Good afternoon, everyone. Thank you for joining us today at the 198th annual meeting of the Hingham Institution for Savings. Our this is our 34th annual meeting as a publicly traded company. And we've got another beautiful day here in Hingham to welcome you all. We'll be conducting the meeting today, both in person and on Google Meet, and I was impressed last year, we did the same thing, and we had about 80 people in attendance here in person, and we had about 95 people on Google Meet attending online, which was great. The ability now to open up meetings like this through that medium. So let me get on with some introductions. We have all of the members of our board of directors here with us today.
Can you all raise your hands so you can be attacked later? We also have some other individuals with us, Mr. Regan, Artie Regan of Regan & Associates. Regan & Associates has been. You can raise your, lower your hand already. Regan & Associates has been, again, designated as, the inspector of elections by our board of directors. Marty Caine and Molly Ebert are with us today from Wolf & Company, our certified public accountants. Thank you for joining us. And last but certainly not least, is Samantha Kirby, our counsel from Goodwin Procter. So welcome, Samantha. We're gonna conduct the meeting again this year in two parts. First is the formal portion of the meeting that addresses the four proposals that are contained in the notice of meeting.
After we have concluded the formal portion of the meeting, we'll move on to a presentation that our President, Patrick Gaughen, will make with regard to the performance of the bank this past year, our strategies, and what we view as the opportunities and challenges going forward. After Patrick's presentation, both Patrick and I will respond to questions. We have solicited questions online, many of which have been submitted prior to the meeting, but we will also take questions from the floor. We always look forward to that portion of the meeting. Before we begin the formal portion of the meeting, there's a few housekeeping matters. First, the meeting is being recorded. Second, all of the Google Meet attendees are in listen-only mode.
Third, as noted in our proxy materials, all voting is done either through proxy or in person. There is no electronic voting available. And fourth, I'd ask all of you, including myself, to silence your cell phones. So thank you. I'd also like to draw your attention to the safe harbor statement that's on the screen with regard to forward-looking statements. And with that, we're here today to consider the following business items. First, the election of directors, second, the election of a clerk, third, the advisory vote on executive compensation, and fourth, the advisory vote on appointment of independent registered public accounting firm. So we'll deal with each of those in turn as they appear in the notice of meeting.
It should also be noted that I've received an affidavit certifying that the notice of the annual meeting was sent to all of the shareholders of record as of March first, and that was sent on March eleventh. So is there any shareholder present today who hasn't voted that would like to vote in person? If not, I think it's been at least 12 years since someone raised their hand and wanted to we took 10 minutes getting their vote done and so forth. But given the fact that there's no one who wishes to vote in person, I'll call upon Mr. Regan to furnish us with a count of the shares that are present, either personally or by proxy.
Mr. Chairman, on this quite brilliant last Thursday in April, there are at least 1,839,034 shares present, represented either in person or by proxy.
There being 1,839,034 shares present out of 2,174,000 , I'll declare that a quorum is indeed present. The first matter to be voted on by the stockholders is the election of directors. The nominees for election are five Class III directors to be elected for a three-year term, each to hold office until the 2027 annual meeting and until their successors are duly elected and qualified. Those individuals are Michael J. Desmond, Robert Lane, Scott Moser , Kara Smith, and Jacqueline Youngworth. Do I hear such a motion?
It having been moved and seconded, is there any discussion on that motion? Any discussion at all? Hearing none, I will call upon Mr. Regan to announce the vote.
Mr. Chairman, each nominee for director of the bank received at least 1,291,677 shares voting for their election, representing over 82% of the shares voting on the item.
The holders of a plurality of the shares present are represented and entitled to vote at the meeting, having voted for the nominees, I hereby declare the same to have been duly elected. So congratulations again, folks. Next matter to be voted on is the election of Jacqueline Youngworth as Clerk of the Bank, to serve until the 2025 annual meeting. Do I hear such a motion? Everyone having been given the opportunity to vote, I'll call upon Mr. Regan to announce that vote.
Mr. Chairman, our Jackie Youngworth received at least 1,848,511 shares voting for her election as Clerk of the Bank, representing almost 98% of the shares voting on the proposal.
Strong vote, Jackie. The holders of a great deal more than a plurality of the shares present, having voted for Mrs. Youngworth as Clerk of the Bank, I declare her so elected. Next item is the so-called say-on-pay resolution, and the proposal calls for an advisory vote on the approval of executive compensation. Do I hear a motion to approve the compensation of the company's named executive officers as disclosed pursuant to the Securities and Exchange Commission's compensation disclosure rules? It having been moved and seconded, is there any discussion, any discussion at all with regard to this motion before we proceed to a vote? Hearing none, I'll call upon Mr. Regan to announce that vote.
Mr. Chairman, at least 1,202,461 shares voted for the say on pay proposal, representing over 76% of the shares voting on the matter.
The holders of a plurality of the shares present are represented and entitled to vote. At the meeting, having voted in favor of the say-on-pay resolution, I hereby declare such a proposal to be adopted. Next item, and last item on our agenda is the advisory vote with regard to the appointment of Wolf & Company as the bank's independent registered public accounting firm for the year 2024 . Do I hear such a motion?
So moved.
Motion having been made and seconded, I'll call upon Mr. Regan to announce that vote.
Mr. Chairman, at least 1,866,396 shares voted for the bank's auditors, representing over 98% of the shares voting on teir ratification.
The holders of a plurality, having voted in favor of the resolution, I will declare it as carried. That concludes the formal portion of the meeting. Do I hear a motion to adjourn?
So moved.
All in favor say aye.
Aye.
Opposed, no. So voted. So we'll move on to the informal portion of the meeting, and I'll get out of Patrick's way.
Are we good? Yeah. Okay, good. Thanks. We're not going to linger on this slide for too long. I expect everyone has read it at this point while we've been voting. We can get the next slide. I guess I'm doing that. We've taken the efficiency to new heights this year. Okay, so the informal portion of the meeting, first, the financial results, second, the operating highlights, and then finally, question- and- answer. We had a decent volume of questions this year. It's my expectation that we'll probably alternate between folks who are in the room and questions that we received in advance of the meeting. To the extent some of those are consolidated, we'll handle those at once, and there are a number of questions that we received.
Banking is a very good business unless you do dumb things. As I said last year, there are dumb things that we've done, and I'm certain that we'll do in the future, and we'll spend some time talking about that. But the essence of what Buffett was talking about here really ran to risk management, and when we talk about credit quality, in particular, exactly where we are still exiting agreement. And despite the fact the environment is a challenging one, in terms of the inversion of yield curve and the positioning of the balance sheet, and where we have been from a credit perspective, I think is critical to where we're going. A couple of different things that we're going to touch on today, the things that we do. Some of this is going to be repetitive.
There are a lot of familiar faces in the audience, and I apologize the extent that I'm repeating ground that we've covered before. There are also some new faces, and I think it's important to get back to basics and talk about some of these things again. So the things we do, first, commercial real estate lending, which for us is principally multifamily lending. We're lending on mixed-use property in urban markets where there's a substantial retail or office component on the ground floor, but really they're buildings that people live in. Second, commercial and personal deposit banking, and then finally, residential real estate lending, which we do for our own account. We don't sell into the secondary market.
As I've said, every year, as I've talked about to folks, excuse me, informally, as I think everyone knows, this is the only thing that we do. There are a lot of things that we don't do. There are some things here that I think are probably worth highlighting in this long list of the things we don't do. We don't have a commercial and industrial lending business, which is commercial lending that's unsecured by real estate, and that has some implications for a number of components of the financial structure of the bank, so it has some implications in terms of the asset sensitivity of the bank, in terms of the funding, but also in terms of the operational expense and in terms of the credit quality. Consumer lending, we don't have a consumer lending business of any variety.
Floats, flies, drives, we don't have it. Investments, so wealth management, trust, advisory, we don't do it. Insurance brokerage, or certainly underwriting, we don't have that business either. For a long time, I think we've talked about this in the past, there has been a bank in Massachusetts that has specialized in rolling up smaller insurance agencies, Eastern Bank, a respected competitor, and this year, they finally sold that roll, I believe, to Arthur Gallagher. And so Massachusetts banks are largely out of this business now, but it's not one that we've ever been in. Secondary market residential, so we don't have a mortgage bank, tax credit, solar lending, cannabis, crypto, but less interesting this year. And then participations. We don't buy other banks' loans or portions of them.
And, for the most part, we do not sell any portion of our loans to others, either for risk management or for other purposes. There's an asterisk next to that because there's a bank that we helped to capitalize in Washington, D.C., and from time to time, we've done participations with them, and we've sold them a piece of what we've done, Founders Bank. But generally speaking, we don't do it. And there are some reasons for that that we've talked about that I think are probably worth repeating. It adds a degree of complication to the real estate lending business that we don't think is offset by the diversification of risk.
