Hanmi Financial Corporation (HAFC) Q2 2012 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Hanmi Financial Corporation Second Quarter 2012 Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Thursday, July 19, 2012. At this time, I'd like to turn the conference over to Henry Hong, Investor Relations Officer. Please go ahead, sir.

Thank you, and thank you all for joining us today. With me to discuss Hanmi Financial's second quarter and first half of 2012 highlights are Jay Yoo, our President and Chief Executive Officer; Lonny Robinson, Executive Vice President and Chief Financial Officer; and JH Son, Executive Vice President and Chief Credit Officer. Mr. Yoo will begin with an overview of the quarter and year-to-date results, and Mr. Robinson will then provide more detail on our financial performance and review credit quality. At the conclusion of the prepared remarks, we'll open the session for questions. In today's call, we'll include comments and forward-looking statements based on current plans, expectations, events and financial industry trends that may affect the company's future operating results and financial position. Our actual results could be different from those expressed or implied by our forward-looking statements, which involve risks and uncertainties. The speakers on this call claim the protection of the Safe Harbor provisions contained in the Securities Litigation Reform Act of 1995. For some factors that may cause our results to differ from our expectations, please refer to our SEC filings, including our most recent Form 10-K and 10-Qs. In particular, we direct you to the discussion in our 10-K over certain risk factors affecting our business. This morning, Hanmi Financial issued a news release outlining its financial results for the second quarter and first 6 months of 2012, which can be found on our website at hanmi.com. I will now turn the call over to Mr. Yoo.

Thank you, Henry, and good afternoon, everyone. For the second quarter of 2012, we generated strong profitability from our banking operations and caused a big boost to our bottom line from the reversal of the majority of the deferred tax asset valuation. Net income totaled $55.8 million or $8.77 per share, including a net tax benefit of $47.2 million, which added about $1.50 per share to earnings. Our return to profitability over the past 7 quarters is a significant accomplishment, and the reversal of the DTA valuation allowance is just one of the results of this achievement. I'll let Lonny to give you more details on the accounting for this item, but I believe it is an important milestone for us and controls our optimism for Hanmi continuing to operate profitably. Our pretax income for the second quarter results were up 16% from the first quarter and even with the results generated in the second quarter a year ago. Pretax net income was $8.6 million in the second quarter and $16 million in the first 6 months of 2012. We are pleased with the steady improvement in our profits, as well as the ongoing improvement in asset quality, expanding net interest margin, improving operating efficiencies and the contributions from our SBA loan originations and sales. Asset quality continues to improve substantially, with nonperforming assets dropping to $46.2 million from $145.8 million a year ago. As a percent of total assets, nonperforming assets were at 1.62% compared to 5.38% a year ago and 1.86% at the end of the first quarter. We are still working to resolve problem assets, but we continue to make excellent progress on all credit metrics. To summarize, Hanmi had a really good quarter and has made significant progress in improving our franchise. We remain focused on maintaining strong capital levels, producing quality core earnings and improving credit metrics so that we can get our regulatory order lifted. We believe we are moving closer to full compliance every quarter. We thank our customers for keeping our franchise so strong, and we appreciate the support of the investment community, as well as the hard work of the Hanmi team. I look forward to giving you more good news in the coming quarters. With that, I'll turn the call over to Lonny to provide more details on our operations and credit quality. Lonny?

