Earnings Call Transcript - RBB Q1 2023

Operator, Operator

Good day, everyone, and welcome to the RBB Bancorp First Quarter 2023 Earnings Call. At this time, all participants have been placed on a listen only mode. And we will open the floor for your questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Catherine Wei, Investor Relations Officer at RBB Bancorp. Ma'am, the floor is yours.

Catherine Wei, Investor Relations Officer

Thank you. Hello, everyone, and thank you for joining us to discuss RBB Bancorp's financial results for the first quarter of 2023. With me today are President and Chief Executive Officer David Morris; Chief Financial Officer Alex Ko; Chief Credit Officer, Jeffrey Yeh; Chief Administrative Officer, Gary Fran; and Chief Risk Officer, Vincent Liu. David and Alex will briefly summarize the results, which can be found in the earnings press release that is available on our Investor Relations website. And then, we'll 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?

David Morris, President & CEO

Thank you, Catherine. Good day, everyone, and thank you for joining us. Despite the industry challenges of the first quarter, Royal Business Bank continued to make progress on the organizational realignment we began a year ago. Since the start of the year, we brought on Alex Ko as our new Chief Financial Officer. And we recently added Bob Franko and Scott Polakoff to the Board of Directors. We believe these actions taken after many productive discussions with our shareholders will allow us to turn the page on the events of last year and build shareholder value. In the quarter, which saw multiple bank failures, we also increased our deposits. For that, we have our loyal customers to thank. We work every day to serve this country's vibrant Chinese-American community, and it is gratifying to see the strength of those relationships in a time of stress. I'd like to take a moment to discuss our strategic priorities for 2023 before handing it over to Alex. First, we are focused on resolving all outstanding matters related to the events of last year. I can assure you that management and the Board are focused on putting these events and the related expenses behind us. Second, we are focused on liquidity and intend to reduce our leverage this year. As a precaution following the bank failures in March, we increased our time deposit financing to ensure we had efficient liquidity on hand. We expect we will maintain a higher level of liquidity and plan to reduce the loan to deposit ratio to 95% by the end of the year. Given the volatility in the market and the economic uncertainty, we believe this is the best strategy to protect long term shareholder value. Third, we intend to focus on supporting core existing customer relationships. Prioritizing these relationships will allow us to reduce our leverage while enhancing our deposit franchise. With that, I am pleased to hand it over to Alex, who will discuss the financial results before we open the call up to questions.

Alex Ko, Chief Financial Officer

Thank you, David. Increasing loan yields and a stable loan portfolio balance drove record revenues in the first quarter, but were offset by increasing interest expense, legal expenses and other professional fees, mainly related to our transition to a new external auditor. Due to these expenses, net income for the quarter declined to $11.1 million or $0.58 per share. Net interest income for the quarter also declined to $34.1 million, mainly due to increased deposit costs. First quarter non-interest income of $2.5 million was stable from the fourth quarter. The increase in loan servicing fee income was partially offset by the decrease in the gain on sale of loans. Core non-interest expenses returned to the normalized run rate. However, were impacted by the legal and other professional expenses, which increased by approximately $2 million compared to the prior quarter. We expect the legal and other professional expenses to decrease going forward. First quarter net interest margin of 3.7% was down 56 basis points from the last quarter but up from 3.5% a year ago. The decrease from the last quarter was mainly due to deposit cost increases, which outpaced loan yield increases. Net loans held for investment increased by $4 million from the last quarter; the small increase is mainly due to the increase in single-family residential mortgage loans, offset by the decreases in other loans. Our yield on average earning assets increased to 5.84% in the first quarter, which was a 9 basis point increase from the last quarter and a 184 basis point increase from the first quarter of 2022. Continued commercial customer activity and rising interest rates drove a $159 million decrease in average noninterest-bearing deposits and a $327 million increase in time deposits over the quarter. Our average cost of interest-bearing deposits for the quarter was 2.75%, which was up 82 basis points from the prior quarter. In addition to the impact of increasing interest rates, part of this increase in deposit cost was driven by a fourth quarter decision to begin reducing deposit concentrations. We are cautiously optimistic that the pace of increases in deposit costs should slow in future quarters. Moving on to credit quality. Nonperforming loans increased to $26.4 million from $23.5 million from the last quarter, due to an increase in single-family residential loans of $4.7 million. Delinquent loans decreased by $961,000 compared to the prior quarter. The company recorded $2 million of provision for credit losses related primarily to qualitative factors in light of anticipated increases in classified loans as the company finalized its loan risk ratings for the quarter. With $2 million of provision for credit losses and minimal net charge-offs, the credit losses coverage ratio increased to 1.29% as of March 31, 2023, compared to 1.23% in the prior quarter. Our capital levels remained strong with all capital ratios well above regulatory well-capitalized ratios, which we believe is prudent given the market risks. With that, we are happy to take your questions. Operator, please open up the call.