And in many instances, it encourages banks to make loans that they may not be appropriately positioned to assess, to make larger loans than they should, even if they're moving the exposure up. And we certainly saw that in the early 1990s. In loan book, when we came to Hingham, there were a variety of participations in the book with the Bank of New England. For folks that were familiar with that story, it's one of the largest failures in the U.S. banking industry prior to the 2008 cycle and the recent failures last year. And the Bank of New England specialized in buying and selling participations across this really diverse network of New England banks, some of which were public, many of which were mutual.
And when they failed, it brought everything down along with it. It was one of the real accelerants to the New England banking crisis at the time. So we don't. Capital allocation, same slide as last year. Attractive, organic growth, reinvesting in the lending business, and in the deposit business. That's looking at incremental growth, principally here in Boston, to a lesser extent in Washington, D.C., although that's a very material piece of the business now, and to a lesser extent in San Francisco, still, I think, a new market from our perspective. Second, minority equity investments, public and private, focused on financial services and technology. If I go back, this, there are some businesses on this list that we actually do have economic exposure to in our equity portfolio.
One of the reasons that we don't do those things, but may invest in them indirectly. Insurance is a particular example, probably payments, which we do not really have here, but might fit into consumer lending, depending on product. They can be very good businesses. There are people that run good businesses to the extent that we can get exposure to that and learn from them, in those minority equity investments. We don't take on the operational expense of running the business ourselves, and we don't, I think probably more importantly, have the hubris or the arrogance to believe that we can do a good job at those things. We get to benefit from the work of some outstanding management teams running some great businesses, and it shows up, over time, in value that's created for our shareholders.
So when that's done on a minority basis, there's no control premium paid, which we'll get to in a moment on mergers. And we don't substitute a belief in our judgment or operational performance ability for theirs. Third, dividends, and maintaining appropriate leverage through regular and special dividends. And then four, repurchases focused on opportunistic, focused on valuation and tax. There are a number of questions on that this year, so I'm going to take some time in the Q&A to walk through our thinking on that and how we evaluate that relative to some of the other options. Not attractive control equity investments or acquisitions.
We continue to think that for the most part, the acquisitions that are pursued in the industry are value destructive over time, that the cost synergies that folks identify don't materialize, that the impact on the bank's clients and the impact on the bank's staff, and thus indirectly, the bank's clients, can be a very negative one. There's a long, I think, track record of that, looking at the empirical data in terms of the industry performance. There are a handful of banks that have done a great job, but they're the exception to the rule.
And when we've seen this in the markets in which we're active, I think particularly in Boston, and in San Francisco over the last year, given some of the events we've seen with the failures or with some of the announced mergers, I think we can see that impact tangibly in terms of the impact on staff, on customers, and ultimately on results for the owners. The 2023 financial results, not our best year. Earnings, $26.4 million. All of this is on a GAAP basis, by the way, so it includes the gains or losses, unrealized and realized in our securities portfolio. Clearly down, from the peak in 2021. And product of that, if we were to look, last year and this year, is the interest rate environment.
The bank continues to have, and I think will continue to have, a balance sheet that is more liability sensitive than not. It is a function of some of the structural choices that we've made in the business. It's also a function of certain choices that we've made in terms of funding the business, some of which we probably would do differently, some of which I think we will change going forward. We'll touch on some of that. But not our best year. I think that's a 6%-7% return on shareholder equity, which is kind of common for the industry, but not acceptable to us, and below, I think, as we described in a number of the press releases, below our long-term performance expectations.
Having said that, I think in probably in 2020 or in the 2021 meeting, we talked about how through the cycle, there'll be periods where we're perhaps overearning. There were some quarters in there that we were delivering returns on equity well into the 20% range. And from our perspective, the structure of the balance sheet and the structure of the business is designed to produce returns through the cycle. This cycle has been a particularly difficult one, more difficult, I think, than we anticipated in terms of the size of the short-term rates and between the short term end of the curve and the long-term end of the curve. But that's no excuse. It's simply describing the environment as it is. And I think as we move through time, there will be periods that we underearn.
I think that's a period that we're in right now. But I think we have a lot of confidence that the business, as it's structured, will continue to produce the returns on equity that we've historically achieved. And this gets to what I was describing in terms of the return on equity for savings banks in Massachusetts in 2023. This goes back to 2019. So you can see that gap between the blue line. The blue line, which is the state, so all savings banks. They're a little bit closer to us in size, and then the green line, which is Hingham. So over time, a substantial gap.
In 2023 , we're sort of in the middle of the pack, between the peers and the state at a little over 6% in terms of our return on average equity. Really, again, not consistent with our expectations, but remarkably in kind of the middle of the pack for Massachusetts banks, which is remarkable to use the word again. Book value per share. We talk about this quite a bit. Over the last five years, a little over $70 in additional value created a CAGR of over 13%, down from last year. Obviously, influenced by the returns on equity in 2022 and 2023 . But it continues to grow.
I think obviously I would prefer, as I think the largest individual shareholder of the bank, that it grows a little bit faster, but it continues to grow. In the last two years, particularly in 2023, a decent amount of that, again, came from our investment operations. Low-cost leadership, even with those results last year, a 57% efficiency ratio. As folks may or may not be aware, that number is driven in large measure by the net interest income of the bank. So the efficiency ratio is the non-interest expense is the numerator, and the net interest income and non-interest income are the denominator. We obviously have very little of the latter. We don't have a fee income business, and that was at 57%.
As the industry goes, it turns out that's actually pretty good, but obviously not consistent, I think with where we would like it to be. In terms of operating expenses as a percentage of total average assets, it's 67 basis points for last year. And we think about those two things together, because that's not impacted by changes in net interest income. And so over time, taking the two of them, I think, gives a picture of what structural leverage looks like in the business and costs. I think this is very important, this next piece. Talk about this every year. We can't talk about this enough. The source of that efficiency is both structural and operational. Game selection and game play, selection being a structural choice. So what businesses do we choose to operate in?
And more importantly, what businesses do we choose not to operate in? Operational being game play. Once we've made those decisions, how do we play? So how do we run the business? Are we able to effectively leverage the best people and technology and adopt, I think, a frugal approach to costs? We talk about being relentless in taking unnecessary costs out of the business, and this is occurring all the time, every year, in good times and in bad times. And I think it's important to note that that doesn't mean cost cutting, it certainly can, but the critical thing is getting operational leverage on the expenses. So it's not a matter of outright reductions in cost.
It's a matter of figuring out how do we run the lending and deposit businesses in a high-quality way, identifying high-quality assets, originating them, servicing them, seeing them repaid, operating a deposit business that delivers unique value to our customers, and do that in a way every year, where we spend a little bit less as a percentage of the total balance sheet every year, year after year. While the total amount that we're spending may certainly grow in any given year, it's that leverage that's the key piece.
I think one of the things, if we were to set the efficiency ratio aside, and we were to set the noninterest expenses as a percentage of the total balance sheet aside, if we were to just think about the number of people that are on the team at Hingham, and the total FTE count right now is, I think 87 or 88 people on the team. When we came to Hingham thirty-one years ago, that was probably around 60 people, between 50 and 60 people. The bank is about somewhere between 35x and 40x larger, with, I think, a very different footprint, operationally. Clearly, more offices from a retail perspective and a very different commercial presence for our customers, on the loan side and on the deposit side.
And I think that speaks to the leverage that the business has when we have great people and when that's supported by technology. And obviously, there have been changes in the industry since then as well. So the lending business, every year, we talk about the last five years' growth. The total loan portfolio, just shy of $4 billion at the end of last year. Of that, about $3.4 billion was commercial at the time. A five-year compound annual growth rate, a little over 14%. Disciplined in the sense that the credit track record that we've had over the last 30 years remains, I think, very strong.
So the slide that goes back to 97, we should add the first 3-4 years next time to take it all the way back to the change of control. So what we're looking at here, these slides will be on our website, so I apologize for the size of the font, the labels, and so forth. We just can't make the screen any bigger. So what we're looking at is net charge offs at Hingham every year, and a comparison to all FDIC-insured banks for every one of those years. The blue bars are the industry. So if we were to look at 2023 , 52 basis points of net charge offs. Net charge offs are actual losses incurred by the bank, net of any recoveries.
In the event that the bank charges off $100,000 on a loan and recovers $30,000 from the guarantor, maybe in an unsecured context, net charge off $70,000, so this is a net of recoveries. And if we look back over a long period of time, the results in the industry have been somewhat volatile in the sense that you can see the significant change in the great financial crisis, which is the giant rise in net charge-offs in the center of this graph. And you can see in more stable times, if we were to look back over the last 10 years or thereabouts, about 50 basis points, give or take, in terms of charge-offs. The red bars, which will be somewhat difficult for you to see, are net charge-offs at Hingham.