Thank you, Jay, and annyeong haseyo to our Korean listeners, and good afternoon, everyone. With strong operating profits augmented by the net tax benefit, our second quarter and year-to-date results were very good. We have been discussing the possibility of recovering our DTA valuation allowance now for several quarters and, frankly, has been something of a moving target. In the second quarter, we reversed $53.1 million, with an offsetting current tax expense of $5.9 million, which generated a net tax benefit of $47.2 million. In the next 2 quarters, we expect to reverse another $10.1 million, which will basically offset any current tax provision for the next 2 quarters, which will bring the total DTA valuation allowance reversal to $63.2 million by year end. And our end result is that we're recovering about $1.69 per share in book value this quarter, which brings our tangible book value to $11.02 per share at the end of June. And even more importantly, our ability to recognize this benefit demonstrates our confidence and that of our outside advisors that our profitability is sustainable and it is more likely than not to continue in the future. In 2013, we expect to have normalized tax provision at approximately 39% of pretax income. The improvement in asset quality, expanding net interest margin and improving efficiencies are all important contributors to our profitability this year. I am particularly pleased with the progress we made this quarter in asset quality. And the metric that really stands out for me is our ratio of classified assets to the bank's Tier 1 capital plus allowance for losses. We brought that ratio down to 32.2% at quarter end, down from 54% last quarter and 101.3% a year ago. The move is a significant one and brings us down below the 40% threshold that the regulators are looking for. We are very pleased to be well below 40% at June 30. Both our operations and balance sheet are improving steadily. We ended the quarter at $2.85 billion in total assets, $1.88 billion in net loans, $2.39 billion in total deposits and a seventh consecutive quarterly profit. Our net loans receivable were down 1% in the quarter and down 4% year-over-year. Our SBA loan originations were $54 million, up from $36.2 million last quarter. The sale of $65.2 million in SBA loans generated $5.5 million in gain on sale of loans. As we discussed last quarter, we did not sell any of the first quarter production, so this gain reflects the production for the first half of the year. Commercial loan originations were $113.3 million in the second quarter and $180.2 million year-to-date. We sold $44.3 million in problem notes for the quarter and $73 million year-to-date, while the note sales generated $5.3 million in losses in the second quarter and $7.7 million year-to-date. The impact of problem note sales cannot be overstated in the successful reduction of nonperforming loans by keeping foreclosed real estate balances low and improving our credit metrics. Loans held for sale were reduced significantly during the quarter to $5.1 million, down from $56 million at the end of the first quarter and $44.1 million a year ago. Our deposit mix is also continuing to improve with core deposits growing to $1.7 billion, up $182 million from a year ago. Year-over-year, core deposits increased with demand deposits growing $78 million. Money market and NOW accounts are up $74 million. Hanmi ended the second quarter with 28.5% in DDA accounts and over 57% in low-cost transaction deposits. Our retail group continues to do a great job of growing low-cost DDA balances in a number of checking and savings accounts. For the quarter, our demand deposits dipped a little from the 29.8% of total deposits at the end of the first quarter but were up from 25.1% from a year ago. Time deposits over $100,000 declined to 28.7% of total deposits at quarter end compared to 36.6% of total deposits a year ago. Focusing on the income statement. We generated $25.2 million in net interest income for the second quarter of 2012, while average interest earning assets were down by 5.8% year-over-year. The 29 basis point drop in the cost of interest-bearing liabilities helped us sustain our margin. Our net interest margin for the second quarter was 3.84%, which was up 15 basis points from the preceding quarter and 19 basis points from the year-ago quarter. For the first half of the year, margin improved 11 basis points to 3.77% from 3.66% in the first half of 2011. While we anticipate our cost of funds will continue to improve moderately during the year, the bulk of the high-cost CDs we added several years ago have now repriced into current lower rates. With the overall cost of deposits at 69 basis points in the second quarter, there is still room for some improvement. It will not just be -- it will not be just as dramatic as we have seen in the past few quarters. Yields