Hanmi Financial Corp Q4 FY2020 Earnings Call

Ladies and gentlemen, welcome to Hanmi Financial Corporation’s Fourth Quarter and Full Year 2020 Conference Call. As a reminder, today’s call is being recorded for replay purposes. At this time, all participants are in a listen-only mode. Following the presentation, the conference will be opened for questions. I would now like to introduce, Lasse Glassen, Managing Director at ADDO Investor Relations. Mr. Glassen, the floor is yours.

Thank you, Operator, and thank you all for joining us today. With me to discuss Hanmi Financial’s fourth quarter and full year 2020 earnings are Bonnie Lee, President and Chief Executive Officer; Anthony Kim, Chief Banking Officer; and Ron Santarosa, Chief Financial Officer. Ms. Lee will begin with an overview of the quarter, Mr. Kim will discuss loan and deposit activities, and Mr. Santarosa will then provide more details on our operating performance. At the conclusion of our prepared remarks, we will open a session for questions. On today’s call, we may include comments and forward-looking statements based on current plans, expectations, events, and financial industry trends that may affect the company’s future operating results and financial position. Our actual results could be different from those expressed or implied by our forward-looking statements, which involve risks and uncertainties. The speakers on this call claim the protection of the Safe Harbor provisions contained in the Securities Litigation Reform Act of 1995. For a list of certain factors that may cause our results to differ from our expectations, please refer to our SEC filings, including our most recent Form 10-K and Form 10-Qs. In particular, we direct you to the discussion of certain risk factors affecting our business contained in our earnings release, our investor presentation, and our Form 10-K. This afternoon, Hanmi Financial issued a news release outlining our financial results for the fourth quarter and full year of 2020, along with a supplemental slide presentation to accompany today’s call. Both documents can be found in the Investor Relations section of our website at hanmi.com. With that, I will now turn the call over to Bonnie Lee. Bonnie?

Thank you, Lasse. Good afternoon, everyone. Thank you for joining us today to discuss Hanmi’s 2020 fourth quarter and full year results. In spite of ongoing challenges arising from the COVID-19 pandemic, Hanmi finished the year with a strong fourth quarter driven by excellent loan production, stable net interest margin, and powerful non-interest expense management. Throughout the pandemic, we have remained focused on helping our borrowers and depositors affected by the crisis, and I am pleased to report that these efforts have been very successful in protecting the value of our portfolio. Looking ahead, our solid balance sheet and capital position, coupled with our strong loan and deposit franchise, gives me confidence that we will deliver profitable growth as we remain cautiously optimistic that the economy will continue to improve. With that as a backdrop, the following are our results and some of the key financial and operational takeaways from the fourth quarter and full year. We reported net income of $14.3 million or $0.47 per diluted share, up from $0.10 per share in the fourth quarter last year. For the full year, net income was $42.2 million or $1.38 per diluted share, an increase of nearly 29% from 2019. Fourth quarter pretax pre-provision income was solidly higher on both a linked quarter and year-over-year basis and benefited from sharply lower interest expense arising from our lowering of deposit costs. New loan production during the fourth quarter was a strong increase of 28% compared with the prior quarter. For the full year 2020, loan production increased 29%, aided by our participation in the PPP program from 2019. As a result of this growth over the past year, loans receivable were up 5.9% year-over-year. Net interest margin of 3.13% held steady from the prior quarter as the reduction in deposit costs offset the declining yield on earning assets. Throughout the year, we were successful in protecting net interest margin despite the increasingly competitive pricing we faced for loans and deposits. We continue to benefit from our strategy emphasizing low-cost deposit generating activities. In fact, nearly 90% of the growth in total deposits this past year came from non-interest-bearing DDAs. As a result, non-interest-bearing demand deposits increased to 36% of the total deposits, up from 30% a year ago. I am very pleased with the results of our ongoing focus on carefully managing non-interest expense, which declined nearly $7 million or 5.4% for the full year 2020. And finally, the Bank remains very well capitalized; Hanmi’s regulatory capital ratios remain very strong, and we are well positioned to continue growing in a safe and sound manner. Moving to asset quality, I continue to be quite pleased with the positive trends that we are seeing in our modified portfolio. In the initial phase of the modification program, first round requests for modifications reached $1.4 billion or 29% of the loan portfolio at the end of the second quarter. In the next phase of the program, second round modifications declined 59% to $579 million at the end of the third quarter, or approximately 12% of the portfolio. As of December 31st, third round modifications declined again by 73% from the prior quarter to $156 million or approximately 3% of the portfolio. As of year-end, 87% of our modified loans are in modified payment status. For all subsequent requests beyond the initial modification, we have completed detailed reviews of the borrower’s financial condition. In some cases, we have required additional credit enhancement, and some loans have been downgraded to special mention or classified. Throughout the pandemic, we have maintained a commitment to proactive asset management and helping our borrowers weather the crisis, while minimizing future charge-offs. Looking at other elements of asset quality, criticized and non-accrual loans increased in the fourth quarter, reflecting, as I noted, our proactive asset management practices. Approximately 75% of our non-accrual loans represent just eight loan relationships over $2 million or more, and we anticipate that several of these will be positively resolved in the first quarter with minimal or no loss. At the end of the year, our allowance for credit losses was $19.4 million and stood at 1.97% of loans excluding PPP. We also had an allowance for off-balance sheet items of $2.8 million and a $1.7 million separate allowance for losses on accrued interest receivable for loans modified under the CARES Act. Taken together with our strong capital position, strong pretax pre-provision earnings, and asset management practices, I am confident we will weather the effects of the pandemic well. Before turning this call to Anthony, I would like to provide an update on several initiatives that we will be focusing on in the coming year that are designed to provide our customers with additional products and services, further diversify our sources of revenue, and safely drive profitable growth. Our new residential mortgage platform will be focused on originating non-qualified mortgages, warehouse lending, and retail mortgages. Production is ramping up with the goal of our residential loans representing 10% to 15% of Hanmi’s loan origination activity in 2021. Additionally, we have rolled out our new digital banking platform, which will initially focus on opening new accounts and online deposit gathering activities. Throughout the year, we plan to expand the digitization of our banking platform to more efficiently scale our services while providing a more convenient and seamless customer experience. Finally, I am pleased with the result of our Corporate Korea initiative, as we nearly doubled the loan and deposit balances contributed by this program during 2020, and we expect to accelerate our efforts in 2021. Here, we are focusing on developing and expanding relationships with Korean companies domiciled in the United States. We currently have a Corporate Korea test in seven strategically located branches, and at year-end, this effort had contributed nearly 10% of our total loans and 8% of total deposits. Looking ahead, we expect our Corporate Korea program to continue generating new loan production and new deposit relationships. With that, I would like to turn the call over to Anthony Kim, our Chief Banking Officer, to discuss the fourth quarter loan production results and deposit gathering activities. Anthony?