Operator, Operator

Certainly. At this time, we'll be conducting a question-and-answer session. Your first question is coming from Kelly Motta from KBW. Your line is live.

David Morris, President & CEO

Hi, Kelly.

Kelly Motta, Analyst

Hi. Good morning over there. I thought maybe we could start with what you're doing with the balance sheet, kind of taking leverage down. And part of those prepared comments you had were that you were focused on what you view as core relationships. Can you kind of dig in a bit more on how you intend to bring leverage down? Is it going to be through loan sales? Are you going to be deemphasizing certain areas of lending? Just curious whatever kind of commentary and color you can fill in around that.

David Morris, President & CEO

We will be tightening our and we have tightened our underwriting guidelines in commercial real estate and construction lending. But more particularly, Kelly, we are pulling back from out-of-area lending. And we're also pulling back on bridge loans and out-of-area. Okay. So we're still going to lend in our areas, pretty much all factors, all loan types to our customers and within our area. But we're going to decrease out of area market and let those loans roll off the books.

Kelly Motta, Analyst

Got it. Okay. Considering that, I mean, last year loan growth had been fairly strong. You were at about 1% annualized growth this year. Is that kind of when factoring in the roll-off of some of these non-core types of lending? Is that kind of what we should be expecting on the loan side?

David Morris, President & CEO

I think it's going to be between the low single digits loan growth. Okay. Low single digits. Whereas we're hoping that deposit growth will be in the upper single digits.

Kelly Motta, Analyst

Got it. Okay. And then with the non-interest bearing declines. I know we've been talking about in the past couple of quarters of some larger relationships that you decided to let go for concentration considerations. Obviously, deposit growth is the source of emphasis now, especially getting the loan deposit ratio down. About how much more related to kind of these larger accounts might be part of, I guess, left to go? And just trying to get a sense of when this deposit base can kind of stabilize especially the non-interest bearing portion?

Alex Ko, Chief Financial Officer

We only have one customer that's over 2% of our total deposit base. And that would be about another $25 million where we would expect it to roll off between now and year end to get it down to our 2% level. Okay.

Kelly Motta, Analyst

Okay.

Alex Ko, Chief Financial Officer

So we completed most of it last year, Kelly. A significant majority of it was finished last year.

Kelly Motta, Analyst

On the expense side, you mentioned the $2 million increase in professional fees partly due to the change in auditors. You incurred approximately $19 million in expenses this quarter. Considering the variables in the first quarter, it seems reasonable to view a $17 million run rate as appropriate. I recognize that you have expanded the team and the board and are implementing various initiatives. I'm trying to grasp what a solid core run rate might be following all the recent changes.

Alex Ko, Chief Financial Officer

We hope to get it below $17 million, but let's start conservatively and be at $17 million and then go from there next quarter. Okay.

Kelly Motta, Analyst

Okay. Great. I will step back. Thanks so much for the questions.

David Morris, President & CEO

Yes, Kelly, can I actually add a little bit more color? Because we do have some increase on the professional fees and the legal fees. I'm not going to go over too much detail on that, but I just want to add a comment that going forward as we indicated in the prepared remarks, I would expect that will go there. Because most of the majority that we know have expensed throughout the quarter and the last year as well. But who knows how much it will come in, but as of now, I would expect that legal and professional fees will decrease. I don't think we will repeat that. So going forward, it will be smaller. I just want to add on that.

Kelly Motta, Analyst

Great. Thank you.

Operator, Operator

Thank you. Your next question is coming from Ben Gerlinger from Hovde Group. Your line is live.

David Morris, President & CEO

Hey, Ben.

