million and average loans outstanding of $71 million. The 6 basis point increase in net interest margin year-over-year was due to an 81 basis point increase in earning asset yields, offsetting a 79 basis point increase in our cost of funds.

The increase in earning asset yields was a result of higher loan and investment yields in the second quarter of 2023 compared to the second quarter of 2022, as well as an improved asset mix in which average loans grew from approximately 55% of earning assets in the second quarter of 2022 to 59% in the second quarter of 2023. Loan yields were 5.01% for the second quarter of 2023, compared with 4.31% for the year-ago quarter. Investment security yields increased 44 basis points from a yield of 1.93 in the prior quarter to 2.37 in the second quarter of 2023.

Earning assets for the quarter in ending June 30th, 2023, declined from the 2Q of 2022 by $593 million. Loans on average grew by $258 million from the second quarter of 2022. Our investment portfolio and deposit balance at the Federal Reserve declined by a combined $865 million, as total deposits declined by $1.9 billion year-over-year. Moving on to non-interest income. Non-interest income was $12.7 million for the second quarter of 2023, compared with $13.2 million for the prior quarter and $14.7 million for the year-ago quarter.

Our customer-related banking fees, including deposit services, international, and merchant bank card services, decreased by approximately $506,000 compared to the first quarter and declined by approximately $495,000 when compared to the second quarter of 2022. However, our trust and wealth management fees grew by $401,000 compared to the first quarter of 2023 and increased by $353,000 year-over-year. The conversion to SOFR of all of our previously originated back-to-back interest rate swaps indexed to LIBOR, generated approximately $100,000 of fee income during the second quarter, compared to $500,000 of fee income during the first quarter of 2023.

BOLI income for the second quarter of 2023 increased from the first quarter by $908,000, including $806,000 in death benefits that exceeded the asset value of certain BOLI policies. BOLI income increased by $1.5 million compared to the second quarter of 2022, due to both the death benefits received in the second quarter of 2023 and higher returns for the underlying investments in separate account life insurance policies used to fund deferred compensation plans.

Compared to the first quarter of 2023, CRE investment income declined by $500,000 due to the inclusion in the first quarter of 2023, a recapture of a previous impairment charge on a CRE investment that paid in full during the first quarter of 2023, as well as a $475,000 decline in the second quarter due to valuation changes in the CRE fund. Compared to the second quarter of 2022, CRE investment income declined by $716,000, as the prior quarter included gains from equity fund distributions totaling $1.3 million. The second quarter of 2022 also included $2.7 million in net gains on the sale of properties associated with banking centers. Expenses.

Non-interest expense for the second quarter was $54 million, compared with $54.9 million for the first quarter of 2023 and $50.9 million for the year-ago quarter. The second quarter of 2023 included $400,000 in provision for unfunded loan commitments, compared to $500,000 in provision for the first quarter of 2023. There was no provision for the second quarter of 2022. Salaries and employee benefit costs decreased $1.7 million quarter-over-quarter, primarily due to lower payroll taxes, as the first quarter of each year typically has the highest amount of payroll taxes.

The $866,000 quarter-over-quarter increase in professional services included increases of $357,000 in legal expense, as well as other professional services that are associated with the timing of various projects. The $3.1 million increase in non-interest expense year-over-year included an increase of $2 million or 6% in salaries and employee benefits due to inflationary pressures primarily experienced in the second half of 2022. FDIC assessments increased by $785,000 over the prior year quarter, as higher assessment rates were effective at the beginning of 2023. Non-interest expense total 1.32% of average assets for the second quarter of 2023.

This compares with 1.36% for the first quarter of 2023 and 1.2% for the second quarter of 2022. Our efficiency ratio was 40.86% for the second quarter of 2023, which compares with 39.5% for the prior quarter and 37.2% for the first quarter of 2022. Since our founding in 1974, we have managed to build a safe, sound, and secure institution with a strategy focused on banking the best small to medium-sized businesses and their owners. We've remained focused on our core values of financial strength, superior people, customer focus, cost-effective operation, and having fun.

