Hope Bancorp Inc Q1 FY2022 Earnings Call

Good day. And welcome to the Hope Bancorp 2022 First Quarter Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Ms. Angie Yang. Please go ahead.

Thank you, Chuck. Good morning, everyone. And thank you for joining us for the Hope Bancorp 2022 First Quarter Investor Conference Call. As usual, we will begin with a slide presentation to accompany our discussion this morning. If you have not done so already, please visit the Presentations page of our IR website to download a copy of the presentation or if you are listening in through the webcast, you should be able to view the slides from your computer screen as we progress through the presentation. Beginning on Slide 2, let me start with a brief statement regarding forward-looking remarks. The call today may contain forward-looking projections regarding the future financial performance of the company and future events. These statements are based on current expectations, estimates, forecasts, projections, and management assumptions about the future performance of the company, including any impact as a result of the COVID-19 pandemic, as well as the businesses and markets in which the company operates or is expected to operate. These statements constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance. Actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. We refer you to the documents the company files periodically with the SEC as well as the safe harbor statements in our press release issued yesterday. Hope Bancorp assumes no obligation to revise any forward-looking projections that may be made on today's call. The company cautions that the complete financial results to be included in the quarterly report on Form 10-Q for the quarter ended March 31, 2022, could differ materially from the financial results being reported today. In addition, some of the information referenced on this call today are non-GAAP financial measures. Please refer to our 2022 first quarter earnings release for the reconciliation of GAAP to non-GAAP financial measures. Now we have allotted one hour for this call. Presenting from the management side today will be Kevin Kim, Hope Bancorp's Chairman, President, and CEO; and Alex Ko, Senior Executive Vice President and Chief Financial Officer. Peter Koh, Senior Executive Vice President and Chief Operating Officer, is here with us as usual and will be available for the Q&A session. With that, let me turn the call over to Kevin Kim. Kevin?

Thank you, Angie. Good morning, everyone. And thank you for joining us today. Let's begin on Slide 3 with a brief overview of our financial results. As we expected, many of the positive trends we experienced last year have continued in 2022. Most notably, we continue to see strong loan production volumes on expanding net interest margin and improvement in our asset quality. We generated net income of $60.7 million or $0.50 per share in the first quarter, up 18% from $51.6 million or $0.43 per share in the preceding fourth quarter. Our return on average assets and return on average tangible common equity increased considerably to 1.37% and 15.01%, respectively, from 1.16% and 12.85%. Moving on to Slide 4. While there were many challenges during the first quarter ranging from the Omicron surge to inflationary pressures to heightened geopolitical tensions, we continue to generate a high level of loan originations. For the third consecutive quarter, we had more than $1 billion in total loan production, which is a record high for the first quarter and reflected a 21% increase over the first quarter of last year. Excluding PPP loans, our first quarter originations this year increased 89% over the loan production volume in the 2021 first quarter. The very strong loan production volume in the first quarter led to loan growth of 6.7% on an annualized basis, excluding PPP loans. During the first quarter, we continued to see robust levels of demand for commercial real estate loans. We had $578 million of commercial real estate loan production, which was down from the seasonally strong fourth quarter production but 86% higher than the first quarter of last year. We continue to benefit from our increased focus on multifamily lending. Multifamily loans accounted for approximately 17% of our total CRE loan originations this quarter. And as a result, our multifamily portfolio increased 13% from the end of the prior quarter. As a result of our increased production of multifamily, warehouses, and mixed-use facilities, along with the reductions in our hotel/motel properties, we continue to create a more diversified, lower-risk commercial real estate portfolio. We had $344 million of commercial loan production in the first quarter. As with the CRE loan production, this was down from seasonally strong fourth quarter. However, the C&I production in the first quarter was higher than any other quarter in 2021, excluding PPP loans, and more than double the non-PPP production we had in the first quarter of last year. Excluding warehouse lines, our commercial loan portfolio increased at an annualized rate of 16% during the first quarter. Within our Corporate Banking Group, the higher level of commercial loan production reflects the success of our efforts to add new banking talent that has increased our ability to target attractive vertical industries and expand our geographic presence. In particular, our telecom and media portfolios continue to grow. And we are seeing increasing production in our healthcare vertical following the addition of this team last year. Our SBA loan production for the first quarter totaled $57 million, which was slightly higher than the preceding fourth quarter, while we had a 27% increase in residential mortgage production. We generally saw good trends in loan pricing in the first quarter with the average rate on new loan originations increasing from the preceding quarter in each asset class. This resulted in our average rate on total loan production increasing by 16 basis points compared with the preceding quarter. The productivity of our banking teams has enabled us to generate a higher level of loan originations despite limiting our production of long-term fixed-rate loans as part of our interest rate risk management strategy. Now I will ask Alex to provide additional details on our financial performance for the first quarter. Alex?