And, I think obviously the difference between the track record that we have had here and what we can see just in the average bank in the United States is substantial. It's been, I believe, 13 or 14 years since we've charged off a single dollar on a single commercial real estate loan. There are a few years here. You'll see there was one basis point of losses in 2020 . That was on a residential loan in Nantucket. I believe we probably talked about it before. And then there are a few years where if you came up close, you wouldn't be able to read a number at all, and that's because we had net recoveries in this year.
2015, in particular, 2013, not only did we not charge anything off, but we were working on recovering some of those de minimis losses in the GFC that peaked at seven basis points in 2009. And in that year, the industry was at 255 basis points. So a pretty decent spread. In terms of portfolio quality, in looking at the last several years, and I think this started with COVID, in terms of what a lot of borrowers were looking for in commercial real estate industry for modifications, followed, and in the last year or two years, the discussion has shifted, I think, in a more focused way to office loans in the United States and commercial real estate, generally.
Some of that conversation is related to some of the troubles that some banks have had in the last 1.5 year . As we've seen asset quality deteriorate across the industry, including, I think, at some very good banks, and certainly here in Massachusetts, in Washington, D.C., where we have a, again, I think, a material business, and San Francisco's issues are somewhat unique, and we can address those in a little bit. It's probably worth noting a couple of things. So first, we have no non-performing or non-accrual commercial loans. None. Not one, not one dollar. There are about 1,700 commercial loans that we have in the bank. Not one of them is non-performing, not a single one, not a single basis point. We have no delinquent commercial loans, so delinquency established at 30 days.
You can see that if you look at a bank's call report, and those loans are often carried as performing, probably up until 90 days. But we don't have a single one, not a single loan, not a single dollar. Third, and I think this is critical, we are not in the business of modifying loans. We're not in the business of extend and pretend. We know that, when we bought that risk at the outset, we've done so with strong borrowers, with very substantial equity cushions, with loan structures that are protective. We are not in the extend and pretend business. So, I don't mean that as a criticism. I think folks need to make the choices they need to make, to make it through a period, particularly if there's substantial office exposure.
But it's not a business we're in. And then finally, of the $3.5 billion in commercial loans as of today, there's a single loan for $460,000 that's currently 15 days past its due date. And I have to confess that I wrote these slides yesterday. There's a decent chance that fellow paid today. Because the loan's probably 12 years old at this point. So in terms of portfolio quality, it's something that I think that is critical, you know, take for granted. We talk about it every year, but it is the product of a lot of hard work. It's the product of the work of our lenders, of our executive committee and our board in underwriting and approving and structuring those loans.
It's the work of the folks in our servicing group that are responsible for making sure we get paid. Watching those loans for all of the other indicia of trouble, you know, whether it's insurance policies that have lapsed or issues on the title, liens, municipal issues, past due real estate taxes, condo fees, all of that. That team does a fantastic job for us. Deposits. Last five years of deposits, a five-year CAGR of 8.4%. Not quite half the CAGR in the loan growth, but not consistent with it, which as we've talked about, is not something that will work. You know, this deposit growth needs to mirror the growth in loans. We can continue to use wholesale funding as a substantial funding source for the balance sheet. I think we intend to continue doing that.
Those have been very reliable funding sources for us over a long period of time, particularly given the multifamily concentration that we have in the real estate book. There are some reasons why that works well, but this is growth that we need to see accelerate. In terms of the approach, personalized service, digital excellence, low fee, no fee, two engines, the specialized deposit group, which we may rename at some point because it's a lot of words to say. That really is our largest and most complex commercial, personal, institutional customers. And then our retail banking group, which is the. It's not this building, so I'll keep going. I do some here? There we go. Massachusetts, in Boston, out on Nantucket, Sarah Congdon, who runs that office, is here with us.
I won't embarrass Sarah by making her stand up. Although we have branch powers at the office in Washington, really, that doesn't look and feel like one of our other retail offices. So really, that group is the presence here in Massachusetts, although, as we'll get to, I think that is likely to change over time. So the commercial deposit focus, we've been talking about this for a number of years. If you look at traditional savings bank balance sheets, they tend to have a significant composition of time deposits and higher rate money markets, sometimes some wholesale funding, and I think a lower emphasis on commercial relationships. If we were to look back over the last 25 years, that's been a process that's slowly changed at Hingham.
So it's been a process that's evolving in a balance sheet that's slowly changed. But given the growth that we've had in the balance sheet, it probably hasn't changed as much as we'd like, sort of in the mid-teens for non-interest-bearing deposits as a percentage of the balance sheet. If we went back 15+ years, that would have been in the low-to-mid single digits. So progress, but not enough. So the Specialized Deposit Group, as I discussed, the relationship managers and the digital banking specialists that handle our largest and most complex customers. Historically, a real growth engine and some challenges over the last two years, in terms of balances, but I think considerable progress, in the expansion of that team. A couple of points that I wanted to note.
First, they're really upgrading the number, and quality of the relationship managers that we have on the team, and then the operational staff, that works with them to onboard those customers, to handle those customer service issues, to address payments problems. I think some real progress over the last year, about a number of new folks on the team here with us today. A continued focus on new business development. This is absolutely critical. There's growth that comes from the existing customer base, but new business development is the only way that we grow the balance sheet over time. It's new customer relationships that are referrals from customers, that are the product of outreach on our part, or the product of marketing activities that prompt inbound interest.
Recruiting new relationship managers, particularly as we grow the business in Washington and San Francisco. One of the questions that we got in advance touched on this, and, I think that there's continued significant opportunity in those markets, particularly on the deposit side. And that's where those relationship managers are focused. Their customers may have lending needs, and we're certainly in a position to address those. But, as we're having conversations with bankers in Washington and San Francisco and, in Boston here as well, we're really focused on deposit gatherers. We have a very strong lending team, and the growth, I think, is likely to be here. The Retail Banking Group, so as I noted, Boston, the South Shore, Nantucket, and Washington, we do have the branch presence there.
A single point of contact for deposit and residential lending. I think that's important to us. The last few years, from a residential lending perspective, particularly last year in the rate environment, somewhat slower, but it's an important part of how we build relationships with customers and solidifying those relationships. Some growth in money market and time deposits last year. Really no attrition in non-interest bearing deposits or not significant attrition, but certainly not the growth that we would have liked. I touched on this a little bit before with the specialized deposit group, and can't overstate the importance of the people here. They are the relationship managers with our customers, with prospects, with folks walking up the street.
And making sure that we have the right people in the right roles that I think are appropriately client-focused is critical. We continue to look at opportunities for branch expansion, particularly here in Boston. There are some locations that we've been looking at for quite a while, and I think it's likely over the next year or two, we'll continue to expand the branch network, particularly north of the river in Boston. And I think likely in Cambridge, if we could identify a location that we were happy with. There's always a lot of space to lease, but that doesn't always mean that it's the right spot for us.
When we've done this, you know, we plan to do this for a long period of time, so we wanna like what we're doing in terms of the space and the position. Looking backwards, this slide is similar to last year. We had the continued problem of hindsight bias. In retrospect, I think there are some things that we would have done differently, and in retrospect, I think there are some things that we would have done the same going through this cycle. The general positioning of the balance sheet, I don't think we would have changed. I think we continued to make the appropriate bets that we did. In retrospect, probably would not have originated as much as we did in 2022, which is something I think we talked about last year.
I think from a credit perspective, there are very safe loans, but we probably were not being compensated for certain types of interest rate risks. In terms of asset liability management, a couple of things I wanted to touch on this year that I think we touched on a little bit last year, the first, asset sensitivity. There are some things that we've done over the last year and a half in terms of the new business that we're writing, that I think over time will make us marginally more asset sensitive, which I think is what we're aiming for. We're not looking to substantially change the structure of the balance sheet, and the, I think, notable thing there is, historically, we've written five-year multifamily loans, and they tend to have five-year options.
So they're priced for five years, and then they reset to a margin over an index, typically the Home Loan Bank. They're fixed for another five years, and then at the 10-year point, it resets again. One of the changes that we made is everything starts adjusting annually after that initial period. And it's namely because borrowers don't give us new prepayment protection in the adjustment legs on those loans. And what that means is there's a certain asymmetry in the risk and return that we take when we face those customers at adjustment. And since we made that change, we've really had no pushback.
So that's not a this year thing or a next year thing, but over time, we think that's probably likely to make the asset side of the balance sheet slightly more responsive, which in thinking about how the current cycle has evolved in 2022 and 2023 and this year, it's not a substantial change I think that we would want to make. It's a change on the margin. Because we're really doing that for periods that are highly unusual. If we look back over the 45- 50 years where we've got decent data, the periods when the curve has been inverted are relatively short.
In terms of liability mix, this is also something that we talked about, and this is something on the borrowing side we've been doing a little bit more attention, I think, as folks have read the financial statements to some of the Home Loan Bank option advances. But really, when we talk about liability mix here, we're talking about pushing out the duration of the Home Loan Bank book just a little bit, and the duration in the brokerage book, just a little bit. I think over time, we're likely to do a little bit more of that, particularly as right now, we get to capture the benefits of inversion as we move out.