As the premier business bank in California, we have successfully executed on this strategy. Our focus will remain steady and consistent. We can continue to provide the best banking products and services to these businesses that represent great American success stories. Despite the challenging environment, we will remain disciplined in our approach to credit. We will strive to produce and maintain consistent earnings, strong capital levels, solid credit, and excellent liquidity. Please stay healthy and safe. This concludes today's presentation. Now, Allen and I will be happy to take any questions that you might have.

Operator (participant)

Thank you. As a reminder to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. One moment while we compile the Q&A roster. Our first question will come from the line of Ben Gerlinger with Hovde Group. Your line is open.

Ben Gerlinger (Managing Director of Equity Research)

Hey, good morning, guys.

Dave Brager (President and CEO)

Morning, Ben.

Ben Gerlinger (Managing Director of Equity Research)

Seems like people mixed up SVB and CVB for a whole quarter. You don't have to comment on that. I'm sure you can't. Anyway, in terms of just the borrowings, I think that laying it out of the $800 million, it gets paid off in November, and then the Bank Term Funding. When you think about the Bank Term Funding specifically, because you do have that high fours rate, and the Fed's now at 5.5, you are getting a positive spread. Is there any appetite or can you pay that down early if deposits in the back half of the year increase?

Dave Brager (President and CEO)

Ben, yeah, I mean, the, the, what's nice about the, the Bank Term Funding Program is you don't have any penalties if you want to pay it off. You know, there was a time where, where the yield curve was, and the fact these are one-year borrowings, that it was just advantageous to utilize it. You know, you get to use par value of collateral rather than fair value, pay it off anytime you want. In fact, we've, we paid off and reborrowed a couple of times to get better rates. Now you can't replicate 4.7 right now. If we do continue to see, you know, growth in the deposits, you know, we could pay that off. You know, more than likely, we'll pay down FHLB first, as it is generally more expensive borrowings.

Having some cash on hand that pays us, what? 540 now versus the 470 is, you know, obviously some positive arbitrage for us.

Ben Gerlinger (Managing Director of Equity Research)

Gotcha. I think that's largely just predicated on your normal seasonality. It seems like you have pretty good inflow of deposits in the back half of the year, we're pretty much at the starting gates for that. Just based on kind of the commentary you typically have with your customer base, I mean, just I'm sure you had a lot more conversations in the first six months of this year than probably any other six-month period. Is that still something that you should expect? You guys typically don't pay up a ton on deposits because you have really great relationships, and you have another ways of rewarding your depositor base. Is that normal seasonality something that we should continue to expect?

Dave Brager (President and CEO)

Yeah, I think we should expect that. Just to make sure we're on the same page, normally, we kind of grow deposits in the second and third quarter, and then deposits in the fourth quarter go down just due to a variety of reasons, bonuses, other things, you know, distributions to business owners. I would expect, you know, something similar on the seasonality side. The pace of the money that left and went outside of the bank, slowed pretty significantly in the second quarter. You know, and I think that should continue to be the case. I mean, you know, subject to a lot of different factors. Every day is a new day in the world out there, but I think the normal seasonality should be sort of anticipated.

Ben Gerlinger (Managing Director of Equity Research)

Gotcha. If I could just sneak one more in. I know that you guys aren't looking to do a transformational deal, but you guys do have a history of making some pretty good roll-up or additional M&A to bolster the broader company. With the first six months being pretty quiet, we've seen not necessarily a floodgate, but we've seen a few notable deals announced this week across the country. Has there been conversational changes? Maybe not necessarily you guys involved, but just has the appetite or the bid ask between the buyer and seller materially changed over the past few months? If kind of juxtaposed against that, do you think you'd be participating anytime in the next year, or do you need some more economic clarity before you really get involved or want to do something?

