Earnings Call Transcript - HAFC Q3 2024

Operator, Operator

Ladies and gentlemen, thank you for welcome to Hanmi Financial Corporation's Third Quarter 2024 Conference Call. As a reminder, today's call is being recorded for replay purposes. Once again, as a reminder, this conference is being recorded. I'd now like to turn the conference over to Ben Brodkowitz, Investor Relations for the company. Thank you. You may go ahead.

Ben Brodkowitz, Investor Relations

Thank you, Matt, and thank you all for joining us today to discuss Hanmi's third quarter 2024 results. This afternoon, Hanmi issued its earnings release and quarterly supplemental slide presentation to accompany today's call. Both documents are available in the IR section of the company's website at hanmi.com. I'm here today with Bonnie Lee, President and Chief Executive Officer of Hanmi Financial Corporation; Anthony Kim, Chief Banking Officer; and Ron Santarosa, Chief Financial Officer. Bonnie will begin the call with an overview. Anthony will discuss loan and deposit activities. Ron will provide details on our financial performance, and then Bonnie will provide closing comments before we open the call up for your questions. Before we begin, I would like to remind you that today's comments may include forward-looking statements under the Federal Securities Laws. Forward-looking statements are 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 may differ materially from those contemplated by our forward-looking statements, which involve risks and uncertainties. Discussion of the factors that could cause our actual results to differ materially from these forward-looking statements can be found in our SEC filings, including our reports on Forms 10-K and 10-Q. In particular, we direct you to the discussion of certain risk factors affecting our business contained in our earnings release, our investor presentation, and in our Form 10-Q. With that, I would now like to turn the call over to Bonnie Lee. Bonnie? Please go ahead.

Bonnie Lee, President and CEO

Thank you, Ben. Good afternoon, everyone. Thank you for joining us today to discuss our third quarter 2024 results. I am pleased with our overall performance this quarter as we delivered strong results, including solid performance across our core operating metrics. We made meaningful progress in executing our growth strategy by further diversifying and expanding our loan portfolio and deposit franchise. Once again, our results demonstrate the value of our relationship banking model, which continues to differentiate Hanmi in the marketplace. While focusing on growth, we also exercised disciplined expense management, maintaining a nimble cost structure that positions us well to navigate key market conditions. In addition, we continue to employ rigorous underwriting standards and credit administration practices to ensure we maintain excellent asset quality over the long term. In a few minutes, I'll come back to the actions we took this quarter that demonstrate our proactive approach to monitoring our loan portfolio. Now let me review some highlights of the third quarter. Net income was $14.9 million or $0.49 per diluted share. Our return on average assets was 0.79% and return on average stockholder's equity was 7.55%. Net interest margin expanded by 5 basis points due to a combination of higher yields on interest-earning assets and lower funding costs. Total loans grew 2% sequentially and new loan production increased by 27%. Our robust loan production was driven by a 26% increase in commercial real estate, a 78% increase in commercial and industrial, and a 35% increase in residential loan production. Deposits grew by 1.2%, led by a nearly 5% increase in noninterest-bearing deposits and a 3.5% increase in money market and savings accounts. Demand deposits now comprise 32% of total deposits. And finally, noninterest expense declined 0.6%. For the third consecutive quarter, we sold residential mortgage loans into the secondary market, bringing year-to-date sales to $70 million. We expect to continue to capitalize on market opportunities to sell residential mortgage loans to diversify our revenue and strengthen our balance sheet. Moving on to an update on the strategic growth initiatives. Our Corporate Korea initiative is performing in line with our expectations. We are seeing a growing number of customer referrals, which is a strong show of our confidence in our team's expertise and capabilities. In the third quarter, we grew corporate Korea loans 6.1% sequentially. This growth was driven by an 89% increase in loan production to $103.8 million. Corporate Korea currently represents approximately 14.5% of our total loan portfolio and 12.4% of our on-loan deposits. Additionally, we recently filed an application to open a representative office in Seoul, South Korea, which we believe will further enhance the growth of this strategic initiative. We recently announced the closing of the branch in Koreatown Plaza in L.A., which is scheduled to be finalized in January 2025. As a reminder, this action is an integral part of our strategy to maximize growth and generate cost savings. As I mentioned previously, we will be opening a new branch in the metro Atlanta area in the coming months. As always, we will continue to evaluate future opportunities to optimize our branch footprint. Next, I'd like to take a minute to discuss our recent credit quality actions, which Anthony will cover in more detail. During the third quarter, we successfully resolved several criticized and nonaccrual loans through sales and payoffs and also recognized the recovery on a previously charged-off loan. In addition, we proactively moved three loans to the special mention category to monitor them more closely. It's important to note that these loans are current, and we are confident that they are adequately protected. In line with our credit administration practices, our goal is to identify and resolve any issues as quickly as possible. At quarter end, the ratio of allowance for credit losses to loans increased by a single basis point to 1.11%. And importantly, the overall credit quality of our portfolio remains strong. With that summary, I will now turn the call over to Anthony Kim, our Chief Banking Officer, to discuss the third quarter loan production and deposit activity in more detail. Anthony?

