Hope Bancorp Inc Q4 FY2022 Earnings Call

Good day, and welcome to the Hope Bancorp 2022 Fourth Quarter Earnings Conference Call. All participants will be in listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Angie Yang, Director of Investor Relations and Corporate Communications. Please go ahead.

Thank you, Andrew. Good morning, everyone, and thank you for joining us for the Hope Bancorp 2022 fourth quarter investor conference call. As usual, we will be using a slide presentation to accompany our discussion this morning. If you have not done so, please visit the Presentations page of our Investor Relations 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 begin 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 of Hope Bancorp, otherwise referred to as the company, as well as the businesses and markets in which the company does and 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-K for the year ended December 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 fourth quarter earnings release for management's reasons and purposes for using non-GAAP figures and 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 Dave Malone, Interim 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. Despite the operating environment becoming more challenging during the fourth quarter, we delivered solid financial results, which reflect the benefits of the lower risk, more diversified loan portfolio that we have built and continued improvement in asset quality. Given the market's expectations for the economic conditions to weaken further in 2023, we became even more selective in terms of new loan production, favoring businesses that are less impacted by consumer spending trends and are more recessionary resistant. Importantly, the lower risk, more diversified loan portfolio we have built continues to improve, with our criticized and classified loans consistently decreasing over the course of the year. In the fourth quarter, we reported net income of $51.7 million, or $0.43 per share, while our pre-provision net revenue or PPNR was $78.1 million. Both net income and PPNR were slightly lower than the preceding quarter, primarily associated with an increase in deposit costs attributed to the highly competitive market for deposits. However, with our solid financial performance as well as a positive shift in AOCI, we generated a 2.2% increase in book value per share and a 2.9% increase in tangible book value per share, while also increasing our risk-based regulatory capital ratios. Moving onto Slide 4, in the fourth quarter, we funded $793 million in new loans, which is lower than the preceding quarter, as it reflects a more selective approach to new loan production and our overall goal to target higher yielding floating loan assets, as well as a lower level of loan demand resulting from higher interest rates, particularly for commercial real estate loans. The fourth quarter also tends to be a seasonally slower period for C&I loan production, which has become a major driver of our overall loan production volumes. As a result of the lower level loan fundings, we had a slight decline in total loans from the end of the prior quarter, although for the full year total loans increased in excess of 10% or 12.2%, excluding PPP loans, which is in the top range of our estimated target. Consistent with the trend that we have seen over the past several quarters as a result of the investments we have made to build our C&I lending capabilities, C&I loans continue to account for the majority of our new loan production. In the fourth quarter, C&I loans represented 54% of our total loan fundings, and the average rate of new C&I loans increased 162 basis points over the preceding quarter, largely reflecting the increase in SOFR rates. In line with our focus on developing relationships with larger, stronger commercial enterprises, our corporate banking group accounted for 79% of our C&I loan fundings in the fourth quarter. We experienced the strongest contributions this quarter from our healthcare and telecom teams. From a geographic perspective, we are starting to see growing contributions from the new additions we have made to expand our middle market lending in the Southeast and upper Midwest areas of the United States. In terms of commercial real estate loans, we have $324 million of fundings, which reflects a decrease from the preceding quarter due to lower loan demand. We attribute this decrease to industry-wide trends as a result of the higher interest rates. In addition, we are targeting lower risk property types and focusing on obtaining wider spreads as part of our cautious approach to risk management, while at the same time improving our profitability. With the targeted segments and increased loan pricing, the average rate of our new CRE loans increased 100 basis points compared with the preceding quarter. Overall, we saw increasing trends in loan pricing in all asset classes during the fourth quarter. Combined with the higher mix of C&I loan production, this resulted in our average rate on total new loan production increasing by 134 basis points over the preceding third quarter to 6.71%. Moving onto Slide 5, demonstrating our ongoing transformation to a lower risk loan portfolio, C&I loans increased by 21.4% over the course of 2022. At the same time, commercial real estate loans grew by just 3.4% during the year, all in all resulting in loan growth of 10.4% for the full year. As a result, C&I loans as of December 31 of 2022 accounted for 33% of total loans, an increase from 30% a year earlier, while commercial real estate loans decreased to 61% of total loans down from 65% at year-end 2021. We have also had success in improving the diversification within each of the buckets of our loan portfolio. In particular, our hotel/motel portfolio represented just 10% of our CRE loan portfolio compared with 14% a year earlier. At the same time, our multi-family portfolio increased to 14% of our total loan portfolio at year-end of 2022 from 8% as of year-end 2021. These results are due to two primary factors. The first being the success we are having with our efforts to target more lower risk CRE property types, and the second being the growing benefits of the investments that we have made over the years to enhance our C&I lending capabilities. Now, I will ask David to provide additional details on our financial performance for the fourth quarter. David?