Dave Brager (President and CEO)

Yeah, I mean, I think it's really a case-by-case basis. Just to your comment regarding the, you know, the conversations. I think the conversations, I would say, picked up pretty significantly after the failures of the banks. You know, people were nervous and scared and looking for a safe haven. I'd say they've slowed a little bit, and part of the challenge is just the economics and the marks and all of the stuff that goes into looking at a deal. We would be open to looking at an opportunity if it was presented to us and it made sense for us, just based on our normal criteria. You know, that probably would impact some of the financial matrix with the marks where they are and some of those things.

Look, we're always, you know, looking and open for conversations. you know, obviously yesterday, the change in or the announcement of the acquisition of PacWest was, you know, something that I think was overall good for the banking industry, just from a risk perspective out there. At the end of the day, we are open, but we will remain disciplined in how we utilize our capital for those types of things and our currency.

Ben Gerlinger (Managing Director of Equity Research)

Gotcha. I mean, has there been more free agency of just kind of the A-plus bankers because of the deals that have been announced this year in California?

Dave Brager (President and CEO)

I mean, there's been a little bit of that. I don't think anything's really happened with the, the one that was announced yesterday. That could and will, I believe, be an opportunity for us, as we move forward through the next, you know, quarter or two.

Ben Gerlinger (Managing Director of Equity Research)

Sounds good. Appreciate the color, though.

Dave Brager (President and CEO)

Of course.

Operator (participant)

Thank you. One moment for our next question. That will come from the line of Gary Tenner with D.A. Davidson. Your line is open.

Gary Tenner (Managing Director and Senior Research Analyst)

Thanks. Good morning.

Dave Brager (President and CEO)

Good morning.

Gary Tenner (Managing Director and Senior Research Analyst)

Hey, I wanted to ask about the pickup in C&I quarter-over-quarter. It looks like line utilization increased, I think, 28% to 31%, which kind of correlates with the dollar increase. Can you talk about the dynamics there, between, you know, increased drawdowns from your existing clients versus potentially maybe brought on new business as well over the last three months?

Dave Brager (President and CEO)

Yeah, I, so in the, in towards the end of the quarter, we did bring on a new large C&I relationship that, that sort of impacted that to a degree. That was probably, you know, a lot of that increase. I don't have the exact number off the top of my head, but, I would say it was, you know, just anecdotally, 75/25 new relationship versus new borrowings from existing lines.

Gary Tenner (Managing Director and Senior Research Analyst)

Great. Just, you know, since it's a sizable, new relationship, could you kind of talk about the relative loan versus deposit, impact of that relationship?

Dave Brager (President and CEO)

This is actually a really interesting- Allen's already laughing, Gary, sorry. This is not a new relationship to the bank. We actually acquired this relationship back in 2018 with the acquisition of Community Bank. They're an extremely large deposit customer, maintaining over $25 million in deposits with us. Back a couple of years ago, they left and went to another bank that offered them a line that we were unwilling to do the size of the line. Ultimately, they never took their deposits from us. They actually left their deposit relationship with us, went to this other bank. They made the decision that they wanted to leave the other bank and bring the line back to us. It's pretty well balanced, actually.

It's probably about 80% coverage of their outstandings on the deposit side. It's kind of an interesting story, just because the relationship never really left, the borrowings did, but then the borrowings came back.

Gary Tenner (Managing Director and Senior Research Analyst)

Got it. I appreciate the color on that. Just any, any commentary you could share on kind of what you're seeing almost through the first month of the third quarter in terms of deposit trends and pricing?

Dave Brager (President and CEO)

Yeah, we didn't disclose that number, but very stable is how I would characterize it. You know, sort of similar to my answer to Ben, we anticipate kind of similar trends historically, kind of second and third quarter deposit growth. Obviously, a lot can, you know, influence that in today's world, but I feel relatively confident that we'll continue those trends between, you know, now and the end of the third quarter. You know, Gary, we actually we've opened an enormous amount of new accounts. I mean, you know, the average balances on our customers' relationships have gone down, you know, because I think they have taken some of that excess cash and invested it in trust and outside investments. We are on offense through all of this.

Gary Tenner (Managing Director and Senior Research Analyst)

Got it. Thank you.

Dave Brager (President and CEO)

You're welcome.