Ben Gerlinger, Analyst

Hey, I appreciate you taking the time. It seems like you managed to address many of the deposit pressures, and overall deposit growth was quite significant this quarter. I was wondering if you could share what the margin was yesterday or the spot rate at the end of the quarter. I'm trying to understand our current position, especially since the margin dropped significantly in the first quarter.

David Morris, President & CEO

Yes, you're correct. We had a compression on the margin for this quarter, given our deposit pricing has gone up dramatically. And going forward, margin forecast to be honest, it's very hard to have accurate margin guidance for now given the volatility. However, in response to your spot rate question, we do have a CD spot rate of about 3.8% as of March 31.

Ben Gerlinger, Analyst

Okay. I was looking more so for the margin, not a CD, but –

David Morris, President & CEO

Yes, but margin is very difficult. I would expect that it will continue to compress, but not to the level that we have experienced in Q1. Given the deposit side, I would expect that increase will slow down as we said in the prepared remarks. So it will continue to compress, but again, not to the level that we have experienced in the Q1.

Ben Gerlinger, Analyst

Got it. Okay. I noticed that you added two board members recently. Can you share more about their roles? Are they being brought on for their expertise, as consultants, or what can we expect from their addition to RBB overall?

David Morris, President & CEO

Okay. Scott was brought on because Scott was a regional director of the FDIC. And so he will bring great knowledge of how our regulatory environment and regulatory agencies work. He will be able to assist the Board and help them learn all about those things. And Bob was brought on because of his past experience of running a bank. The only other person who has run a bank before that's on the board is myself. And so, we believe having Bob on board with his connections locally to deposit gathering, to investors and to the real estate market, I think is invaluable to the bank.

Ben Gerlinger, Analyst

Got you. That's helpful color. Thanks. I’ll step back.

Operator, Operator

Thank you. Your next question is coming from Andrew Terrell from Stephens, Inc. Your line is live.

David Morris, President & CEO

Hey, Andrew.

Andrew Terrell, Analyst

Hey, good morning. Maybe just a follow-up on one of Ben's questions. Just to clarify that the CD spot rate at 3.8% at March 31. Just making sure does that include the broker time deposits or is that just retail customer? Is that an all-in number of 3.8?

Alex Ko, Chief Financial Officer

Yes, it's all in the CD rate of 3.8%.

Andrew Terrell, Analyst

Okay. Got it. And then how does that compare to rates from a retail perspective that you're offering in the market right now?

Alex Ko, Chief Financial Officer

No, we are offering a little bit higher than that. We used to have a deposit campaign, but we don't do that anymore now, but we just do it in our pocket raise, which is more selective to the customers. It's a little bit higher than the spot rate that we just discussed.

David Morris, President & CEO

Okay. Gary, are you there? Can you add any of the color of what you're doing with all the promotions and so forth?

Gary Fran, Chief Administrative Officer

Yes, sure. I think moving forward, obviously, deposit cost is a priority for RBB, both total number of deposits and then the cost of what we're trying to get. So a lot of the promotions we've been considering we're doing sort of on a quarterly basis and we're tailoring those to each specific market. So for example, something in New York that may work better for that customer base is something different than what we'll be running in California. And that's sort of a shift in strategy versus what RBB used to do. Generally, I think due to our customer relationships and the kind of existing customer base, as well as the new customers that we have in and around our geographic presence, we're seeing about 25 basis points to 50 basis points better than our other competitors. So although the overall cost of deposits has been rising, I think we're doing a little bit better than our competitors and a lot of that has to do with the way we position some of the products and services as well as some of the customer relationships we have with our bankers that are on the ground meeting with those customers.

Andrew Terrell, Analyst

Yes, okay. I appreciate all the added color there. If I can go back to some of the commentary around the loans and deposits. On the loan specifically, how much in loans do you have that you would classify as out of market loans? And then further, how much would you consider out of market bridge lending?

Alex Ko, Chief Financial Officer

So then, our specified loan amounts out of market. We have a total of about $410 million out of market that is considered out of state or out of market loans. Our policy limit is about a little bit higher than that; we are, as David mentioned earlier, that is our main focus to derisk our out of market lending.

