RBB Bancorp Q3 FY2021 Earnings Call

Good day, everyone, and welcome to the RBB Bancorp Conference Call for the Third Quarter 2021. At this time, all participants are in a listen-only mode. Later, you will have an opportunity to ask questions during the 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. Good day, everyone, and thank you for joining us to discuss RBB Bancorp's financial results for the third 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; EVP and Strategy Officer, Simon Pang; EVP and Chief Lending Officer, Tammy Song. 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'll open 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 factual. 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 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 requested. Now, I'd like to turn the call over to Alan.

Thank you, Catherine. Good day, everyone, and thank you for joining us today. We are pleased to report another quarter of record earnings, strong loan growth, and improving performance ratios. Loan growth during the third quarter was driven by nationwide originations of construction and commercial real estate loans. We were pleased with the geographic diversity of loan originations and believe it validates our strategy of expansion into Asian-American communities across the United States. Higher loan balances and stable loan yields contributed to an increase in interest income. Continued focus on our cost of deposits further reduced our interest expense resulting in record net interest income during the quarter. Net interest income benefited from a $1.8 million grant that was awarded to the bank to help address the economic impacts of COVID-19 in distressed and underserved communities. We are proud to have received this grant and believe it is a testament to our focus on community development. Our net interest margin remained stable from the previous quarter but was down modestly from a year prior due to asset liquidity. Despite the excess liquidity, ROA and ROE increased from last quarter and last year when they were impacted by the effects of the pandemic. 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.

Thank you, Alan. I'll start by reviewing some of the highlights of our income statement before moving on to our balance sheet. Net income grew 14.8% from last quarter and 80.3% from a year earlier to a record $15.4 million, or $0.77 per diluted share in the third quarter. Third quarter results included the impact of a $1.8 million grant that increased net income by $1.3 million and EPS by approximately $0.07. Our normalized net income benefited from several factors due to an increase in earning assets and stable yields. Net interest income increased $1.5 million from the prior quarter. Interest expense decreased by $382,000 from the prior quarter due to continued management of the cost of our time deposits. Non-interest income increased by about $1.4 million as the grant I mentioned made up for lower loan sales gains. Net interest expense was down modestly from the last quarter and up about $0.5 million from a year ago, primarily due to increased compensation costs. Net interest margin was 3.38% for the third quarter, an increase of 5 basis points from the second quarter and down 21 basis points from a year prior. ROA and ROTCE rebounded in the third quarter to 1.54% and 16.17%, respectively. Adjusting for the impact of the grant, ROA and ROTCE would have been 1.51% and 15.82% respectively, which is still a healthy increase from last quarter's results. Net loans held for investments totaled $2.8 billion as of September 30, which was a $130 million increase from last quarter. We had a very strong quarter of growth in commercial real estate, construction, and other loans, while SRF mortgages and C&I loans each decreased about $10 million. The growth in other loans is the result of relationships with leading providers of point-of-sale financing solutions for the home improvement industry. We expect to continue to add approximately $5 million of lease loans per month until mid-next year. Our non-QM mortgage production, which is our most profitable mortgage product, continues to lag due to the rate environment. Our average yield on earning assets for the quarter was stable from the last quarter at 3.97% and down 66 basis points from the prior year. As with the NIM, this year-over-year decrease was primarily due to lower returns on our excess capital. Turning to deposits. Commercial customer activity, which has driven a rapid increase in non-interest-bearing deposits over the past three quarters, led to a $90 million increase in average non-interest bearing deposits, but $115 million decrease at the end of the quarter in comparison with the end of last quarter. Our average cost of interest-bearing deposits for the quarter was 0.51%, which was down 8 basis points from the prior quarter and 63 basis points from the prior year. Non-performing assets decreased by $5 million to $14.5 million in the second quarter, decreasing 12 basis points to 0.38% of total assets. The sharp decline in non-performing assets was due to payoffs. The return to non-accrual status on large mortgages and pre-pandemic SBA guarantees. As of October 15, we had one loan in COVID-19 deferment, totaling about $241,000. We took a provision for credit losses of $1.2 million in the third quarter, primarily attributable to loan growth. Our capital levels remain strong with all of our capital ratios well above regulatory minimums. With that, we are happy to take your questions. Operator, please open up the call.

And we will take our first question from Nick Cucharale with Piper Sandler. Your line is now active.

I would like to start on loan growth. Nice to see the pipeline follow through that you were discussing last quarter. Do you still feel like you'll be in the 9% to 10% growth range for the full year '21? And is it likely that commercial continues to be the growth driver?

I think our loan growth will be closer to 8% this year, and we hope to maintain growth between 8% and 9% on a consistent basis.

