Good morning, everyone. Welcome to the Bank of Marin Bancorp's Q3 2023 earnings call. If you would like to ask a question during the Q&A period of this call, please, please press star five to enter the queue. You may also press star five to remove yourself from the queue. If at any time during the conference call you need to reach an operator, please press star zero. I will now turn the call over to Yahaira Garcia-Perea.
Good morning, and thank you for joining Bank of Marin Bancorp's earnings call for the third quarter ended September 30, 2023. I'm Yahaira Garcia-Perea, Marketing and Corporate Communications Manager for Bank of Marin. During the presentation, all participants will be in a listen-only mode. After the call, we will conduct a question and answer session. Joining us on the call today are Tim Myers, President and CEO, and Tani Girton, Executive Vice President and Chief Financial Officer. Our earnings press release and supplementary presentation, which we issued this morning, can be found in the investor relations portion of our website at bankofmarin.com, where this call is also being webcast. Closed captioning is available during the live webcast as well as on the webcast replay. Before we get started, I want to note that we will be discussing some non-GAAP financial measures.
Please refer to the reconciliation table on our earnings press release for both GAAP and non-GAAP measures. Additionally, the discussion on this call is based on information we know as of Friday, October 20th, 2023 , 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 on these risks and uncertainties, please review the forward-looking statement disclosures in our earnings press release as well as our SEC filings. Following our prepared remarks, Tim, Tani, and our Chief Credit Officer, Misako Stewart, will be available to answer your questions. And now I'd like to turn the call over to Tim Myers.
Thank you, Yahaira. Good morning, everyone, and welcome to our third quarter earnings call. Our improved third quarter results reflect meaningful progress that we made to reposition our balance sheet out of borrowings and securities and into deposits and cash to expand our net interest margin, increase our liquidity diversification, and improve our interest rate risk position. We generated 16% sequential growth in net income while maintaining comparable loan balances, strong credit quality, and well-managed expenses. We further strengthened our core deposit franchise during the quarter by engaging new customers and deepening ties with existing clients through exceptional service and our local market expertise. These efforts led to strong deposit growth for the second consecutive quarter, including growth in non-interest-bearing deposits, which continue to represent 48% of our total deposits.
Notably, during the quarter, we added more than 1,200 new accounts, 38% of which were with new clients. While deposit costs increased in the quarter, the pace of increase slowed dramatically from the second quarter as we continue to effectively manage our deposit costs in an ongoing competitive environment. Interest-bearing deposit costs increased 31 basis points between June and September, compared to 77 basis points between March and June. Historically, our overall cost of funds has trended well below peer averages, reflecting our long-term approach to customer engagement, which emphasizes building connections with a full suite of products and services rather than competing on price alone.
We continued to work hard at improving our net interest margin by executing on our balance sheet initiatives, which not only include raising deposits and building our loan pipeline, but also reallocating part of our investment portfolio to cash and applying fair value hedges to other securities. Those actions enabled us to expand net interest margin by 3 basis points from the second quarter. We also substantially paid down our short-term borrowings during the quarter with cash flows from our securities and loan portfolios, as well as deposit growth as part of an ongoing strategy to reduce interest costs and support our net interest margin. While borrowings and cash fluctuate with day-to-day changes in deposits, the borrowing balance net of cash fell to zero earlier this month.
We expect our funding cost increases to remain moderate in coming quarters, given expectations that Fed rate hikes and customer migration of funds from operating accounts to interest-bearing accounts will continue to slow. Our loan portfolio and loan production was relatively stable in the third quarter as we remained disciplined in our underwriting. However, our loan pipelines have expanded meaningfully, and fourth quarter loan production is shaping up to be strong, particularly in the area of commercial and industrial, where we are seeing a nice diversity of attractive opportunities. We generated momentum in the third quarter that has continued into the fourth quarter, and since quarter end, have funded or approved for funding amounts exceeding Q3 total originations.
