Earnings Call Transcript - HAFC Q2 2021

Operator, Operator

Ladies and gentlemen, welcome to Hanmi Financial Corporation's Second Quarter 2021 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 a presentation, the conference will be open for questions. I would now like to introduce Lasse Glassen, Managing Director at ADDO Investor Relations. Please go ahead.

Lasse Glassen, Managing Director

Thank you, operator, and thank you all for joining us today. With me to discuss Hanmi Financial's second quarter 2021 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 then 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 the session for questions. In 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 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 second quarter of 2021, along with the supplemental slide presentation to accompany today's call. Both documents can be found in the Investor Relations section of our website at hanmi.com. I will now turn the call over to Bonnie Lee. Bonnie?

Bonnie Lee, President and CEO

Thank you, Lasse. Good afternoon, everyone. Thank you for joining us today to discuss Hanmi's 2021 second quarter results. Hanmi delivered another strong performance in the second quarter highlighted by a sharp increase in loan and lease production, growth in deposits, improving credit quality, and significant earnings expansion. Our strong operating momentum, coupled with a significant pickup in business activity as economies in our markets reopen, has Hanmi poised to continue driving solid results in the second half of the year. Today, we reported net income for the second quarter of $22.1 million, or $0.72 per diluted share. Net income increased 33% from the first quarter and over 140% from a year ago. Our second quarter earnings reflect strong revenues and controlled expenses as well as the recovery of a credit loss expense from improving asset quality. Our loan production remained quite robust in the second quarter with a single-quarter record when excluding PPP loan origination. Excluding PPP loans, our loans grew 2.5% from the first quarter. Deposits were also up 2.2% from the prior quarter and similar to recent past quarters, growth came from non-interest-bearing DDAs that now represent nearly 42% of our total deposits. Next, I would like to provide an update on our modified portfolio and the encouraging trends we continue to see as we emerge from the pandemic. At June 30th, loans modified under the CARES Act declined 38% from the first quarter to end the second quarter at $72.3 million, representing just 1.5% of loans. We continue to stay in close contact with these borrowers, who remain affected by the pandemic to work on mutually beneficial solutions. Moving on to other measures of asset quality, and further demonstrating our asset management practices, I am especially pleased to report that we successfully resolved $12.4 million of filling tax credit loans without any loss to the bank. We have now seen non-accrual loans decline by more than 50% since the end of 2020. Even more encouraging, we are beginning to see loan upgrades, including loans moving from classified to special mention to pass. A year ago, we faced tremendous uncertainty and the hardship of the pandemic. While the challenges of the pandemic continue, I believe Hanmi's commitment to proactive asset management has significantly helped both the borrower and the bank. Balancing these positive and encouraging trends with prudence, our allowance for loan losses stood at 1.78% of loans excluding PPP. We also continue to have a separate allowance for possible losses and accrued interest receivable for loans currently or previously modified under the CARES Act, now down to $0.7 million. As a result of our conservative allowance and strong capital position, I am confident we are well positioned to manage asset quality as we emerge from the pandemic and the economy continues to reopen. With that, I would like to turn the call over to Anthony Kim, our Chief Banking Officer, to discuss the second quarter loan production results and deposit gathering activities. Anthony?

