RBB Bancorp Q2 FY2025 Earnings Call

Greetings, and welcome to the RBB Bancorp Second Quarter 2025 Earnings Call. Please note, this conference is being recorded. I will now turn the conference over to your host, Rebecca Rico. The floor is yours.

Thank you, Ali. Good day, everyone, and thank you for joining us to discuss RBB Bancorp's results for the second quarter of 2025. With me today are President and CEO, Johnny Lee, Chief Financial Officer, Lynn Hopkins; and Chief Credit Officer, Jeffrey Yeh. Johnny and Lynn will briefly summarize our results, which can be found in the earnings press release and investor presentations 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 Bancorp's President and Chief Executive Officer, Johnny Lee. Johnny?

Thank you, Rebecca. Good day, everyone, and thank you for joining us today. Second quarter net income totaled $9.3 million or $0.52 per share and included $2.9 million of after-tax net income for an employee retention tax credit refund. The increase in net income was also driven by another quarter of solid loan growth and stable earning asset yields, which supported a $1.2 million increase in net interest income and a 4 basis point increase in NIM. Loans held for investment grew by $92 million or 12% on an annualized basis, with growth in almost all categories. We continue to see strong results from our in-house mortgage origination business, which originated $120 million of mortgages in the second quarter. These contributed to our total second quarter loan originations of $183 million at a blended yield of 6.76%, which will continue to support our asset yields and margins going forward. Our pipelines remain full, so we expect to continue to see loan growth, though likely at a more moderate pace than we experienced in the first and second quarters. We're pleased with our loan growth so far this year and believe we're making good progress on our efforts to expand originations. Net interest margin increased to 2.92% and has increased by 25 basis points over the last 4 quarters. Absent rate cuts, our funding costs are likely close to stabilizing at this level. And at the same time, we may see increases in yields on earning assets, which should support incremental margin increases over the next few quarters. We remain focused on resolving our nonperforming loans as quickly as possible while minimizing the impact to earnings and capital. We did have some charge-offs, which Lynn will discuss in more detail, but we do not see any increase in our total nonperforming loans in the second quarter. Criticized and classified assets increased. However, the majority of the additions this quarter are loans that remain on accrual status. We continue to work through our remaining nonperforming criticized and classified assets and expect to be able to report additional progress in the coming quarters. With that, I will hand it over to Lynn to talk about the results in more detail. Lynn?