It's not indefinite, but certainly as we go from six months to a year to 18 months to probably somewhere in the two to three-year point, we capture some benefits today, and we make the liability side of the balance sheet slightly less responsive. Looking forward, key challenges. There are more of them than last year, so the text is a little bit smaller. Credit quality, so you might think this is a little bit strange to see here, given the description of the portfolio that we talked about before, but the first thing I think about when I get into work in the morning is the loans. Very first thing I do after I'm on the system is look at the daily past due list. I want to see, is there anybody who's late?
To the extent that I don't sleep well and it has to do with business, it's always thinking about the loans. Credit risk kills banks. There are certainly exceptions to that. I think in the last year, we have seen a few of them. But over a long stretch of history, the bank killer, the real bank killer, is credit quality, it's loan quality. Because that's the thing that triggers issues elsewhere in a bank's financial statements. That continues to be, I think, a challenge. The environment that we see around us in terms of the commercial real estate markets is one where there are a lot of opportunities for us, but there are clearly a lot of difficulties that other banks are facing. We certainly can't imagine that we'll be immune to those forever.
And so that's something I think we're very attuned to. How do we look at those loans and identify incipient problems, issues that might be arising, the funding conditions? I think there's a couple of pieces here. First, the stabilization of the margin. This year has obviously been a very challenging and difficult year. We look back over the last probably three-plus to four years, we've seen relatively steady NIM compression. And at first, that was a product of lower rates during the period in COVID, as the asset yields were coming down, and then after that, it was a product of the repricing of the liabilities. Obviously, given the wholesale component of the balance sheet, our liabilities reprice more quickly and more in line with market.
One of the things that that means is that to the extent that we're at a point in time where short-term market rates have been relatively stable, for some period, and without speaking to any expectations about that, we certainly saw in the first quarter that that margin compression, slowed considerably and may be over. A very stable margin in the first quarter, and in particular, the liability costs, really are not moving in the way that they had moved over the last year. But mechanically, like a giant aircraft carrier. Although my understanding is the analogy. It is pricing it as loans come back to us, either on adjustment or maturity.
There's some work that we've done around certain covenants that we have in the loan documents, that again, has been, I think, out at the margin, no pun intended, but has been impactful in terms of moving loan yields. The movement in loan yields is slower than I would like, but it is simply a product of time. As we originate new loans and as the book reprices, that's going to come back to us. Borrowing strategies. I talked about this a little bit, moving out a little bit and capturing some of the inversions to the extent we can. We're able to do some of that in January. Of course, hindsight being 20/20, wish we had done a little bit more, but we continue to benefit from pushing the home bank out a little bit.
Rates that probably reduces our sensitivity somewhat, a very rapid decline in short-term interest rates, but not for very long. Just that immediate responsiveness that we might have seen in March or April or May of 2020 in COVID is a little bit diminished. Adjusting asset sensitivity, I think we've talked about. Commercial lending, so the team, the market conditions, the opportunities. Some of this, I think we can touch on in questions. We've got a great team in Boston and on Nantucket. Oh, Jeff is here. Hey, Jeff, from our Washington office. And that's the team that I continue to look to build exceptional and range of abilities there.
There have been a lot of banks over the last year that I think have gotten out of the business of lending in commercial real estate, and it is not a business that we are going to enter and exit in a Jekyll and Hyde-like fashion. There are reasons for that in terms of the relationships with our customers, but also in terms of our understanding of the collateral and our understanding of the marketplace. I think market conditions and opportunities, maybe I'll touch on in questions other than to say, I think we continue to see opportunities to originate really high-quality loans with strong borrowers, probably with better pricing and better terms than we did a year ago or two years ago. I think that's in large measure a function of a lot of the disruption in the market that we've seen.
Scaling SDG, this is the challenge of every year. The team, how do we invest in it? How do we find new relationship managers that are focused on clients in the way that we want them to be? How do we dial in the support model so that we're delivering on the proposition, service proposition for the clients? That's really important. And that's everything from opening to servicing those accounts. That's a real distinguishing factor between what we're doing, and the experience that clients have at other banks commercially. And it's an area where we, I think, do a very good job, but there's a lot of room for improvement. And it goes beyond just being friendly or a kind of generalized concept of service.
One of the banks that disappeared this last year, I think as folks may know, had exceptional relationships with their clients, a great deal of customer affection in some ways. And one of the ways that they did that was that they made banking disappear for their clients. Their clients wanted problems to be solved and solved quickly. And I think to the extent that we can make that service experience a frictionless one, those are investments that are worthwhile. Finally, Washington and San Francisco, which I touched on a little bit, really significant opportunities there that we need to figure out how to take advantage of and take advantage of more quickly.
And then finally, eliminating waste and process improvement. Again, a perennial task. You know, at 67 basis points last year, probably a little bit lower now of expense to total assets, and there is still quite a bit of room left for us to take waste out of the bank, and it's not cost-cutting, it's just the smart deployment of technology and being thoughtful about where we spend and about how we run processes. That takes us to the end.
We have some questions.
I think.
Were submitted in advance, and we can go down that list, and then entertain questions from the floor.
Okay. At the risk of countermanding you, why don't we start from the floor for one, and then-
Yeah, okay. That may wake people up more. All right.
Mostly, I just.
Go.
I just want a break from reading.
All right. Good. Let's go. Questions? Someone? Anybody.
I'm sure there are some good questions out there.
Yes, back there. We should hire that guy. Actually, he already works for us. Thank you. Thank you, Tyler. No, we didn't. Tyler's always got good questions.
Yeah, I'm pretty sure. And I'll apologize to the person to whom I was talking to about this before, because I'm gonna repeat a little bit of what I said. If you look back to. So first of all, we'll start at first principles. For those who don't know, the Federal Home Loan Banks, a system of government-sponsored entities. There's a number of banks across the country, they are member-owned, so the banks and insurance companies, their members capitalize them. They've existed for nearly 100 years now. They were the product of the Great Depression and some of the changes in the housing finance system in the United States.
Over, I would say, probably since the nineteen eighties, they have played a role in housing finance in the United States that has been the subject of, I think, some debate and disagreement. There are a number of different perspectives on the role that they play in the housing finance system and the way in which they relate to banks. I'll eventually get to your question, Taylor. I'm just gonna work through a little bit of the history, because I think it's important. The reason I say 40 years is really the savings and loan crisis in the 1980 s. There were some material changes in how savings institutions in the United States were regulated. The regulatory structure for the Home Loan Banks changed.
There was a significant involvement by the banks and a number of institutions in the nineteen eighties that failed that ultimately failed, and the product of that crisis was again a number of changes in how the Home Loan Banks were regulated. There has always been, I think, some degree of tension between the Home Loan Banks and their primary federal regulator, which is the Federal Housing Finance Agency. I'd say the prudential regulators in particular the insurer, the FDIC, and those that believe that the Home Loan Banks are drifting from or straying from their housing finance mission, and are adopting a role that is a lender of second to last resort, or maybe, let's just say, insufficiently focused on the housing mission.
And over time, those debates have emerged generally at periods where there has been some stress in the general banking system. So if we go back to 2008, 2009 , 2010 , the great financial crisis, there were very similar discussions about the role of the Home Loan Bank in the banking system, in housing finance. And they were probably, arguably more salient concerns in the sense that, the federal regulator needed to consolidate a number of the Home Loan Banks, because of asset quality issues on their own balance sheets. The bank in Boston, the Home Loan Bank that we're a member of, had a number of years that were difficult years.
They were no longer paying dividends on the membership stock, and they had stopped the redemption of membership stocks. So to the extent that banks had stock in the Home Loan Bank, they could no longer redeem that. And it was largely a product of a relatively large amount of private label MBS on the Boston Bank's balance sheet, where there were some significant asset quality issues. And so I tell all of that history or that story because I think what we see now is an echo of some of the underlying debates that have been going on for a long time. They tend to just surface like cicadas on a 10-year cycle. For folks that are interested in it, I'd highly recommend reading the report that the FHFA put out late last year, The System at One Hundred.
That was in progress before some of the relationships between, in particular, the Federal Home Loan Bank of San Francisco and a number of West Coast banks were highlighted in the press last year, Silvergate being first, in January, and then Silicon Valley Bank and First Republic. And I'm gonna be cautious how I express this, but I think there are folks in that coalition of interests on different sides of the debate about the structure of the system, that have probably been aggressive in terms of tying what happened at those banks to the behavior of the Federal Home Loan Bank of San Francisco or the system in general. The system was always intended as a lender of last resort.
At its creation, the savings banks were not members of the Federal Reserve at the outset of the creation of the Federal Reserve System, and so that really was a role the Home Loan Banks were intended to play by statute. I'd recommend reading that report. I think it gives some insight into the debates around the system. As those debates work themselves out, to the extent there are changes in the system, and I don't know how I would handicap the probability of those changes at this time. Some of those changes impact us in a negative way. Some of those changes would impact us in a very positive way.
