RBB Bancorp Q4 FY2022 Earnings Call

Good day, everyone. And welcome to the RBB Bancorp Earnings Conference Call for the Fourth Quarter 2022. At this time, all participants are placed on a listen-only mode and the floor will be open for questions and comments after the presentation. Please note that today’s event is being recorded. It is now my pleasure to turn the call over to your host, Ms. Catherine Wei. Ma’am, the floor is yours.

Thank you. Good day, everyone. And thank you for joining us to discuss RBB Bancorp’s financial results for the fourth quarter of 2022. With me today are President, CEO and CFO, David Morris; SVP and Chief Accounting Officer, Shalom Chang; EVP and Chief Administrative Officer, Gary Fan; EVP and Chief Risk Officer, Vincent Liu; and EVP and Chief Credit Officer, Jeffrey Yeh. David 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 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’d like to turn the call over to David Morris. David?

Thank you, Catherine. Good day, everyone, and thank you for joining us today. Loan growth, increasing loan yields, and declining expenses drove record fourth quarter and 2022 results, with quarterly net income of $17.6 million and earnings per share of $0.92, and an annual net income of $64.3 million and earnings per share of $3.33. Net interest income for the quarter was stable at $39 million as the positive impact of loan growth and an increase in yields was offset by sharply higher deposit costs. Fourth quarter noninterest income of $2.4 million was down slightly from the third quarter due to lower loan sales and servicing fees. A $3.6 million decrease in net interest expenses from last quarter was primarily attributable to a bonus reversal of $2 million and lower loan origination commissions of about $500,000 as new compensation guidelines took effect. Basically, the team, myself included, missed Board established goals on deposit gathering and loan originations, and our compensation was affected as a result. Fourth quarter net interest margin of 4.26% was down slightly from last quarter but up from 3.43% a year ago. We remain cautiously optimistic that we will be able to maintain our NIM around 4% in the first quarter, but expect that it will likely peak in the third quarter of last year. Annualized return on average assets and return of total common equity were 1.8% and 14.59%, respectively, in the fourth quarter. Net loans held for investments increased by about $111 million to $3.3 billion in the fourth quarter, with CRE and residential mortgages showing good growth while construction and other categories decreased for the last quarter. Our yield on average earning assets increased to 5.75% in the fourth quarter, a 62 basis point increase from last quarter and a 178 basis point increase from the prior year. Continued commercial customer activity and rising rates drove a $108 million decrease in average non-interest-bearing deposits over the quarter. Our average cost of interest-bearing deposits for the quarter was 1.93%, up 111 basis points from the prior quarter as the expected catch-up in deposit costs materialized. We continue to be below our competitors on deposit pricing but have been forced to increase rates to retain deposits. Non-performing loans were stable at $11.5 million from last quarter, and loans 30 days to 89 days past due returned to a normalized level after a temporary increase in the third quarter. Subsequent to our adoption of CECL, we recorded a provision for credit loss of $3 million in the fourth quarter of 2022, compared to $1.8 million in the third quarter of 2022. We also recorded a reversal of provision for off-balance sheet commitments of $930,000 in the fourth quarter of 2022, compared to a reversal of $28,000 in the third quarter of 2022. Our capital levels remain strong, with all of our capital ratios well above regulatory minimums. We purchased 49,000 shares in the fourth quarter at an average price of $20.77. We have 433,000 shares left on the buyback. Finally, we are saddened by the tragic loss of life in the three recent shootings in California, including the one last Saturday in Monterey Park. All of our employees are safe, but are understandably upset by such a horrific event that occurred so close to one of our branches. In response to this tragedy, we made a $20,000 donation to the Asian Pacific Community Fund, of which 100% of the donation will be going to victims' families in an effort to help the community recover. With that, we are happy to take your questions. Operator, please open up the call.

Thank you. Our first question is from Kelly Motta with KBW. Please go ahead.

Hi, David. Thank you. Thanks for the question. Can I start off with expenses? You noted in your prepared remarks that there were some reversals in there. I’m just trying to get a sense of what actually fell out of the run rate, as well as what’s a good kind of go-forward outlook and starting point given the movement that occurred this quarter?