Anthony Kim, Chief Banking Officer

Thank you, Bonnie, and thank you for joining us today. I'll begin by providing additional details on our loan production. Third quarter loan production was $348 million, up $74 million or 27% from the second quarter with a weighted average interest rate of 7.92% compared to 8.31% last quarter. The growth in loan production was primarily due to an increase in commercial real estate, C&I, and mortgage. We remain disciplined with our underwriting as we seek opportunities that meet our high-quality standards in the current rate environment. CRE production was $110 million, up from $8 million in the second quarter, primarily due to increased production from our Eastern region. The elevated interest rate environment continues to impact the traditional and refinancing activity. We remain pleased with the quality of our CRE portfolio. It has a weighted average loan-to-value ratio of approximately 48% and a weighted average debt service coverage ratio of 2.2x. SBA loan production decreased $3 million in the third quarter to $52 million from $55 million in the second quarter but still exceeded our quarterly target range of $40 million to $45 million. This consistent production underscores the key hires we have added to the team and the growth we are generating in our SBA markets. C&I production during the third quarter was $105 million, an increase of $46 million or 78%. The increase was driven by strong demand from Corporate Korea, which represented $60 million or 57% of total C&I loan production. Total commitments for our commercial lines of credit were over $1 billion in the third quarter, up 2% on an annualized basis. Outstanding balances grew by 12%, resulting in a utilization rate of 46%, up from 41% last quarter. Residential mortgage loan production was $41 million for the third quarter, up 35% from the previous quarter due to higher demand for purchase transactions as interest rates declined from elevated levels. Most of our current lending opportunities continue to be in the purchase market as refinance activity remains subdued. Residential mortgage loans represented 15% of our total loan portfolio, the same as one year ago. As Bonnie noted, during the third quarter, we sold approximately $21 million of residential mortgages from our portfolio and are currently exploring additional portfolio sales contingent on market conditions. With respect to Corporate Korea, we again saw healthy demand from these customers who accounted for $104 million of total production which includes approximately $60 million of C&I production. Our efforts to expand and grow these relationships are continuing to bear fruit. USKC loan balances were $918 million, up $52 million or 6% from the second quarter and represent approximately 15% of our total loan portfolio. Turning to deposits. In the third quarter, deposits were up 1% from the previous quarter, although our demand deposit accounts grew nearly by 5% or 19% annualized over the same period. We continue to expand our partnership base with our Corporate Korea clients with a deposit production of $49 million in the quarter. Our team is building new relationships that we believe can grow over time. At quarter end, Corporate Korea deposits represented 12% of our total deposits and 16% of our demand deposits. The composition of our deposit base remains relatively stable, which reflects the success of our relationship banking model. During the third quarter, our mix of noninterest-bearing deposits increased from 31% to 32%. Turning to asset quality. We resolved multiple criticized and nonaccrual loans through sales and payoffs and also recognized a recovery on a previously charged-off loan. Within criticized loans, classified loans decreased by $8.1 million from payoffs of which $6.8 million were nonaccrual loans, resulting in $1.7 million in recovery, upgrades of $6.1 million, also a decrease in special mention loans, and we completed the sale of a $27.2 million nonaccrual loan subsequent to the end of the quarter. In addition, we proactively moved three loans to special mention and monitor them more closely. Total loans totaling $109.7 million are hotels, one located on the East Coast and the other on the West Coast. Both hotels have had a slow post-COVID recovery. The third loan is a C&I loan to a healthcare management company where the cash flow was impacted by a fire in one of its hospitals. Importantly, the guarantors and sponsors for all three loans have strong liquidity and cash flow, which mitigates risk. We do not believe these events are indicative of a larger trend. These loans have been current during the entirety of their terms and are adequately protected. While our allowance for credit losses increased relative to loans, the ratio only increased by 1 basis point to 1.11%. And now I'll hand the call over to Ron Santarosa, our Chief Financial Officer, for more detail on our third quarter financial results.