In most cases, our new loans are coming onto our books at meaningfully higher rates than those being paid off, and we expect this will provide further support for our NIM. David Bloom, who joined us as Executive Vice President and Head of Commercial Banking in July, is emblematic of our ongoing recruiting efforts and the results that follow. A commercial banking veteran with more than 25 years of experience, David is responsible for the vision and growth of the bank's commercial banking division, comprised of eight regional offices located throughout Northern California, including our wine practice. We believe his growing team is well-positioned to drive further momentum late this year and moving into the new year. Importantly, with new commercial client relationships comes the potential for fee-based opportunities and new deposits.
We believe that this will help the bank generate improved profitability, continued robust earnings-generated capital, and strong returns on behalf of our shareholders. Critically, as we pursue growth, we remain focused on prudent risk management and strong credit quality that reflects our consistent underwriting standards and customer selection across cycles. We also continue to proactively manage our credit and support our borrowers, building momentum with high-quality credits while carefully monitoring our loan portfolio and rating risk appropriately. Nonaccrual loans totaled 0.27% of the loan portfolio at September 30, compared to 0.1% at June 30. We moved two loans totaling $4 million to nonaccrual status in the third quarter. The increase was driven by a legacy acquired bank loan, and we are working with that borrower to ensure the best possible outcome.
All of our nonaccrual loans are collateralized by real estate, with no expected credit loss as of quarter end. Classified loans comprised only 1.9% of total loans at quarter end, up only slightly from the prior quarter. Looking closer at our commercial real estate portfolio, which accounted for 74% of our total loan balances as of September 30, 23% were owner-occupied, which we believe carry a different risk profile than non-owner-occupied loans in this environment. Our $364 million non-owner-occupied office portfolio is granular and consists of 142 loans with an average loan size of $2.6 million, the largest loan being $17 million. The weighted average loan-to-value was 56%, and the weighted average debt- service coverage was 1.68 x based on our most recent data.
Earlier this quarter, we conducted a review of the refinance risk in our non-owner-occupied commercial real estate portfolio, the results of which can be seen on slide 13 of the earnings presentation. We evaluated 36 loans totaling $97 million, with total commitments over $1 million each, that mature or reprice in 2023 or 2024. We determined that the refinance risk on these loans is manageable, with weighted average debt -service coverage ratios ranging from 1.28-2.01 x across the four cohorts based on current rates. In summary, we made important progress on both sides of our balance sheet in the third quarter and continue to make headway as we position the bank for improved profitability in the quarters ahead. Finally, the bank is pleased to welcome Cigdem Gencer to its board of directors, as announced in our recent 8-K.
Cigdem brings extensive leadership and financial services experience to the board, including the development and execution of transformative growth, expansion, and investment strategies for organizations. In 2021, she established an executive coaching and organizational consulting firm, in which she also serves as an executive coach. With that, I'll turn the call over to Tani to discuss our financial results in more detail.
Thanks, Tim. Good morning, everyone. First, I'll start with some key highlights for the quarter. We generated net income of $5.3 million in the third quarter, or $0.33 per diluted share, up from $4.6 million, or $0.28 in the second quarter. As Tim noted, the increase was driven by a 3 basis point increase in our tax-equivalent net interest margin to 2.48% from 2.45% in the prior quarter, due primarily to higher rates on interest-bearing cash balances generated from security sales and the addition of a $102 million dollar fair value hedges in the form of interest rate swaps. We recorded a $425,000 provision for credit losses on loans in the quarter, compared to $500,000 in the prior quarter.
The provision was due primarily to increases in qualitative factors related to trends in adversely graded non-owner-occupied commercial real estate loans and the potential impact of higher interest rates and other external factors on both our non-owner-occupied commercial real estate and construction portfolios. Non-interest income totaled $2.6 million for the third quarter, down $141,000 from the second quarter. The modest decline was primarily due to a decrease in debit card interchange income. The sale of $82.7 million investment securities generated a loss of $2.8 million, and that loss was offset by a gain on the sale of our remaining 10,439 Visa B shares, which had a zero carrying value. Non-interest expenses of $19.7 million in the quarter were down $918,000 from $20.7 million last quarter.