And the reason I say that is that those differing interests that are pushing for the reform of the system, in particular, those that believe that the Home Loan Bank system has strayed from the housing finance mission. Much of what they're looking for, by way of reform, would be excellent for us. Because really, our balance sheet is focused on housing-related assets. It's primarily multifamily assets, which is buildings that have five or more units. And then beyond that, one to four family investment properties and one to four family properties that folks live in, mixed-use properties that have a residential component.
So our business, I think, is very closely aligned and is probably more closely aligned, at least when we've looked in the Boston region, with the housing purpose, the housing mission, than anyone else's. So I think a lot of those reforms, again, very early, hard to know how they'll play out, but I think could be of benefit to us. You know, more deeply discounted advances from the Home Loan Bank for multifamily assets, more deeply discounted advances from the Home Loan Bank for affordable multifamily, differential dividend payments. So all of the banks that are members at a Home Loan Bank that capitalize it in that cooperative structure receive currently dividends.
Those dividends are not differential, and there's been quite, I think, a push among some of the reform-oriented elements at the FHFA and publicly, that would like to see those dividends be paid on a differential basis in some way that's linked to the housing purpose of the member. So if you imagine that all the banks in the system have a level dividend now, and in the future, they adopted a system in which the dividend payment or rate depended on the extent to which you lent on multifamily and single-family homes, well, that would be just fine with me.
In terms of the long-term strategy of the bank and the role that wholesale financing plays there, I think we're likely to see some changes in the system, but I don't think they change the fact that the Home Loan Bank system is a critical source of housing finance for multifamily, for affordable and for singles, and is likely to remain so for a long, long time, and we're likely to continue to incorporate those borrowings or those advances as a pretty central piece of the business.
But I would say also, Tyler, to the extent—and I think your question related to recent restrictions on borrowing from the Home Loan Bank, limitations, and what our response to that has been. We have moved collateral from the Federal Home Loan Bank to the Federal Reserve Bank of Boston, so we actually have more off-balance sheet liquidity available today than we did a year ago. I think we've got off-balance sheet right now, undrawn, about $540 million with the Federal Reserve Bank and another $140 million undrawn with the Home Loan Bank. So we have shifted that around, and it's had. So it has had an impact to that extent, but it really just required our getting better at assigning collateral to the Federal Reserve Bank as opposed to the Home Loan Bank.
I think on that topic, we had a number of questions on borrowings, and I'm thinking that, maybe we could move through these all together and sort of jump off from where Taylor was. So this one you just touched on, borrowing availability of the discount window and the Home Loan Bank. So I think we've covered that. This is a good one. You know, they're all good. In interagency communication.
Some are better than others.
In the summer of 2023 , this is Christian Olesen , who was here last year. Following the banking turmoil of March of 2023 , the Fed and FDIC wrote the Discount Window should be part of bank's contingency planning. Have you noticed any change in how the Fed operates the Discount Window, such as the ease or speed of moving collateral to or from the Fed, or how the Fed or the FDIC talk about the Discount Window? So for folks that have looked carefully at the balance sheet, you know, we've had a small positioning of collateral Discount Window for a long time now in the HELOC portfolio. And periodically, every year, we have tested the Discount Window, as I think is prudent. We'll borrow a little bit, and then we'll just pay it right back.
Do we pay it back the same day, Christian, or do we let it sit overnight in the Fed account? Overnight. Yeah. So we pay a little bit of interest. And I think historically, a fairly low percentage of U.S. banks have done that. I think that was one of the things that Christian Olesen here was sort of pointing at some of the coverage of the discount window, and that was a real problem in March of 2023, when Silicon Valley and Signature, and to a lesser extent, First Republic, really Signature and Silicon Valley were, I think, more significant examples of this. They had not positioned a lot of that collateral.
And the Federal Reserve does a number of things for the banking system, and some of those things it does every day for every bank in terms of querying and settlement, our master account, in terms of wire system, the ACH system. And it does an incredible job at some very high volume, sensitive, no fail allowed tasks, clearing of check items in the United States for the most part, handled through the Fed. The discount window has historically not been something where, I think, the Fed invested a great deal of time and energy from an operational perspective. So when we borrow from the Home Loan Bank, and in talking about that, I'm talking about the entire life cycle.
The pledging of the collateral, the review of the collateral by the Home Loan Bank, the granting of availability, the technical process by which we borrow and repay. That is a business that the Home Loan Bank is in every day of the year, and it's something that they've gotten very, very good at. It's not a business the discount window is in. You know, for the most part, no one borrows from the discount window other than running a test, and for the most part, people don't do that or have not done that historically. I think one of the things that we've seen over the last year is a significant investment by the Fed in making the discount window easier for banks to access from an operational perspective.
So that's, again, the entire life cycle, the pledging of the collateral, the review of the collateral, and then the execution of the borrowings. And that is not the product of any unique or differentiated insight from us or our experience with them. It just seems to be true, given the pressure coming, I think, from the Fed and the FDIC. It does seem like from an operational perspective, when we have run tests recently, the Fed is running those tests for a lot of other folks. So it does seem like there's been a shift in the industry, and that's been reflected in the operational practices at the Fed.
There's some discussion publicly about probably for much larger banks, requiring some use of the discount window on more than a test basis periodically to, as the saying goes, destigmatize the use of the discount window. But I don't anticipate that that will apply to us, given our size. This one was an important one, too. Taylor Finch. Taylor had some questions last year. Could you describe the movements in the rate paid on your Federal Home Loan Bank borrowings? The rate paid was.
4.68.
He's the young one. 4.68% in the first quarter, substantially less than Fed funds. The rate paid historically had been at a slight premium to Fed funds from the first quarter of 2022- 2023. The increase in rate paid closely matched the increase, but the cost of these borrowings leveled off substantially after the first quarter of 2023. What's the driver of this leveling off and the persistent discount? So in looking at the, financial statements, there is a portion of our Home Loan Bank borrowings that beginning, in early 2023, and over time, this has increased and decreased, and we've moved some things around and adjusted certain things within it, that are in the form of Home Loan Bank option advances.
The basic structure of those advances is that they have somewhat more duration, and the Home Loan Bank retains the option to call that funding back from us after a specified lockout period. Could be three months, could be six months, could be longer. We started doing that in early 2023, when we started to see that the likely endpoint of this cycle would be above the four hundred basis points that we typically modeled as the outside range of a negative scenario. We had some concern that rates could remain higher for some period of time. In retrospect, we probably would have liked to have done this thing on a fixed rate basis without the option component a little bit earlier.
But I think as we discussed last year, the window for doing that was probably about six to nine months before that, and it was a brief one. And I'm not sure whether, in retrospect, we could have known that that was the window and those were the steps to take. But the reason, Taylor, that you see that change is that a significant portion of our borrowings there are in that Federal Home Loan Bank option advance structure. And as those are called, we make decisions on whether to replace them or take that funding and roll it short at a higher rate. And so that drives that delta. I think that covers it on borrowings. There's one that was very similar to what we already touched on. Do we have other questions?
Anyone? Connor.
San Francisco. For those of us who know the market by reading the newspaper, what's something that's either overlooked and, or nuanced or underreported to all over the market?
So I would suggest that for those that know the market by reading the newspaper, I'd highly encourage you to follow the work of Heather Knight at The New York Times, who runs their bureau office out there now. She's a long time writer for the Chronicle and moved to The Times last year. Just, I think, a phenomenal chronicler of what's going on in the city, and I think a very fair one. Not a total booster. I think a lot of her writing has captured some of the challenges that the city faces. And I think the characterization of the office market in San Francisco that you get from reading popular press is a fair one.
That's a very distressed market, particularly downtown and really more than downtown in Mid-Market in SoMa. There are some particular sub-neighborhoods in the city where the distress in that office market, the characterization you read of it is fair, and in some ways, maybe insufficiently weak. It might be worse. I think that the characterization of the city with respect to public safety, with respect to business activity, I think those are areas where an informed, critical, fair consumer of popular press probably is not getting a fair picture of what's going on in the city. I think that particularly over the last year and a half, those challenges still exist, but they are much more contained in geographic scope than you'd think from reading the papers.
And I think the other thing that I would say is that we hint a little bit about this. I think I included something in the annual report. The governance challenges in San Francisco are significant ones, but it does seem like over the last two years, there have been some real changes. And I think this is probably the product of some of those public safety issues a few years ago, where the balance and I hesitate to get into politics, but I do think this is important given the governance in the city. The balance between maybe what we'll say centrist or moderates and progressives has changed.
And I think that in terms of housing supply, in terms of some of the basic governance of the city, in terms of making it a place where businesses are likely to continue to locate, I think there has been a swing back of the pendulum a little bit. But can't recommend Heather's work enough. I think it's fantastic.