Thank you, Kevin. Beginning with Slide 5, I will start with our net interest income, which totaled $133.2 million for the first quarter of 2022, which was fairly stable with the preceding fourth quarter but increased 9% year-over-year. Our net interest margin increased 8 basis points quarter-over-quarter to 3.21%. Excluding the impact of purchase accounting adjustments, our net interest margin increased 10 basis points quarter-over-quarter to 3.19%. The increase was primarily due to a more favorable mix of higher-yielding earning assets. We also benefited from a 22 basis point increase in our average yield on investment securities due to slower prepayments, lower premium amortization, and a higher yield on new purchases. Looking at the second quarter of 2022, we expect relative stability in our net interest margin. Increases in our loan yield from the anticipated rate hikes in the later part of the second quarter will likely offset our expected deposit cost increases. Most of our variable rate loans repriced immediately. Although a portion of our variable rate loans repriced on a monthly or quarterly basis. So we will not see the full benefit of the second quarter rate hikes until the third quarter. Given our improved deposit mix and a higher level of commercial relationships, while we expect deposit costs will increase in the near term, we believe our deposit beta will be lower this time around than what we experienced in the previous interest rate rising environment. We plan to remain conservative in deposit pricing. And we will continue to closely monitor our deposit and the liquidity position in light of the recent economic and global events that have taken place. Moving on to Slide 6. We remain in an asset position as of March 31, 2022, and are positioned to benefit in a rising interest rate environment. Of our new loan production in the first quarter, 43% represented variable rate loans. And as of March 31, 2022, variable rate loans also accounted for 43% of our total loan portfolio. Now moving on to Slide 7. Our non-interest income was $13.2 million for the first quarter, up slightly from the preceding fourth quarter. We have declines in international service fees as well as other income, which was primarily attributable to a fair value adjustment to equity investment and lower CRA investment dividend income. These declines were offset by an increase in net gains on sales of SBA loans due to an increase in both the volume of loans sold and the average net premium. Moving on to non-interest expenses on Slide 8. Our non-interest expense was $75.4 million, representing an increase of 2% from the preceding fourth quarter. The most significant variance was a 7% increase in our salary and benefit expense largely due to seasonally higher payroll taxes and vacation accruals as well as lower deferred loan origination costs. However, much of this increase was offset by lower levels of expenses in most other areas, including advertising and marketing, data processing, professional fees, and OREO expenses. Now moving on to Slide 9. I will discuss our key deposit trends. As of March 31, 2022, our total deposits declined 3% from the end of the prior quarter, primarily representing a 21% reduction in time deposits. For the end of the quarter, we reduced our brokered money market and time deposits by approximately $350 million in light of a material increase in the cost of these deposits, which exceeded the cost of other funding options available to the bank. The cost of our interest-bearing deposits declined by one basis point quarter-over-quarter. But with the lower contribution of non-interest-bearing demand deposits, our overall cost of deposits increased by one basis point. Now moving on to Slide 10. I will review our asset quality. We saw continued improvement in asset quality in the first quarter as expected. Most notably, the strategic actions that we took in 2021 drove a 21% decrease in our criticized loans as sustained improvement in borrowers led to upgrade. Payoffs also contributed to the $106 million decline. Non-performing assets declined by $9.4 million due primarily to a decline in accruing TDR loans as a result of payoffs. Following the portfolio derisking actions in 2021, our loss experience continues to be very low. We had just $1.5 million in charge-offs during the first quarter, while we had $19.4 million in recoveries, most of which related to one large relationship that was charged off in the third quarter of 2021. The significant amount of net recoveries contributed to a negative provision for credit losses of $11 million in the first quarter. The allowance for credit losses coverage ratio as of March 31, 2022, was 1.06% of loans excluding PPP compared with 1.02% as of December 31, 2021, while our coverage of non-performing assets increased to 145% from 126%. The increase in our coverage ratio reflects an increased level of risk and volatility in the macroeconomic forecast. Now moving on to Slide 11. Let me provide an update on our capital position and return. The increase in interest rate during the first quarter resulted in unrealized losses in our investment portfolio that negatively impacted tangible common equity per share by approximately $0.80. Despite the increase in unrealized losses in the first quarter, we remain strongly capitalized to support our continued balance sheet growth as shown on this slide. With that, let me turn the call back to Kevin.