Anthony Kim, Chief Banking Officer

Thank you, Bonnie. During the second quarter, Hanmi generated excellent new production volume, totaling $466 million in the quarter, up 33.8% from the prior quarter's volume of $348 million. Growth was driven by strength in CRE loans, residential mortgages, C&I loans, and strong lease volume, partially offset by lower production of SBA loans, which benefited from $131.5 million in second draw of PPP loans last quarter. Altogether, excluding the impact of PPP loan production in previous periods, loan production in the second quarter was an all-time record for Hanmi. Looking at the loan production in more detail, second quarter production consisted primarily of $186.1 million of CRE loans, $66.6 million of residential mortgages, $99.4 million of C&I loans, and $42.6 million of SBA loans. Rounding our second quarter production was $70.9 million of commercial equipment leases, which returned to levels we were seeing prior to the pandemic. Newly generated loans and leases for the quarter, again excluding PPP loans, had a weighted average yield of 3.74%. I'm also pleased to note that commitments under commission lines of credit expanded by $100 million or nearly 17% from the prior quarter, to $705 million. Balances on these lines increased by $17.1 million compared to the prior quarter, reflecting a second-quarter utilization rate of 39.1%. Next, I would like to provide some additional color on our new residential mortgage platform and corporate Korea initiative, both of which are continuing to generate momentum and contribute meaningfully to our results. Beginning with our new residential mortgage platform, second quarter lending activity included approximately $67 million of residential mortgages, along with $63 million of warehouse lending. In addition, new commitments on the warehouse lines of credit have increased to $110 million as of the end of the second quarter. Looking ahead, we expect residential mortgage production will continue to ramp up during the year with a goal of residential mortgage loans comprising 10% to 15% of Hanmi's loan origination activity in 2021. We continue to be pleased with the results of our corporate Korea initiative, which is focused on banking Korean companies with a presence or offices in the United States. Year-to-date, corporate Korea loan production totaled $87 million, and at quarter end corporate Korea loans comprised 11% of our total loans with a very strong pipeline entering the second half of the year. We continue to expect the corporate Korea program to generate double-digit growth in loan production in 2021, along with a meaningful contribution in deposits. Finally, overall business activity in many of our key markets has picked up nicely as the economies in key markets are reopening and this has resulted in a very strong loan pipeline for Hanmi. As such, loan production should remain robust and grow solidly in the second half of the year. Loan payoffs in the second quarter of $264.8 million included $140 million of PPP loans. Non-PPP loan payoffs were in line with the levels experienced in recent quarters. The weighted average interest rate of the loans that paid off in the period excluding PPP was 4.25%, or 51 basis points higher than the same adjusted weighted average yield of new production in the quarter. The solid loan production in the quarter, coupled with the loan payoffs and sales, resulted in loans of $4.82 billion at the end of the second quarter, up 2.5% from the prior quarter, excluding PPP loans. Our underwriting continues to be very disciplined. The weighted average loan-to-value and weighted average debt coverage ratio of our CRE loan portfolio as of the end of the second quarter were 48.7% and 1.9 times respectively. Both metrics were essentially unchanged quarter-over-quarter. Moreover, we continue to intend to limit origination activities within certain high-risk industries that were most impacted by the pandemic. As I've done throughout the course of the pandemic, I would like to provide an update on our hospitality portfolio, which has been, the loan segment that was impacted by COVID-19. As of June 30, hospitality loans declined by about 5% from the prior quarter and represent 18% of our loan portfolio. Our hospitality loans are conservatively underwritten. The average loan balance remains at just $3.2 million with a weighted average debt coverage ratio of 2 times and a weighted average loan-to-value ratio of 50.1% at origination. At quarter end, 12% of the hospitality portfolio was criticized, with approximately half of these loans stemming from metropolitan-based properties. However, we have obtained current appraisals for these properties in the last 12 months, and the current weighted average loan-to-value of all the criticized hospitality loans was 68.0%. Nonaccrual hospitality loans represent only 1% of its portfolio, with only two loans over $3 million. We continue to believe that our exposure to the hospitality segment and the associated risks are manageable. Turning to deposits, Hanmi had another strong quarter. Total deposits were $5.63 billion at the end of the quarter compared with $5.51 billion at the end of the preceding quarter, representing a 2.2% quarter-over-quarter increase and an 8.1% increase from a year ago. Similar to recent prior quarters, we continue to benefit from an improving mix shift of deposits as much of the growth is being driven by non-interest-bearing demand deposits. The key drivers of the increase in DDA during the quarter came from a combination of new deposit relationships and growth from introducing larger accounts, which included a significant inflow from existing corporate Korea accounts. In fact, as Bonnie noted earlier, DDAs now represent nearly 42% of total deposits, up from 36% a year ago.