Our policy to accrue has been to accrue at 6% of pre-tax bank earnings. We are changing that to accruals to pre-tax Bancorp earnings right now. The biggest change is the amount that we have conformed our bonus structure to that of our peers. For example, I am now eligible to receive up to 150% of my salary versus before when the President and CEO was eligible to get 2.5% of our pre-tax earnings. That was the biggest number and the biggest change. I don't think 2.5% of our pre-tax earnings would have been like $2.5 million for me, so that would just not have worked out. That’s not 1.5 times my salary.

Got it. Thanks for the help. Just trying to understand how that ties into the go-forward run rate. It seems like there was this reversal perhaps in 4Q for what…

Yeah.

…what you have accrued on a go-forward basis. If we were to kind of back out how the reversal, maybe that's a different way of asking what number we can build off of, because $13 million after the prior three quarters feels low, but again, you also had the wrap-up of the investigations and things like that. So I’m just trying to understand when you take out kind of reversals in 4Q, what would be more normal had you been accruing under how you anticipate to do so going forward?

If you look at it the way I do, I still have a few executive-level positions open, and those will receive bonuses next year. It won't be the full $2 million, but it could be a significant amount, and we will be looking at pre-tax income at the holding company level rather than the bank level. This will give you a more accurate picture of what we will actually spend since our bonuses are based on Bancorp numbers. Regarding legal expenses, I expect these to decrease significantly, while our auditing expenses will rise because we switched to an accrual method, which is much more costly than our previous approach. So, I do believe legal expenses will decline, but I'm not completely certain right now. Those fees should actually decrease by a couple of million dollars on an annual basis.

Okay. Got it. I assume excluding Gateway, which…

Right.

…Can you and is the close of that still 2Q? How are things progressing with that acquisition?

We will know come March 1st, I would hope.

Got it. That’s helpful. Maybe last from me and then I will step back and let some more into the queue, but just wanted to ask on the deposit side. There’s been some pressure on non-interest-bearing deposits over the past year after increases during COVID. I am wondering about the cadence of deposit flows when you anticipate starting to slow down and it looks like the gap was funded with time deposits, was any of that brokered funding? Just any color as to the cadence of mix shift and…

Okay. Our biggest issue has been we have these couple of trust accounts which I have talked about in the past. We asked to have moved last December from about $550 million with us down to between $250 million and $300 million, which they did. But one of them is a crypto company exchange and that went again with the crypto winter from $250 million down to approximately $150 million at the end of the third quarter. Then in the fourth quarter, we asked to have one of the customers we did not really like, that sub customer, to move away. Two weeks later, they moved that customer out of our book, and we went from $150 million down to $25 million. So that’s the big issue with the demand deposits. $300 million was planned to go off, then we had the crypto winter, and then we asked one big customer to move away, okay. And that is not FDX or anybody else that’s headlined in the news, just so that you know.

I understand, David. That's useful information. If I could quickly ask a follow-up, those accounts are quite significant. Now that you've reduced those levels, could you share any details about the largest account sizes at the bank? I'm not sure if you want to present it as the top 10 accounts or in some other way, but I'm just curious about any insights you can provide.

We have a policy now of no single relationship over $100 million with the bank anymore. We do have most of our high-value depositors who have deposits over $25 million, either directors or former directors or also former Presidents of banks that left companies we have purchased, okay. So when you look at that, we have a good number and we have retained a good number of deposits from either the chairperson or the President of the banks we have purchased in the LA region.

Awesome. Thanks for all the color today, David. I will step back.

Thank you. Our next question is coming from Nick Cucharale with Piper Sandler. Please go ahead.

Good day, everyone. How are you?

We are great.

Good. I just wanted to make sure I heard your NIM commentary correctly. You are expecting a 4% in the first quarter, and do you have any color on that — on the trajectory throughout the year or just sense of magnitude at this point?

I think our NIM will be contingent as — I think the history of rates going up and up and up has ceased. Most of our competitors are in the 4.25% range on CDs. For us to attract CDs we have to be around 4%. So you are going to see everything re-price to about 4% if we want to retain those depositors for the remainder of the year. I think you are going to see over the next quarters our NIM going down even though rates may go up still 75 basis points. I don’t think the deposit rates are going to continue to go up as much. I may be wrong about that because they haven’t really with the last rate increase at an increase. The community priced everything starting September and early October at 4%, 4.25%, 4.5%, 4.75%. That’s where they have been pricing. So we have taken a conscious effort to keep everything between 4% and 4.25%.