Thanks, Johnny. Please feel free to refer to the investor presentation we have provided, as I share my comments on the company's second quarter of 2025 financial performance. Slide 3 of our investor presentation has a summary of our second quarter results. As Johnny mentioned, net income was $9.3 million or $0.52 per diluted share. Second quarter results benefited from the recognition of a $5.2 million employee retention credit or ERC refund, which is included in other income. We also recognized related ERC advisory costs of $1.2 million, which are included in professional service fees. There is no similar income or expense in any of the other quarterly periods presented. Adjusted for the ERC refund and associated fees, net income would have been $6.5 million or $0.36 per diluted share. Also, excluding ERC-related income and expense, pretax pre-provision income increased $1.4 million due to higher net interest income of $1.2 million and higher noninterest income items of $1 million, offset by higher noninterest expense items of approximately $800,000. Net interest income increased for the fourth consecutive quarter to $27.3 million and was driven by loan growth and stable asset yields. The overall loan yields remained above 6% and were supported by the quarter's average production yields of 6.76% and loans repricing in the current higher interest rate environment. As Johnny mentioned, we had another quarter of net interest margin expansion, our fourth in a row, driven primarily by an 8 basis point reduction in total deposit costs. Our spot rate on deposits on June 30 was 2.95%, which was 10 basis points below the second quarter's average of 3.05%. So we may get incremental improvement in the fourth quarter. But until we get some rate cuts, we are likely to see limited reductions in our funding costs. The second quarter also included a full quarter of more expensive FHLB term advances after they were refinanced late in the first quarter. Second quarter noninterest expenses increased by $2 million to $20.5 million, of which $1.2 million was directly related to the receipt of the ERC refund from the IRS. Higher compensation expenses related to executive management transition and incentive payments for increased loan production also contributed to the increase. We expect noninterest expenses to return to an annualized run rate of about $18 million in future quarters. Slides 5 and 6 have additional details on our loan portfolio and yields. The loan portfolio yield was relatively stable at just over 6% when compared to the last two quarters. Slide 7 has details about our $1.6 billion residential mortgage portfolio, which increased modestly and consists of well-secured non-QM mortgages, primarily in New York and California, with an average LTV of 55%. Slide 9 through 11 have detail on asset quality. The $2.4 million provision for credit losses was due to $1.5 million for net loan growth and the impact of economic forecasts and a reserve for a loan on a partially completed construction project. Net charge-off of $3.3 million, which has previously been established as a specific reserve, was related almost entirely to one lending relationship. NPLs decreased $3.6 million or 6% to $56.8 million and represented 1.76% of loans held for investment at quarter end. Accounting for our specific reserves of $7.4 million, our net NPL exposure decreased 3% to $49.4 million. Substandard loans increased $14.6 million, totaling $91 million at the end of the quarter. The increase was primarily due to a couple of downgrades totaling $20.6 million, partially offset by charge-offs of $3.3 million and payoffs and paydowns totaling $2.7 million. Of the total substandard loans at June 30, $30.2 million were on accrual status. Past due loans increased by $12.1 million to $18 million due mostly to additions, including an $8.5 million CRE loan, which has since been brought current. And it's worth noting that with a 1.58% allowance for loan losses to total loans held for investment ratio, we believe we have appropriately addressed the risk in our nonperforming loans. Slide 12 has details about our deposit franchise. Total deposits increased at a 6% annualized rate from the first quarter to $3.2 billion, with growth in noninterest-bearing deposits and CDs more than offsetting a decline in money market accounts. Our tangible book value per share increased to $25.11. Our capital levels remained strong with all capital ratios above regulatory well-capitalized levels. With that, we are happy to take your questions. Operator, please open up the line.

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

Maybe just starting off here on capital and the buyback. I think you announced the $18 million buyback in the middle of the second quarter. You used a little bit of it in the month or so you had it. Can you maybe just speak to how active do you want to be with that new program, just given where shares are trading, but also factoring in credit work out?

Sure. Thanks, Brendan, for the question. Based on the timing of when we had the opportunity to announce the buyback, we think that's a little bit why you've seen the modest participation. We obviously view our stock as attractive at its current trading price relative to our tangible book value. The amount that got approved based on current trading prices would represent about 5% of our stock. So we view it as a modest amount of cash. I think we have sufficient liquidity and affordability and with respect to how it relates to the fact that we have been working through our higher elevated NPL levels. We've had plenty of capital to support that initiative, plus our high coverage ratio, which I just concluded my comments with. So I think we're able to do both.

Okay. All right. Great. And then maybe turning to asset quality. Can you offer a little more color on the loans that were downgraded both to substandard and special mention for the quarter?

Over the quarters, we have about $27 million of the downgrade to special mention mainly because the bank is actually enhancing our credit quality control. The difference is that we have more frequent control for those credits. Those credits are many of those bridge and get loans, they have a little update in stabilizing the income. They are paying regularly and the LTV is still manageable. However, this is one of management's efforts to enhance operational control on that. So you can see an increase in special mention that is notable to the information that compared to the previous quarter, but we consider it a credit enhancement.

There were a few downgrades to substandard, primarily due to two credits that remain on accrual status. These cases illustrate the shift to a higher interest rate environment and our ongoing collaboration with the borrower. While we currently see some conservatism in our perspective, we believe that this classification was appropriate at the end of June for those credits. Additionally, there were a few smaller downgrades, but the focus was on those two main credits that were added during the second quarter.

Okay. Okay. That's helpful. Maybe I'll just sneak one more in here. This year, you've been pursuing this dual path of growing loans again and trying to kind of move the top line higher while also working through asset quality issues. I mean like for how long is that dual path sustainable for like if we're still seeing inflows into criticized presumably, it takes a little longer to work that out. Is there still the ability to and desire to keep growing loans at the same time as you work through credit issues?

