RBB Bancorp Q2 FY2024 Earnings Call

Good day. And welcome to the RBB Bancorp’s Second Quarter 2024 Earnings Conference Call. At this time, all participants are on a listen-only mode. After management's prepared remarks, there will be a question and answer session. I would now like to turn the call over to your host, Catherine Wei. Please go ahead.

Thank you. Good day, everyone. And thank you for joining us to discuss RBB Bancorp's results for the second quarter of 2024. With me today are Chief Executive Officer, David Morris; President, Johnny Lee; 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 company's SEC filings. Now I'd like to turn the call over to RBB's Chief Executive Officer, David Morris. David?

Thank you, Catherine. Good day, everyone, and thank you for joining us today. RBB reported second quarter net income of $7.2 million or $0.39 per share as we saw further signs of stabilization with modest loan growth, and no change in funding costs. Net interest margin declined 2 basis points. But as Lynn will explain, we are cautiously optimistic that it will begin to expand in the third and fourth quarters. What really is going to drive our results is deposit-funded loan growth. Loans increased by $20 million in the second quarter, supported by approximately $115 million of loan production at a weighted average rate of 7.4%. However, and more importantly, we are seeing increased loan activity and our loan pipeline is expanding, which we expect will support further net loan growth going forward. Interest expenses declined from the first quarter as we continue to reduce our reliance on wholesale funding to 4% of total deposits. This is down from about 16% of deposits a year ago and 7% at the end of last quarter. We did see an increase in non-performing loans in the second quarter, primarily due to three loans migrating to non-accrual, but we believe we are appropriately reserved based on updated appraisals we have obtained during the second quarter. These three loans total $22 million and consist of a $10 million C&D loan, a $7.3 million CRE loan, and a $4.7 million C&I loan secured by a personal residence. We are very focused on reducing the levels of NPLs. And by way of example, we expect to settle through trustee sales, two SFR non-accrual loans totaling $8.1 million with loan-to-values less than 50% in the third quarter. While we recognize that in this environment or any environment for that matter, a 48% increase in non-performing assets could be a cause for concern. We are comfortable with the underlying collateral of our troubled loans and expect we will be able to resolve them without material loss. With that, I'll hand it over to Lynn, who can go into some more details about the quarter. Lynn?

Thank you, David. Please feel free to refer to the investor presentation we have provided as I share my comments on the company's second quarter of 2024 financial performance. Slide 3 of our investor presentation has a summary of second quarter results. As David mentioned, net income was $7.2 million or $0.39 per diluted share, a decline of $0.04 from last quarter's $0.43 per share. Net interest margin decreased 2 basis points due primarily to the impact of the $22.5 million in loans that migrated to non-accrual, which reduced interest income by $710,000 and net interest margin by 8 basis points. Net interest income decreased by $912,000 to $24 million with $520,000 of that decrease coming from the impact of the non-accrual loans. Interest income decreased $1.9 million due to a $1.7 million decrease in interest income on average cash balances and the aforementioned $520,000 reduction, offset by a net increase in loan interest income of about $300,000. Average cash balances decreased $109 million quarter-over-quarter. Trimming our cash balances allowed us to reduce our reliance on wholesale funding and reduce our expenses or interest expenses by $1 million in the second quarter. Decreasing our wholesale funding also helped us maintain a stable cost of funds compared to the last quarter. Non-interest income increased slightly to $3.5 million and benefited from $359,000 of distributions on an equity investment made for CRE purposes and higher gain on sale of loans. While we recognized $292,000 in gain on OREO, this was less than the $724,000 in gain on OREO we recognized last quarter. Non-interest expenses were relatively stable at $17.1 million and we expect them to remain at close to this level for the third and fourth quarters. Commercial real estate loans and construction loan development loans were stable at 39% and 7% of our total loans, and Slide 6 has additional details about our exposure in those portfolios. Slide 7 has details about our $1.5 billion residential mortgage portfolio, which consists of well-secured non-QM mortgages primarily in New York and California with an average LTV of 61%. Starting on Slide 9, we added a couple of asset quality slides to the presentation that we hope will help investors understand our non-performing loans in light of the increase we reported this quarter. On Slide 12, you will see our allowance for loan losses remain stable at 1.37% of total loans held for investment. However, due to the increase of non-performing loans, our allowance to non-performing loans ratio decreased to 76%. We expect this ratio to recover in future quarters as we resolve the non-performing loans. Slide 13 has details about our deposit franchise. Total deposits were stable from the first quarter at $3 billion as wholesale funding was successfully replaced with retail deposits. In addition, non-interest bearing deposits remained relatively flat for the second quarter in a row. Our average all-in-cost deposit for the second quarter was unchanged at 3.59% from the first quarter. Tangible book value per share increased to 24.06 due to earnings and accretive share repurchases, offset by our shareholder dividends of $3 million. We repurchased about 448,000 shares at an average price per share of 18.01 in the second quarter. Our capital levels remain strong with all capital ratios above regulatory well-capitalized levels. With that, we are happy to take your questions. Operator, please open up the call.

