RBB Bancorp Q2 FY2021 Earnings Call

Good day, everyone, and welcome to the RBB Bancorp Earnings Conference Call for the Second Quarter 2021. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please note that today’s event is being recorded. I would now like to turn the conference over to Catherine Wei. Thank you. Please go ahead.

Thank you. Good day, everyone, and thank you for joining us to discuss RBB Bancorp's financial results for the second quarter of 2021. With me today from management are President and CEO, Alan Thian; EVP and Chief Financial Officer, David Morris; EVP and Chief Credit Officer, Jeffrey Yeh; and EVP and Chief Risk Officer, Vincent Liu. Management will provide a brief summary of the results, which can be found in the earnings press release that is available on our Investor Relations website, and then we will open up the call to your questions. During this conference call, statements made by management may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based upon specific assumptions that may or may not prove correct. Forward-looking statements are also subject to known and unknown risks and uncertainties and other factors relating to RBB Bancorp's operations and business environment, all of which are difficult to predict, and many of which are beyond the control of the company. For a detailed discussion of these risks and uncertainties, please refer to the required documents the company has filed with the SEC. If any of these uncertainties materialize, or any of these assumptions prove incorrect, RBB Bancorp's results could differ materially from its expectations as set forth in these statements. The company assumes no obligation to update such forward-looking statements unless required by law. Now I would like to turn the call over to Alan Thian. Alan.

Thank you, Catherine. Good day, everyone, and thank you for joining us today. The continued strength of our differentiated business model delivered record earnings and a healthy return on tangible common equity in the second quarter. Consistent focus on our deposit franchise resulted in significant growth of non-interest bearing deposit, which now represents approximately 30% of our total deposits. Our reported interest margin declined due to excess liquidity, while our disciplined loan origination efforts kept loan balances and yields stable. We had a strong quarter of non-mortgage loan growth, which made up for another soft quarter in mortgage. We were also pleased to announce our entry into the Hawaiian market, which is home to vibrant Asian-American communities. We are excited to enter this new market and bring our relationship-based banking model to Hawaii. We remain well positioned to pursue additional organic and strategic growth opportunities and look forward to continuing to enhance long-term shareholders’ value. With that, I will turn the call over to David to discuss some of the quarter’s financial highlights before opening up the call for questions. David?

Thank you, Alan. I will start by reviewing some of the highlights of our income statement before moving on to our balance sheet. Net income grew 7.4% from last quarter and more than doubled from a year earlier to a record $13.4 million or $0.67 per diluted share. We reported stable quarter-over-quarter pretax pre-provision income of $19.5 million. Our net income benefited from several factors. First, net income increased $1.4 million due to stable interest income and interest expense, alongside a decrease in the provision for loan losses. Non-interest income decreased by $800,000, primarily due to lower mortgage loan sales, but was largely offset by lower non-interest expense as costs normalized after a seasonally high first quarter. Net interest margin was 3.33% for the second quarter, a decrease of 40 basis points from the first quarter, and down nine basis points from a year prior. Adjusting for the excess liquidity we are carrying, our net interest margin in the second quarter would have been 3.8%. Loans held for investment totaled $2.7 billion as of June 30, which was stable from last quarter. We had another good quarter of growth in commercial real estate which grew at a 15% annualized rate and construction, which grew at a 52% annualized rate. Unfortunately, our non-QM mortgage production, which is our most profitable mortgage product, continues to lag, leading to a $57 million decrease in our mortgage loan portfolio. We are acting to revitalize the non-QM origination channel, but continue to be challenged by the rate environment. Our average yield on earning assets for the quarter was 3.99%, down 50 basis points from the prior quarter and 66 basis points from the prior year. As with the NIM, this decrease was due almost entirely to lower returns on our excess capital. Deposits, once again, showed very strong growth with total deposits increasing by $249 million, and non-interest-bearing deposits increasing by $153 million. We are pleased with the rapid progress we have made improving our deposit base, but intend to monitor the new balances for some time before we deploy them into higher-yielding assets. Our average cost of interest-bearing deposits for the quarter was 0.59%, which was down 14 basis points from the prior quarter and 83 basis points from the prior year. We still expect some improvements in our deposits as less of our high-cost CDs mature and are replaced by lower-cost deposits. Non-performing assets decreased by $700,000 to $19.5 million in the second quarter, decreasing five basis points to 0.5% of total assets. As of July 15th, we had four loans in deferment totaling about $3 million. We took a provision for credit losses of $628,000 in the second quarter, primarily attributable to loan growth. Our capital levels remain strong with all of our capital ratios well above regulatory minimums. Finally, before we take your questions, in mid-June, we were notified that we were awarded $1.8 million under the U.S. Treasury CDFI Rapid Response Program. We were one of only eight banks in California to receive this award, and we feel it is a testament to our reputation as a community-focused lender. These funds will allow us to respond to the economic impacts of the COVID-19 pandemic in distressed and underserved communities. With that, we are happy to take your questions. Operator, please open up the call.

Your first question is from the line of Nick Cucharale with Piper Sandler.

Yes. I would like to start on loan growth. It looks like paydowns and payoffs have impeded the year-to-date growth in the single-family book. But what is your expectation for net loan growth for the remainder of the year?

I still think we will be on target at 10%. 9% to 10% loan growth.

Okay. Is that target predicated on the prepayment and paydown slowing significantly from the second quarter level?

I see in the mortgage side of things the prepays are beginning to slow. We also believe that the second quarter in the commercial side is going to decrease significantly, but our loan origination pipeline is very strong right now, particularly on the commercial side.