Still an incredibly wealthy portion of the country. I think the rents certainly, but have essentially recovered close and have certainly stabilized. So for our small multifamily, typical product, I think it's a strong market. And I think we have some competitive opportunities there. As Patrick mentions frequently, First Republic was a very different bank out there than it was here. We never saw them as a competitor in the multifamily market here in New England, but in the San Francisco Bay Area, going down the peninsula, they did almost every other multifamily and so forth. And obviously, that they're not going to be servicing that market in its current configurations. Some real opportunity there.
I, I think on that point, we had a question from, from Adam Mead . How much of a threat or headwind is JPMorgan Chase in the San Francisco Bay Area market in terms of capturing loan volume? Can you talk about how our strategy has, hasn't changed considering JPMorgan's takeover of First Republic? I think one of the things that I talked about last year, I was clearly incorrect about, was the rapidity with which we might be able to exploit some of the challenges in San Francisco after First Republic's failure. I don't think I was wrong about the substance, but I do think I was wrong about the timing.
And in part, that was because, when JPMorgan Chase acquired First Republic, in May of last year, I think they were wise to not immediately start to merge the bank into sort of the big bank of JPMorgan. That was true on the deposit side. It was true on the loan side. I think they were initially careful about the relationship that they had with staff at the bank. And I think the product of that, probably across all the markets, certainly in San Francisco, was that we didn't see kind of a wholesale fragmentation of the customer base and the team, at least early on. I think over time, JPMorgan, obviously, I think, an outstanding bank in a number of respects, but also very large.
I think it has been difficult for them to retain a lot of the best staff. There are a number of folks that have joined us that are phenomenal. I don't want to speak for them. And there are a number of folks that we continue to have conversations with coming from First Republic, where the client focus that had made that a place that they enjoyed working was less present at JPMorgan Chase. The ability to solve problems for customers was diminished. And over time, the natural friction that customers have, it started to increase as they were dealing with JPMorgan Chase itself.
And now that we're a little over, a little under, I apologize, but almost exactly a year, I think it was May first, from the acquisition, I think we're starting to see some of those trends accelerate in a number of different ways. I think that's true in the lending business. I think there are probably other reasons for that, Adam, but I think one of the things that we see is that there are customers who, very difficult for them to get answers. I mean, it's just they don't their banker might have moved on. It's hard for the replacement contact to navigate the bank.
So I think we're gonna continue seeing more of that in terms of lending customers, in terms of deposit customers, and in terms of folks that would be interested in joining our team, and we would have an interest in speaking to. Having said all of that, JPMorgan Chase is a ferocious competitor on small multifamily. That's true across all the markets, and it's, I think, likely to continue to be true in California, where they had a substantial presence even before the acquisition of First Republic. You know, if it had been up to me, probably would have preferred that someone else bought First Republic.
But we play the cards that were dealt, and given our size relative to the size of the markets that we're talking about in Boston or in San Francisco, First Republic was never present in Washington materially. I don't think it materially impacts what we should be able to do with customers and with teammates.
A lot of questions on buybacks, Pat.
Yeah. So Edgar, Robin, Christian, Jack, these are all written in slightly different ways, and so I'll pick the one that is most concise, which is: What is your reasoning for and against doing stock buybacks? So I think if we went back all the way to this slide. In the past, we've talked about how these options that we list as attractive are not necessarily in order. Organic growth, minority equity investments, repurchases, dividends. It's probably worth noting that the first two options are in some ways substitutes. Obviously, we don't have a $4 billion equity portfolio, and so they're not pure substitutes. But the first two options are both capital allocation options in which capital is retained in the business and invested in something.
It might be in the balance sheet, so it might be capital that's leveraged in the form of deposits and borrowings and deployed in the form of loans, or we don't do this, but potentially fixed income securities. Or it's retained in the balance sheet, it's not leveraged, and it's invested in an equity position in another company. It could be public, it could be private. And then the second two options, dividends and repurchases. The first, obviously doesn't change the share count, and the second does. So I think it's kinda helpful to start with the lay of the land in terms of what we're talking about. These are all options that should be thought of, I think, together, because there are businesses where the first two options are probably inappropriate.
So we have some investments and have had some investments over time in our public equity portfolio, where they run a great business, they have a particular niche. I'm talking about banks, if it's not obvious. They operate in maybe a rural market where they have substantial market share. They have a relatively low cost of funds, and they've got excellent credit quality because they understand what they're doing. There are some examples like that in urban markets as well. There's one that comes to mind, but they have not deployed those earnings back into the business. And they haven't done that because they don't perceive there are additional incremental lending opportunities, and so they return it to the owners, either through dividends or repurchases.
So I tell that story because all of these things, you know, we're comparing one to another, and we're thinking about, at any given time, what can we deploy in the lending business? What does the loan quality look like? What does the pricing on that lending business look like relative to our funding costs? What do we think we would reasonably provision for, for credit losses, which is always been more than our actual loss experience over time, but I think it's still prudent to do that. What does the incremental expense on that deployment of capital look like on that incremental growth in the lending business? Then what kind of return on equity do we get from that? And there are periods of time where that will look very attractive. There will be periods of time where it looks less attractive.
And the attractiveness of it also probably needs to be measured in retrospect, which is to say that we need to fund those assets for a number of years. The funding of those assets is somewhat uncertain. We make some assumptions about that, some of which we know because of the structure of the balance sheet, some of which we don't. And at the end of that process, we have some sense of what is the return on the investment of incremental capital look like in the business? A couple of years ago, we talked about this thought experiment where we actually pile up all the earnings all year long, and then we make one decision at the end of the year. Do we put it back in, or do we return it to the owners in some way?
And I think that also helps clarify this question and how we would think about that. When it comes to repurchases, the basic math of it is, I think, fairly simple to the extent that we're repurchasing, not just at a discount to tangible book, but at a discount to what we think the earnings capacity of that dollar of book value per share would be going out two or three years. Because remember, when we repurchase, the remaining shareholders have the benefit of that, not just in that first year, but in the second year and then thereafter. And we take those two things and compare them. There's a little tweak, which is that we have some tax disadvantages because we don't have a holding company, but those have become less material over time.
And, there would be some tax penalties for the first $2, $3, $4 million. There's a specific number. I think it's about $2.6 million or $2.7 million of repurchases, where effectively the price we're paying is twice whatever we would pay in the market. Over a longer period of time, that's obviously less likely to be material given the size of the balance sheet. And we look at the return on that, we look at the return on the incremental investment, and we compare them.
I think we continue to believe that in the current environment, the incremental return on the lending business that we're doing, given the pricing that we're obtaining on it, even if we were funding that at market rates, and even if we were assuming that we were match funding it with two or three-year money in the wholesale markets. Those returns are fairly attractive right now, and they continue to exceed what we think the return would be strictly from repurchasing. So I think that sort of speaks to what is the thought process that we're going through when we do that.
I think it's also important to note that because we don't have a holding company, any repurchases would be something that we would need to obtain regulatory approval for, and that's something that periodically we've done in the past and had authorizations from them. But it adds a different angle, whereas organic reinvestment in dividends and minority equity investments don't have that dimension. But it really is a question of what generates superior returns over time for the owners. Anything from the room? Go ahead.
Permission to count.
Go.
In the 10th year, let's say, repurchases today, the loans originally are more economical than they are. Those loans can take off. And say, I assume the assumption that I'll forever own more if I don't sell anything. How does the current pricing environment of loans in the tenth year or twentieth year, or that exists in 50 years from now? But today's decision on.
Yeah. So I got a sign at the back of the room that told me to repeat the question on the microphone, the folks that are on the video. And I apologize, Derek, but I don't think I'm going to be able to do that. I'll try and summarize it, and if I unfairly summarize it, speak up. I think the essence of Derek's question was that thinking about the comparison between repurchases and compounding out indefinitely over time, whereas the returns from incremental growth, those ones. I think, approve in one respect, in a sense. Those individual loans will be repaid. Whereas purchase asset.
I think that the thing to remember is that if we were in the bond buying business, that would absolutely be true, because the impact of making that loan and the spread, the impact of buying that bond and the spread between that bond and our funding costs, less our expenses, times our leverage, would be the return we would have during that period. I think when we think about the relationships that we build with customers, as we make loans, we also gather deposits. And as we make loans, we lower the cost of making the next incremental loan.
Because if we've lent you money on your first three-family, and then your second three-family, and then your third three-family, and your fourth three-family, and now 15-20 years later, you're one of our largest borrowers, and we don't have a loan that's larger than $2 million, and you own a substantial portfolio, Somerville, or Dorchester, or whatever, deposit banking for you and for your family companies. I think it's not simply that it's the production cost of the next loan, it's the deposit funding. So we have a little bit of pitter-patter rain in one of the speakers in the room here. So in thinking about the returns from that growth, I probably feel it's not just that piece of business, it's the impact that that has on the next piece of business.