Your first question is coming from Brendan Nosal with Hovde Group.

Just to start off here, you certainly struck a bullish tone on both loan growth and the margin for the back half of the year. I was hoping you could help us size up the opportunities in both these areas over the next two quarters?

Okay, Lynn will start.

Let me start and then we can turn it over to a few people for details. So I think relative to the first half of the year, we are cautiously optimistic. We had reported net no growth in the first quarter and $20 million net growth in the second quarter. So I think relative to those two quarters, we are expecting increased growth. I can definitely appreciate that the current environment is still leaning towards low percent-digit growth. So I think I don't know if that helps with the bullish tone, and we can go into other details on pipelines. And then on the net interest margin, we had to report the impact of placing or the migration of a couple of non-accrual loans, which impacted our net interest margin by 8 basis points. So I think with ongoing loan growth, we are optimistic that we wouldn't have any additional large non-accruals to report in the absence of those. I think that's where we would like to see our net interest margin stabilize and possibly come off of the floor we're at now.

And maybe one more for me, just on the migration you saw in non-accruals. I mean, how would you folks characterize migration for these three credits or maybe talk about the drivers? And given that it's in three different portfolios, it feels like it's tough to say that these are kind of one-offs, but I'm kind of just curious if there's any common driver in that migration.

I don't think there is a common driver in the migration of the loans that you saw with the increase here at all.

So I would agree. I don't think we're seeing any trends that we're concerned about based on those moving to non-accrual. Obviously, every time you have someone move to non-accrual, you have to take a hard look at the rest of your portfolio and determine if there's anything else that looks similar that could have exposure. And at this point, I don't think we've identified anything or have anything to report. Two of the loans we did indicate are within one relationship. So they happen to be in different portfolios but I think that would be the only item, I guess, that has a common denominator.

Your next question is coming from Kelly Motta with KBW.

It looks like your loan sales picked up again this quarter. Wondering if you could provide any color as to if that was residential or SBA, as well as your pipeline for loan sales as we look towards the back half of this year?

We have seen a pickup in our SBA. So most of this is SBA but we still are gaining also a little bit of traction in our mortgage portfolio also. So Lynn has the exact details if you need them.

Actually, I don't have those right at my fingertips. I think that on SBA, we're seeing wide spread, so that part's been successful. And then I think with the interest rate environment, we've seen a little bit more on the mortgage, but the majority is SBA.

And then maybe a question for you, Lynn. It looks like the securities yields ticked up slightly. Just wondering if you are reinvesting any of the cash flows into the securities book or the driver of that as we think about that side of the margin?

I think what we're seeing for the yield itself on the securities portfolio is probably a higher percentage that was in short-term commercial paper, given the inversion in the yield curve. So I think that probably had the most impact as at a higher percent of our earning assets and average loans when I look at the whole earning assets. So I think that was the main driver of the securities yield increase.

And I know you guys have been working through and making solid progress towards remediation of several items. I think the SEC investigation is done, and you're still working towards AML. Just wondering, as you guys work through those processes, if there's any additional expenses or if you continue to expect that those are all currently in the expense run rate.

I believe they're currently in the expense run right now.

Your next question is coming from Matthew Clark with Piper Sandler.

Maybe first on the margin. Lynn, do you have the average margin in the month of June on an adjusted basis, excluding that 8 basis points of interest income reversals, and then maybe the spot rate on deposits at the end of June?

I believe my comment regarding the trend of the net interest margin is relevant to your question about April, May, and June. We are observing that it is stabilizing based on the information we've shared. I had intended to include the spot rate in the investor deck, and I apologize for missing that. Please give me a moment to retrieve that information. In the meantime, do you have another question, Matthew?

I was going to get to the CDs and the roll rates there. Just remind us what's maturing in the third and fourth quarter, at what rate and what you expect them to renew at?

I think 95% of our CDs will mature in over 12 months, and that maturity is fairly evenly distributed. Recently, the cost of deposits has begun to ease, especially over the last week or two. If you had asked me this question a month ago, my response would have been different, as the funding rates were coming in similar to how they were rolling off due to the prolonged period of high rates. However, we are noticing some softening, although it's not as significant as we would prefer. There may be opportunities for repricing to be slightly lower. I can't provide the exact basis points. David, do you have anything else to add?

No, I mean, I think you said everything. Our portfolio is pretty evenly dispersed over the months.

What are your updated plans for the $150 million of FHLB that is maturing in the first quarter?