Yes, this is Johnny. I believe we can definitely continue on that path. We remain very focused on the non-performing loans we have. I think we're making good progress in that area. Additionally, on the growth side, as I've mentioned in previous quarters, it has been consistently strong. We have a robust pipeline, so we feel confident in managing both aspects effectively.

Yes, Brendan, I would like to add to Johnny's comments. I believe we are successfully executing our business model. We have a healthy pipeline that has allowed us to achieve 12% annualized loan growth. We have demonstrated strength in both our mortgage and commercial portfolios. You may have noticed some additional loan sales this quarter, and we anticipate that this could increase in the second half of the year, which reflects our continued management of the loan-to-deposit ratio. Additionally, our coverage ratio stands at approximately 136 to 138 when excluding specific reserves from our loan growth this quarter. Looking ahead, there may be an opportunity for that ratio to decrease slightly as we continue to resolve some of the larger credits that have been in the spotlight over the past few quarters.

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

Just first one, just on the kind of loan and deposit growth deposits trailing loans here, loan-to-deposit ratio, obviously, up over 100% now. But it does sound like the pipeline on the loan side remains healthy, and you also expect maybe a more measured pace of growth going forward. So just trying to think through those moving parts? And is there some deliberate effort to maybe tighten the screws a little bit on the pipeline? And just any commentary around your outlook for deposits?

I can share that we've focused on quality when it comes to new loans and relationships at the bank. We've been very selective in the loans we bring in. On the deposit side, we're constantly looking for ways to generate more deposits through various initiatives. For example, we launched a special promotion on a money market bundle that has been effective in attracting new deposits to help fund our activities. While our loan-to-deposit ratio is high, I believe that in the second half of the year, as we continue to grow our loans, we may have opportunities to sell some loans to relieve some pressure. We will keep managing that to maintain a good balance.

Matthew, I think in the investor materials, we've shared our new production levels were $180 million this quarter at a rate of kind of $675 million and how that compares to the prior quarter. So our annualized growth rate is up at 12%, I think it was slightly higher than that in the first quarter. I think it's been strong, and we've kept our origination rates fairly high given the current market. So I think we're evaluating that. I think that there's probably some net loan growth; we would expect potentially some loan sale activity to pick up in the second half of the year. And then just to comment on deposits. I think that we have been very successful in growing organic deposits, and we have plenty of capacity for wholesale funding. So there's room to bring the loan-to-deposit ratio down a little bit if need be. So I think we're watching that closely but very comfortable with where we ended the quarter.

Okay. Great. And then on the deposit cost side, an expectation for maybe some stabilization without Fed rate cuts. The spot rate is obviously down, just helpful going into 3Q. But do you feel like even when the Fed does start to cut that deposit costs might not come down as much as you previously thought just because you need to keep rates up to generate the deposit growth?

So that, I would like a crystal ball for. Look, I think there is a lot of competition for liquidity, and I don't think that's going to change even when rates come down. But we were successful in moving our deposit rates down almost 100% after rates moved down 100 basis points. So while there could be somewhat of a lag, I would expect we would be successful in moving down our cost of funds should rates decrease. We remain liability-sensitive. But it doesn't happen overnight, and it would stair-step down. But that would be our expectation that we would be able to push down on our deposit costs. I think historically, we've shared to the extent it's helpful as we look out over the next quarter or so, about 1/3 of our CDs that are maturing coming off at about 415, 420 and I think those have an opportunity to price down into the current market, not a significant amount because rates are higher for longer, but somewhat.

Okay. And just to clarify the amount of CDs that are coming due this quarter and I assume new pricing is around 4.

Yes, yes. So it's basically all of our CDs. So all of our CDs mature within 12 months, I think like 99.5% and then 1/3 of them mature next quarter. We've had a pretty even CD ladder over a 12-month horizon. And those have continued to just reprice into the current market.

Okay. Great. And last one for me, just to clarify the expense run rate going forward. I think I may have heard you say $18 million, but I think if you exclude some of the noise, it is around $19 million this quarter. So just wondering where the relief is coming from.

Sure. So the rest of it, we had a little bit of extra costs associated with the executive management transition. I think there are some timing items related to some of our director compensation. We filed some form 4s associated with them. And then I think just the timing on some legal costs accumulated this quarter. So I think some of that's expected to normalize and bring us back down to about $18 million.