Ron Santarosa, Chief Financial Officer

Thank you, Anthony, and good afternoon, all. Third quarter net interest income was $50.1 million, up 2.9% from the second quarter. As Bonnie noted, our net interest margin expanded 5 basis points to 2.74%. Net interest income increased $1.4 million due to a $500,000 benefit from one additional day in the quarter, a $700,000 benefit from an improved rate environment, and a $200,000 benefit from a higher level of interest-earning assets. Looking to net interest margin, we saw a 2 basis point increase from loans and other interest-earning assets, a 2 basis point increase from lower borrowing and debt costs, and a 1 basis point increase from lower deposit costs. Following the Fed's decision to lower the federal funds rate by 50 basis points, we lowered the interest rate paid on our savings and money market accounts and lowered our offering rates on new time certificates of deposits. For the month of September, the cost of interest-bearing deposits was 4.22%, down 7 basis points from the month of August. Looking more closely at the rate paid on savings and money market accounts, they were each down 11 basis points. Turning to October to date. The rate paid on savings accounts was down 30 basis points from the third quarter average, while the rate paid on money market accounts was down 23 basis points. Together with our now accounts and time deposits, the cost of interest-bearing deposits for October to date was down 17 basis points from the third quarter average of 4.27%. Regardless of what the Fed may or may not do at their upcoming meetings, we will respond accordingly to any changes in interest rates. Now turning to noninterest income. Here, we recognized a gain of $900,000 from a branch sale and leaseback that drove a 5% increase from the second quarter to $8.4 million. Second quarter noninterest income included a $300,000 death benefit on our bank-owned life insurance. In addition, gains on sales of SBA loans for the third quarter were $100,000 less than the second quarter. While trade premiums remain the same quarter-over-quarter at 8.54%, the volume of loans sold declined $500,000 to $23.0 million. As Bonnie mentioned, we have sold residential mortgage loans for three consecutive quarters. For the third quarter, we sold $20.9 million of residential mortgages at a premium of 2.32%. Noninterest expense for the third quarter was down $200,000 or 0.6% to $35.1 million. The decrease essentially reflects the $300,000 branch consolidation charge that occurred in the second quarter. Pulling this all together, pretax pre-provision income jumped 9.4% from the second quarter, with notable growth in net interest income and well-managed expenses. Credit loss expense for the third quarter was $2.3 million, representing the entire provision for credit losses as the provision for off-balance sheet items was nil for the quarter. Turning to the allowance. We had net charge-offs of $900,000 for the quarter, which combined with the provision led to the $69.2 million balance at the end of the third quarter or 1.11% of loans. Loan charge-offs included $1.1 million, offset by $1.7 million of recoveries on previously charged-off loans. The allowance for credit losses increased $1.4 million due to quantitative and qualitative considerations of $3 million, offset by a decline of $1.6 million in specific allowances from loan payoffs. Turning to equity capital. Our negative AOCI declined to $22.9 million as expected because of the lower interest rate environment at the end of the third quarter. In addition, the company repurchased 75,000 shares at an average price of $19.10 during the quarter. 1,255,000 shares remain available under the share repurchase program. Tangible book value per share at the end of the third quarter was $24.03 and our tangible equity to tangible asset ratio was 9.42%. The company and the bank continue to exceed minimum regulatory capital requirements, and the bank continues to exceed the minimum capital required ratios for the well-capitalized category. The company's common equity Tier 1 capital ratio was 11.95%, and the bank's total capital ratio was 14.28%. With that, back to you, Bonnie.