Thank you, Bonnie. Hanmi generated solid loan production volume totaling $327.8 million in the quarter, up 27.8% from the prior quarter’s volume of $256.6 million. We experienced growth across all major categories, with the exception of SBA loans. More specifically, fourth quarter production consisted primarily of $187.1 million in commercial real estate loans, $71.4 million of commercial and industrial loans, and $27.5 million of SBA loans. Rounding up fourth quarter production was $39.8 million of commercial equipment leases, nearly doubling third quarter new lease production. New lease generated loans and leases for the quarter had a weighted average yield of 4.11%. This compares to the previous quarter's weighted average yield of 4.57%. Of note, commitments under commercial lines of credit increased nearly 15% from a year ago to $588 million. However, balances on these lines fell by $12 million quarter-over-quarter at quarter-end, reflecting a four-quarter utilization rate of 42.7%. During the fourth quarter, Hanmi sold $21.6 million of SBA loans, generating a gain on sale of $1.8 million. I was pleased with our execution in the quarter as SBA trade premiums increased to 10.09% in the period. Fourth quarter payoffs of $160 million remain elevated compared with the level experienced in the past recent quarters. The weighted average interest rate of loans that paid off in this period was 4.44% or 33 basis points higher than the weighted average yield of new production in the quarter. The solid loan production in the quarter, in conjunction with the loan payoffs, resulted in loan receivables of $4.8 billion at the end of fourth quarter, up 4% on an annualized basis from the prior quarter and up 5.9% from a year ago. Hanmi remains committed to conservative discipline underwriting criteria. For the commercial real estate portfolio, consistent with asset quality data from prior quarters, the weighted average loan-to-value and weighted average debt coverage ratio as of the end of the fourth quarter were 48.6% and 1.9 times, respectively. In light of the economic disruption caused by the pandemic, we expect to maintain more conservative underwriting standards, which include limiting origination activities within certain high-risk industries and closely monitoring the economic impact on our customers over the near-term. Now, I would like to provide an update on our hospitality portfolio, the segment of our portfolio most affected by the pandemic. As of December 31st, hospitality loans totaled $907 million or 19% of Hanmi’s total portfolio. Our hospitality loans are conservatively underwritten. The average loan balance is just $3.3 million, with a weighted average debt coverage ratio of 2 times and a weighted average loan-to-value ratio of 50.3%. At year-end, hospitality loans comprise $124 million or 78% of the modified portfolio, down 72% from $441 million at September 30th. Of the $124 million of modified hospitality loans as of year-end, we were able to secure a payment reserve as additional collateral on $52.5 million or more than 42% of total amounts. Overall, we believe COVID-related risks are manageable, and we continue to work with our hospitality customers to help them through the crisis and return to normal loan payment schedules. Moving on to deposits, we remain very pleased with the strength of Hanmi's deposit franchise. Total deposits were $5.28 billion at the end of the fourth quarter, compared with $5.19 billion at the end of the preceding quarter, representing a 1.6% quarter-over-quarter increase. For the full year, deposits grew 12.3%. Importantly, we saw an improving mix shift of deposits as higher-cost time deposits declined throughout the year and were replaced with non-interest-bearing demand deposits, which comprise the vast majority of our total growth in deposits during the year. As a result of our fourth quarter loan production and deposit gathering activities, our loan-to-deposit ratio was 92.5%, compared with 93.1% in the prior quarter.