Contributing to the reduction was a $675,000 decrease in salaries and benefits related to decreases in accrued incentive and profit sharing expenses and 401(k) contributions. Additionally, our annual charitable contributions grant program normally occurs in the second quarter, resulting in another $618,000 reduction quarter over quarter. Finally, FDIC insurance costs declined $197,000 due to a second quarter catch-up adjustment for the statutory rate increase to bolster the Deposit Insurance Fund. These decreases were partially offset by a $533,000 net increase in other expense, primarily resulting from a $688,000 increase in expenses and fees associated with our customers' participation in reciprocal deposit networks to bolster their FDIC insured balances.
Our third quarter earnings translated into a return on assets of 0.52% and return on equity of 4.94%, up from 0.44% and 4.25% in the prior quarter. The efficiency ratio improved to 72.96% from 76.91% in the prior quarter, due to both higher net interest income and lower non-interest expenses. We continue to maintain a high level of capital and liquidity, as well as an allowance for credit losses equal to 1.16% of total loans. All capital levels remain strong and meaningfully above well-capitalized regulatory requirements. Our total risk-based capital improved to 16.6% and 16.1% for Bancorp and the bank, respectively, during the quarter.
Our TCE ratio was comparable with prior quarter, despite pressure from AOCI, resulting from rising interest rates in the quarter. Bancorp's quarter -end tangible common equity was down 1 basis point to 8.63%. The $7.2 million decline in AOCI, resulting from after-tax marks on our AFS portfolio, net of fair value hedges, was mostly offset by earnings and a reduction in tangible assets. After adjusting for $107 million in after-tax unrealized losses in our HTM securities portfolio, our TCE ratio would be 6.1% for Bancorp. Importantly, our liquidity covers all of our uninsured deposits by over 200%. Liquidity and contingent liquidity of approximately $2.1 billion at quarter end consisted of cash, unencumbered securities, and total borrowing capacity, and does not include our ability to tap the brokered deposit markets.
Uninsured deposits remained at 29% of our total deposits as of September 30. Our largest depositor represented just 0.8% of total deposits, and our combined four largest depositors represented 3% of total deposits. Our board of directors declared a cash dividend of $0.25 per share on October 20, 2023, which represents the 74th consecutive quarterly dividend paid by Bancorp. As we noted on last quarter's call, the board of directors renewed the share repurchase program for $25 million, effective through July 2025. There have been no repurchases in 2023, as we have focused on continuing to build upon our already strong capital position.
We continue to believe that our emphasis on the fundamentals of relationship banking and risk management, combined with our strong liquidity and capital, will continue to serve our customers and shareholders well across all interest rate and economic cycles. At Bank of Marin, we are committed to fostering a culture of excellence, effort, and engagement as our teams work together on the execution of our strategies to increase operational efficiencies and improve long-term profitability. With that, I'll turn it back to Tim to share some final comments.
Thank you, Tani. In conclusion, we continued to build upon our valuable core deposit franchise in the third quarter, emphasizing our relationship-based banking model to increase deposits while maintaining an attractive deposit mix and healthy liquidity levels. We also proactively managed our balance sheet, enabling us to expand our net interest margin in the quarter. We bolster our commercial banking team and are attracting new clients that are seeking financing to pursue new opportunities and expansion plans, and we are deepening our relationships with existing clients. This is enabling our lending teams to build a strong pipeline that we believe will lead to loan growth, increased interest income, and ongoing margin and earnings improvement. Finally, I want to thank everyone on today's call for your interest and your support. We will now open the call to your questions.
To join the queue to ask a question, please press star five on your telephone keypad. Again, that's star five on your telephone keypad to ask a question. Our first question comes from Jeffrey Rulis from D.A. Davidson. Your line is now open. Please go ahead.
Good morning.
Morning, Jeff.
Morning, Jeff.