Operator (participant)

Thank you. One moment for our next question. That will come from the line of Matthew Clark with Piper Sandler. Your line is open.

Matthew Clark (Managing Director and Senior Research Analyst)

Hey, good morning.

Dave Brager (President and CEO)

Good morning.

Matthew Clark (Managing Director and Senior Research Analyst)

Maybe just on the margin first, trying to get some visibility into the next quarter, if you have the spot rate on interest-bearing deposits at the end of June and the average margin in the month of June?

Allen Nicholson (EVP and CFO)

Yeah, I think we actually noted that it was 41 basis points in June, Matthew. You can look at the deck, and you'll see a monthly trend, so that should give you more color there. You know, in terms of the outlook for our net interest margin, you know, let me start with what you'll see in our Q. You know, we always disclose a 200 basis point up and 200 basis point down ramp over 12 months. On a static balance sheet, you know, that's going to generate, over the first 12 months, an increase in net interest income of 1.5%, and over a 24-month period, 2.7.

Likewise, if rates were happen to go down 200 basis points, it's a modest decline of 1% in the first 12, and then cumulatively over the 24, it'd be a -3. I will give you a little more color on the very short-term outlook, and I think, you know, it's reasonable to assume that we could have some improved asset mix on the earning asset side, you know, in the near-term quarter or quarters, and, and as well as potentially improve the, the funding mix, with less borrowing. I think, our outlook is that, we, we think there's a reasonable chance of, of a better NIM and, you know, but obviously, that's subject to maybe the Fed increasing even further, in September.

Dave Brager (President and CEO)

Matthew, just one other, on page 39 in the investor deck, the cost of interest-bearing deposits was 1.04% in the month of June.

Matthew Clark (Managing Director and Senior Research Analyst)

Got it. Thank you. Okay. It doesn't sound like it from your prepared comments on the AFS portfolio, but any change in your willingness to restructure the securities portfolio given, you know, regulatory capital strengthening even further here?

Dave Brager (President and CEO)

No, I mean, we'll always evaluate it and determine if there's opportunities. You know, as we commented, the balance sheets and the liquidity position is strong, and there's no need to really do anything there.

Matthew Clark (Managing Director and Senior Research Analyst)

Okay. Expenses down a little bit here this quarter, including lower comp. Can you give us kind of a sense for the run rate outlook here in the second half?

Dave Brager (President and CEO)

As you may recall from prior years, we generally do salary increases mid-year. You know, the third quarter over the second quarter should see some growth, you know, probably 2%-3% in overall staff and benefit expenses. You know, the professional service number can be a little choppy quarter to quarter as we do different things. We have a lot of projects we continue to invest in to improve long-term efficiencies. But generally, we continue to be very focused on keeping expense growth in the low single-digits to the extent we can. Obviously, the big unknown for us is going to be how we have to account for the special assessment from the FDIC. How does that $8+ million show up? Is it in one quarter? Do they change it?

It's split over multiple quarters. We'll have to wait and see.

Matthew Clark (Managing Director and Senior Research Analyst)

Okay. On the office CRE portfolio, it looks like 26% of it, matures or reprices over the next two years. Do you have any examples, or have you experienced any of that type of, you know, any maturities or repricing to date, here more recently? I assume you've kind of looked through, you know, what's coming due and repricing, you know, what's kind of the outcome of what you found?

Dave Brager (President and CEO)

I mean, we do a lot of testing. As we've said before, we, you know, do an annual review of every loan that's over $1 million in the bank, we look at, you know, all the economics, you know, the rent rolls, the, the, you know, the NOI on the property, how everything's going. We have obviously had, we always have every month, probably every week, and maybe sometimes daily, you know, repricing or maturities of loans. You have to remember, most, I'd say the vast majority of those loans are not based on prime. You know, there might be very few that are even based on prime. Most of those are based on, you know, a five-year Treasury. The typical structure would be a 25-year amortization, 10-year term, five-year fix, repricing at year six.