So can you give me a sense for — at this point, obviously, a lot can change and it’s a wildcard, but what are your thoughts in the middle of the year? Do you think the magnitude starts to slow down in terms of the cost increases on the liability side or just any sort of quantification would help there?

Well, I think, like I said, about 4% first quarter. We are optimistic on that. The second quarter, I think, will be around 3.75%. I think it will be about 25 basis points for the next couple of quarters.

That’s helpful. Okay. Thank you. And then in light of your capital position and valuation, are you expecting more forceful repurchase activity over the course of the year relative to 2022?

We are hoping to do that, okay.

Thank you. Our next question is coming from Tim Coffey with Janney. Please go ahead.

Hey. Good morning, David.

Hi, Tim.

Just a follow-up on the deposit cost questions there. What were or what was your spot rate on deposits at the end of December?

What do you mean by spot rate? What’s our offering rate?

Yeah. What was the rate of interest-bearing deposits at December 31st?

What we were offering was around 4.18%.

Okay. Yeah. Okay.

Yeah. Yeah. Yeah.

Okay. So we are talking about a sizable step-up in the cost of your interest-bearing deposits from where you…

Yeah.

If we kind of flip to the loan side and the borrower side of the equation, what kind of commentary are you hearing from them? Is it more related to rates or is it just more economic outlook that’s given the many kind of hesitation?

Well, everybody that has a floating rate loan wants to try to fix it at 7.5%, which we are not doing. If they pay off the loan, we get the prepayment fee. Loans in general, commercial lending has slowed down greatly in the last two months. I think it’s all rate driven.

Okay. Okay. And then what’s the — I mean how should we think about the efficiency ratio going forward? It seems like it’s got the possibility to break above 40. Does it hit 45?

I haven’t done any modeling of that, Tim. I think we will be — I haven’t done any modeling, so I can’t answer that question.

Okay. Okay. And then, sorry if I missed this, I might have already been asked, but do you have any sense of where your non-interest-bearing deposits as a percentage of total deposits might exit this year?

I think our non-interest-bearing deposits will stabilize. We still have some customers who want to go. Everybody wants their DDAs to become interest-bearing, but for a business that’s kind of hard to do because you need to have cash flow. We still follow Reg D on all the interest-bearing stuff. So we still count six transactions. So I think it’s going to be relatively the same.

Okay. Okay. Great. Yeah. All right. Those are my questions. Thank you very much.

Thank you. Our next question is coming from Ben Gerlinger with Hovde Group. Please go ahead.

Okay. You will have to…

Hi, Ben.

Good morning. I apologize if I’m going overboard on expenses, but considering the new hires outside of Gateway, would it be appropriate to estimate around 16 hires per quarter for the remainder of the year, totaling between $32 and $64 for the year? Am I thinking about this the right way?

Total expenses should be in the 16.2 range, something like that.

Okay. Yeah. That’s fair. Okay. I had pretty close. I’m sorry. It’s just a lot of puts and takes, so forgive me for that. And then kind of just for diligence perspective, just sort of curiosity, do you have any other crypto-related clients, either lending or deposits?

Well, we only have the two. One is active, and the other one is in CDs. So we don’t worry about it.

Got you. And then my last question is kind of more of a philosophical 10,000-foot view. You just said that lending demand has come down and overall customer deposit rates have continued to go up. Is there any source of new deposit initiatives that could be used rather than going to the market at a high CD rate? I know you are not going to have as much loan demand to match again, so just curious if there are different avenues of funding outside of CDs or broker deposits.

Well, we hired Gary. One of the things he’s going to do is take over the New York region, and we have a lot of interesting thoughts on different things that we could try. You won’t really see much of that probably until the third quarter or fourth quarter of this year, but we are going to implement a lot of things in New York that may be slightly different than what we do here in California. At least I think here in California, we are a completely a relationship bank. Once you contact all your relationships, you only grow as your relationships grow. So we could bring in additional relationship officers to help grow faster here in California and so forth also. But that would be adding to the expense side, and/or we would have to reallocate headcount to do such.

Got you. So kind of sit tight. If there’s a result, it’s more so the latter six months of the year…

Yeah.

…if there’s anything this year. But if there are expenses, probably ramp?

Yeah. We have things in our strategic plan that we are looking at, but we are not ready to announce any of those things at this time. There are some things that we are planning to do that could really help on the deposit side. One of them is that we don’t really do C&I variable loans, and we are putting in a C&I platform that will hopefully be able to attract depositors and the C&I customer to the bank.