Thank you, Alex. Now moving on to Slide 12. Before I discuss our outlook, let me briefly comment on our new $50 million stock buyback program announced in the first quarter. To date, we have not repurchased any shares under the new buyback program. While we believe the valuation of our stock still presents a good opportunity, the operating environment changed with significantly higher levels of volatility and uncertainty around interest rates, inflation, and the overall general macroeconomic environment, which was further hampered by the war in Ukraine. We will continue to evaluate the situation closely. And when we believe it is opportune and prudent to do so, it is our intention to be active with buying back our stock under the current program. Now let me provide a few comments about our outlook. We continue to execute very well, and we expect to see a continuation of many of the positive trends that we experienced in the first quarter. That being said, I think it is fair to say that compared with the beginning of the year, there is now a higher level of uncertainty regarding the operating environment for the remainder of 2022 and a wider range of possible outcomes for our financial performance this year. Inflationary pressures, geopolitical unrest, and the expectations for the number and pace of interest rate increases have all escalated over the past three months. And there is growing concern about a possible recession later this year or in 2023. While our loan pipeline remains healthy, it is difficult to predict how loan demand will be impacted later in the year by these macroeconomic and geopolitical headwinds. We are seeing some signs of stronger corporate clients pulling back from potential deals as pricing on new loans has increased. With the increased productivity of our banking teams, the momentum we have in attractive vertical industries, our asset-sensitive balance sheet, and the success we are having in controlling expenses, we have many catalysts in place to drive further growth in earnings and returns. But we are mindful of the potential challenges to the operating environment, so we are cautiously optimistic at this point. And if the economy and loan demand remains strong, we expect to deliver another strong financial performance this year. We believe that the actions we have taken to significantly derisk our loan portfolio, reduce concentration levels, develop relationships with larger, stronger corporate borrowers and increase our exposure to lower risk asset classes should put us in a better position to manage through an economic downturn. Over the past few years, the changes we have made to our business mix and the transformation of our balance sheet have significantly strengthened our franchise and improved our ability to operate in a variety of economic environments. While we are hopeful that economic conditions remain strong, we take gratitude in the fact that our organization is sounder and stronger than it has ever been. As a result, we believe we can continue to deliver good results for our shareholders in a more challenging operating environment. With that, we would be happy to take your questions and add any additional color as requested. Operator, please open up the call.

We will now begin the question-and-answer session. And our first question will come from Chris McGratty with KBW. Please go ahead.

Great. Thanks for the question. Kevin, maybe a high-level one to start. You guys have made tremendous progress in the balance sheet composition over the past five years. I'm interested in how you're thinking about how the deposit mix will shift with rate hikes and also just the pace of overall deposit growth.

Sure, Chris. Yeah, I agree with you. We made very good progress in terms of deposit mix, especially the increase in the non-interest bearing deposits. The composition has gone up substantially, benefiting from the increase of our C&I portfolio. You might sense that in this quarter, there was a little bit of reduction in the non-interest-bearing deposits. But as I said earlier, there are some timing differences. There was one large customer that withdrew the balance for the quarter end. But as of now, we see the non-interest-bearing deposit balances coming back. It is slightly higher than the year-end balances. So I don't anticipate big challenges on the non-interest-bearing deposit accounts. For the CD accounts, we strategically lowered our CD balance. Because in the last interest rate rising cycle, we did experience that CDs have been the most rate sensitive and have had the most expensive categories of the parties. So we strategically put disciplined pricing on the CD. So that triggered some attrition of the CD. However, in the rising interest rate environment and the Federal Reserve having a QT implemented in Q2, I think there will be some cautious plan for us to prepare for the growth of the loan portfolio. I think there will be some extent of pressure for our deposits. But again, with the big success of our C&I portfolio and the good deposit mixes, I expect the deposit beta will be lower than what we experienced last time. But again, there's a lot of uncertainties and volatility in the market. So we are cautiously monitoring those deposit beta.

Okay. Great. Thanks. I think last quarter, you referenced kind of a rule of thumb. Each quarter point was around $7 million annually to net interest income. Just interested, has that at all changed in the last three months? And as we get more frequent and sooner rate hikes, does the marginal benefit of that, I would imagine that declines as you get into hike 4-5 and 6?

Last time, we mentioned that a 25 basis point increase would likely lead to an increase of $5 million to $7 million in net interest income, with $6 million being the expected figure. This expectation remains valid; however, we now anticipate more frequent and larger interest rate hikes. Specifically, we expect a 50 basis point increase in May and June. If the 50 basis point increase occurs in May, we could see an additional $10 million to $12 million in net interest income over the next 12 months. An additional 50 basis points in June would similarly bring in another $10 million to $12 million of net interest income for the following year. It's important to note that SBA loans are repriced quarterly, and due to a short-term lag in certain variable rate loans, the effects of the rate hikes in May and June would primarily benefit our net interest income starting in the third quarter of 2022. Overall, I expect 2022 to be favorable for net interest income due to our asset-sensitive position. However, we are approaching the second half of the year with caution due to significant uncertainties surrounding economic trends and interest rate fluctuations.