Bonnie Lee, President and CEO

Thank you, Ron. I want to express my gratitude to our team for their unwavering commitment and dedication to serving our clients. I especially appreciate our bankers and support staff who consistently build meaningful relationships with our customers and contribute to the ongoing growth of our franchise. We are well positioned for a strong close to 2024 and future sustainable growth. Our balance sheet is robust as evidenced by our healthy capital ratios and ample liquidity. Our loan pipeline is solid, and we are on track to achieve our low to mid-single-digit loan growth target range for this year. We have a stable base of core deposits and a healthy mix of DDAs. We are committed to well-controlled expenses. And finally, overall, the credit quality of our loan portfolio remains strong. We are confident in our ability to continue driving growth and enhancing franchise value for all stakeholders. Thank you for your time today. We will now open the call for your questions. Operator, please open the line.

Operator, Operator

Our first question is from Kelly Motta from KBW. Please go ahead.

Kelly Motta, Analyst

Hi, good afternoon. Thanks for the question. I think kicking off with the margin, I really appreciate all the comments regarding the funding side of things and the spot rates. But I'm hoping you could help me out a bit on the loan side. I know you have some prime in there that is going to reset next quarter. All in all, how should we be thinking about that as it pertains to low yields, mixing that in with new production, and what your idea of the margin is as we look to this next quarter? Do you expect some continued expansion off this level?

Ron Santarosa, Chief Financial Officer

So Kelly, working back on your question, right now, if we anticipate another 50 basis points of rate declines, 25 for November, 25 for December, we think that net interest margin, again, holding all the other elements equal, could expand between 10 to 20 basis points. With respect to the loan yields, it's a bit more of a challenging question because it starts to involve a little bit of the mix that we have, the changing mix, and then the increments that Anthony and his team had. But aside from that, what we try to do to address that question is we introduced another slide in our deck where we show the rate sensitivity of the loan portfolio and our interest-bearing deposits against the day-weighted average of the Fed funds target rate between the first quarter of 2022 and the second quarter of 2024. So, again, if you think about it, second quarter '24 was about a year since the Fed last did a rate increase. One way to analyze what might happen during the fourth quarter and forward is the inverse stair step. That illustration can be found on Page 19 of our slide deck. All things being equal, we'd like to think that as we stepped up in the rate environment, we should step down in the same fashion. The caveat to that, though, is the time book drags because it has to do with how quickly they reprice. The loans will step down slightly, and then we would envision there's a point at which prepayment speeds might start to pick up depending on how far the short-term rates go. So against all the things we know and don't know, that's kind of what we're thinking about.

Kelly Motta, Analyst

Got it. That's helpful, Ron. And just a point of clarification, that 10 to 20 basis points of NIM expansion you're talking about, what time period is that? Is that...

Ron Santarosa, Chief Financial Officer

Fourth quarter. If you will...

Kelly Motta, Analyst

Fourth quarter.

Ron Santarosa, Chief Financial Officer

A full increase due to the fixed rates that could occur, one-third of the way of the 25 that could occur in November and then you can just say nil for the last 25 that may happen in December.

Kelly Motta, Analyst

Got it. That's helpful. That's great. Look, your NPAs are really low. Your capital is strong. You're trading at 80% of tangible book value. Why not get more aggressive with the buyback here? How are you guys thinking about it right now?

Ron Santarosa, Chief Financial Officer

So we get that question each quarter, and I've got a bit of explanation. For everyone that fears asset quality, we don't have enough capital for everyone that looks at capital, we have too much of it. The Board and management take into consideration all the things that could happen, may happen, won't happen, and are trying to find a line that best manages the risk relative to that notion. Certainly, we were surprised, I use that word, at the end of September, the way rates declined. If you look at the curve today, all that's been erased. So all of the measures you want to look at from a tangible book value perspective, they basically retraced their steps. That's the other element that makes it a little bit more challenging to determine what the correct amount is. All that said, I think what we've demonstrated over several quarters is that we do manage capital well. Our payout ratio for the first nine months, just on dividends alone was 51%, when you factor in the share repurchase, that increases to 64%. So a large part of our earnings have been returned through dividends and share repurchase. I'll leave it at that.