As you mentioned, this is the second quarter in a row with very strong non-interest-bearing deposit growth, even when compared to the industry. Can you give us some color on how you have been able to drive such a robust advance there? And has that prompted any change in strategy at the bank?

Okay. I will break it out into three groups. One group is our existing customer base, which accounts for maybe a third of this growth. Another third consists of new customers with significant balances. The final third comes from the amount of excess liquidity in the market. There is just a lot of excess liquidity out there, and that reflects in our growing deposit accounts. We believe that some of this excess liquidity will go away over a period of time instead of all at once. We want to increase our loan production as much as possible. We are not selling non-QM loans at this moment; we are holding onto every loan we can to keep our mortgage loans stable until production returns to normal. We are also investing a couple of hundred million dollars into shorter-term investments to earn better returns while keeping it short because we do believe rates will rise.

That is great color, David. And lastly, just a nice pop in SBA sales in the quarter. It looks like you are capitalizing on a favorable environment there. What is your expectation for that business and the revenue it can generate?

Well, this is Alan. The third and fourth quarter on SBA should at least be the same as our first two quarters.

Yes. I do think that the SBA is now more operational than last year, which was all PPP. Our origination team is out and about, so I think we will do okay for the rest of the year.

In addition, many small businesses that were suffering last year are now trying to recover. Thanks to the PPP and other assistance programs, we expect to see more inquiries about SBA financing for inventory and property purchases. The demand for industrial properties, particularly in Southern California, is strong with multiple bids on almost all properties small businesses are looking to acquire. So we see strong growth in the business and industrial sector.

Thanks for the color and thank you for taking my questions.

Your next question comes from the line of Kelly Motta with KBW.

Alan, I believe earlier in your prepared remarks, you talked about there are still a lot of strategic growth opportunities. You are entering Hawaii, which is a new market for you. Just wondering if you can expand a bit on any updates on how M&A is looking since the last quarter?

Yes. In fact, after the pandemic, we see a lot more institutions looking for alliances or partnerships. We probably see at least two to three more targets that we have been looking at; these banks are not huge, but they have good asset quality and are strategically located with some nice distribution outlets. They are looking for partnerships because many believe becoming part of a larger organization is the best way to survive or grow after the pandemic. We see several opportunities in Northern California, Texas, Georgia, Atlanta, and Washington state as well. There are more opportunities now than pre-pandemic.

Great, thanks, Alan. On the non-QM mortgages, David, you mentioned that getting that channel up and running is a priority. Do you have a sense of when production will normalize and what needs to happen for that to occur?

it seems that the pandemic has affected non-QM competition, particularly from land bank lenders, who focus on smaller margins and are more aggressive in underwriting and processing due to fewer compliance issues. Since early this year, we have shifted much of our focus to retail banking, bringing in customers from our own branch system. This strategy has proven successful in bringing in our customers who prefer us over land bank lenders. I believe it will take at least two quarters to normalize the volume.

Got it. Thanks, Alan, that is helpful. Last question for me. Expenses dropped nicely quarter-over-quarter, similar to what was mentioned on the last call. How should we be thinking about the expense run rate in the back half of the year?

As with every company around the country, we are experiencing pressures on salaries and other costs. I would say our quarterly expenses will be between $14.7 million and $15 million going forward.

Your next question comes from the line of Andrew Terrell with Stephens.

I hear you loud and clear on the non-QM aspect of the mortgage business. However, David, do you have updated expectations on Fannie Mae mortgage sales in the second half of the year? Is there an increased appetite to put more Fannie production on your balance sheet?

We have considered putting on Fannie Mae loans, which are 30-year loans that probably won't prepay very quickly at current sub-2.75% rates. We have decided to continue selling our Fannie Mae production at this time. We review our strategy quarterly as the economic environment and rates can change significantly.

Okay, great. The blended mortgage gain on sale margin this quarter appears to be around 2.5%. Given there may be a lesser mix of non-QM sale volume, do you anticipate compression in the gain on sale margin moving forward, or are we likely at or near the floor?

Currently, our Fannie Mae gain on sale margins have been averaging closer to 2.5%, and I would hope to see the margins go up slightly in the third quarter, particularly in August and September. So, right now, the average gain on sale margin is approximately in the 2.5% to 2.6% range.

Understood. Did you repurchase any shares this quarter? Can you also talk about the appetite for repurchases moving forward?

Yes, we repurchased 222,000 shares in the quarter. Our appetite for repurchases will depend on our stock price and market conditions, but we expect to repurchase more shares in the third quarter, likely around 250,000 shares. We still have 456,000 shares in our program available for repurchase.

I appreciate you taking my questions. I will step back.

We do have a question from Andrew Terrell with Stephens.

Just one more quick one. Can you remind us what you have in CDs maturing in the back half of the year and what the rate differential between the back book and the new CDs is today?

We have $415 million maturing in the third quarter at 87 basis points. Our ongoing one-year rate is about 50 basis points. For the fourth quarter, there is $272 million maturing at approximately 73 basis points, which will fall to about 50 basis points.

Okay. Perfect. Is the yield on new productions still around the low 5% range for new originations, or do you see any competition that may pressure yields moving forward?

It is very competitive out there, but I believe we can maintain our yields at their current levels throughout the rest of the year.

Thanks for taking my questions. Congrats on the quarter.

Okay. Thank you.

There are no additional questions at this time. I will turn the call back over to management for closing remarks.

Once again, thank you all for joining us today. We look forward to speaking to many of you in the coming days and weeks. Have a nice day.

This does conclude today’s conference call. Thank you for participating. You may now disconnect.