Okay. That's great color. Thank you. Maybe just one more on the SBA. Net income has been creeping up the last few quarters in your fees. Any outlook or commentary you could provide about the either gain on sale margins and the pace of loan sale?

As far as we observed, the premium in the secondary market is holding up pretty nicely so far. And in terms of the volume of SBA loan sales in the coming quarters, so long as the premium in the secondary market remains at the current levels, we plan to sell a similar volume of SBA loans that we did in the first quarter.

Great. Thanks, guys.

The next question will come from Gary Tenner with D.A. Davidson. Please go ahead.

Thanks, good morning. I just wanted to ask a follow-up just on the balance sheet structure. We saw the securities portfolio shrink a little bit this quarter. I'm just wondering, is that kind of as we saw some lower deposit balances in the quarter, did you just allow the cash flows to roll off? Or how are you thinking about managing that side of the balance sheet on the asset side as we go through the next few quarters?

Yes, the deposit balance does affect our total asset size. Our disciplined pricing on CDs has led to some attrition, and there were timing differences in non-interest-bearing deposits. When looking at our overall funding costs, we noticed significant interest rate increases on broker deposits and borrowings towards the end of the quarter. As a result, we strategically reduced those broker deposits. However, we have plenty of funding alternatives available, such as over $3 billion in FHLB borrowings and about $2.5 billion in investment securities that are for sale, which we maintain for liquidity purposes. For our projected loan growth, we still have sufficient funding resources, including retail deposits, borrowings, and investment securities.

It seems that there has been some resurgence this quarter or since the end of the quarter regarding non-interest-bearing DDA. Your loan deposit ratio was approximately 97% at the end of the quarter, but it may decrease slightly. What range are you aiming for in managing that loan deposit ratio while balancing the costs associated with deposits against your loan demand?

Yeah. Gary, at 97%, I think if you compare this rate like two-three years ago, it was normal. We used to have like 98% or close to 100%. But for the last two-three years, we maintained our loan-to-deposit ratio much lower. But this quarter, it went up. I think that is again due to our liability side showing a temporary kind of reduction. I would expect our loan-to-deposit ratio to be below 95%, certainly lower than 97% we experienced in this quarter moving forward.

Thank you. And if I could just ask one last question just on PPP, what the average PPP balances were for the quarter, Alex, and then the associated revenue that was recognized in the quarter.

Sure. Our average balance for the PPP for Q1 was $165 million compared to $280 million in Q4, which reflects a significant decrease. The PPP fee income recognized for Q1 was $4.1 million, while it was $5.2 million in Q4.

So is there something like $2 million left of PPPs?

Yeah. PPP fees Q4 compared to Q1, about $1 million lower.

I'm sorry. But how much is remaining of PPP fees?

Sure. The remaining as of March 31 is $2.96 million, so relatively small amount left.

Perfect. Thank you.

Sure.

The next question will come from Matthew Clark with Piper Sandler. Please go ahead.

Hey, good morning. On the loan balances, it sounds like the mortgage warehouse was down about $320 million if you back into the 16% annualized growth ex warehouse. Can you just remind us where those balances sit today and what you're assuming for the warehouse in your high-single-digit to low-double-digit loan growth this year?

Let me address that. There has been no significant change in our available warehouse lines, which were just above $1 billion as of March 31, but utilization has dropped significantly along with industry trends. In the fourth quarter, the line utilization as of December 31 was slightly above 51%, and it decreased to 30% by March 31. While we maintain strong relationships with our current clients, our outstanding balance was just over $300 million at the end of the quarter. Warehouse lines represented only about 2% of our total loan portfolio. Any further decline in utilizations from this point will not pose as strong a challenge to our loan growth as it did a few years ago. Therefore, I don't expect it to significantly impact our loan growth projections. We anticipate well-balanced and diversified portfolio growth across our commercial real estate, commercial, and consumer portfolios, aiming for low double-digit or high single-digit growth based on current assessments.

Okay. Great. And then just shifting gears to the reserve to loan ratio, I think 106, excluding PPP, up about 4 basis points. You mentioned increased uncertainty around rates and inflation, geopolitical, all that stuff. Do you feel like we stabilize here? I know it's somewhat dependent on the macro factors, but do you feel like it grinds higher? Or do you feel like we stabilize here and just stay above where you were day one, I think, at 96 basis points?