Thank you, Kevin, and good morning, everyone. Starting with our net interest income, it reached $150.5 million for the fourth quarter of 2022, showing a slight decline of 1.7% from the previous quarter. Although we recorded a 2.1% rise in our average earning assets during the fourth quarter, this increase in interest income was negated by higher deposit costs. Our net interest margin fell by 13 basis points quarter-over-quarter to 3.36%. The average yield on interest-earning assets rose by 70 basis points from the previous quarter due to the repricing of variable rate loans and higher pricing on new loans. However, this increase was countered by an 83 basis point rise in our average cost of deposits, mainly attributable to a reduction in non-interest bearing deposits and higher rates across all interest-bearing deposit categories. Looking ahead, we anticipate continued pressure on our net interest margin in the first quarter of 2023 because of expected rising deposit costs as maturing time deposits renew at higher rates and projected increases in average time deposit balances. While we expect continued increases in loan yields to partially offset the rise in deposit costs, we foresee margin compression extending into the first half of 2023, influenced by various factors related to our balance sheet composition and the interest rate environment. Turning to our new loan production, 65% of it in the fourth quarter was in variable rate loans, which constituted 46% of our total loan portfolio as of December 31, 2022. Regarding our non-interest income, it totaled $12.1 million for the fourth quarter, reflecting a 9% decrease from the prior quarter. This decline was primarily driven by reduced gains on SBA loan sales due to lower sales volumes and decreased swap fee income. Additionally, we had a one-time gain of $375,000 from selling equity investments in the third quarter that was not repeated in the fourth quarter. On the non-interest expense front, it was $84.5 million, relatively unchanged from the previous quarter. We saw a decline in salaries and benefits costs mainly due to reduced incentive compensation expenses, along with a shift from OREO expenses to OREO income as a result of fair value adjustments. These positives were somewhat balanced out by small increases in other non-interest expense areas. For the first quarter of 2023, we expect non-interest expenses to rise due to anticipated increases in salaries and benefits, as well as earnings credit rates tied to certain deposit segments. We project our non-interest expense as a percentage of average assets will remain within 1.79% to 1.81%. Regarding deposit trends, our total deposits rose by 1.5% compared to the end of the previous quarter. This increase, along with a relatively stable loan portfolio, resulted in a reduction of our net loan to deposit ratio to 97.2% at the end of the fourth quarter, down from 99.2% at the conclusion of the prior quarter. We observed a decrease in non-interest bearing deposits during the fourth quarter, with nearly 40% of this decrease stemming from commercial depositors relocating their excess liquidity to interest-bearing accounts. Seasonal fluctuations, particularly related to property tax payments and standard year-end movements in operating cash flows among some large commercial depositors, also contributed to this decline. To balance the drop in non-interest bearing deposits and bolster our liquidity, we increased our time deposits. Looking ahead to 2023, we expect our non-interest bearing and core deposits to stabilize and begin a growth trend as we implement our deposit strategies. In terms of asset quality, we noted positive trends throughout the portfolio in the fourth quarter. Total non-performing assets as of December 31, 2022, fell by 28% from the previous quarter to $69 million, reflecting reductions in non-accrual loans and loans delinquent for 90 days or more, as well as accruing TDRs. By the end of the quarter, non-performing assets accounted for just 36 basis points of total assets, down from 51 basis points at the end of the third quarter. Criticized and classified loans also decreased by 8% in the fourth quarter, and over the full year, they dropped by 48%. This improvement can be attributed to two main factors: steady asset quality improvement as borrowers showed sustained recovery from the pandemic, and our ongoing efforts to de-risk our higher-risk loan portfolio through renegotiation and sales. Our overall loss experience remains low, with net charge-offs of $6.4 million in the fourth quarter or 17 basis points of average loans on an annualized basis. For the entire year, we recorded net recoveries of $12.2 million. In the fourth quarter, we set aside a provision for credit losses of $8.2 million, primarily due to a drop in projected macroeconomic variables. As of December 31, 2022, our allowance for credit loss coverage ratio was 1.05% of total loans, and our coverage of non-performing assets rose to 234% from 166% at the end of September 2022. Lastly, on our capital position and returns, all our capital ratios, except for the Tier 1 leverage ratio, improved from the previous quarter, thanks to our strong financial performance. Our tangible common equity to tangible assets ratio remained robust at 8.29% as of December 31, 2022, up by 20 basis points since September 30. As announced yesterday, our Board of Directors declared a quarterly cash dividend of $0.14 per share, unchanged from the last quarter. During the quarter, we did not repurchase any stock and still have $35.3 million remaining from our $50 million stock repurchase program.