David Morris, President & CEO

Yes, Andrew, I want to emphasize that we are involved in mobile home parks outside of our main market, and this is an important aspect of our core business. Therefore, we are focusing on that $410 million figure.

Alex Ko, Chief Financial Officer

That is included. Yes, that's correct.

David Morris, President & CEO

Okay. So the number is probably closer to $250 million that we're targeting to get off the books.

Alex Ko, Chief Financial Officer

Yes. Actually a little bit less than that.

Andrew Terrell, Analyst

Got you. Okay. And then could you maybe give some just color on what types of relationships those are? And then just given they are out of market, how are they sourced? Are they primarily syndications?

David Morris, President & CEO

Our market mainly includes multifamily term loans to bridge loans. These loans are relatively short-term, typically lasting about one to three years.

Andrew Terrell, Analyst

Yes, most of these were originated in 2019-2020.

David Morris, President & CEO

And we basically started to derisk starting from last year.

Andrew Terrell, Analyst

Okay. And then just to clarify. So there's around $250 million maybe not all of that runs off this year, but that's kind of the portion that you might look to about a market that you might look to run off the balance sheet, do you think you can still grow loans in the low single-digit range in 2023 despite that, call it, $250 million headwind?

Alex Ko, Chief Financial Officer

Yes. I think so. We may not have stellar growth. We may have a quarter with declining loan growth. But I think overall we could do that.

David Morris, President & CEO

And I add a little bit, actually the loan demand is actually high. We are very cautious in underwriting and also very cautious in us doing our due diligence in this market.

Andrew Terrell, Analyst

Okay. Understood. And then last one for me and then I'll step back. Can you just remind us what the exposure is to office commercial real estate?

Alex Ko, Chief Financial Officer

It's about $50 million.

Andrew Terrell, Analyst

Okay.

Alex Ko, Chief Financial Officer

Yes, about $50 million. So it's not very much.

Andrew Terrell, Analyst

Yes. So just a really small portion. Okay. Well, very good. Thank you for taking the questions.

Operator, Operator

Thank you. Your next question is coming from Kelly Motta from KBW. Your line is live.

Kelly Motta, Analyst

Hi. Thanks for giving me the opportunity to ask a follow-up. I understand that you're aiming to maintain higher liquidity on the balance sheet. I noticed that you increased cash by about $15 million, reaching approximately $200 million at the end of the period. Is this an ideal cash level for you, or is there any excess? I'm trying to gain a better understanding of this as we evaluate the size of the balance sheet.

David Morris, President & CEO

Sure, Kelly. As you noted, we have a cash including due from banks. So we have a $231 million as opposed to last quarter, December year end it was only $83 million. So intentionally, we increased. But given the market volatility, I would expect to continue to maintain this level or even higher as deemed necessary. But I think this quarter, the management's top priority is given what's happening; it was liquidity management. I believe we did a good job in terms of liquidity, including this available cash to be sufficient enough to weather through this liquidity challenges.

Kelly Motta, Analyst

Thank you. My last question is about your pending deal. I'm curious if the gateway is still something you're looking to pursue or if there have been any changes in perspective due to the market volatility, especially since I know it has been extended a couple of times.

David Morris, President & CEO

We continue to have discussions with all the relevant parties. No decision has been made at this time, Kelly.

Operator, Operator

Thank you. Your next question is coming from Ben Gerlinger from Hovde Group. Your line is live.

Ben Gerlinger, Analyst

Hey, everyone. Thanks for the follow-up. I was interested in the positive mix shift you mentioned, especially with time deposits increasing for you and other banks due to rising rates. Do you have any internal limits in place? Looking back over the last couple of years, it seems like around 70% of your funding comes from this. I’m wondering if there are any thresholds you avoid exceeding.

Alex Ko, Chief Financial Officer

Currently, we do have policy limits under our ALCO guidelines. Yes, I can't recall what they are, but we do have them.

Ben Gerlinger, Analyst

Got you.

David Morris, President & CEO

I think it's around 66% or 65%, but I need to check. It might be less now, possibly around 60%.