on interest-earning assets were 4.57% in the second quarter, up a single basis point in the quarter and down 10 basis points from a year ago. For the first 6 months of 2012, yields on the interest-earning assets were down 14 basis points to 4.57% compared to the previous year. We expect improving cost of funds by 7 basis points in Q3 and 2 basis points in Q4. Assuming the adequate deployment of the current excess liquidity in the coming quarters, we expect a modest improvement on our NIM. Noninterest income in the second quarter of 2012 was $7.2 million, almost double the $3.6 million in the preceding quarter and up 19% from the $6 million earned in the second quarter a year ago. Year-to-date, noninterest income was down 6% to $10.8 million from $11.5 million in the year-ago period. The biggest component of differences was in gains from the SBA loan sales, losses from note sales and gains on sale of investment securities. Going forward, we anticipate that the losses from note sales will decline substantially, while gains from SBA loan sales will continue to contribute to revenues. Noninterest expense in the second quarter of 2012 was $19.8 million, up 5% from the $18.7 million in the first quarter of 2012 and down 14% from $22.9 million in the second quarter a year ago. The first half of 2012, noninterest expense fell 12% to $38.5 million from $43.9 million in the first half of 2011. Salaries and employee benefits, our largest overhead cost, the increase on this line item reflects severance paid in connection with workforce reduction and increased bonus accruals for this year. In the Other category, where the big cost savings, is our OREO-related expenses, which were only $69,000 in the second quarter compared to $806,000 a year ago. For the first half of 2012, OREO expense was just $25,000 compared to $1.6 million a year ago. The efficiency ratio for the second quarter of 2012 was 61.07%, an improvement from 66.56% in the first quarter and 72.67% a year ago. I will now turn the discussion to the loan portfolio and credit quality. Total classified assets at June 30 of 2012 were $143.7 million compared to $230.7 million at the end of the first quarter and $388.7 million a year ago. This is a huge accomplishment for us, and I want to congratulate JH and his team for their hard work on improving our asset quality. Nonperforming assets, including loans held for sale, decreased 70% to $49.7 million compared to a year ago. That is a reduction of $118.7 million from $168.4 million a year ago. Nonperforming loans, excluding loans held for sale, were 2.31% of total gross loans at the end of June compared to 6.99% a year ago and 2.54% at the end of the first quarter. We are continuing to find selling a number of small packages of nonperforming loans, bring better prices and selling bulk packages of NPLs. We are also seeing an overall reduction of new loans migrating to classified loans with only $7.5 million in new loans migrating to classified status in the quarter compared to $31.6 million in the first quarter. Our nonaccrual loans included $15.1 million or 33.4% of which are performing restructured loans that are current and paying on a modified agreement. Despite the improvement in overall asset quality, our provision for credit losses bumped up in the quarter to $4 million, up from $2 million in the first quarter. Our net charge-offs were $13.4 million compared to $11.3 million during the first quarter of 2012 and $16.5 million during the same quarter a year ago. Of the total second quarter charge-offs, $5.3 million were in partial charge-offs with loans with collateral shortfalls, $8.4 million due to note sale and $1 million were in additional charge-offs, offset by recoveries of $1.3 million. The allowance for loan losses totaled $71.9 million or 3.69% of total gross loans at the end of June compared to $109 million or 5.27% of total gross loans a year ago. We still have an ALLL that is well above the 2.88% of average reserves held by U.S. banks and almost double the 2.11% average reserves held in banks in the $1 billion to $5 billion asset size according to SNL Financial data as of March 31, 2012. The allowance for loan losses to nonperforming loans was 159% at quarter end compared to 161% in the preceding quarter and 75% a year ago. Again, based on SNL data for March 31, 2012, our reserve levels far exceed the 60.27% coverage ratio for U.S. banks and 44.89% ratio for banks in our size range. To recap, we are pleased with the continued stabilized core earnings. We are focused on asset quality resolution and believe we have made incredible progress. We are focused on high-quality earning asset growth and improving efficiencies within our organization in the future. We will continue to work hard to provide the returns that you, our shareholders, deserve. Thank you for your confidence in our team. Henry?

