Hope Bancorp Inc Q2 FY2024 Earnings Call

Good day, and welcome to the Hope Bancorp 2024 Second 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. Please go ahead.

Thank you, Megan. Good morning, everyone, and thank you for joining us for the Hope Bancorp 2024 second quarter investor conference call. As usual, we will be using a slide presentation to accompany our discussion this morning, which is available on the presentations page of our IR website. Beginning on Slide 2, we start with a brief statement regarding forward-looking remarks. The call today contains forward-looking projections regarding the future financial performance of the company and future events, as well as statements regarding the proposed transaction between Hope Bancorp and Territorial Bancorp. The closing of the proposed transaction is subject to regulatory approvals, the approval of the stockholders of Territorial Bancorp, and other customary closing conditions. Forward-looking statements are not guarantees of future performance; actual outcomes and results may differ materially. Hope Bancorp assumes no obligation to revise any forward-looking projections made on today's call. In addition, some of the information referenced on this call today are non-GAAP financial measures. For a more detailed description of the risk factors and a reconciliation of the GAAP to non-GAAP financial measures, please refer to the company's filings with the SEC as well as the safe harbor statements in our press release issued this morning. 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; Julianna Balicka, our Chief Financial Officer. Peter Koh, our Chief Operating Officer, is also 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 us begin on Slide 3 with a brief overview of the quarter. For the second quarter of 2024, we earned net income of $25.3 million, or $0.21 per diluted share. Excluding notable items, our net income was $26.6 million and our earnings per share were $0.22. Notable items this quarter included merger and restructuring-related costs and a partial reversal of a prior accrual for the FDIC special assessment. Our results this quarter reflect continued progress in improving our financial performance following our strategic reorganization late last year. During the second quarter of 2024, our net interest margin expanded, our operating expenses decreased and our return on assets improved. We are diligently working on our merger integration planning with Territorial Bancorp and look forward to closing the pending transaction by year-end. Territorial will contribute stable and low-cost deposits to our franchise and their loans will more than double Hope's residential mortgage portfolio. On Slide 4, you can see that we ended the quarter with strong capital and all our capital ratios expanded from March 31, 2024. As of June 30, 2024, our total capital ratio was 14.42% and our tangible common equity ratio was 9.72%. Our high capital ratios are a strong base with which to support emerging growth opportunities. Our Board of Directors declared a quarterly common stock dividend of $0.14 per share payable on August 22nd to stockholders of record as of August 8, 2024. Continuing to Slide 5, at June 30, 2024, our total deposits were $14.7 billion, essentially stable quarter-over-quarter. Our frontline continued to execute well with an increase in our non-interest-bearing demand deposits and other customer deposits, largely offsetting a planned runoff of broker deposits. Moving on to Slide 6, at June 30, 2024, our gross loans totaled $13.6 billion, a decrease of $87 million or less than 1% quarter-over-quarter. $30 million of this decrease was from SBA loans sold in the second quarter. Overall loan production improved this quarter. Residential mortgage growth was once again robust and commercial real estate loans were stable. However, this was offset by elevated payoffs and pay downs within C&I loans. Based on our strengthening pipelines, we are looking forward to positive loan growth in the third quarter. On Slides 7 and 8, we provide more details on our commercial real estate loans, which are well diversified by property type and granular in size. The loan-to-values remain low with a weighted average of approximately 47% at June 30, 2024, and the profile of our CRE portfolio has not changed. Asset quality is stable and 98% of the commercial real estate portfolio was pass graded at June 30, 2024. With that, I will ask Julianna to provide additional details on our financial performance for the second quarter. Julianna?

