RBB Bancorp Q4 FY2023 Earnings Call

Good day, everyone, and welcome to the RBB Bancorp’s Fourth Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode, and a question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the floor over to your host, Brian Stevens. Sir, the floor is yours.

Thank you, Matt. Good day, everyone, and thank you for joining us to discuss RBB Bancorp's results for the fourth quarter of 2023. With me today are Chief Executive Officer, David Morris; President, Johnny Lee; Interim Chief Financial Officer, Lynn Hopkins; Chief Credit Officer, Jeffrey Yeh; Chief Administrative Officer, Gary Fan; and Chief Risk Officer, Vincent Liu. David and Lynn will briefly summarize the results, which can be found in the earnings press release and investor presentation that are available on our Investor Relations website, and then we'll open up the call to your questions. I would ask that everyone please refer to the disclaimer regarding forward-looking statements in the investor presentation and the Bank's SEC filings. Now, I'd like to turn the call over to RBB's Chief Executive Officer, David Morris.

Thank you, Brian. Good day, everyone, and thank you for joining us. We undertook several initiatives last year to position RBB for the future. We strengthened our management team by adding respected senior executives, including Johnny Lee as President and Lynn Hopkins as Interim Chief Financial Officer. We restructured our operations and established a more formal reporting structure to better manage our national franchise business. We increased liquidity and mitigated balance sheet risk by reducing our loan-to-deposit ratio and strategically exiting certain higher-risk loan relationships. We also addressed regulatory concerns by adopting enhanced corporate governance policies and reconstituting our Board of Directors. With respect to the consent order we disclosed in October, we believe we have addressed all the deficiencies identified, but there could be no guarantee that additional measures will not be required. We are also pleased to share that we were notified by the SEC that they have concluded its investigation and that they did not intend to recommend any enforcement action against the bank. Some of the actions we took last year, namely corporate governance and AML related expenses, increased liquidity and payment of our target 95% loan-to-deposit ratio, and a reduction in higher-risk, higher-yielding loans did impact results. But with the majority of the work behind us, we are better positioned to create long-term shareholder value and expect profitability to improve over the coming quarters as we resume deposit-funded loan growth and take steps to optimize our cost of financing. In the fourth quarter, we were able to recognize the $5 million CDFI ERP award that I mentioned last quarter as we distributed the funds to related recipients. Before I hand it over to Lynn, who we are thrilled to have as part of our team, I did want to mention that we were active buyers of our shares in the fourth quarter and invested approximately $6.7 million to repurchase almost 400,000 shares. We have exhausted our current buyback authorization but recognize the benefits of having a buyback in place and expect to discuss a reauthorization at the next board meeting. Lynn, welcome and take it away.

Thank you, David. I've been here for about a month and a half, and I'm still getting up to speed, but needless to say, I'm very happy to be part of the RBB team. I look forward to reconnecting with everyone in the coming weeks. Please feel free to refer to the investor presentation we have provided as I share my comments on the company's fourth quarter of 2023 financial performance. Slide 3 of our investor presentation has a summary of fourth quarter results. We achieved $12.1 million in net income or $0.64 per diluted share. Net income for the fourth quarter benefited from the recognition of a pre-tax $5 million CDFI ERP award. Adjusting for this revenue, fourth quarter net income would have been $8.6 million or $0.45 per diluted share. Tangible book value per share increased 4% during the fourth quarter to end the year at $23.48 due to net earnings, lower unrealized losses on our securities portfolio, and share repurchases. Yield on our interest-earning assets was relatively stable from last quarter, but interest income declined slightly due to a $102 million reduction in average loans held for investment. This reduction, combined with a rate-related increase in interest expenses, resulted in a $1.9 million decrease in net interest income and further pressure on net interest margin, which declined to 2.73% in the fourth quarter. Credit quality improved in the fourth quarter, with nonperforming loans decreasing by 21% to $31.6 million. This decrease was primarily due to the payoff of a $9.9 million nonperforming construction loan with no additional losses. Our allowance for loan losses remained stable at 1.38% of total loans, compared to 1.36% at the end of the third quarter. Noninterest expenses totaled $16.4 million, declining by 2.9% compared to the prior quarter, primarily due to lower salaries and benefits expense. We anticipate total noninterest expenses to increase in the first quarter due to a temporary seasonal increase related mostly to taxes and to reflect compensation adjustments as we start the New Year. As a result, noninterest expenses are expected to be around $17.5 million. Slide 4 includes summary balance sheet information, and you can see the decline in loans held for investment. As David mentioned, we believe there are near-term steps we can take to reduce our funding costs, which should benefit margins and net interest income. Slide 5 provides additional detail about our loan portfolio, which totaled $3 billion at the end of the year and had a fourth quarter annualized yield of 5.96%. Commercial real estate loans, which include construction and land development loans, comprised 45% of our total loans, and Slides 6 and 7 have some details about our exposure. We continue to have limited CRE office loan exposure, which stood at $43 million and represented 1.4% of total loans at the end of the fourth quarter. Slide 8 has details about our $1.5 billion residential mortgage portfolio, which consists of well-secured non-QM mortgages in New York and California, with an average LTV of 61%. Slide 10 has some details about our deposit franchise. Total deposits were $3.2 billion at the end of the fourth quarter, a $20.7 million increase compared to the third quarter. This increase was due to a $53.5 million increase in interest-bearing deposits and a $32.8 million decrease in noninterest-bearing demand deposits. Included in the increase in interest-bearing deposits was a $20.4 million reduction in wholesale deposits, which were replaced by non-maturity deposits. Our average cost of interest-bearing deposits for the fourth quarter was 4.08%, an increase of 25 basis points from the third quarter, versus the 36 basis point increase from the second quarter to the third quarter. We continue to expect the pace of increases in our deposit costs to slow in future quarters. Our capital levels remain strong with all capital ratios above the regulatory well-capitalized thresholds. With that, we are happy to take your questions. Operator, please open up the call.