This completes our prepared remarks. Operator, we are now ready for the Q&A.

[Operator Instructions] The first question is from the line of Joe Gladue with B. Riley & Co.

I had a couple, I guess, questions about the improvement in asset quality, the decline in classified loans and such. Just wondering if we can expect to see, I guess, some lower costs related to that, whether it's legal and professional fees, OREO costs. Or is there more to come there? Is it still too early to be looking at that?

Joe, it's a good question, and I'll try to address the certain components. One of the things that we saw, we had an elevated loan loss provision of $4 million. We don't expect those levels to be continuing. If we were going to project a loan loss provision on a go-forward basis, it's probably going to be high side at $2 million and maybe a little bit less than that going forward. And that's largely due because where our classified asset ratio level is and our nonperformings and what have you. We do expect to have some reduction in professional fees, probably about $250,000 on a quarterly run -- going forward on a quarterly basis, reduction from where we're at today. We do see -- we did some reduction of employees, and so we'll probably see some rationalization there going forward. It's another $250,000 in savings there. We won't see the $5.3 million in loss on sale of loans. We're not expecting to see a substantial amount of note sales on a go-forward basis for the same reason we just mentioned, that we think we've got the level that we're at. We see a particular situation that we need to get rid of. We'll do a note sale, but it's not going to be nearly the levels that we did in the first 6 months. So that's going to come down dramatically, so you won't see higher loan loss provision and the loss on sale of loans. And those are 2 big items that I think will reduce quite a bit.

Okay. Just looking at the decline in noninterest-bearing checking accounts, was there some government deposits or some other big chunk that was driving that down that I just wouldn't, I guess, see in that?

I think we touched on this a little bit in our call in the first quarter. We expected some of that to probably go out because of tax payments and what have you. It came in in March, and then there was a little bit of an outflow related to that. I don't know that I can point on any particular item that would drive that, but I just -- generally speaking, those numbers move up and down. I mean, we're not that far off from where we were. I mean, we've seen deposits higher than 29.8% and obviously lower than where they're at today, but it does move around. And so I still feel pretty good with our DDA somewhere between 28.5% and 29% on a go-forward basis at this point based on the rate environment.

Okay. And just one other, I guess, in the press release, you talked about the -- the yield on securities was up in the second quarter versus first quarter. Was that just changing mix or what...

A slight change in mix. I'm not saying that those yields are going to continue. We have -- we did sell -- we did do a sale of securities, and they were poorer performing bonds that we thought we had optimal pricing, so we executed that sale. To do that, we are -- we do have a lot of excess cash. We will probably be driving some of that into the investment securities portfolio with, as you would expect, lower yields. Our goal, obviously, is to take the excess cash and liquidity and deploy it in loans when they become available. But I would say that's -- I'm not expecting that yield in that portfolio to continue at those levels.

I'll ask one more. I guess I probably asked this one last quarter, but in terms of SBA loan originations, we sort of ramped up to a good run rate. Should this be a good level to sort of expect going forward, or there's still some more ramping up to do?

We've got our team in place, and we're pleased with the job that they've done so far. I've talked to the SBA manager and JH here, and we expect a run rate of $2.5 million in SBA gain on sale will probably be a good number going forward. We're not saying that we can't do a little bit better than that, but we say that the $2.5 million is probably a safe number to go with.

Our next question comes from the line of Scott Valentin with FBR Capital Markets.

Just with regard to the loan originations, I know you just mentioned the SBA originations increasing, but also other originations increased pretty dramatically from the first quarter. I'm just wondering what kind of -- I mean, do we expect further growth in origination volumes from here and at what pace?

Yes. We do see a ramping up of loan originations, and we were quite pleased with what happened with the other loans in the second quarter. We do expect to see somewhere -- maybe $200 million in total loan originations in third quarter and about maybe $150 million in the fourth quarter. Usually, third quarter is the strongest seasonal growth period from that standpoint. We do expect to have an annual loan portfolio growth year-over-year approaching 5%. We might not quite get there based on the paydowns, but keep in mind, we're not going to have the note sales which was $73 million for the first 6 months, so we don't have to offset that from that standpoint. But we still plan to have strong SBA loan sales going forward, pretty much in line with what we've done for the first 6 months. But we think we have a chance to do 5% annualized growth from the end of 2011.

Okay. And then in terms of the loan types you're targeting, is it commercial real estate or C&I? Maybe you can comment on level of competition. We've heard some markets, that you're seeing certainly low rates on some loans?

It's a very competitive market. I'm not going to say that it isn't. We obviously are trying to develop C&I business, but we are doing our share of commercial real estate in the marketplace. And the economy, though it's gradually improving, is still very tough out there, and you've got the high-quality borrowers that multiple banks are chasing. And to some extent, they can dictate some pricing here. So it's very competitive. We're doing our best to keep the pricing up the best we can, but with the limited number of eligible borrowers out there and the economy, not in full recovery yet. It's still a challenge.