Thank you, Kevin. Beginning with Slide 9, our net interest income totaled $106 million for the second quarter of 2024, a decrease of $9 million from the first quarter. Approximately $4 million of the sequential decrease was attributable to the net impact of the payoff of our bank term funding program borrowings in late March and early April, which we paid off in full with interest-earning cash. Quarter over quarter, our net interest margin expanded by 7 basis points to 2.62%. A notable highlight is the deceleration in the quarterly increase of our cost of deposits. Quarter over quarter, our average cost of total deposits increased by only 3 basis points, the lowest quarterly rate of change since the first quarter of 2022. On Slide 10, we show you the quarterly trends in our average loan and deposit balances and our weighted average costs and yields. On to Slide 11, our non-interest income was $11 million for the second quarter, an increase of 34% from $8 million in the first quarter. We resumed sales of SBA 7(a) loans as secondary market conditions improved. We sold $30 million this quarter and booked a net gain of $2 million on sale. We plan to continue selling SBA loans in the second half of the year. Moving on to non-interest expense on Slide 12, our second quarter 2024 GAAP non-interest expense was $81 million compared with $85 million in the first quarter. Excluding notable items, non-interest expense for the second quarter was $79 million, down 4% quarter-over-quarter and down 9% year-over-year. The largest component is salary and employee benefits expense, which was down 7% quarter-over-quarter and 16% year-over-year. You can see the positive impact of the restructuring in the year-over-year comparisons. Now moving on to Slide 13, I will review our asset quality, which continues to remain stable. Non-performing assets at June 30, 2024, were $67 million, down 37% quarter-over-quarter. The non-performing asset ratio improved to 39 basis points of total assets at June 30, down from 59 basis points as of March 31. Net charge-offs for the 2024 second quarter were $4.4 million or an annualized 13 basis points of average loans, compared with 10 basis points annualized in the first quarter. Net charge-off levels continue to be low and manageable. For the second quarter, the provision for credit losses was $1.4 million compared with $2.6 million last quarter. At June 30, 2024, our allowance for credit losses was $156 million, representing 115 basis points of loans receivable. The reserve coverage ratio has been essentially stable, comparing with 116 basis points as of March 31, 2024 or 115 basis points as of December 31, 2023. With that, let me turn the call back to Kevin.

Thank you, Julianna. Moving on to the outlook on Slide 14. In terms of our fourth quarter 2024 outlook relative to the fourth quarter 2023 actual results, we have the following updates. Fourth quarter to fourth quarter, our outlook for average loans to grow at a percentage rate in the low single digits remains unchanged. Residential mortgage loan growth continues to be robust. Commercial loan production continues to strengthen and we expect the pace of paydowns and payoffs to moderate. Accordingly, we are looking forward to positive loan growth in the second half of the year. We now expect net interest income for the fourth quarter of 2024 to decline approximately 10% from $126 million in the fourth quarter of 2023. Approximately 3% of this decrease comes from the net impact of the payoff of the bank term funding program, which contributed a positive $4 million to our net interest income in the fourth quarter of 2023. Relative to our initial budgeting, our net interest income expectations are lower, reflecting the cumulative impact of payoffs and paydowns in the first half of the year, market-wide loan spread compression on new originations, and the year-to-date shift in deposit mix. We successfully controlled deposit costs in the second quarter, but deposit pricing remains very competitive as long as interest rates remain high. In our outlook, we are factoring in one Fed fund's target rate cut of 25 basis points in September of 2024. Overall, we expect the second quarter of 2024 to be at or near the trough in terms of net interest income, with quarterly growth by the fourth quarter of 2024 mainly driven by loan growth. In the second quarter, we resumed SBA loan sales and expect to continue to sell SBA loans in the second half of the year. We remain very focused on disciplined expense control. We now expect our fourth quarter 2024 operating expenses, excluding notable items, to decrease by more than 7% from $85 million in the fourth quarter of 2023. This is an update compared with our prior outlook for an expense decrease of over 5%. Lastly, we continue to assume an essentially stable asset quality backdrop and stable reserve coverage, which was 115 basis points of loans as of June 30, 2024. Overall, as you see on Slide 15, we are right on track toward realizing our medium-term financial goals, namely high single-digit loan growth plus revenue growth over 10%, and efficiency ratio under 50%, leading to a return on assets over 1.2%. Following our reorganization in the 2023 fourth quarter, 2024 is a building year as we focus on core deposit initiatives, operating efficiencies, and process improvements to support scalable and profitable growth. We are excited about our pending merger with Territorial Bancorp, whose contribution will accelerate the achievement of our medium-term targets. With that operator, please open up the call for questions.

Our first question comes from Matthew Clark with Piper Sandler. Please go ahead.

Good morning, everyone. I would like to discuss the loan growth outlook. Achieving low single-digit growth by the fourth quarter suggests we will need a significant increase in the second half. Can you explain what will drive that growth and how the pipeline looks at this point?

Well, Matthew, as you may recall, we have historically excelled in new loan originations. Our loan production engine was the key factor for our organic growth at a much quicker rate than most peers prior to COVID. However, during the past two years, we faced industry-wide challenges, primarily related to deposits on the liability side of our balance sheet. Therefore, when we underwent a strategic reorganization in October 2023, it aimed to enhance growth in both loans and deposits of high quality. We prioritized improving our deposit franchise before aiming for significant loan growth. Our results for the second quarter of 2024 show that we started to see the benefits of this focus on deposits, including a notable decrease in broker time deposits, an increase in customer deposits, and a minimal rise in our average deposit costs, along with the expansion of our net interest margin. We now anticipate an increase in our loan balances in the second half of 2024 as we continue to emphasize high-quality growth in both loans and deposits. Our loan pipeline has been developing nicely, and we expect that loan growth will pick up in a stronger deposit environment. We feel confident that our loan production will drive growth in the latter half of the year, as we have demonstrated in the past.