That would be based on the five-year Treasury. If you look at the difference in the five-year Treasury from five years ago to today, that would give you a good indication as far as how those loans would reprice. To date, we really, and I don't know of one, and I asked this question of our Chief Credit Officer and our sales leaders. I've asked if we've had to have any customers rightsize their loans, based on, you know, the cash flow from the property or how we value the property at reset or maturity. To date, there really hasn't been anything that has been material and no problems with our customers being able to cash flow and maintain solid debt service coverage ratios according to the covenants in their loan.

Matthew Clark (Managing Director and Senior Research Analyst)

Great. Last one for me, just getting back to M&A and more explicitly, did you have any interest in PacWest, and why or why not?

Dave Brager (President and CEO)

We, as been our stated approach to M&A, we want to do $1 billion-$10 billion. We want to stick kind of with banks that are more similar to us. You know, there were a lot of things that I would have said that I would have been interested in, but there were also a lot of things that I would have said I wouldn't have been interested in. I think that, you know, for us, you know, we want to execute on our strategy. We want to remain CVB. We want any bank that we look at acquiring to be able to fold into our culture, our processes, our credit quality, all of those things.

I just think that right now, that's would be a pretty big ask of anybody to go through some of that. I mean, I'm, I'm happy for the overall banking industry that, you know, that was sort of taken off the table, but I do think that it probably wouldn't have fit our criteria.

Matthew Clark (Managing Director and Senior Research Analyst)

Understood. Okay. Thank you.

Dave Brager (President and CEO)

You're welcome.

Operator (participant)

Thank you. One moment for our next question. That will come from the line of Kelly Motta with KBW. Your line is open.

Kelly Motta (Managing Director of Equity Research)

Hi, good morning. Thanks for the question.

Dave Brager (President and CEO)

Good morning.

Kelly Motta (Managing Director of Equity Research)

I wanted to start on the excellent deposit trends you guys had this quarter. I appreciate all the color there. I'm just wondering if you could maybe step back and talk more broadly. I know there's been obviously a lot of disruption out west, and wanted to see if any of the inflows you're seeing have been from new customers that you're able to, like, win from this disruption versus how much of these deposit flows are from existing customers just running their business or coming back after, you know, some initial headwinds in March?

Dave Brager (President and CEO)

Yeah. Well, I mean, it's really kind of a tale of in the second quarter, it's kind of a tale of the early quarter and, and later in the quarter. In the early quarter, I would say there was a little bit of disruption just from, you know, the failures. We really, you know, we did have some impact there, but it really wasn't significant. As I think I mentioned, you know, our kind of average existing customer balance has been, you know, is down, quarter-over-quarter. A lot of, and when you ask a question about the new deposit relationships, the $647 million, I don't have a breakdown of how many are of that is new customers vis-a-vis existing customers opening new accounts, but the vast majority of it is new customers to the bank.

I mean, we really, you know, started working on this last year. We changed our incentive plan to really focus on deposits. We, you know, the disruption has helped us, you know, with some of the bank failures. We've opened accounts from those banks. A lot of the people that were at First Republic or, or Silicon, we haven't got a ton from Silicon, but a lot of the customers that were there, you know, they left bigger banks, and they don't, they don't really want to go back to bigger banks. Our specialty deposit groups, like Specialty Banking, our Government Services, they've been very active. In those two sort of verticals, you know, the majority of those deposits are non-interest-bearing because they're operating funds or other people's money in short-term escrows, that type of thing.

We still haven't seen a full, you know, return of where we were at the high point, on the Specialty Banking side. Government Services continues to generate new relationships with cities and municipalities and districts. Specialty Banking is, you know, probably having one of their best new production years ever. I, I'm, you know, I never thought I would say our deposit pipeline might be, you know, bigger than our loan pipeline. Yeah, we have a lot of things going, and I think, you know, with the more recent disruption, could create even more opportunities for us.