Thank you, Anthony, and good afternoon all. Let’s begin with pretax pre-provision income for the fourth quarter, with net interest income of $46.9 million, non-interest income of $7.8 million, and non-interest expense of $30.9 million. Pretax pre-provision income was $23.8 million, up 4.1% quarter-over-quarter when we adjust the fourth quarter for the $1 million benefit associated with the litigation settlement. Fourth quarter pretax pre-provision income benefited from higher net interest income and higher non-interest income. Looking at net interest income, we posted $46.9 million, up 2.8% from the prior quarter. Driving the increase was a reduction in interest expense, which fell 19% or $1.8 million due to lower rates paid on interest-bearing deposits. This was partially offset by lower interest and dividend income, which declined by 0.9% or $500,000, reflecting lower prepayment penalties and a modest decline in average yields on loans. Turning to net interest margin for the quarter, it was the same as the prior quarter at 3.13%. The average yield on loans for the fourth quarter was 4.34%, down 8 basis points from the third quarter. However, the average rate paid on interest-bearing deposits dropped 23 basis points to 64 basis points. Our net interest margin also benefited from the continued shift in deposit mix, with higher costs and time deposits declining by 4.1% and lower-cost money market and savings accounts increasing by 11%. As Anthony noted, the weighted average interest rate on new loan production for the fourth quarter was 4.11%, slightly below the average yield posted for the quarter. However, we expect the average rate paid on time deposits will decline again as higher rate maturing deposits renew into lower rate time deposits. As a result, we anticipate our net interest margin to remain at about the same level. Non-interest expenses were $30.9 million in the fourth quarter, up slightly from the prior quarter, primarily due to the change in other real estate owned and repossessed personal property activity. Notwithstanding this modest increase, the increase in revenues helped our efficiency ratio improve by 120 basis points to 55.53% in the fourth quarter from 56.73% in the prior quarter. Our credit loss expense for the fourth quarter was $5.1 million. It included a provision for loan losses of $5.7 million, a negative provision for off-balance sheet items of $2.9 million, and a $2.3 million provision for losses on accrued interest receivable for loans previously or currently modified under the CARES Act. Looking to the balance sheet, our allowance for credit losses increased to $90.4 million from $86.6 million after the provision of $5.7 million and net charge-offs of $1.9 million. Included in the allowance for credit losses were allowances for credit losses associated with individually impaired loans. While the macroeconomic conditions continue to improve, we continue to assess the risk factors associated with the pandemic, and these risk factors, together with an increase in specific allowances for and an increase in individually impaired loans, led to an increase in the allowance for credit losses. Our return on average assets and our return on average equity in the fourth quarter were 0.92% and 1.01%, respectively. Finally, our tangible book value per share increased to $18.41 at the end of the fourth quarter, and our tangible common equity ratio remains strong at 9.13% as to all of our regulatory capital ratios. With that, I’ll turn it back to Bonnie.