Hoping to get an update on—I think you've identified a couple months ago the percent of loans that were repricing in the next 12 months. I think it was around 30%. Has that meaningfully changed as of today?
No, there's a slide in the deck on page 17 on for in the investor presentation on the total but that's, I'll let Tani go on some of the details on that.
Yes. So Jeff, the 29% in when we discuss that in the context of our interest rate risk and, and where our net interest margin is headed, that includes prepayment projections, whereas what you can see on page 17 in the deck or the presentation, if you add up the first two columns in the loan repricing schedule, that 17%, there are no prepayment rates applied to that.
Got it. Okay. And, you know, as you both kind of talked about the puts and takes of the bigger picture on margin, it sounds more positive than not. You know, high level margin conversation, the outlook here is to continue to scratch out some expansion or kind of, how do you see it as those deposit costs kind of held at, held at bay?
Yeah, exactly. So, we had talked about that on the last call, and I think, for some of the factors, what we expected was what actually transpired. But again, that was, absent any loan growth and also any change in deposits. Obviously, we had more, we had more growth in deposits, and also the rates on the deposits went up, so that's where you would have gotten the, the differential. So as we look forward from today with a static, balance sheet, so similar expectations, obviously not quite as much lift if we don't make any changes associated—you know, last time we worked in the changes associated with the security sales, excuse me, and the interest rate swaps. This time, we have not done any of those as of yet this quarter.
So if you just look at a straight static balance sheet, with no changes in market rates, no changes in deposit rates, you know, that ranges from 2-5 basis points in lift on average margin in a quarter.
Yeah, I would say, Jeff, from a, you know, less sterile standpoint, analytically, and, and Tani's right, is, you know, we are seeing that pace of deposit costs decelerate. You know, when you look at the deposit campaign we did this last quarter versus the prior quarter, the weighted average cost on that was very, very similar, almost identical. And, the yield on new loans coming on was 7.69% in the quarter. So, I think we mentioned in the script there that we have had an acceleration of loan closings. We had expected some last quarter, but those are materializing now. And so if we get that loan growth on top of what Tani mentioned, we're optimistic we can continue to show that expansion, barring any unforeseen circumstances there.
Great. Appreciate the color. If I could ask about the deposit side. Tim, you talked about, I think you said 1,200 new accounts added, and a large portion of those were new clients. What, if you could kind of range bound what the newer clients, where are they coming from? Is it from some of the struggled or, you know, failed banks in your region, or is it community banks? Is it larger banks? Do you get a sense for where those clients are coming from?
Yes, it's, it's all of the above. We are continuing to benefit from what happened with some of the banks that were taken over, but we're also getting accounts from just other large banks. You know, I think the, the press and the market drove people that direction, but fundamentally, there's still a strong desire and love of the community banking model or appreciation of that, and so we continue to benefit from that. The bulk of it that we brought in, meaning not current account fluctuations, you know, it was about, I don't know, $80 million or $81 million of that was interest bearing. But again, that weighted average cost was 3.63% just for interest bearing. So we continue to get DDA. None of that was broker deposit activity, and very little CD activity.
It's just blocking and tackling deposit gathering, but it is across the board in terms of sources.
Yeah, and I'd say you can see, you can see in the deck, on page 16, what the cost of deposits was in September versus June. But in general, you know, the deceleration in the increase in cost of deposits is significant. It was about half this quarter versus what it was last quarter.
That's great. Thank you.
Thank you, Jeff.
Our next question comes from the line of David Feaster from Raymond James. David, your line is open. Please go ahead.
Hi, good morning, everybody.
Morning, David.
Morning, David.
Maybe just following up on the margin discussion. You know, you guys, that's assuming a static balance sheet, if I heard you correctly, and you guys have been—you've done a great job managing the balance sheet. I'm just curious, how do you think about it going forward? You know, you built cash balances this quarter. Are there any expectations to continue pruning the securities book and pay down borrowings? You know, that would only be additive to the discussion, I would think. But I'm just curious, you know, kind of how you think about managing the balance sheet going forward?