Sure. This is Peter. I can respond to that. As you know, notwithstanding the recovery, we did have some reserve build in the first quarter focused on the macroeconomic softness potentially coming from higher interest rates and all that. I think at this point, we are looking at this very carefully. I think there is a little bit too much uncertainty or volatility right now to make that type of projection in terms of reserve levels going forward. But it will be a reflection of various factors and variables, I think, really depending on how we view the overall macroeconomic environment as we move forward. As you know, the reserving process under CECL is a life-of-loan reserving process. So we look out over the course of the life of the loan, which covers some of the uncertainty we're starting to see potentially rising in late 2022, perhaps 2023. So it's a little bit too early to determine that. But we are comfortable with the current reserving levels at 1.06%. We felt that the slight build this quarter was appropriate based on what we're seeing.

Okay. And then just circling back to the margin outlook. Relatively stable margin in the near term sounds conservative. And maybe that's just for the upcoming quarter, but it sounds like we should see some expansion with the repricing of that loan portfolio. Maybe just to confirm that. And then the 43% contribution of variable rate loans, I mean, do you feel like you're going to pull through 43% of the Fed rate increases over time? Or do you feel like competitive pressures might dampen that?

Sure, Matt. Let me answer the net interest margin kind of projection. Yeah, it was more Q2, we expect it will be stabilized. And also, as I mentioned earlier, the full impact of the variable rate, the 43% of our loans will be in the third quarter, because some time lag, like SBA loans are repriced on a quarterly basis. So there is definitely some conservative outlook embedded in this year. And also on the liability side, on the deposit side, I'm fairly comfortable that our deposit beta will be much lower than during the last interest rate raising environment. But I want to put some cautious mode in here because of uncertainties. We still have a lot of funding resources available; just be cautious for the economic variables and QT and the inflation and the interest rate, all those kinds of things. So I kind of agree with you, there is some conservative outlook included in our NIM projection, especially for the second half of the year. And also, I think a second question about the 43% of variable rate loans. Do we expect that have a full impact from the interest rate increase? Yeah, even though there will be some lag quarterly versus immediately. But I think it will impact, but I also wanted to mention the severe competition that we see in both variable and fixed rate loan portfolios as well. So again, we would hope for and we would expect that impact from the increase on the variable rate loan. I think we will see most of them. But again, some competitive pricing pressure from our competitor market pricing perspective.

Okay. Thank you very much.

Our next question will come from Tim Coffey with Janney. Please go ahead.

Great. Thank you. Good morning. Thank you for the questions. Just looking at the expense guidance, say, averaging right around 1.7% of average assets. Does that imply a growth rate in the kind of mid to high-single digit range for the year?

Yes. That's correct.

Okay. And then, Alex, what is a reasonable amount of cash that you would like to keep on the balance sheet? Is it closer to below the period-end level of around $280 million?

We deployed our excess cash into higher-earning assets, which contributes to the margin expansion of 8 basis points reported and 10 basis points when excluding PPP and other accretion. As of March 31, our cash balance is approximately $280 million, down from $376 million last year, indicating a reduction of nearly $100 million. I do not expect a significant decrease in the cash balance from the bank. However, we currently hold about $2.5 billion in investment securities. If necessary, we may be slow to reinvest in these securities instead of focusing on paydowns, as we might allocate those funds to our loan portfolios. In summary, I don't foresee a substantial reduction in our cash and cash equivalents going forward.

Okay. Thank you. I appreciate that. And then, Alex, real quick. What deposit beta are you using from the last cycle? What was the range there?

Last cycle was about 75% ranges. It was quite high. But firstly, I expect it will be a much lower deposit beta for this cycle.

Right. Okay. Great. And then just on the SBA production that you're anticipating in the forward quarters, do you get any sense that you might have pulled some of that forward and borrowers taking advantage of getting in before the rates start to move higher?

We do see some potential headwinds developing in the small business area. So I think that will potentially impact the small business SBA loan customers as well. But it's hard to say whether it's been pulled forward or not. The loans that we do are generally all variable rate loans. So there will be some potential headwind there. But as we look at our pipeline, we don't see much impact yet. We actually think that if the economy continues to perform well, I think we'll have very good production levels in SBA throughout the year.

Okay. Great. Thank you very much. Those are my questions.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks. Please go ahead.

Thank you. Once again, thank you all for joining us today. We hope everyone stays safe and healthy. And we look forward to speaking with you again in three months. So long, everyone.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.