Thank you, Ron. As I noted at the beginning, we remained focused on helping our borrowers and depositors affected by the pandemic. We also remain equally focused on our communities and the health and well-being of our employees; without those we could not have succeeded. Overall, I am very pleased with our performance against the challenging backdrop of COVID-19. Our solid finish to the year demonstrates the durability and resilience of the Hanmi franchise. As such, I am confident as we look ahead to a new year that we have the ability to emerge from the pandemic, well-positioned to drive profitable growth and value for our shareholders. I look forward to sharing our continued progress with you when we report our first quarter for 2021 results in April. Thank you.

That concludes my prepared remarks. Operator, we would now like to open a call for questions.

Thank you. Our first question is from Matthew Clark with Piper Sandler.

Hey. Good afternoon. First question was just around the margin. Ron, do you happen to have the amount of PPP-related income on a net basis that helped NII and how much is left?

For the fourth quarter, net interest income or interest income, I should say, from the PPP activity was $1.8 million, a little change from the third quarter at $1.7 million. We did have a level of forgiveness, but they were small balance loans, $50,000 or less. So that really didn’t change the contribution for PPP in the fourth quarter as compared with the third quarter.

Any amount you have left just over in the ballpark?

We initially had about $303 million, and by the end of the year, that number was down to $296 million. We still have some progress to make.

Okay. Got it. And then regarding the hotel portfolio, are you identifying any opportunities to sell hotels in the current environment? I learned about another bank last week that managed to sell some hotels at par and I’m curious if you would consider something similar.

Sure. And that is a possibility, and time to time we have interested buyers as well.

Okay. And then just on the ACL 1.97% I believe, 1.97% ex PPP, is the expectation that you’ll probably continue to build reserves kind of incrementally as you see maybe some additional migration from criticized into non-accrual, or do you feel like we’re at a point where we might be peaking and we can start to release a little bit maybe next year or this year, I’m sorry?

What you will find, Matt, is that there was a shift in the allowance for credit losses, with a larger portion assigned to individually impaired loans and a smaller portion being more general. If you compare the third quarter to the fourth quarter, you will see a reduction in one category and an increase in the other, leading to a net increase of about $5.1 million, which isn't significant. As we move through the first, second, and third quarters, we will examine the broader impacts of the macroeconomic conditions. Assuming those conditions improve, attention will turn to the specific circumstances within the portfolio. Yes, it may result in a negative provision. I tend to be more conservative, some might say pessimistic, but this is a possibility I expect may come into play, though I believe it will be more towards the latter part of 2021 rather than the beginning.

Okay. Can you share your updated thoughts on capital return, specifically regarding the possibility of a buyback, considering the stronger earnings and the ability to cover the dividend? Is this a realistic option for the upcoming quarter?

So as we’ve mentioned in our previous calls, the Board does take up the dividend and capital each quarter. They will do so again here shortly. And the decision with respect to dividend and share repurchase, I’m sure, will be known soon.

Okay. Regarding the tax rate, it looks lighter this quarter. Should we anticipate it to be around 30% or possibly a bit lower moving forward?

No. As you said, on a quarter, Matt, the tax rate will vary around the 30%. But as you see, we finished the year at around the 30%. So barring any changes in the tax law, I think, 30% is still a fairly good target effective tax rate.

Hi. Thanks for the question this afternoon. Okay. Well, I know it’s still early, but with losses, do you have an idea of the general ballpark of kind of what you’re expecting at least in the coming year? And also, if you have what the specific reserve was that component of the reserve ratio, that would be helpful?

To address part of your question, Kelly, the specific allowances at the end of the year were $14.1 million, an increase from $3.7 million at the end of the third quarter. I identified impaired loans at about $91 million at year-end, compared to $69 million at the end of the third quarter. Regarding charge-offs, this quarter is approximately $2.1 million, if I recall correctly. I believe that figure represents a somewhat regular pattern. The first quarter of this past year was marked by a specific troubled loan relationship, and we experienced a favorable recovery in another quarter, leading to a significant event. Therefore, aside from any specific credits that may arise occasionally, I would suggest that the fourth quarter and the second quarter of last year are likely to reflect normalized figures. We are still trying to better understand the long-term effects of the pandemic, which are two data points I would consider.

Great. With regards to the hotel portfolio, how much of it currently falls into the special mention and criticized non-performing loan categories? Additionally, I noticed in your slide deck that much of what's left concerning modifications in Texas seems affected by a larger loan or are there just several credits in that market facing challenges? Thanks.

I will try to answer first part of the question. Total downgraded, special mention and classified category is about $86 million and then Texas loans kind of center into three or four loans there in Texas represent a higher percentage of the modification. Does that answer your question?

Sorry, I was on mute. When you mention four loans in Texas, are you talking about the hospitality segment loans on slide 13 or just in general?