Kelly Motta (Managing Director of Equity Research)

Great. Maybe I'll lead into just then with the deposit pipeline and kind of how we should be thinking about the size of the balance sheet going ahead. I appreciate the commentary on securities. Just as we look ahead with what you're seeing in the pipe for deposits and considering what you have with borrowings, like, how should we be thinking about the overall size of the balance sheet? Do you expect that to grow? Tying it into what you had talked about with the margin and commentary around that, like, any color on where we should expect NII to kind of exit the year and kind of the outlook for that as we consider both sides of the balance sheet and the size?

Dave Brager (President and CEO)

Kelly, I don't think the balance sheet size will change dramatically. Certainly, as deposits grow, our most likely reaction to that is to reduce the amount of debt on the balance sheet. You know, we are going to look to try to grow loans, of course, let the security portfolio pay down a little bit. You know, we could modestly grow, we could modestly decline, just depending on some of those factors. You know, in terms of the net interest margin, once again, I think some of it's going to be predicated on changing the asset mix, changing the funding mix.

We do feel that it's reasonable that, you know, in the near term, maybe the second quarter is the worst net interest margin this year, but we still have to see how the Fed reacts later in the year.

Kelly Motta (Managing Director of Equity Research)

Okay, got it. Provided that, you know, what you're thinking with, what you see for margin with, you know, maybe assuming the forward curve, it's fair to say we, you know, flattish balance sheet and some kind of modest NII growth. Any just way to size that?

Dave Brager (President and CEO)

I think it's, you know, we don't really give poor guidance. I think I'll just leave it with the comments I already gave you, Kelly.

Kelly Motta (Managing Director of Equity Research)

Got it. Thank you so much.

Operator (participant)

Thank you. As a reminder, if you would like to ask a question, please press star one one. One moment for our next question. Our next question will come from the line of Tim Coffey with Janney Montgomery. Your line is open.

Tim Coffey (Managing Director and Associate Director of Depository Research)

Thanks. Morning, gentlemen.

Dave Brager (President and CEO)

Morning.

Operator (participant)

Morning.

Tim Coffey (Managing Director and Associate Director of Depository Research)

Just, most of my questions have been asked and answered, but I had to have one question on speaking of PacWest, can you describe kind of what your level of optimism is that pressures on deposit costs might come down near term, given that PacWest was running some fairly aggressive deposit campaigns within your footprint?

Dave Brager (President and CEO)

Look, I think there's a lot of people running fairly aggressive deposit rate campaigns in our footprint, so I'm not sure that PacWest in and of itself will change much of that. I just go back to the point that I've made, you know, we bank operating companies, and we don't have a lot of people that are chasing yield. I mean, there is some of that, as evidenced by the increase in the cost of interest-bearing deposits, but you know, the majority of our deposits are operating companies, so, you know, we are focused on that. One thing I'm sort of trying to give you some of the color around here.

You know, one of the things I, I looked at, is just kind of the mix of the new, the new loan opportunities we're looking at, the new deposit opportunities. You know, there's a significantly higher portion of the new loans we're doing and the new deposit relationships we're getting that are really operating companies, C&I companies. I think, you know, the result of this has been a good thing, just sort of with the focus of our people to, you know, make sure they're going after the right types of businesses and not trying to necessarily do the next investor commercial real estate loan. So, you know, I, I'm pretty, you know, positive on, on where that's going.

I think, you know, we will see, depending on, again, what the Fed does, we will see some continued pressure on the, on the funding, on the deposit side, but it has moderated a little bit. My, you know, my, my hope is that that continues.

Tim Coffey (Managing Director and Associate Director of Depository Research)

Very good. That was my questions. Thank you for the time.

Dave Brager (President and CEO)

Yeah, you're welcome.

Operator (participant)

Thank you. I'm showing no further questions in the queue at this time. I would like to now turn the call back over to Mr. Brager for any closing remarks.

Dave Brager (President and CEO)

Great. Thank you. I want to thank everybody for joining us this quarter. We appreciate your interest and look forward to speaking with you in October for our third quarter 2023 earnings call. Please let Allen or I know if you have any questions. Have a great day, and we'll talk to you soon.

Operator (participant)

Thank you all for participating. This concludes today's program. You may now disconnect.