Ron Santarosa, Chief Financial Officer

Thank you, Anthony, and good afternoon all. I would like to begin with net interest income. As we reported, our second quarter net interest income of $49.6 million increased 7.8% from the prior quarter, and our net interest margin of 3.19% increased 10 basis points as well. Looking deeper into our results and setting aside the effects of PPP loans and the benefit of non-accrual interest, we would see that net interest income increased approximately $1.8 million quarter-over-quarter, essentially representing a higher volume of liquid interest-earning assets and the benefit of lower cost and interest-bearing deposits. Turning to our net interest margin, adjusted in the same fashion, we would see about a seven basis point decline quarter-over-quarter as the benefit from the fall in the cost of interest-bearing deposits was more than offset by the higher levels of lower-yielding securities and interest-bearing deposits at the Federal Reserve Bank. Again, as we reported, we did see a 2.5% increase in loans for the second quarter after adjusting for PPP loans. As Anthony mentioned, we anticipate loan growth in the second half of the year, albeit at modestly lower yields. Altogether, we anticipate that this mix shift in liquid interest-earning assets will continue to dampen net interest margin and continue to keep it in the low 3s. Moving to our non-interest income of $8.9 million, we saw our traditional SBA trade premiums rising to 12.55% for the second quarter compared with 10.66% in the first quarter, driving our gains on sales higher to $3.3 million. At the end of the second quarter, traditional SBA loans held for sale were $21.9 million. Loans held for sale also included $14.1 million of Second Draw PPP loans that we sold early in the third quarter for a gain of approximately $300,000. Service charges, fees, and other income remained consistent quarter-over-quarter. Non-interest expenses were $30.8 million for the second quarter, essentially flat with the first quarter after adjusting the first quarter for $1.4 million of capitalized costs from Second Draw of PPP loans. Our efficiency ratio improved to 52.66% from 52.92% for the prior quarter. Pulling this all together from a pre-tax pre-provision perspective and adjusting for the effects of Second Draw of PPP loans as well as certain other items, we saw a pre-tax pre-provision income of $27.4 million, up solidly from the first quarter. Our second quarter results also included a $3.3 million recovery of credit loss expense. This was comprised of a $4.1 million negative provision for loan losses, a $0.5 million reduction in our allowance for accrued interest receivable for current or previously modified loans, offset partially by a $1.3 million positive provision for off-balance sheet items. Looking to the balance sheet, our allowance for credit losses decreased to $83.4 million from $88.4 million, and the coverage ratio excluding PPP loans also declined to 1.78% from 1.94%. Overall, we believe our allowance for credit losses adequately reflects various economic forecasts as well as the heightened levels of near-term uncertainty as we continue to emerge from the pandemic. We will continue to closely monitor and evaluate the evolving economic environment and update our loss allowances accordingly. Our return on average assets and return on average equity for the second quarter were 1.38% and 14.91% respectively. In addition, our tangible book value increased 3.7% to $19.27 per common share at the end of the second quarter, and our tangible common equity ratio remains strong at 9.01% as do all of our regulatory capital ratios.

Bonnie Lee, President and CEO

With that, I'll turn it back to Bonnie. Thank you, Ron. Hanmi has enjoyed a record-setting second quarter that kept up the very strong performance throughout the first half of 2021. I am very pleased with our expanding loan production, improving asset quality, and most importantly, robust earnings growth. I'm very proud of the tremendous efforts of the entire Hanmi team, without whom our success would not be possible. As we look ahead to the second half of the year, the momentum that we have built combined with a significant increase in business activity as the economies in our key markets reopen has Hanmi well-positioned to drive continued strong results in the second half of the year. I look forward to sharing our continued progress with you when we report our third quarter results in the fall.

Lasse Glassen, Managing Director

Operator, that concludes our prepared remarks. We'd now like to open the call for questions.

Operator, Operator

Thank you. Ladies and gentlemen, we will now begin our question-and-answer session. [Operator Instructions] Thank you. Our first question comes from Matthew Clark with Piper Sandler. Please proceed with your question.

Matthew Clark, Analyst

Maybe first Ron on the core margin outlook, I think you said down seven basis points in the upcoming quarter. Is that on a reported basis or on a core margin basis?

Ron Santarosa, Chief Financial Officer

That would be on a core adjusted basis. So, if you look at the benefits that we received in the second quarter from PPP loans and the non-accruing loan interest capture and reduce the first quarter for the same ideas, you'll see that the net margin is down about seven basis points. So, first it was on an adjusted basis 3.13%. We're down 7% from that.

Matthew Clark, Analyst

Okay. I thought you were talking about the upcoming quarter. My apologies. Okay. And then you have the average PPP loan balance in the quarter?

Ron Santarosa, Chief Financial Officer

For the quarter? Just give me a minute.

Matthew Clark, Analyst

I'm guessing it's about $190 million but -- if that's right.

Ron Santarosa, Chief Financial Officer

For the quarter, looking for the averages here we go 254,435.

Matthew Clark, Analyst

Okay. Okay. And then shifting gears to -- on the deposit side of things do you happen to have the spot rate on deposit costs at the end of the quarter?

Ron Santarosa, Chief Financial Officer

So cost of deposits. I believe we're within about two to three basis points from the average for the previous quarter. So we'll continue to see the benefit of the time deposits repricing lower. But that rate of change has become very, very small quarter-over-quarter now like if you measure from the first to the second and probably to third.

Matthew Clark, Analyst

Okay. Got you. And then what are your thoughts on the expense run rate from here?

Ron Santarosa, Chief Financial Officer

Again I think, very happy to see both first quarter and second quarter when you adjust the first quarter for the cost capitalization from Second Draw of PPP, about the same, that $30 million idea. So, I continue to see it running at that same level with just little bumps here and there potentially offsetting each other for inflation or for some other activities. But the $30 million sounds about right to me.

Matthew Clark, Analyst

Okay. And did you guys buy back any stock in the quarter? And what are your thoughts about the buyback going forward?

Ron Santarosa, Chief Financial Officer

So we had no share repurchases in the second quarter, and we understand where the market is today. And so we have very active discussions with our Board of Directors on our capital actions whether it's share repurchase or dividend. So that will be taken up again here in the third quarter.