In hospitality.

Thanks for filling me in. Couple of questions. First on SBA, obviously, fourth quarter production was a little bit lighter there than it had been or was in the third quarter. What should the expectation be for early 2021 that were up in the second round PPP might negatively affect demand for SBA or maybe just, probably, what are you seeing in terms of demand today?

I think it would be useful to provide an overview for 2021. On average, we expect to produce around $30 million to $35 million quarterly. In particular, for the first quarter, we have a strong pipeline of SBA loans and plan to book them during that time.

Okay. All right. Thank you. And then on the time deposit side, even with the shift of the mix of deposits, I think, it’s still near 25% of total deposits that you are in. Can you maybe walk us through, maybe some of the CD maturities over the next few quarters, maybe give us a sense of how much more you think you would want to try to work out of the Bank or into different deposit buckets versus renewing?

Yeah. We have about a little over $260 million maturing in the first quarter at 1.44%. So, historically, our retention ratio is about 70% to 75% of the CDs. In 2021, I think, a little over $900 million is maturing. So I would say, we’ll retain about 70% of that at a lower rate between 0.4% or lower.

Thanks. What was that last part in terms of the rate?

We will likely be able to re-price at 0.4% or lower.

Okay. Great. And then last question is that the $2.3 million provision for losses on accrued interest receivable. Was that effectively a loan that was on full payment deferral, so the interest was capitalized? But then after the deferral period, collection of that what integrator doubt? Is that the capital of that?

No. So what we did is we looked at all the loans that were modified, either formally modified or currently modified under the CARES Act. So, if you recall, I think, as Bonnie mentioned, we started off at about $1.4 billion, we’re down to about $156 million. So we looked at where we were in the collection of all of that interest, recognizing that some of those borrowers maybe downgraded further or moved to non-accrual and so we did an assessment to determine what are the potential losses for that pool. So it’s not related to a specific loan. It is related to that pool of loans that were at one time modified or currently modified. So think of it as a general allowance, not a specific allowance to a specific credit.

Great. Thanks for the color.

Thank you.

Yeah. Thank you. Afternoon, everybody. Bonnie, I want to follow-up a bit on the residential mortgage origination business. And I apologize if you’ve talked about this on previous calls, but it’s been a really busy year. Has that program already started up?

So we spent our fourth quarter setting up the platform, and then we did a little bit of a production in the fourth quarter, not meaningful, but starting with this quarter, the department will kick into gear and they will go with full production mode.

Okay. Okay. Well, do you have any kind of idea on when you might be hitting full speed on that? Is it like mid-year or sooner?

Yeah. We definitely should be in full gear soon.

Okay. And did you say that you expect that to be 10% to 15% of originations?

Yes.

Hi. Thanks. I want to follow up on loan growth, what are your expectations for loan growth this year? And I know there’s clearly some moving pieces with the PPP forgiveness both on Round One and new PPP loans coming on with Round Two, but what are your thoughts on loan growth this year?

So I think excluding the new PPP program, I would expect the 2021 loan growth to be low-to-mid single-digit growth.

Great. Okay. And then shifting to back to the hospitality portfolio, it’s good to see the overall portfolio seeing that the modifications come down the way they have, and looking at slide 13, it is nice to see that most of the loans are in the non-modified category at this point. Is this due to better operating performance or are the sponsors writing more checks if needed for their properties, or is it a combination of both?

I believe our borrowers are generally performing at or above industry standards for hospitality owners. Early on, the PPP programs have been beneficial, and the upcoming PPP programs we are anticipating will also provide support.

Got it. And then the last question is about the Corporate Korea initiative. Thank you for the details regarding the loans and deposits. I was wondering if these are primarily in your existing Southern California market, or if they are on a national scale, allowing you to target Korean domiciled companies regardless of their location for these loans and deposits.

So, there are Corporate Korea companies all over the United States, particularly the automobile sectors are in Georgia and Alabama area. But pretty much in terms of Corporate Korea companies, they are in major U.S. cities or states.

I see. So there is 10% of loans and 8% of deposits that you guys have it is kind of across the U.S., is what you are saying?

Correct. Correct. But, yeah. And then larger contribution is obviously from California and somewhat Texas area, Texas, Georgia area. But, yeah, it’s pretty much made up within national footprint.

Thank you for listening to Hanmi Financial’s fourth quarter and full year 2020 results conference call. We look forward to speaking with you again next quarter. All right. Thank you, again, ladies and gentlemen. This does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a great evening.