Kelly Motta, Analyst

Great. Maybe last question for me and then I'll step back. But with the special mention migration, it was good to see the NPAs worked out. I'm hoping maybe you could spend a couple of minutes, I think the commentary on that was you're watching it. It's all current. Just wondering what specifically drove that migration there and what gives you comfort with the ultimate loss content of that portfolio and being able to be resolved favorably?

Bonnie Lee, President and CEO

Sure. I'll handle that. We have been very proactive in identifying and resolving potential problem loans as evidenced by recoveries and payoffs we had this quarter. The three loans that we have identified and placed in special mention, two of them are commercial real estate loans, hotel loans, one on the East Coast and another on the West Coast. Both loans have had a slow post-COVID recovery, which caused the recent operating performance metrics to be less than anticipated. That's why we proactively downgraded and placed them in the special mention category. For the one on the East Coast, the buyer is entertaining a sale and has already received the LOI from a potential buyer. All three loans, as I said, are current and they are well secured by the collateral of the guarantors. Based on the information we have today, we do not anticipate any of these loans to become nonperforming.

Kelly Motta, Analyst

Great. Thank you so much for the color, Bonnie, and thanks, Ron. I'll step back.

Operator, Operator

Our next question is from Gary Tenner from D.A. Davidson. Please go ahead.

Ahmad Hasan, Analyst

Hi, guys. This is Ahmad Hasan on for Gary Tenner. Firstly, can you give us a little more color? I know you had pretty strong introduction this quarter. Any commentary on loan pipelines and how we should think about them in the next quarter?

Anthony Kim, Chief Banking Officer

Yes. Looking at the fourth quarter pipeline, it came in at a similar level as well as a similar yield as the third quarter. So we're optimistic that we can produce a similar level of loan production in the fourth quarter.

Ahmad Hasan, Analyst

Thanks. I appreciate the color on that. And thanks for the detail on the CD maturity slide. You have a little over $1 billion in CDs at around 5% that are repricing next quarter. How should we think about the cost of that? How aggressive are you guys going to be?

Anthony Kim, Chief Banking Officer

Looking at last quarter, a little bit less than $500 million mature, and we were able to reprice 73 basis points lower than what it rolled off at. Considering that new production rate we're paying right now ranges from anywhere between 4.1% to 4.3%, depending on the term of the CD, typically three to six, nine months. So we are hoping and are optimistic that we will reprice at 4.18%, which is the third quarter retention rate or below because we sense that all of our competitors are also lowering the CD rates by more than 50 basis points.

Bonnie Lee, President and CEO

Just in terms of retention and the historical retention of the CDs, looking at the last four quarters, the maturing CDs we've retained on the lower end about 78%, and on the high end, about 84% to 85%. So just in terms of the overall retention rate is in that range.

Operator, Operator

Our next question is from Adam Butler from Piper Sandler. Please go ahead.

Adam Butler, Analyst

Hi. Good afternoon, everyone. This is Adam on for Matthew Clark. Thanks for the disclosure again on that new slide. I'm just curious more on the loan side. Just how have the repricing characteristics progressed quarter-to-date? Do you have a spot rate on the loan portfolio? And can you remind us what the fixed and floating rate portions of your overall portfolio are?

Ron Santarosa, Chief Financial Officer

Sure. The loan yields for quarter-to-date, which is a little bit challenging for us because some of the information doesn't come in until month end. But it's about the 6% idea, whether that's 5.98% or 6.01%, it can vary, but it seems like for October, it is going to be at that level. As we look at the variable rate portfolio, the pricing characteristics, whether it floats, which is a very small piece of our book, adjustable which you could think of primarily as being the SBA book, but that only moves once a quarter. We have a host of hybrids that have even longer tails in terms of when they reprice. We think that the loan book will probably keep its yield, particularly given the increments that Anthony and his team are producing. We are not anticipating too much of a decline in the loan yields in the rate environment. Probably not until such time as the rates drop enough that might start pushing borrowers to prepayment activity. But we're not quite there yet. So we think the fourth quarter would be a pretty good quarter.