Your first question is coming from Nathan Race from Piper Sandler.

Question just on the expense run rate into this year. I appreciate the guidance for 17.5% as a starting point for the first quarter. But just curious on how you think about the cadence of expenses in the 2Q and 3Q as well?

Sure. Thanks to meet you over the phone here. So when we think about noninterest expenses, I think there's a couple of ways, but one is our operating expense ratio relative to our earning assets. We think we've observed that it was closer to about 185 at the beginning of 2023, and it migrated down to about 163 in the fourth quarter of 2023. I think as we look forward with some of the initiatives the bank undertook in 2023 and the expense related to those, we would anticipate that noninterest expenses might look closer to 170 of average earning assets, plus or minus some basis points.

Okay. Got it. And then does that higher expense run rate for the first quarter, does that contemplate some hires that you guys have made recently? And if so, how do you guys kind of think about those hires impacting the growth outlook in both loans and deposits going forward?

I think without getting into all of the details of hires and the ins and outs of the solar expense, I think we believe we have the appropriate staff to be able to achieve goals in 2024 and grow appropriately. So I think it's all included in the number.

Okay. Thank you. And if I could just follow-up. Are there any kind of guideposts that you guys can provide in terms of how to think about both loan and deposit growth during 2024?

So I think that at the end of 2023, we have our loan-to-deposit ratio down just below 95%. I think again, with the actions the bank took during 2023 and given the current economic outlook, we expect to participate in some loan growth. It might be a little bit premature to provide specific guidance there. We do expect to fund our loan growth with deposit growth as we move forward here. It provided a range, but it might be a little bit too wide at this point.

Understood. I appreciate that, Lynn. And if I could just follow-up with David on the pace of share repurchases going forward. I understand that you guys will likely be reengaging in the authorization that's out there, coming out of the fourth quarter, but just any thoughts on just the pace of buybacks over the next quarter or two?

I would think the pace of buybacks should be similar to that we had in the fourth quarter. I think that's pretty much what we want to do.

Your next question is coming from Kelly Motta from KBW.

I wanted to discuss the loans in the pipeline. Could you take a moment to talk about it? I know Johnny has been focusing on building the pipeline and developing commercial and industrial relationships. I'm curious about the current status and whether we could expect another quarter or two of loan contraction as things start to stabilize.

Kelly, this is Johnny. Well, last year, as you know, we were trying to achieve the loan-to-deposit ratio of 95%. So we were kind of navigating through that, and there was demand, obviously, but then we're trying to balance it so that we don’t overshoot it. So we had actually already positioned ourselves to build that momentum for growth this year. And I would simply share that the pipeline right now looks relatively promising. But I think the challenge right now is the mix. We have demands on all fronts, but obviously, we want to optimize the returns. But I think credit quality is still first and foremost as far as selecting the types of deals to take on. But credit quality and then definitely, we want to generate appropriate returns, and that's how we're looking at this pipeline right now. Overall, I think I'm relatively pleased with it, but then generally, it's usually a slow month, but I think the momentum is definitely there.

Got it. That's helpful. As we look ahead, I know you have worked hard to bring the loan-to-deposit ratio down to a more normalized level. I'm curious about your perspective on growth and how you anticipate funding. Is it still retail CDs that many banks are relying on? What does the funding outlook look like at this time? If and when we get rate cuts, how quickly do you think betas will react on the downside?

Sure, Kelly. Let me start. I will mention off of Johnny's comments. I think the pipeline is building, and I think there is an expectation that we will convert that into net loan growth. And as we look at the ratio of loan-to-deposits, we brought the ratio down. There's probably an opportunity for that to move between, call it, 95% to 100%, as we look at other sources for funding. I think we all know that the Fed's program has been out there. I think we've been successful in bringing in some non-maturity relationship deposits and other time deposits. So I think there is an opportunity for growth. It will be funded with deposits with some focus on the commercial side of the business. There's an expectation that we have an opportunity to grow demand deposits, which are obviously very helpful for net interest income and the margin. With respect to your comment or question about betas, I think we can appreciate that the talk about interest rates potentially coming down in the second half of this year. None of us know exactly the timing or magnitude. We think staying flexible on the funding side of the balance sheet is going to be important. So having some non-maturity deposits can be helpful, potentially staying a little bit shorter to give us that flexibility. And then, I don't know that I have a comment necessarily on the betas per se, but we definitely recognize we're not going to navigate through probably a changing interest rate environment.