And, Matthew, this is Julianna. If I can add just a couple more comments. Quarter-to-date, for example, our commercial loans are up. And when we look at the second quarter, the issue for us in the second quarter or the headwind for us in the second quarter has been the elevated payoffs and paydowns, as opposed to production meeting budget to actuals and our commercial real estate was able to beat budget. So we feel comfortable when we look out into the second half of the year that the drivers are aligning well.

Okay, great. And then on the loan yields, they were down this quarter. Not sure if that was just due to the SBA loan sales or not. Just any commentary there and the related outlook?

The loan yields reflect the mix of originated loans versus those that were running off. This year, there has been spread compression in commercial loans during origination, which impacts loan yields. Additionally, there are non-yield items like changes in prepayment fees and non-accrual income reversals from quarter to quarter. When we assess the origination yields for commercial real estate or commercial loans compared to 2023, we observe market-wide spread compression that influences our outlook. This is partly why we revised our net interest income outlook downward in our slide.

Got it. And then on the margin, do you have the average for the month of June and the spot rate on deposits at the end of June?

I have the spot rate for the end of June, which is at 3.43%.

Okay. And then on the SBA loan sales…

Sorry, 3.43%, just to make sure we're talking about the same number, 3.43% spot rate of total deposits.

Yeah. Got it. And then on the SBA loan sale, should we assume a similar amount gets sold in the second half of the year per quarter?

Yeah, I believe so. We began to sell the SBA loans in the second quarter, and we are currently selling more loans in the third quarter. I expect the total loans to be sold in the third quarter will be more than the number that we had in the second quarter.

Great. Thanks again.

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

Great. Kevin, in Slide 15, the medium-term targets, which are '26 and beyond, if I look at current profitability, I mean, that's basically a doubling of your ROA. You talked about the expenses. What rate outlook is incorporated into this medium-term target?

It's based on the current forward curve, although for the rate cuts for the rest of this year, as you can see, we're only factoring in September just because things near-term have so much variability. But in the longer-term, we are factoring in the current forward curve on fed funds, which eventually settles at around 3.75%. But hold on, let me get you the 2026 and '27 numbers in a second. Go on to your next question.

Okay, great. I guess the follow-up would be what betas are you assuming in the down rate for both deposits and for your assets?

Well, the variable rate assets, floating rate assets, as you know, are loans, those are going to have a high beta because those reprice automatically. It's just a matter of timing within the month of when the rate cuts happen. And for deposits, we are assuming a lagged beta, a low beta upfront for the first several cuts before we kind of get to a more normalized beta over time.

Okay.

One thing I will point out is to go ahead.

No, no, go for. Go ahead.

One thing I'll point out is in this quarter, we have gone through an exercise of reviewing our deposit pricing and making sure that all the exception pricing and exceptions are warranted, so to start to control our deposit costs ahead of rate cuts. And so we're not assuming a high deposit beta up front, but we are assuming that we will be able to continue to be disciplined in how we approach deposit pricing post our reorganization. That is a change to our practice compared to before and an improvement.

Okay, great. And then just the last one I had would be just tax rate. How should we think about the tax rate from here?

We are assuming 26% for the full year. So that does have a lower tax rate in the second half of the year based on when certain tax credit investments and their amortizations hit our P&L.

Okay. Thank you very much.

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

Thanks. Good morning. Hoping you could provide the CD maturity schedule for the back half of the year with the rates that are coming off?

One second, and let me finish answering Chris's question. For 2026, we anticipate the terminal fed funds rate at the end of 2026 to be around 4.25%, with a decrease to 3.75% in 2027. The rates for our CDs maturing in the second half of the year are expected to be in the range of 5.10% to 5.12%. In the third quarter, we have $1.56 billion maturing, and in the fourth quarter, we have $2.1 billion.

And what's your sense, at least going into the third quarter, what the renewal rate outlook would be?

I think the renewal rate outlook will be hopefully lower than the current one for the simple reason that we have recently reduced pricing.

Okay. Thanks. And then my other questions were mostly answered, but I noticed in your walkthrough of the non-recurring items in the quarter, the tax provision was different on the press release versus the deck. I'm assuming the press release is the correct one, but just wanted to confirm that?

I will use the earnings release and the tables as your primary source document.

Sounds good. Thank you.

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

Thank you. Once again, thank you all for joining us today, 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.