Matthew Clark, Analyst

Okay. Thank you.

Operator, Operator

Thank you. Our next question comes from Tim Coffey with Janney. Please proceed with your question.

Tim Coffey, Analyst

Thank you. Right. Bonnie, Anthony I wonder if you can kind of give me a little more idea on the pipeline for the residential mortgage product. The growth we're projecting for the second half is pretty strong and was strong in this quarter. I'm just kind of wondering, if you can tell me where you're getting the successes from.

Anthony Kim, Chief Banking Officer

Yes. We spent a couple of previous quarters setting up the corresponding lenders and warehouse lenders. So the increased production came from both retail and corresponding lending. So as during the for the past for the next two quarters, both retail and corresponding lending will ramp up.

Tim Coffey, Analyst

Okay. Okay. And then Ron just not to dig too deep into this but it seems like the kind of the goal going forward is to focus on growing NII while trying the best you can to manage margin. Is that about right?

Ron Santarosa, Chief Financial Officer

Yes.

Tim Coffey, Analyst

Okay. All right. Those were my questions. Thank you.

Ron Santarosa, Chief Financial Officer

Thank you.

Operator, Operator

Our next question comes from Gary Tenner with D.A. Davidson. Please proceed with your question.

Gary Tenner, Analyst

Thanks, my questions have mostly been answered but just wanted to ask about the commercial real estate production in the quarter in terms of what kind of sub-segments you're seeing in most of that production?

Anthony Kim, Chief Banking Officer

It came from mostly industrial properties, as well as multi-family and office properties occupied by credit tenants.

Gary Tenner, Analyst

Is that primarily in California? Or are you getting any growth out of your other markets?

Anthony Kim, Chief Banking Officer

Right now only California, as well as some from Texas area and New York area.

Gary Tenner, Analyst

And then with regard to the PPP sales, do you plan to sell additional PPP prior to forgiveness or repayment?

Ron Santarosa, Chief Financial Officer

Our sales to date have been the Second Draw of PPP. So everything that we've originated we've sold. With respect to first draw of PPP, we've been using the forgiveness route. But as that windows down, we will take a look at what's there to decide if there's anything elsewhere to expedite the finality of the program but for the most part first draw of PPP has been through the forgiveness process.

Gary Tenner, Analyst

Okay. So the small amount of PPP loan sales you mentioned early in the third quarter is all that's currently --

Ron Santarosa, Chief Financial Officer

All second -- those are all Second Draw.

Gary Tenner, Analyst

Right. Okay. All right. Thank you.

Operator, Operator

[Operator Instructions] Our next question is from Kelly Motta with KBW. Please proceed with your question.

Kelly Motta, Analyst

Hi, good afternoon, everyone. I apologize, if this has already been asked I accidentally fell off the call for a little bit. But I was wondering if there was any comment on the CRA exam? And Ron, from what I can tell from the expense commentary, it doesn't seem like there's going to be any additional costs associated with that. But maybe any color around cost of compliance with that. Thank you.

Bonnie Lee, President and CEO

Sure. So we don't believe that we will incur any significant additional cost other than what's normally expected.

Kelly Motta, Analyst

Okay. Thank you. That’s all. All my other questions were asked and answered. So thanks so much for having the questions.

Bonnie Lee, President and CEO

Thank you.

Operator, Operator

Thank you. Our next question comes from Jason Stewart with Jones Trading. Please proceed with your question.

Jason Stewart, Analyst

Hey, good afternoon. Thanks for taking the question. I wanted to ask you about what your thoughts were on the residential mortgage market and the changes at FHFA? And perhaps how that changes the opportunity set that you see in residential mortgage? Thanks.

Anthony Kim, Chief Banking Officer

Well, actually we've been focusing on the non-QM products not on the FHFA side. So that's not going to affect us much. But then on the payoff side, I've seen elevated levels of payoff because of the rate environment.

Jason Stewart, Analyst

Okay. But in terms of the fact that we might move the credit box a little bit wider, what products do you think make the most sense for Hanmi and make the most sense for the GSEs going forward?

Anthony Kim, Chief Banking Officer

Well, with a low rate environment, with a 30-year fix under 3%, as I said, the product that makes sense for us is non-QM products, which range about 3.75% to 4.25%. So we'll continue to concentrate on that selling the product.

Jason Stewart, Analyst

Okay. Appreciate. Thanks.

Operator, Operator

Thank you. There are no more questions at this time. I would like to hand the call back over to management for any closing comments.

Lasse Glassen, Managing Director

Thank you for listening to Hanmi Financial's Second Quarter 2021 Results Conference Call. We look forward to speaking with you again next quarter.

Operator, Operator

Thank you, ladies and gentlemen. This does conclude today's conference. You may disconnect your lines at this time and thank you for your participation.