That's super helpful. Maybe last one for me, and I'll step back. Flipping through the slides, I really like the slides on the office and all the color you guys provide. On Slide 6, it looks like there's about $9 million in office with LTVs over 85%. Just wondering if David or anybody could provide some color on what kind of sits on the bucket and how concerned or not you are with office in general and kind of that higher LTV portion?

This is Jeffrey. We have a loan that is currently in forbearance, and we have an agreement with the borrower. The borrower is collaborating with their tenants, which are government entities, and we are not worried about the source of rent payments; they just need to coordinate with their tenant. We are somewhat optimistic that this issue can be resolved by the end of the forbearance agreement.

Your next question is coming from Andrew Terrell from Stephens.

Could you provide an update regarding the office loan? Where does it appear on the balance sheet, and what is its current risk rating? Is it classified as criticized or classified at this time? Additionally, is there a specific reserve established for that loan currently?

In terms of the specific reserve, there is no specific reserve because they should be able to cash flow based on the source of the rent. And besides them, based on the value of the collateral, we have done the impairment analysis and indicated no impairment.

And it is certainly classified though.

No, no classified loan, yes.

Okay. Got it. Very good. Thank you. If I could go back to David, just you mentioned in the prepared remarks kind of taking steps in 2024 to optimize the cost of funding or maybe the cost of deposits? And then I heard some of the commentary around just the expectation to lean a little more heavily into the C&I oriented business, which would obviously carry a greater mix of DDAs and some core funding there. Is that really the kind of strategy? Or is there anything else that you're looking at that you could kind of elaborate on that, that you could leverage you could pull in kind of 2024 to optimize the cost of funding?

Well, there are multiple options out there, Andrew. And without getting into any real specifics, it's not just the loans and deposit ratios. It's also other investments, other items out there to help us with the cost of funding and so forth. I said loans, I'm sorry, there's other types of vehicles, besides just deposits that can help us. Also, we do promotions like every bank does, and we can guide those promotions into something that is lower yielding than the highest rate CD and something that would give us flexibility to go down the curve quicker, okay? Also, it won't be locked in.

Okay. Understood. And maybe just following up on that point specifically. Can you refresh us on any time deposit specials you're offering right now and kind of what the term or duration and the rate is on the specialty you're offering? And then, if you could also just remind us on the repricing dynamics for the first quarter, how much you've got rolling off and at what cost?

Right now, we do not have a special out there in the market for time deposits. We do have a special out for, I believe, it's DDA right at the moment. Okay, personal checking and business checking. Now also, I'll have Lynn answer the rest of the question.

Sure. So, like I said, we ended the quarter with our cost of deposits for the fourth quarter being about 4%, 4.08%. And within the numbers at the end of the year, we have about $275 million in wholesale funds that are maturing in the first quarter. Those are pretty fully priced in, in the current interest rate environment. So to the extent that we need to roll those, I think they would have limited impact on our net interest margin. There is a portion of our retail deposits that will reprice in the first quarter. And again, I think that we're seeing some inversion in the yield curve related to funding costs. So, to the extent that they're very short-term, they might reprice up a bit. To the extent that we look out 12 months, we're probably pretty close to current carrying rates. So, I think it's going to have a bit of a muted impact as we look forward and as our funding base continues to reprice in the current environment. Hopefully, that's helpful. I think the time deposits that are coming off are between $450 million and $500 million, and then we'll work to retain those in the current marketplace.

Okay. Perfect. No, that's very helpful. I appreciate it. And lastly, if I could sneak it in. Can you just remind me, the $150 million of FHLB that's termed out at, I think, a low 1% cost right now. I think the maturity of that was in 2025, if memory serves. Can you just remind me the specific maturity dates for the FHLB borrowings?

It would be the first quarter of 2025, late first quarter 2025. There are multiple maturity dates. So, but it's all in the first quarter of 2025.

Your next question is coming from Tim Coffey from Janney.

Dave, could you discuss whether you are open to originating loans for sale in the near term?

On the mortgage side, yes. And SBA also mortgage and SBA, yes.

How do you see that market evolving over the course of this year? Do we need the rate cuts in the back half of the year to really start to engage that customer base?

I think on the mortgage side, I don't know if you specifically need rate cuts. What you really need is a decrease in the long end of the yield curve since that's what affects mortgage pricing. We need the 10-year treasury to drop back down to around 3% like it was before it went above 4%.

And then just kind of on your reserve. And obviously, I understand what comes through the income statement is dependent on the economy and the economic outlook. But if it continues to improve and you've derisked the portfolio, do you see a real reason for a dramatically increased provision this next year?

Really, we cannot project that out right now, Tim. We don't have a crystal ball, and we do not know what's going to happen with the economy and so forth. However, saying that our loan portfolio has improved in its quality and so forth. So, and if it continues to improve, there may be something down there.

We have reached the end of the question-and-answer session. I will now turn the call over to David Morris, President and CEO, for closing remarks.

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

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.