Adam Butler, Analyst

Okay. That's very helpful. Thank you. Also just on deposit balances this quarter, it was good to see some meaningful growth, particularly in the DDA category. I was just trying to get a sense of the deposit pipeline as you see it, the competition that you're experiencing, and if there was any seasonality this quarter that we should be aware of.

Bonnie Lee, President and CEO

I wouldn't say it's a seasonality issue. Our loan production this quarter included really good production in the C&I category. Most of our positive DDA growth is coming from our business commercial accounts. It's been our experience that when we have really good growth in C&I loans, we also have a strong growth in DDA.

Adam Butler, Analyst

Okay, great. Thanks for the color there. Moving to expenses, there are a few moving parts with the closing of the branch and the planning to open a new branch. I think you opened a new office in Seoul, as you mentioned in your prepared remarks. How are you thinking about the overall expense run rate from this quarter going forward?

Ron Santarosa, Chief Financial Officer

First, we've not opened up a representative office yet in Seoul, South Korea; that's underway but could be a '24 event, it could be an early '25 event. Regarding the opening of our Georgia branch in the Atlanta metro area, that's scheduled for the fourth quarter. In the first quarter, we have the planned consolidation of an L.A.-based branch. All together, what I would point out is that seasonally, our spend on advertising and promotion increases at least $0.5 million from what you've seen in the third quarter. The OREO for closed property expense seems to have a run rate now, but that can always be a surprise, particularly as you get to year-end. So you could see noninterest expense up at least $0.5 million to maybe $1 million. The advertising promotion spend will be there.

Adam Butler, Analyst

Okay. That was super helpful on the timing of the offices and branches. I appreciate it, and thank you for taking my questions.

Operator, Operator

Next question is from Matthew Erdner from JonesTrading. Please go ahead.

Matthew Erdner, Analyst

Hi, good afternoon, guys. Thanks for taking the question. I want to talk about the loans held for sale. The increase there is pretty significant quarter-over-quarter but it's still not a significant percentage of your loan portfolio. Specifically, the nonaccrual, about half of it is on the nonaccrual. Is your expectation to sell those at par? What led to the increase in that line item? Or is it just a timing thing?

Bonnie Lee, President and CEO

We placed the particular loan on a loan held for sale at the end of September. However, we successfully sold that note, and it closes this month. We provided the $1.1 million reserve charged off, so we don't expect any further loss to come from that particular sale.

Matthew Erdner, Analyst

Yes, that's helpful for that. And going forward, where are you guys going to opportunistically sell loans? Is it mostly going to come from the residential space?

Bonnie Lee, President and CEO

Year-to-date, we sold about $70 million in residential mortgage loans, and I think we're going to probably continue to do that at least in the fourth quarter. For 2025, I think we have to observe the market conditions and make decisions accordingly.

Matthew Erdner, Analyst

That's helpful. One last question on this. How have the margins been gain on sale-wise compared to maybe six months ago? And as part of this strategy, are you looking to improve your loan-to-deposit ratio going forward?

Ron Santarosa, Chief Financial Officer

The SBA loans, which we historically sell each quarter, typically represent our held-for-sale category at each reporting date. The premiums on those have been in the 8s, around 8.5 for the third quarter. They will likely remain around that level for the fourth quarter. On the residential mortgages, as we've pointed out, we are selling those each quarter. We expect the premiums to be around 2, 2.2, 2.3 for the fourth quarter. This depends on market appetite and similar factors. As for the loan-to-deposit ratio, we are not necessarily managing it in that way. Rather, we aim to have a portfolio on our balance sheet to produce spread income and maintain production capabilities while also having the opportunity to sell production for gains.

Matthew Erdner, Analyst

Thank you for that. That's very helpful.

Operator, Operator

This concludes the question-and-answer session. I would like to turn the floor back to management for any closing comments.

Bonnie Lee, President and CEO

Thank you all for joining our call today and for your interest in Hanmi. We look forward to sharing our progress with you through the final quarter of 2024. Thank you.

Operator, Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you again for your participation.