Given our loan-to-deposit ratio is on the higher end and our intention to maintain a healthy amount of on-balance sheet liquidity, we may consider exploring the wholesale market for options if we don't see sufficient organic loan growth. This could involve FHLB advances or other wholesale sources. We will need to navigate the interest rate environment as it stands in the first quarter of next year. I can’t say for certain that those funds are being prefunded since we anticipate interest rates will decrease. Unfortunately, it seems we might face some repricing higher in the first quarter next year. As for spot rates, they are similar to the average rate for the quarter.

Your next question is coming from Andrew Terrell with Stephens.

Just a couple of quick ones for me, most of mine were asked already. On the loan growth, just to clarify, Lynn, I think you said still kind of expectations for low single digits for the year. I think last quarter, we were talking about low to mid-single digits. I guess any overall change to the loan growth message?

I don't think so if it's low to mid. I mean as the year has moved on, if you're looking kind of for the rest of this year, again, relative to the first half, I think we're looking at something more. I don't know if you want to add just a couple of comments on pipeline or the mortgage.

Our pipelines right now, Andrew, are very, very strong but we also have payoffs and those types of things that also need to be calculated into this. We're also in a very trying environment. It's a very trying environment right now to try to get loans, and we are competing as best as we can. But we do expect, relative to the first half of the year, the second half of the year will be better.

As you consider the current composition of the pipeline, have there been any changes in the mix compared to three or six months ago? Is the slightly increased optimism perhaps related to the improvements in commercial and industrial lending, commercial real estate, and single-family loans? Can you provide any specific details on that?

I don't think so. I think it's 50-50 basically commercial, residential.

Have you adjusted spreads on new loans? Last quarter, we were at 8.3%. For new origination yield, you mentioned $7.4 million. This quarter, production yields have seen significant compression. It could be related to a change in mix, but have you actively lowered spreads?

Before I turn it over to discuss the current rate, I want to note that the 8.3% we recorded last quarter was influenced by factors such as commercial and industrial loans compared to our single-family portfolio, which typically has a lower commoditized rate. This is how we arrived at the average production yield of 7.4% that we reported. If we analyze the numbers by product, there are distinct differences. Regarding the trend in spreads, I will let you take it from here, David.

Our rates for mortgages are approximately 7.25% as a starting point. For commercial loans, the rates range between 6.75% and 10%, depending on the specific product.

We have a follow-up question coming from Brendan Nosal with Hovde Group.

Just wanted to hit on the buyback before the call wrapped up. You guys were quite active this quarter repurchasing shares, but the price is up quite a bit from that average price throughout the second quarter. Just kind of curious what your appetite is to continue making use of that authorization over the next few quarters?

I think we still have a pretty strong appetite since our stock price is still below our tangible book. But to your point, the stock price has moved up nicely, and I think we'll consider looking at all aspects of it. Maybe it could moderate but we still have 0.5 million shares under our authorization there.

We have an additional follow-up question with Kelly Motta from KBW.

I would like to get more details on the NPAs. I appreciate the comments regarding the possibility that two of them were from the same borrower. I know you set aside specific reserves this quarter. Can you provide more insight into what gives you confidence in recovering those without incurring losses? Additionally, with the increase we observed this quarter, was that linked to a particular review or something similar? Do you foresee any potential issues that could worsen the NPAs and maintain them at this elevated level?

I'll start, then I will pass it off to Lynn for further details. This was not a result of any review, examination, or audit. It was just part of normal banking operations, you could say. When you look at it, there are two loans and two borrowers, each with distinct circumstances that led to this situation. We went out and obtained new appraisals, which we discounted, and that's how we assess impairment on these loans. We believe that on one loan, we've been proactive, and we expect to accept the deed in lieu of foreclosure for that loan, allowing us to sell the property in a calm and normal manner to maximize its value. Lynn, I'll let you take it from here.

So Kelly, all of the loans that are for nonperforming, kind of talking to your comment about specific reserves. So going through a comprehensive CECL process, we can run a lot of models. But once something is impaired, obviously, it has to go through detailed individual review. So in some respects, you might take comfort that this group of loans has been specifically looked at and measured. To the extent that it's collateral-dependent, we do charge off, which is some charge-off level that you saw in the quarter. And then there's limited specific reserves on our nonperforming loans. So I don't know if that answers your question on the specific reserves. And I agree with David's comments, as we looked at, we put in Page 10 of the deck, so that to facilitate the conversation given the uptick and how we specifically looked at many of our non-accrual loans. Unfortunately, as we all know, it takes some time to work through them. I think we're going to be urgent about it, but we obviously have a lot of things we have to comply with. We'll work through it in the third and fourth quarter of this year.

You have a follow-up question from Matthew Clark with Piper Sandler.

Thanks, and I apologize if I missed it. But any commentary on the expense run rate, the noninterest expense run rate going forward after a seasonal decline in compensation?

It was a quick one. I think we believe our expense run rate will be approximately at the same or similar level that we have in the second quarter.

There appear to be no additional questions in queue at this time. I would now like to turn the floor back over to David Morris for any closing remarks.

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

Thank you, everyone. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.