Is commercial expected to remain the primary growth driver, or will it shift slightly?

Yes, I think commercial is going to be more of a driver than real estate is. I mean, mortgages.

Okay. That's helpful. On the deposit front, some contraction after generating very strong non-interest-bearing growth in the first half of the year. What was driving those declines at the end of June?

It's a couple of our customers with just normal transactional volume. In fact, their volumes are back up now, Nick.

Very nice. Okay. And then can you update us on your expectations for the gain on sale business. I'd appreciate your take on each of the channels.

I believe we are aiming to achieve slightly better results than this quarter, targeting around the $2 million mark. I expect SBA might perform a bit better this quarter compared to last, based on the current pipeline, which looks promising for SBA. Mortgage is likely to remain about the same.

Great. And then lastly, I see the branch deal is slated to close in short order. Could you provide an update on M&A opportunities and your thoughts on a potential transaction?

Okay. We are constantly looking at organizations. We have a couple that we're looking at today. Again, we're looking to possibly expand into Northern California, Houston, or the Seattle region, okay? Those are our priorities.

We will take our next question from Tim Coffey with Janney. Your line is open.

David, can you repeat what you said about the point of sale in the home improvement loans and the other loan line item?

Okay. So we have an agreement with an organization that produces home improvement loans, and we have committed to put on $5 million a month through, I think, May of next year. So that's what we are doing.

Okay. What are the yields on those?

The yields are approximately 4.75 after accounting for all associated costs. The duration of those loans is only about 2.5 years. The goal is to utilize our excess liquidity instead of investing it in bonds that may decrease in value. We are actively pursuing this approach.

Okay. Are you noticing that the loan growth observed this quarter, particularly in commercial real estate, indicates that your clients are beginning to invest?

Can you repeat the question, Tim?

Yes. I'm trying to figure out if you're seeing greater activity among your commercial real estate investor clients or if this is just kind of a one-off thing.

I think we're seeing continued interest in commercial real estate lending in the areas where we are located. I mean, I think the volume is still there.

Well, David is right that we see a strong demand in quite a few sectors. We see actually the strongest sectors right now as industrial properties. Not only have the prices of industrial properties increased significantly, but the demand for industrial property is tremendous, pushing prices even higher. Other than that, we do not see — on commercial assets, we do not really see any increases in shopping centers and commercial offices, but we do see a strong demand on construction loans and subsequently breaching into hard financing in the multifamily area. It could be total 100% apartments or we see a lot of mixed-use developments with about less than 10% retail on the first floor and the upper floors being residential units. At the same time, another area where we see strong demand would be mobile home parks and RV parks. Additionally, even on the hotel side, we see loan growth and demand coming back as well. But however, on the hotel and motel side, we underwrite very carefully. In general, we see strong demand in almost every sector of commercial real estate asset, except for shopping centers and commercial offices.

Okay. Great. That's very helpful. And then has your outlook on the capital returns or allocation changed at all given kind of the growth in outlook that you're seeing right now?

No. I mean, it hasn't changed.

We will take our next question from Kelly Motta with KBW. Your line is open.

I apologize. I dropped off accidentally off the call. You may have covered this, but I was hoping you could provide some color on your Hawaii branch expansion and the opportunities you see in that market as well as whether or not that's an area you would potentially consider adding to once you get a location established there.

Okay. Kelly, we're very excited about Hawaii because we think we can bring especially our mortgage and CRE products, along with our bridge products to the islands. So we're very happy with that. We don't think that we will see huge growth in the first year, but I think probably starting in the second year after we get everything implemented and established, you'll begin to see significant growth there.

This is — again, we are very excited, but this is only one branch in Hawaii. So, on the deposit side, we will really try to understand the market. In the next year, we expect very little growth in our deposits, mainly because, besides understanding the market, we are trying to assemble a good team of retail managers with our staff to ensure they are well trained, understand the system, and understand our product. So first of all, I believe the first six months after the escrow close will be more about getting to know RBB on both the loan and deposit side. On the loan side, we do have inquiries on loans, both mortgage and commercial. So we believe that with a branch in Hawaii, it will really help us to generate loans from Hawaii. So we are very optimistic about acquiring that branch.

Got it. And I apologize if I missed it, but turning to expenses, they were very well controlled this quarter. I was wondering if you had provided any update or color on how you're thinking about the push-pull of expenses next quarter and into next year.

Again, typically, our expenses increase at the beginning of the year because we have salary increases and so forth like that every year. I think our expenses will be a little bit higher than they were this quarter, let's say, rebounding back to where we were in the second quarter of about $14.7 million, maybe $14.8 million, okay? We will likely increase most in the salary area by probably in the 5% range due to the inflationary pressures that we're seeing in the market.