We've gotten better over time at assessing that in terms of whether this is likely to be real relationship business over time or more transactional. I think there's room for improvement there, though. Was that a fair accounting of your question?
Okay.
Yeah, and I think they do. So if we were to look at the largest relationships we have from a credit and deposit standpoint, they tend to be very long-standing. Their relationships with individuals where we've banked them, we've banked their family over a longer period of time, and I think we're likely to continue banking them over a longer period of time. You know, there are a number of families where we've seen at least one or two generational transitions. And when we do that, I'd love to do more of that, but when we do that, that business is particularly profitable because we tend to have every aspect of that customer's banking business. Maybe not every loan, there's something that goes elsewhere because it doesn't fit with what we have, but we have the core deposit relationships.
And we have, I think, a sense from a credit perspective over time, that those borrowers know what they're doing. And that's not something that's measured quantitatively. It's a little bit more Kentucky windage, but I don't want to name the individual customers. I'm trying to hold back on that, but there are customers where, based on a long track record of experience. You know, we're still very focused on the assets, but we have a lot of confidence in their ability, in their kids' ability to manage these assets and run them profitably. And when we think about the cost to acquire, the cost to underwrite, the cost to put those loans on the books, and the cost to service those loans, all those different costs fall when we have better information about our customers.
And so I do think in comparing those two things, one of the things that we're getting by being engaged with the specific types of customers that we're engaged with in the markets that we're engaging them in, with respect to multifamily, is that we're lowering, in some ways, our future costs of doing business with them. Whether from a credit standpoint or from a sort of back-office, non-interest expense standpoint. You know, we're still doing all the things that we need to do, but if I were to think about a loan tha. Again, we're not gonna talk names, Sean. But I'm thinking about one relationship where every deal we've done with this individual and their family, they all look very similar.
The buildings.
The buildings. Oh, yeah. I mean, it.
Same paint.
It's the same paint, it's the same trim, it's the. And delivers a phenomenal product for his tenants, and his kids are involved, and he's a great long-term customer of the bank. And there's gonna be a loan proposal. We're gonna look at it, the executive committee, we're gonna kick it. We're probably not gonna look well. Now, we're gonna look at it at the board in that instance. We're gonna run third parties. We're gonna appraise that piece of collateral. Probably we're not gonna have environmental, given what he does and where it is, but we're gonna send it to our attorneys, we're gonna structure it. It's gonna be the same docs that we do a 200-unit building with. So there are no shortcuts there.
But on the other hand, it's probably a five to 10-second conversation between Sean Sullivan , who's sitting in the back here, who manages that relationship, and my dad or myself. You know, "So-and-so is looking at this property. It's on this street. It's next to the other one that you did. You remember?" "Yeah, I remember that building." "Here are the base economics, basic economics." "Yeah, that sounds right. Okay, let's do it." And that was the whole thing, and that went right back to the customer. And it didn't take any longer than the way that... Honestly, it's probably much more efficient than me prattling on for five minutes on this topic. And I think there are real benefits to that. Yeah, I think there could be a.
Can you ask me to repeat the question?
Okay, I can't read.
So the counter to the counter was. And again, tell me if I'm being unfair here. Is there a situation in which we could do both A and D at the same time? Is that fair?
Yes.
I think there is.
Correct.
And for the folks at home, Derek said that was a fair answer. Okay. We're getting out of time. We got a little bit. So a couple of lending-related questions, to touch on. So this one we could do real quickly. Approximately how much has loan pricing measured as the spread over SOFR or relevant interest rate benchmarks for new CRE loans changed over the last one-to-two years? And it has probably been the case that the spreads that we're achieving over the underlying rates have increased over the last one-to-two years. I think that's true in the market. I think there's probably. There's at least two reasons for that, and then we'll move on to some other things.
One is that traditionally, everyone has priced off the belly of the curve, so has priced against a five-year treasury or home loan bank advance in pricing their multifamily loans. As the curve is inverted, that spread to that point on the curve has been insufficient. So I think one of the things that everyone involved in the business has done is see spreads expand, and they're doing that because they need to capture back to the inversion, and then they need to account for credit and their own profitability. So I think those spreads have increased for that reason. I think they've increased because the competitiveness of the market has changed. Particularly in the last year since we last met, there are more banks that have simply said, "No mas," on commercial real estate.
I think that means that for particular types of situations, I think we see this particularly on some office to residential conversion or some of the situations in which customers are attempting to bridge from an office property to a residential conversion, and maybe they're not permit ready, but we can handicap the risk of entitlement permits. In that area, in particular, I think there's also been some expansion spreads because there's just less competition. You know, there are fewer folks that are lending there, and they hear commercial real estate, and they're not interested, or they hear office, and you could be lending on the White House, and the loan committee would say, "No." But I think a really good question.
So, another one: Could you offer more detail on your office loan book? Are there any areas of that book you've identified challenges? What mitigants do you see? We talked a fair bit about this last year. Fortunately or unfortunately, things at Hingham don't change very quickly. I'm not sure that I have a great deal to offer incrementally over that conversation last year. You know, our office book has about 100 loans in it, between $400 million-$500 million. It is more urban than not. It is not sort of classic investor non-owner occupant office towers or big buildings. We have a number of large owner occupant office loans with nonprofits.
We have a number of office loans with very long-term leases, with federal government tenants, that have substantial term left on them, and substantial doesn't mean 24 months instead of 12. We have a number of office buildings that our customers have purchased that are uniquely located relative to the tenancy. There's one that I think we featured this in our annual report. I think it's a great example. It's an office building in Alexandria, Virginia, it was purchased by one of our clients from Brookfield, a large real estate asset manager. And the building in question is physically and functionally integrated with the courthouse for the city. So the building was developed at one time, and it's two separate locuses, loci.
But functionally, those buildings are integrated, and they share a common parking garage. So when we think about the headwinds to office, the tenancy in that building is principally attorneys. And attorneys whose practice puts them into that courthouse each and every day. Well, they're not working remotely, and they're not downsizing. These are not firms that have several hundred thousand sq ft that they've leased. There is a reason that property works, and you have to put your hands on the building and understand the real estate and go see the dirt to know that. If that was not the case, and it was a mile away, and it had a similar rent roll, I'd think about the property very differently.
So a lot of, a lot of buildings where the use is a particular one, a lot of owner occupants. We see a lot of occupancy in the portfolio. We are not seeing, I think, the issues that we've seen in the industry generally. And we have a lot of very strong borrowers. I use the word borrowers deliberately, because in the lending business, you'll often hear the phrase sponsor. And I don't really know what sponsor means. It doesn't appear in any of our legal documents. It generally doesn't involve any obligations of repayment or performance. But in the instances that I'm thinking of, I mean, our largest office loans, we face large national nonprofits, and we face them directly. They're not sponsors, they're borrowers.
So over the last year, we really have not seen problems in that book. We have not seen any late payments. We have not seen any delinquency. We've certainly not seen any non-performance without beating the dead office building. We've not seen any charge-offs. So thus far, you know, I think that we feel that our borrowers have positioned themselves appropriately and the leverage that we've extended them has been appropriately conservative in office. And if anything, I think we've seen over the last year opportunities to help our borrowers take advantage of some of those challenges. Whether that's the. It is less frequent that they're acquiring office buildings at a discount, at a very low basis and running them economically.
It's more frequent that we're seeing acquisitions of office buildings for conversion, particularly in Washington, D.C., although more recently, we've started to see that in Boston as well. I think to the extent that that use makes sense and it makes sense of the property, and we have a strong borrower, and we're at a basis that's very protective for us. That's business that we really like doing, and so, Taylor, in terms of the challenges, I think we see more opportunities there, particularly with our borrowers that are they're in the apartment building business, owning, operating, developing. I think they're seeing opportunities. They're starting to materialize, and we're I think happy to participate in that, especially when so many banks are not. Anything else in the room? Sir.
Yes, I was not at last. Notice, losses are always important and subjective. I wonder if you still work with them.
Marty, do you want to touch on it or Brian, and then I'll touch on it as well?
The critical audit matter there illustrates the role of the rule for the auditor to identify such kind of testing financial statement.
So we're talking about the critical audit matter in the opinion. So in response to the PCAOB rule to do so, and as you indicated, the allowance for loan loss is a significant part of most every bank. So in last year's opinion, the 2022 opinion, you will also see that particular item. It was tailored specifically this year to incorporate the adoption of ASC 326 CECL. So the wording is slightly different, the concept is the same. So it's designed to point it out and give the reader a little bit more color commentary as to how the auditor approached it.
Bill, I want to thank you for that question. That's the first time in my 32 years of doing annual meetings that the CPAs have ever had to answer a question. So that's good. That's right.
Thank you, Bill.
Thank you, Marty.