Sure. Yeah. No. I really appreciate the color over there. Thank you.

Our next question is coming from Andrew Terrell with Stephens. Please go ahead.

Hey. Good morning.

Good morning.

David, maybe just on the last point first, getting into maybe a little more C&I type lending that could bring deposit relationships with it as well. Can you just talk about maybe, I mean, obviously, maybe a bit different type of lending than the current composition of the balance sheet. Can you just talk about kind of risk parameters in place as you make that kind of pivot or step more heavily into that market?

Well, let me step back for a second, Andrew. We already do C&I and we already have the risk parameters set. They haven’t changed. The issue is, it takes us two weeks to do a loan. It needs to be done within a day. On a C&I loan you have to be able to have this loan done within a day, and it takes us two weeks. So that's what we are really doing.

Okay. Got it.

And just so you know, on the rest of our book, we have either decreased or have loan-to-value on almost every product twice, okay? So by 5 basis points each time and we have increased our debt service coverage ratio by 5 basis points also on every product type. We did that over the year too. But that isn’t — we are not even seeing loans that fall out of those boxes even right at the moment.

And what are aggregate across CRE portfolio aggregate loan to values and debt service coverage rate at?

I would say aggregate would be the policy, probably, the aggregate is 125. Actuals will probably be north of 130, and loan-to-value is around 60 now. Actual would probably be in the 50s.

Okay.

Now mortgage is slightly different. We are still at a maximum loan-to-value of 70%, but the average loan-to-value for our mortgages is around 60%.

Okay. And if I could shift over to the fee income side, can you just maybe provide some expectations for gain on sale and then overall fee income as we move into 2023?

We are noticing that New York investors have decreased their rates from 8.5% to around 7.5%. However, we are still not offering loans at that rate, and in the mortgage sector, we are approximately at 7%. If we can lower it a bit more, we might begin selling some loans. We currently have two $30 million pools with a bank, a Chinese-American bank located on the East Coast, that is interested in potentially purchasing them. One of our main objectives is to increase the gain on sale of loans to about $2 million per quarter.

Okay. And then last one for me is just kind of a point of clarification on the margin and the interest-bearing deposit costs. I think you mentioned spot interest-bearing costs at the end of the year low 4%. I just want to make sure I am hearing you right, but the full quarter average for interest-bearing costs was 1.93%…

Right.

…what that cost was at the end of December?

Right. That’s what that is.

Okay. That it was low.

Now the cost that I am talking about is our offering rate to our customers.

Okay. So the incremental funds as opposed to what was already on the balance sheet?

Yeah.

Okay. Understood. Thanks for taking the questions.

Okay.

Thank you. Our next question is coming from Kelly Motta with KBW. Please go ahead.

Hey. Thanks for having me step back in the queue. Just know we spent a lot of time on the deposit side and your loan growth was really strong this quarter. I know you have to balance what’s going on in your markets, in the economy, as well as pressure on funding. But just wondering on kind of what your broader outlook is for loans as we look throughout 2023. Is it mostly going to be CRE and residential driven? I know you spoke about C&I as something potentially to ramp up over time, but just generally wondering what your thoughts are for this upcoming year?

I see what we are hoping is mortgage will take a back seat because we have already put our mortgage portfolios together about 40% to 43% of our total portfolio, which really, if you think about it, is the safest loan you can do, especially at a loan-to-value of 60%. So we don’t really want to grow that. With the rest, we want to grow CRE and C&I. C&I is not going to be a huge growth number this year, and we will see how well it does. It will take time to roll it out to larger loans maybe at the end of the year. But most of our growth will be in the commercial real estate side. We have rates anywhere from like 6% and 7% to 8% and up to 10% right now on those products. I see maybe in the summer time, you may see a little bit more construction out there because of they can build. We have had a month of rain. No one is drawing down on their construction loans. But we are not going out and particularly stressing any one category.

Thanks, David.

Hi. Just to really answer your question, I do see production to be significantly below 10%. I would say mid-single digits this year.

Thank you.

As we have no further questions in queue at this time, I will hand it back to Mr. Morris for any closing comments you have.

Once again, thank you all for joining us today. We look forward to speaking to many of you in the coming days and weeks. Happy New Year.

Thank you. And this does conclude today’s conference call. You may disconnect your lines at this time and have a wonderful day. And we thank you for your participation.