We will take our next question from Andrew Terrell with Stephens. Your line is now open.

I might have missed it, but did you buy back any shares in the quarter? And David, just to make sure I heard you correctly, is the expectation still to kind of continue with the repurchase moving forward?

We did buy back some shares in the quarter. I don't have the number in front of me, but it wasn't that large because of the market price we had sitting out there. We will continue to buy back shares later in the quarter this year, but not a significant — not a huge number, okay? When I say a huge number, it won't be over 100,000.

Okay. Perfect. Thanks for the color. I appreciate it. And then just back to your point on deposit growth, I wanted to make sure I heard correctly. If I look at the non-interest-bearing balances point to point, there was a decline of, I think, $115 million this quarter. But did I hear correctly that the expectation was that some of this would come back to the bank?

Yes. In fact, it already has.

And we will take our next question from Ben Gerlinger with Hovde Group.

I was wondering if you guys could just take a 10,000-foot view, think a little bit bigger picture. I know that this year is setting the stage for even stronger '22 and '23 in terms of growth. And then you also have the addition of the Hawaii branch and the construction purchasing of loans. Curious on why you think you — there is the need to do a whole bank acquisition. I know that you have a pretty growth trajectory going forward, notably better than some of your peers. And your valuation is improving. I'm just kind of curious on, one, the desire to do it and if there's anything you're looking for in terms of loan categories for specialty lending or things like that? Or two, would you also be open to doing lift-outs? Or is it a whole bank acquisition only?

Well, I'll start with that it doesn't necessarily have to be a whole bank acquisition. It could be branches or it could be product lines. It could be anything of that nature, and it could also be anything from some type of finance company to a full-fledged bank. Number two is we are looking for specific marketing areas that we want to be in that now we could open de novo in those places. We find that it is much more difficult to open de novo in a separate state or distant geographic region. So that's the emphasis about it. We want to expand our market area and so forth. And the third thing is we tend to get a pretty good return on some of the investments that we have done in different locations.

Our strategy, actually since day one when we opened our bank in 2008, is further — we — and for us and our IPO, our strategy is to serve Asian-American communities across the United States. We believe that is something that we do best and think we will continue to do. We are definitely looking to acquire a whole bank situation if there are opportunities. The reason for Hawaii's acquisition was that the seller wanted to sell for certain reasons and believed it would benefit them. But, however, we see that as an opportunity for us to expand into a new market, which we have had inquiries about from Hawaii many times. So we believe that would be a good start for us to establish our foothold. The other areas, like David said, we would prefer to acquire a whole bank if it's within our niche market. It could be a niche bank or it could be mentioned bank, however, with most of their branches in the niche market area. Again, we keep talking about Northern California, we talk about Seattle, we talk about Houston, in fact, there's another area that we would be very interested in looking into would be Phoenix, Arizona. Lately, there's a lot of foreign investment going into Phoenix. We see that Phoenix is a real upcoming market. So that is another market that we may pursue branches in, or we may just buy a branch or, hopefully if not, we would then go de novo and set up a branch. So, we will look to those major cities where we see a large population of Asian-Americans.

But, Ben, I want to make sure you realize that ever since the start of this bank, organic originations have been very important to us also. We continue to believe that this bank can grow between 8% and 10% every year organically.

Yes. No, I mean, that is really helpful color. I appreciate that insight. And since you did say, I mean, also to reiterate that growth through acquisition is also an important part. Maybe I'm digging a little too deep here, but I was wondering if you could provide a little clarity on potentially why we haven't seen something recently given California disruption? Is it selling prices are too high relative to expectations or maybe a cultural fit that wasn't appropriate? Is there anything that kept you on the sidelines? Or is it just…

We're not really on the sidelines. I wouldn't categorize it as being on the sidelines. We just haven't found the right fit yet. We have turned down deals where, culturally, we didn't think it fit or where pricing wasn't right. We couldn't get to a price that we thought was acceptable. So, we have turned down some deals or — I shouldn't say turned down. We never got to the finish line on the deals. So I wouldn't say that we're sitting on the sidelines. We just haven't gotten somebody that fits yet.

Okay. Because we're looking at deals that can have immediate accretion as well as we believe in the long run, it's not just cost savings during the long run, but there’s potential for us to expand into new markets or to other markets that are either different product lines or customer bases. We believe we are still continuing to stay in most of the areas where we see a lot of growth in population and in our niche market.

And there are no further questions on the line at this time. I will turn the program back over to management for any additional or 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 RBB Bancorp conference call for the third quarter 2021. You may disconnect your line at any time, and have a wonderful day.