And I think, Marty, if I get this wrong, or Brian, the chair of the Audit Committee, please, correct me. I mean, I think a critical thing to note there, no pun intended, is that the methodology by which we calculate the allowance for loan losses or the current expected credit loss, the reserve, to make it more simple, is always a critical issue for the auditors every year. And it's not a question of criticism, it's simply that is the most sensitive and really the most significant estimate in the financial statements. To the extent that we have cash, we have cash. Their valuations are not Level 3, they're not product of complex modeling or estimates.
That the amount of money that we have lost on the loan book is by necessity an estimate, because we haven't actually lost any of it. Can I say that, Marty? Okay. We haven't lost it yet. We're under CECL. I'm not sure I could say that either. We haven't actually charged off anything. So that estimate of those losses is that estimate of processes is always something that's at the top of the agenda with Wolf.
So the theory changed the behind the calculation bill, and everybody spent a lot of time changing their internal processes, and lo and behold, people came out with roughly the same numbers. And I don't want to hesitate to say that. I do want to hesitate to say that the work involved was substantial, both internally in terms of the auditors, but whether the result is a more accurate depiction of anything, I have my doubts.
So I think we can touch on one or two more. There's one that I think is important here, and it's a more general question. And this was from Robert Van Voorhis . Robert, I apologize if I didn't pronounce your name correctly. Given the bank's liability sensitive model, how do you think about the competitiveness of the bank in higher interest rate environments relative to its competitiveness in lower interest rate environments? Does the actual level of interest rates make a difference to competitiveness, or is it just the changes in interest rates that matter for the bank? I suppose that I think about it this way: Most banks prioritize spending on branches and various operating expenditures to attract low-cost deposits with hopes that they gain competitive advantages from a lower cost of funds.
Whereas, and please correct me if I'm wrong, Hingham focuses on reducing operating expenditures with hopes of gaining a competitive advantage on lower relative operating expenditures. In effect, the goal is to lower the total cost of making loans, that is the cost of funds and operating expenses. And most banks try to do this through optimizing the former, whereas Hingham is optimizing the latter. Said less thoughtfully than Robert put it. I, I think the question goes to, what does the relative performance of the book, the bank look like in a so-called higher for longer interest rate environment? And I think it's an important question, because it goes to whether the ability of the bank to generate returns in the mid-teens is something that's simply a function of very low short-term interest rates.
Occasionally heard from some that they believe that to be true. I think that's clearly not true. If we look back over the last 30 years, if we looked in five-year segments or 10-year segments, there has been a production of returns in the teens, sometimes high, sometimes mid, sometimes low. Occasionally below ten, in the inversion years in the mid-2000s, and certainly last year, as well. And so there's been differences over time, but in a number of different interest rate environments, where short-term rates were high, were low, were somewhere in between. The bank was able to deliver those returns over time. It was impacted, in particular, by volatility at the short end of the curve. So that was a problem.
If we look at 2006 and 2007, clearly been a problem in the last 18 months to 2 years. But the core, I think, competitive advantage, to the extent there are any competitive advantages in banking, which as we've previously discussed, is, it's kind of a dreadful business, in the sense that it's, it's very competitive. There's no protection of intellectual property. There's no. We're not a sole supplier to anyone. To the extent that those advantages don't exist, and it is largely a business in which people are taking price on both sides, I think over a longer period of time, the ability to take cost out will be a driver of returns, whether interest rates are low or high. And that's true even if short-term rates remain high.
That obviously, I think, makes the path towards mid-teens profitability a different one than if we were to see some change at the short end of the curve. But I think over a longer period of time, it is not something that depends on shorter short-term rates. To the extent that if we look at short-term rates and we look at the five-year point on the curve over a long period of time, the average positive spread has probably been somewhere between probably around 125 basis points, give or take a little bit. And on that, we layer on two hundred basis points to account for cost and credit, maybe a little bit more, depending on the environment, and net of cost, paying taxes levered ten times to keep the math easy.
You see a return that's in the mid-teens. And that is true, whether short-term rates are close to the zero bound as they were for a long period in the teens, or quite a bit higher as we saw in the aughts or in the late 90s. And to the extent that we are considerably more efficient now than we were five years ago, than we were 10 years ago, than we were in the early aughts when there was a period of what we could say was higher for longer. When we were nowhere close to the zero bound. To the extent that we're considerably more efficient now, I think that that positions us really quite well.
We have, I think, real doubts that over a longer period of time, the spread between the market price for money and the price that banks pay is likely to persist. So in a higher rate environment, higher rates for longer so-called environment, our market rate funding, we're paying what we're paying on it. There is no catch up there, there's no catch-up beta. But the gap between that and what we see out in the environment is a significant one. I think that we have not seen a higher for longer rate environment in which there was the ease of switching, there was the transaction cost that we see now in terms of searching for alternatives, in terms of opening new accounts. Consumers that may have stayed put in prior rate regimes like that are looking at alternatives.
And when they're looking at alternatives, I think that we're well positioned for that. And because of our cost advantages, we can absorb that. As we've seen over the last two years, in a very difficult period, but we have also done mid-single digit returns on equity. And last year was actually quite a bit higher. And so I am not as pessimistic about that. I don't think that the model requires low rates. It does require some positive spread. That is important. Whether that's achieved by changes at the short end or the long end, over time, it doesn't matter. In the short run, obviously, I'd obviously prefer it to probably be achieved in both ways.
But structurally, I don't think it's a challenge, and I think the cost advantage is something that everyone will need to develop. Because the competitiveness for that low-cost funding is gonna continue.
It does take us till 4:00 P.M. It takes us to 4:07 P.M., a little longer.
You know, for folks that remember the meeting in 2020, it was entirely with the exception of the two of us in our boardroom. In 2021, we, I believe we met again in person, and in 2022, and in 2023. We've experimented with different formats for this meeting, in the room, questions in advance, questions via a live chat. That was challenging, so we discontinued that. One of the things that we'd also done over time is collect those questions to the extent that we thought that they were unanswered, put them in 8-K and answered them there. Did that in 2021.
I thought we would do that last year, but when I went back to the office and sat down with all the questions, I found that the essence of most of what was kind of we had covered in the meeting, so ultimately did not. We made the judgment into that since I committed and fell short last year. But I think there are some good questions here that when we go back and sit down, we may answer in a supplemental. Because there are some good questions that we haven't covered.
I'd also add, Patrick, that, you know, this annual meeting, we've gone a little over two hours today. And I know that, that is a lengthy period of time, but this is a business that we take very seriously, and we're really pleased that we have significant shareholders who come to the meeting, travel some distance. Hopefully, the dialogue is a fruitful one and provides some insight, both to the folks that are physically here and the folks that are online. I mean, we look forward to the dialogue. We look forward to as high a degree of transparency as is possible. I know some of our professionals that are with us today, I'm sure, have a significant experience attending various annual meetings. This is probably a longer one.
But, as I say, we take the business very seriously, and we appreciate your participation and the thought that you put into so many of those questions. I'm very pleased with the format, and thank you, Patrick, for the presentation. Thank you everyone else for the questions and participation. Thank you.
Yeah, everyone, there are some folks that have traveled quite a ways to be here. Some folks that are repeat visitors, some that are new. Yeah, as I think everyone knows, there are a lot of folks who have been here since the beginning. Yeah, I don't think we think of ourselves as bankers. We think of ourselves as owners first. It certainly is true of our family. And we came to Hingham under some difficult circumstances. Circumstances in which management and ownership were not fine. Could have been. And we've certainly been to some annual meetings. There's one that I can think of a number of years ago, where we showed up at the bank, at the address and proxy notice, and it was the bank's main office.
The folks that were there were lovely. They were very confused as to why we were there. They asked whether we had meant to attend the lunch. We were very confused. What lunch? It was 2:00 P.M.
We didn't get an invitation to lunch.
We had not got an invitation to lunch. In this instance, it was the bank's practice to have a luncheon at a lovely venue with two dessert courses, actually. Afterwards, they would hold the shareholder meeting, publicly traded bank, by the way, with just the board at the bank's main office in the boardroom. The staff shuffled us downstairs to the break room, and we had some coffee. About thirty or forty minutes later, the CEO and Chairman showed up and explained things and explained to us that the shareholders didn't actually attend the shareholder meeting. They attended the lunch. Which we made sure to be at the lunch the next year. I tell this story. I ate several macaroons.
I made sure that it was worth our while. I tell the story because for us, you know, for that institution, shareholders, owners, were something to be kept at bay, and for us, we think of ourselves as shareholders and owners first. So we really enjoy this, and we love doing it. I really appreciate everyone who's traveled here. I love the questions, and the more difficult, the better, Derek. Next year, maybe we'd go three or four rounds.
Yeah.
We'll get you your own microphone next year. I won't have to repeat the questions, so again, I really appreciate everyone coming, and I thank you for your participation, and your interest, and your ownership here in the bank.
Thank you, everybody.