I'll talk high level and let Tani jump in. But we continue to look at that all the time. If we can sell securities, particularly funding the loan growth, you know, obviously have a more definable earn back period that way, there's more clarity into that. We've been successful in paying down those borrowings. In fact, for, you know, a number of days during the quarter, we were—if you net from the cash, the $83 million from the prior security sales, if you net that from borrowings, we were - $10 million for a while. We were sitting at $0. So we've seen the ability to work that down. But your question's a great one, and we will continue to look at that.
We're being sensitive to managing all the stakeholders here, shareholders, regulators, and want to maintain liquidity on the balance sheet. But we definitely want to look at what we can do to fund loan growth and continue to reposition that NIM.
Yeah, I would just add, you know, I think it's an exciting time. If you see what the originations were at the beginning of Q4, you know, that's a time where we can really take some more action and do some redeployment on the balance sheet. So, you know, I think there's possibly some opportunities coming up for us here.
That's terrific. And maybe just following up on that point, could you talk about some of the dynamics that you're seeing on the loan side of the equation? You know, maybe just first of all, I guess, a pulse of your markets and how demand is trending. But just given some of the hires that you've talked about and the commentary on, you know, originations already exceeding the third quarter levels, I'm just curious, you know, where you're having success, where you're seeing opportunity to gain clients and new lending opportunities, and how good risk, y ou know, where are good risk-adjusted returns at this point?
Sure. So we are seeing a mix, with a higher weighting towards C&I right now. Certainly, that comes with new hiring and focus. But we're also starting to see opportunities within CRE, meaning as prices have come down and rationalized and panic has abated, buyers, customers, prospects looking to make purchases at those lower values, where those number all pencil out. We're seeing a mix of all of that. And it's also a good mix between new and existing customers, and you always want to see that kind of mix across all those things, type, borrower type, et cetera. So, it you know, it's been very encouraging. Some of it is stuff that was stuck in the pipeline for some time. As you know, these things work their way through the system, we are being very cautious.
There's other factors out there that slow that process down. A lot of it's just brand new customer referrals from some of the hiring we've done. So, I'm encouraged by the diversity of that.
That's terrific. And the last one from me: You guys have done a great job managing expenses in a challenging revenue environment, still investing for growth. I'm just curious, how do you think about the expense trajectory going forward, some of the puts and takes there, and how new hires are you seeing more opportunity to invest and add new hires at this point? Where are they coming from? And just, again, maybe some higher level commentary on the expense trajectory more broadly.
I'll start on the hiring and then let Tani talk about the expense front. We are seeing opportunities. We're in the process of trying to fill some open positions on the production, lending side. We've benefited across the bank in the different divisions from some of the disruption in the market and been able to hire some really good people. But we continue to be reluctant to throw a lot of money at people that we can't really map out a road to return on that, meaning, you know, big team hires, et cetera. But we are trying to be very selective, and the people we have hired are making a difference. So we'll continue to look at that, but it'll be in a pragmatic, incremental approach.
On the general expense side, I'd say that this quarter continues to be indicative. Fourth quarter is typically when all the true-ups happen, but, you know, the team has been really persistent about trying to make sure that we're doing our true-ups as we go throughout the year. So you saw a few happen in the third quarter. The one thing that, you know, could bounce around a little bit, the reciprocal deposit costs did go up as the balances went up. Those balances went up at quarter end. They came down a little bit after quarter end. So those deposit fees could fluctuate somewhat, but those have become a larger component of our other expense category.
Okay. That's helpful. Thanks, everybody.
Thank you.
The next question comes from the line of Woody Lay from KBW. Your line is now open. Please go ahead.
Hey, good morning, guys.
Good morning, Woody. How are you?
I'm good. Wanted to start on the deposit side. I mean, you know, it was another good quarter of deposit growth. You know, excluding the normal seasonality, do you think that these trends can continue sort of in the near to medium term, or would you say most of the heavy lifting has been done at this point?