Thank you, David. Now moving onto Slide 13. Let me briefly summarize our financial performance for 2022 versus the outlook that we initially provided a year ago. In terms of loan growth, we guided that our reenergized focus on business development was expected to lead to high single digit to low double-digit loan growth for 2022, excluding PPP. We achieved the higher end of our guidance with 12.2% loan growth excluding PPP. We initially guided for stable net interest margin for the beginning of the year and then revised to continued margin expansion for the second half of 2022 and flat to slight compression in the fourth quarter, potentially offsetting to a small degree year-to-date margin expansion. In 2022, we experienced margin expansion in the first three quarters of the year, which was partially offset by margin compression in the fourth quarter, aggregating to a 23 basis point increase in NIM for 2022. In terms of profitability, we guided for enhanced net interest income expansion driven by rising interest rates and earnings as asset growth in the range of 13% to 16% for the full year. We achieved the lower end of this guidance with net interest income in 2022 increasing by 13% over 2021. We said non-interest expense to average assets would range from 1.65% to 1.7% near-term, and later updated the guidance to 1.75% to 1.8% for the full year, and we achieved the middle range of this guidance with 1.78% non-interest expense to average assets for 2022. And finally, we projected that our criticized loan balances would trend down by approximately 20% to 30% by year-end. We basically achieved that by mid-year and revised this guidance to a reduction of 30% to 40% for the full year. We actually delivered a 48% reduction in total criticized loans from the year-end of 2021 to year-end of 2022. All in all, we delivered solid financial performance, which was consistent with our guidance, notwithstanding the volatility that we all experienced in 2022 with the pace of interest rate hikes having been faster than at any time in recent history. Now moving onto Slide 14, I will wrap up with a few comments about our outlook and priorities for 2023. It is clear that 2023 will be a challenging year on numerous fronts. Given the current level of economic uncertainty, we will continue to maintain our selective approach to new loan production and continue to focus on generating higher yielding C&I loans that are more resistant to recessionary pressures. As with 2022, we expect our strengthened and expanded C&I lending capabilities will be a major driver of new loan production in 2023. With larger contributions coming from the more recent additions that we have made to the corporate banking group and our increased presence in newer geographic markets, we are confident in our ability to generate strong loan production without compromising on our underwriting or pricing criteria. As a result, and while maintaining our cautious approach to new loan production in the current environment, we expect to generate loan growth in the mid single digits in 2023. This lower level of projected loan growth will also enable us to focus more heavily on building a lower cost stable core deposit base. The deposit strategies that we are implementing now are focused on further strengthening our retail foundation of individual and smaller business customers, as well as our larger corporate client base. However, for the near-term, we expect higher deposit costs will mitigate the expansion of our net interest income. We anticipate that our net interest income for the full year of 2023 will increase modestly with higher costs of deposits and borrowings offsetting, in large part, higher interest income from the growth in our earnings assets. We are also expecting the run rate of our non-interest income to trend lower in 2023 versus 2022 due to a reduction in net gains from SBA loan sales. While premiums available in the secondary markets have somewhat stabilized, we believe that maintaining a greater portion of these higher yielding assets in our portfolio, while interest rates remain at these high levels will add greater long-term value by way of interest income. Given the challenges of the current operating environment, we will also further strengthen our focus on disciplined expense controls, while we leverage the significant investments in talent and capabilities we have made in our franchise over the past few years. We are looking deeply across the organization and our branch network for opportunities to further enhance efficiencies, while at the same time strengthening our presence in targeted markets. While we are fully cognizant that 2023 will be a challenging year, we expect the pressures on our margins and profitability from the rising deposit costs will diminish as we progress through the year. As a result of the significant investments that we have made in our organization over the past few years, we are a much stronger and much more diversified franchise today than we have ever been. We believe we are well-positioned to effectively manage through economic downturns and build shareholder value for the long-term. 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. The first question comes from Matthew Clark with Piper Sandler. Please go ahead.