Our next question is coming from Andrew Terrell with Stephens.

I wanted to revisit the topic of credit that we discussed earlier. It seemed like you indicated you might be adjusting or tightening the credit control process. Could you elaborate on that? Does this require a more comprehensive review of the portfolio under the new standards, or can you provide more details on this?

Andrew, it's Lynn. I'm going to hand it over to Jeffrey shortly, but I want to make a brief comment. The majority of the special mentions relate to one specific type of loan, which is our GAAP and bridge financing, and that constitutes a smaller segment of our portfolio. Thus, it doesn't apply to all loan categories. Most issues have been dealt with and are reflected in the second quarter results. We'll continue to manage this moving forward. The special mention status is anticipated to be temporary. Jeffrey can provide more details, but that's my clarification.

This is John. We're just simply taking a more conservative approach to making sure we're keeping an eye on these credits, but they're very, very manageable loan-to-value ratios, global cash flow is strong. And none of these borrowers here that moved to special mention have past due. They are all current and accruing.

Okay. Understood. I appreciate that. And then Lynn, I think you talked about maybe some more loan sales in the back half of the year. I'm assuming that's single-family. And do you have the amount that was sold this quarter as you pick up in the gain on sale line? Just wondering if you have any kind of expectation for the back half?

I don't know that there is anything that we can share for modeling purposes. I think it's more the level of production, the type of products that we have and managing the size of the portfolio relative to the whole balance sheet. So we see opportunity there. On the single-family portfolio, I would just share that the premiums are pretty small in the market. Obviously, if rates come down, those might have a better opportunity, depending on how prepayment speeds play out. But we also have the opportunity with our SBA loan portfolio. And I believe Johnny has spoken in the past, we've added some resources in that area. So I think that's an area that's increased some production, and we usually sell the guaranteed portion. So the combination of the two would be what we'd be generating any gains.

Our next question is coming from Kelly Motta with KBW.

Most of mine have been addressed at this point, but I did want to touch base on the deposit side of things. You did have some nice noninterest-bearing growth this past quarter. I'm wondering if you could provide some color as to the drivers of that. I know C&I has been a focus here, and you did have some growth now for the last several quarters. So wondering if you could provide your track record with gaining commercial customers and how that's tracking? And any sort of color as to what drove the noninterest-bearing increase this quarter.

Kelly, this is Johnny. I can share some insights, and maybe my colleague would like to add as well. Thanks for the question. Firstly, we've been very focused on enhancing and expanding our relationships with our frontline associates, credit via branch, and commercial lenders. This approach has certainly contributed to an increase in our DDA deposits. Additionally, we are particularly focused on bringing in new C&I relationships, which, although they currently make up a small portion of our total loans, still help in generating good DDA deposits. Moreover, we recently launched promotions to attract new relationships by bundling money market and DDA products, which we initiated at the beginning of June; this has been gaining strong momentum in bringing new relationships that add both money market and DDA deposits.

And then Kelly, I think when you're looking at our trends, what we observed was, I think we had a couple or one or a couple of larger withdrawals in the first quarter. And I think the composition and more granularity to our noninterest-bearing deposits were driven by the efforts that John described. So that's what we're observing.

Great. That's helpful. And then maybe just one last modeling question from me, Lynn. Your tax rate was a little lower this quarter; I think it was around 28%. Is this a good run rate on a go-forward basis? And I'm wondering if this change in the California tax law has any material impact on your outlook for the tax rate?

Sure. So good question on the California tax rate. We did include the impact of our taxes in this quarter, so we did have a small catch-up impact in the second quarter, and it won't have a material impact overall, but we will actually have a little bit of a benefit from that. So I think it's a reasonable tax rate. We've been below the effect of or the statutory rate anyway. But yes, both are in there, Kelly.

As we have no further questions on the line at this time, I would like to hand it back to Mr. Lee for any closing comments.

Thank you. 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 great day.

Thank you, ladies and gentlemen. This does conclude today's conference. You may disconnect your lines at this time, and we thank you for your participation.