No, I think it can continue or should continue. I think like a lot of these trends, it'll decelerate. So if you looked at our new deposit gathering activity, that was $152 million, call it, in the prior quarter, $90 million this quarter. But we intend to continue that effort, and we want to continue the deposit mix. But it's really the seasonality, I think, that's going to that we see in the large depositor operating account fluctuations, where we might see upward or downward trends affecting the results. But, no, I think, you know, the behavioral attributes that have allowed us to be successful should continue, and that ultimately leads to treasury management fee income growth. It adds to lending opportunities. It's behavior we want to continue. I just think it will continue to decelerate.
I just don't know at what pace.
Yeah, and I would just add that those large depositor fluctuations, that's part and parcel of our business model and has been forever. But also the third quarter, what we did observe was, you know, sort of during the months of late July and August, we saw the activity go down a bit because of vacations, not only people here, but customers being on vacation. And we did see that activity start to pick up again towards the end of the quarter. So, you know, as long as we stay engaged, I think we stand to continue the trend. But as Tim said, maybe not quite as heavy as in the second quarter.
Got it. That's, that's great color. I wanted to switch over to credit, and when I look at your office slide, it looks like the average occupancy rate ticked up for the San Francisco office portfolio. Do you think that sort of represents a positive trend, or is that just sort of a quarter-over-quarter fluctuation, that's, that's not really representative of much?
Yeah, I wouldn't read too much into that. We're actually seeing some weakness in the market. There is weakness in the market. What we are starting to see, that's interesting, is activity per borrowers' landlords is increasing in terms of tenant investigation of taking down space. But right now, what you're seeing is a rationalization of the market, meaning are landlords willing to accept what tenants can pay per market rents today? And so we're seeing that ongoing negotiation. And so I really am loath to predict a run rate, Woody, based on that trend, because we are seeing a softening, you know, people not renewing leases. And as the landlords look for new tenants, again, can they live with, you know, five, 10-year or seven, 10-year leases at today's current market rate? And there's a bit of a standoff there, and, you know, that'll play itself out.
But, you know, all those deals got good sponsorship and decent loan-to-values, in some cases, excellent loan-to-values, which gives us flexibility for time. But San Francisco is still a weak market right now for leasing up new or empty space.
Right. Thanks for that. And then last, I just wanted to follow up on the special mention loan bucket. Were there any trends there in the third quarter? Any color there would be helpful.
Exactly what I was just saying. So that's, two of the properties we moved into there were properties in San Francisco, where tenants had chosen not to renew. We're pretty aggressive when we downgrade, so watch credits, for example, is a very transitory bucket for us. So we're pretty aggressive in downgrading the special mention if we think there's a threat to the primary source of repayment. But those are properties where one, in particular, where the lease isn't up yet, tenant has said they're leaving, landlord's looking for a new tenant. And again, you get back to that rationalization of accepting longer-term leases at current market rates. So, the increase in special mention or classified is similar, I'm sorry, criticized, is very similar to the amount that moved in the prior quarter. We just have a lot of transitory activity there.
So we'll aggressively downgrade when we see a threat to that primary source, but oftentimes we can work out. But that goes back to the softness in San Francisco.
All right. Thanks for taking my questions.
Yep.
The next question comes from the line of Andrew Terrell from Stephens. Your line is now open. Please go ahead.
Hey, good morning.
Morning, Andrew.
If I could just follow up on credit for a moment. The $3.8 million loan that you called out that went nonaccrual this quarter, it looks like it was acquired. Do you have just what the specific reserve or the mark is against that credit? And was this one that you had marked as PCD in the transaction originally or originally identified as being a potential problem loan?
I'm going to let Misako Stewart, our Chief Credit Officer, answer this question. So, go ahead.
Yes, there is no specific reserve for that particular loan because we do still have adequate or sufficient loan-to-value coverage on that. And the loan did go into non-accrual, but since quarter end, they did bring the payment current. So actually, as of this date, you know, the loan is current on payments. And we're, you know, we're continuing to work with the borrower. The deal happens to be in an industry that we normally are not in, so it's kind of an isolated situation, and we're continuing to work with the borrower.