Hi, good morning. Could you provide more details on the decline in non-interest bearing deposits? What factors contributed to this decline, and what makes you confident that you'll be able to stabilize these balances, or potentially grow them this year?

Well, the outflows of non-interest bearing deposits have a very close relationship to the higher interest rates. People are more sensitive to the earnings opportunity with their funds at the bank. So, there was a somewhat meaningful migration from the non-interest bearing deposits to interest-bearing deposits. But we believe much of the migration of those non-interest bearing deposits may have happened already with the expectation that interest rates are viewed to have reached their peak. So that's how I see the market as of today. Unfortunately, it's a function of what and when the Fed does with the rates then we do not have any control over the actions. So, we are just focusing on what we can do internally, and we are implementing a number of deposit initiatives focused both on corporate and retail core deposits that we believe will help protect and strengthen our lower-cost deposit base.

So, there was nothing in there that was related to customers leaving the bank maybe that we might have been a little chunky.

No. No, I think it has a lot more to do with the macroeconomic and market interest rate environment.

Okay, great. And then just on the interest-bearing deposit costs, we see the average for the quarter, but do you happen to have the end of the year kind of spot rate on either total deposits or interest-bearing?

Yeah. Our spot rates on deposits as of December 31 was 2.16% for total deposits and 3.12% for total interest-bearing deposits.

Okay. And if you have at the average monthly NIM in December.

Monthly NIM in December, let me see.

3.28%.

Okay, great. And then just last one from me on the net charge-offs this quarter. Can you just give us a sense for what drove that, if there was anything unusual there if that was kind of managing down criticized or if that's a more reasonable range going forward?

Sure. This is Peter. Yes. The charge-offs this quarter were slightly elevated. We don't see any real systemic issues there. I think really just one-off cases. I think just part of our overall practice management to try to exit and resolve some of these loans. So, yeah, slightly elevated, but again, I think we're just one-offs.

Okay. Thank you.

The next question comes from Chris McGratty with KBW. Please go ahead.

Great. Kevin, you talked about the normalization of the mix of deposits getting back. Could you just provide a little bit more color? CD, I assume you're talking about just greater CD mix and perhaps a downward pressure on DDA, but any context of what you're modeling specifically to get to that slight growth in NII for the year.

Maybe I can try to answer that. This is Peter. I think our overall deposit base had a strong reliance on CDs in the fourth quarter. As we explore other opportunities and initiatives, we are seeing many potential areas for growth. This includes non-interest bearing accounts with our existing customers, as well as money market or savings accounts. We have various initiatives we can pursue this year that differ from the heavy reliance on time deposits we experienced in the fourth quarter.