Ben Gerlinger, Analyst

Okay. Got you. And then just wanted to follow-up on the question –

Alex Ko, Chief Financial Officer

I would like to provide some additional detail on that. We purposely increased the proportion of CDs. We did notice a decline in non-interest bearing deposits due to the changes in concentration. However, I believe the increase in CDs helps us secure our funding sources for specific timeframes. We are not offering CDs for two or three years; instead, we are focusing on nine months to a maximum of one year to ensure our funding stability. Therefore, I don’t perceive this increase in CDs as negative; it actually provides more security. While the cost may be higher compared to alternatives, increasing these CD deposits was advantageous. Additionally, while we do have broker deposits, we are experiencing notable success with retail deposits from the CD segment as well.

David Morris, President & CEO

Okay. Are there any –

Ben Gerlinger, Analyst

Yes. No, I got it. Thanks. Appreciate the color.

Operator, Operator

Thank you. Your next question is coming from Andrew Terrell from Stephens Inc. Your line is live.

David Morris, President & CEO

Hi, Andrew.

Andrew Terrell, Analyst

Hey, thanks for the follow-up. I was hoping to get maybe a better sense of the non-interest bearing deposit flows in the quarter. Can you help us think about the cadence throughout the quarter on a monthly basis, just how the non-interest bearing balances progressed? And then, so far quarter to date in April, have you seen any kind of stabilization in non-interest bearing deposit balances?

Alex Ko, Chief Financial Officer

Yes. I will attempt to answer that. I don't have that monthly breakdown in front of me. But as I said earlier, those decrease of the noninterest bearing deposit was due to one large relationship, strategically reducing that starting last year. So that has continued into Q1. So that's the reason why we have a decrease. And also given the interest rate market, those non-interest bearing deposits migrated to CD or higher earning method. So that will continue, but not to the level that we have experienced, given the market expectation for the interest rate for May is a minimum of 25 basis points or even decreases, I would expect that run off of the noninterest bearing deposit will slow down going forward. But I think, again, I don't have the monthly breakdown, but it got stabilized since the March 31 or liquidity crisis. I didn't see much acceleration of those non-interest bearing run off.

Andrew Terrell, Analyst

Yes. Okay. Do you have how much of the decline in the quarter was related to that one relationship?

Alex Ko, Chief Financial Officer

One relationship was $26 million. Okay. We already reduced it significantly throughout 2022.

Andrew Terrell, Analyst

Yes. Okay. And one last for me just on buyback. I didn't see any this quarter. Just updated thoughts, I mean, with a slower level of balance sheet growth, you guys sit in a really strong capital position right now. Just love to hear your thoughts on whether buyback is of interest?

David Morris, President & CEO

The Board is still discussing it at this time.

Operator, Operator

Thank you. Your next question is coming from Joseph Maccando from Finance Investment Society. Your line is live.

Unidentified Participant, Analyst

Hi. First, I want to thank you guys for handling the liquidity crisis very well as a shareholder. And just thank you for being pretty good management over this last quarter. I wanted to ask more questions about the buyback that we're just asking about. I understand that you guys have to create a good liquidity level to navigate throughout this crisis. But there are lots of opportunities to repurchase shares at what you may seem like to be an accretive value going forward. And due to your high liquidity position in the market, would potential mergers or acquisition activity be something that you would consider above the buyback or just overall when you're redeploying your earnings?

David Morris, President & CEO

Hi. Right now, I think it's too early for us to be comfortable with any mergers and acquisitions beyond what has already been announced. While I believe the banking system is very stable and we're in a strong position, we could see situations like what happened on March 10th occur again with some larger banks. Therefore, I don't think pursuing M&A is a wise decision for us at this moment. The Board is currently more focused on returning capital through dividends, which I see as the priority. Additionally, they are considering reinstating the buyback, but that will likely take another month or two.

Unidentified Participant, Analyst

All right. Thank you for clarifying that.

Operator, Operator

Thank you. There are no further questions in the queue.

David Morris, President & CEO

Once again, I really want to thank our customer base who has stuck with us during March where everything was going crazy and appreciate them very much. And just so that you know, most of our customer base that has multiple millions of dollars with us are also investors in this bank. So, we want to thank them and so forth. I also want to thank you for who have joined us today. We look forward to speaking to many of you in the coming days and weeks. Have a great day. Thank you.

Operator, Operator

Thank you everyone. This concludes today's event. You may disconnect at this time and have a wonderful day. Thank you for your participation.