Okay, great. I appreciate the color. And then a lot of banks have been giving some color this quarter around the reserve against their office portfolio. Is that something you guys have offhand that you could share?
A specific reserve? Are you-- is that what you're asking on, on?
Yeah, yeah, a specific reserve against the office portfolio.
Yeah, we don't have a specific reserve. However, we did make some adjustments in our Q factors and our qualitative factors under CECL to kind of increase the risk factor for our non-owner-occupied real estate, which would include office. So that's kind of where the reserves would be coming from, but no individual reserve.
Okay, understood. And then just I wanted to make sure I understood that the page 13 of the presentation, the refinance slide correctly, and I appreciate the data. It's very helpful. For the four loans that are $11.6 million out maturing in the fourth quarter, I just want to make sure the 1.28 debt service coverage is based on a 3.80 weighted average current rate, correct?
No, it's not. It's actually stressed to current market rate.
Okay, understood. Okay. I appreciate it.
Yeah, for everyone's benefit, we may not have done a good job spelling that out, but those are the current rates. We took current lease rates, current rent rolls, current tenancy, and said, could these loans sensitize those to repricing at current market rates to see what our exposure was on that. And so we did it in two buckets, loans coming due by way of maturity or loans that reprice, because those are somewhat different risk buckets, but similar, underlying risk factors is can these things cash flow when you reprice them at market rates? We wanted to demonstrate it for ourselves, do that analysis and demonstrate that they have adequate debt coverage.
Yeah, let me.
So that rate there is indicative of how far those would have to move between there and the stressed rates to get to those debt service coverages.
Right, right, right. It means that based on the current rate that they're paying on, the debt coverage would be much higher than what's indicated here, because the weighted average debt service ratio that you see on this page is stressed.
Understood. Okay. Yeah, definitely still really strong, especially understanding that you've already stressed that debt service right there. Okay, very good. And then just one last one for me. I wanted to get maybe updated thoughts. You've obviously got a really strong capital position. Maybe updated thoughts on the buyback, I think, about $25 million outstanding. Just how are you thinking about that, given where the stock's trading at right now?
Well, we continue to believe we'd love to do that based on the valuation. We think it's a great deal, obviously. Similar to my—I answered, I think, David, on security sales and, you know, having ongoing conversations with different stakeholders, including the regulators, about their appetite, given fears around potential credit losses, what that might mean, but it's something we remain keenly interested in. It's probably a matter of timing.
Okay. Thank you for taking all the questions.
Thank you, Andrew.
The next question comes from the line of Matthew Clark from Piper Sandler. Your line is open. Please go ahead.
Thanks, and good morning.
Morning, Matthew.
Just a few more all around the margin. Just trying to fine-tune the forecast here. Loan yields were basically flat this quarter. Was there anything unusual there? And, you know, we see the repricing slide, and we know about new loan production coming on a lot higher. But maybe just any commentary around this latest quarter and then kind of the lift you might expect going forward.
I think some of the yields of loans paying off are a little bit higher, depending on the loan category. So the average yield of loans paying off was 6.20%. That's a little bit high, and so there wasn't a huge rate differential. You had overall loan compression, albeit marginal, and I think that all affected an average yield. But that average yield of loans coming on at 7.69%, you know, if we can continue that trend, again, that 6.20% is high for loans coming off, that should, that should expand or be more differentiated.
Yeah, and if you look at the yield on the quarter before loan fees, we had lift of 5 basis points there. And I think what happened in the loan fees and cost amortization is that if memory is serving correctly, we had some payoffs last quarter. So we had some fees that were associated with those that lifted the yield a bit.
Got it. Okay. And then, the trend in interest-bearing deposits you show on slide 16, you know, call it 10, 10, 11 basis points per month in terms of the rate of increase, and it sounds like you expect things to moderate. Do you happen to have? Well, I guess you gave. Y eah. Do you happen to have the spot rate at the end of September? I'm just trying to get a sense for, does that, you know, 10 basis point increase get cut in half going forward or not?