Chris, if I may add, we do not view time deposits as our primary source of funding, obviously. In the immediate quarter, as banks continue to compete for deposits, we expect continued inflows of our CDs into our mix. But we see opportunities to track lower cost core deposits. And eventually, we are really trying to help build our core deposit customer base for the long-term. So, as we go toward the end of 2023, I think we have a much improved deposit mix. For the immediate term, we still expect to see inflows of our CDs.

Okay. Thanks, Kevin. The other question is on capital. I guess twofold question. Your stock is sitting at tangible book. Obviously, the environment is uncertain. But thoughts on buybacks at or below tangible book. And also, can you remind us on your current thoughts on the convert that's going to get put to you later in the spring?

Okay. Chris, given the volatility in the market, we think it would be prudent to maintain a conservative stance on capital for the near term. I would expect that any activity related to our convertible notes should precede any other capital actions. And in terms of the convertible note, which we expect to be put by investors in May of this year, we have been very actively looking at various options to pay off those convertible notes. We are currently in the final stages of our analysis. I expect that we would be able to make an announcement closer to the end of the first quarter. Having said that, considering our current valuation in the market, I can assure you that we are very actively monitoring opportunities to reenter the buyback market.

Okay. Okay. So, I guess, the range of outcomes for the convert would be to replace it at a higher cost, potentially use excess cash, if you have any to pay it off, that's kind of how you're thinking about the balance.

Yeah. Well, we don't know. I think it is a little premature to share whether the convertible notes will be fully refinanced or we will just refinance a portion of that.

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

Thanks. Good morning. Just wanted to ask about the expectations for, I guess, balance sheet growth in 2023. You talked about mid-single digit loan growth. Wondering if there's a piece of that that could be funded by securities, cash flows or cash on the balance sheet? Or do you expect that kind of balance sheet growth and deposit growth is pretty well mocked up with that loan growth over the course of the year?

We plan to fund our new loan production mainly with our deposits. Obviously, we are currently seeing approximately $50 million per quarter of cash flow being generated from our investment portfolio, but we currently plan on 100% reinvestment back into the investment portfolio. So, we believe that mid-single digit loan growth will be funded by our deposit growth, and our expectation for the deposit growth will be pretty comparable to our loan growth.

Okay. And then I think a couple of times you have mentioned deposit strategies that you're implementing. Can you give us any more color on what you're doing there? Are they kind of business line oriented? Or is it just greater kind of pressure on loan customers to bring deposits over? Just some more color there. Thank you.

Gary, this is Peter. Yeah. We would like to share more information. But I think for competitive reasons, we can't disclose too much. But I do just want to share we do have sort of a multi-prong approach to this. And I think the focus, as we mentioned before, really will be in terms of the core deposits. And so, I think every category that you see there that would be considered core deposits we are building and currently implementing strategies around those.

Thank you.

The next question comes from Tim Coffey with Janney. Please go ahead.

Great. Thank you. Good morning, everybody. Thanks for the opportunity to ask a question. Kevin, can you kind of provide some color on the pipeline that you're seeing right now?

Yeah. The pipeline for the first quarter of this year is down compared with the start of the fourth quarter of 2022, but I think that is normally expected due to seasonality factors. And the smaller pipeline is also due to the higher interest rate environment and the overall impact it has industry-wide on CRE loan demand. In addition to that, given the looming recession, we are also exerting greater pricing and credit discipline as we continue to be more selective in our lending practices and favor businesses that are less impacted by consumer spending and are more recessionary resistant. So, the pipeline is smaller and that is not really unexpected.

Okay. Are you seeing any stresses within your current borrowers from a higher rate environment?

Well, we are really trying to focus on customers who are more recession resistant. So far, we have not seen any significant impact on loan demand for those types of customers. But obviously, high interest rates will impact all areas of lending, and we are very cognizant of that.

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

Thank you, Tim.

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

Thank you, Andrew. 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 next quarter. So long, everyone.

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