Yeah. So we don't have the spot rate for September 30, but what we gave you was the rate for the month of September, which was 100 basis points on the total cost versus 82 in the month of June. So 28 basis point lift over the three months.
Okay, great. And then, just any additional commentary around expenses for next year? You know, how should we be thinking about growth? Are we shooting for expenses to be flat on an operating basis, or do you think there might be some modest growth?
Well, we have some investments we want to continue to make around efficiencies and digitalization. That being said, that investment's been slower this year. The branch closures we announced, the savings this year because of accelerating TI costs, was more minimal, but next year, that's a $1.4 million annualized savings. So we're doing our best to, you know, to cover investments or any further increases in expenses with, you know, offsetting that with savings like that. And we'll continue to do that, so we don't have any large expense things planned that would deviate too far from that. But we also, you know, caveated, we want to be opportunistic with hiring and other things. And I say that with nothing in mind, but I think that's the general picture.
We normally will plan for, you know, merit increases, and so that's, that's gonna, you know, give you an upward trend just in general.
Yep. Okay. Got it. Thank you.
Thank you.
The next question comes from the line of Tim Coffey. Your line is now open. Please go ahead.
Great. Thank you. Morning, everybody.
Morning, Tim.
Hey, Tim, if we can circle back to the San Francisco office book. How much of that is criticized or classified at this point?
Let's see here. Hold on, let me do the math. So about, of the $71 million, there's about 25% that's in the classified bucket. And then, yep.
That continues and has been skewed, Tim, by that large?
Yep.
Substandard that we get downgraded two Decembers ago. So, you know, we've had the movement in there. We just mentioned into criticized, but that one large $17 million loan really contributes the bulk of that.
Yeah.
It has for some time.
It's one borrower. You know, we're not seeing any deterioration, not any notable improvement, but no deterioration. There's good sponsorship behind it, so loan payments are being made as agreed, and we're continuing to work with the borrower.
Okay. Okay, that's great. And then, Tim, as you talk to some of the commercial real estate investors at your bank, what's their temperature like right now? Are they still waiting for things to get worse and pick up better deals, or do you see them getting more interested in being back in the market?
We're seeing interest pick up. I don't want to, you know. We don't have a large enough portfolio to be statistically relevant there with my opinion, but we are seeing activity pick up, whether it's in North Bay, Sacramento, but we are seeing people interested at acquiring properties at what look like depressed or degraded prices, and that's creating opportunities. So, you know, and that right sizes the credit risk, right? As we're doing those at higher returns, we're also funding loans that are rationalized appraised value in this environment. So, you know, I don't wanna, I don't know if that's a trend yet, but it's becoming more visible.
Okay. Well, that's positive, relative to where we were earlier this year.
You know, yeah.
And then, as you kind of move forward with your deposit gathering strategies, do you have a target loan or deposit ratio you'd like to get to?
Well, I mean, we'd love it to be higher than it is, right? So we, we wanna lend into this, yeah, with the higher yields. And so, you know, we'd love to continue to raise deposits at manageable costs that are relationship deposits, that will come down in cost over time and pay off the borrowings, et cetera. But we really want to grow the loans, and so if we can get back to a historical trend line for us on that, you know, that's really where we'd like to be, but no one set number target.
Yeah, we have a lot of headroom to go where, I mean, we used to talk about, you know, what would, what would the cap be on that? And, you know, unlike a lot of the larger banks, we don't really have an appetite or haven't historically for getting loan-to-deposit ratios over even not only 100%, but even 90-95%, so.
Right. Okay. Well, thank you very much for your time. Those are my questions.
Yeah, thank you very much.
There are no further questions in the queue. I will now pass the call over to Tim Myers for closing remarks.
Thank you again, everyone, for your interest in joining us and the outstanding questions, and we look forward to talking to you again next quarter.