Okay. And one final question. Just regarding capital management, you're kind of, I guess, restructured based on the regulatory agreement you have in place, but is there a possible timeline? You're sitting on quite a bit of capital now compared to a year ago. I'm just wondering maybe is there timeline we can think where return of capital becomes a possibility in a form of a dividend and/or a buyback?

Well, it's a good question, and as long as we're under any regulatory order, that really is not a discussion that really makes any sense at this point. We need -- I'm in process of evaluating the options available to us. There are certain guidelines that we have to follow from Delaware corporate law for the holding company and obviously, I think there's California financial code that comes into play. And obviously, the regulatory endpoint in regards to upstream in dividends from the bank to have cash to do any type of a dividend or a stock buyback. So we're exploring that. In the event that we're not able to grow in our capital on a timely basis, those are things that we'd like to look at very seriously. But as far as having a firm answer, as far as when that would happen and what we can do, I'm not far enough down the road on that to really give any more color than that.

Our next question comes from the line of Julianna Balicka with KBW.

I was wondering if you can talk a little bit more about the pipeline of loans that you have into the second quarter, but also maybe on the outflows that you're having from your loan portfolio due to refinancing maybe within your bank or also out of the bank as opposed to the outflows related to asset quality, so just kind of on the run rate of what's -- on the turn in the portfolio.

This is JH, official of the bank. Regarding to your question, approximately $107 billion in TRD loan is maturing in the year of 2012, and our retention so far, 98%. We retained the [indiscernible] maturity of the loan. And we continue to try our best to retain our reserve maturity loans as long as the loan is sound loans. And also, we try to marketing our new, it's a good loan size, by utilizing 31 [indiscernible].

Yes, so Julianna, we're retaining most of the $107 billion. It's up for maturity this year, very strong retention rate. We do have amortization. Our portfolios is running -- it's probably around $80 million -- yes, I think it's about $80 million a quarter. So we've got those -- those are numbers to work against as far as -- obviously, offsetting that with our originations.

That makes sense. And what kind of pricing are you seeing on new loans both from -- at your bank and also in your market?

During the second -- during the half of the year, always -- new loans, it compares with a -- 24% is the fixed rate and then 78% variable. Among fixed rate, our weighted average is 5.14%, and our variable is 4.65%. So we are still good -- pricing so far.

Yes, we're getting pretty good pricing, but it's very competitive out there, Julianna, as you would imagine. And we'd like to hold these levels going forward, but I can't say for certain that we're going to be able to do that.

[Operator Instructions] Our next question is from the line of Gary Tenner with D.A. Davidson & Co.

Most of my questions have been answered, just a couple of quick follow-ups. In terms of the loan production outlook for the rest of this year, was there any amount of purchased loans or syndicated loans in there, or was that all just pure Hanmi originated product?

You're talking about for the rest of the year?

Yes.

Yes, for the rest of year, the numbers that we gave you did not include any purchased loans. Those are all our own internal production.

Okay. And was there any purchased in the second quarter?

None to speak of. We did the $64 million in the first quarter, and there was basically nothing in the second quarter.

Okay. I think on the SBA production, you mentioned $90 million of originations this year. Any change in the gain on sale of premiums on those?

The gain on sale of premium is surprisingly strong, and it's actually -- it's moved up a little bit from what I'm understanding from our lending people and SBA manager. One of the problems is when you go over 10% premium, you have to share that with the SBA. And so that's where it takes some of the wind out of the increase, but the market is very brisk. It's very strong. We're excited about that, and we do expect to continue to originate at levels that we have. And so we're not seeing any probably significant change on our gain on sale recognition at this point from where we're at.

Okay. And just one last question on the tax expectations for the rest of the year, the reversal of $10.1 million, I think you'd said that that should offset any current tax provision, so basically a 0 tax line?

Yes. We're going to have a 0 tax provision, so basically pretax earnings will drop to the bottom line for quarter 3 and quarter 4. And as I guided in 2013, which will be the same for the third and fourth quarter, our effective tax rate is about 39%.

[Operator Instructions] And at this time, I'm showing no further questions. I'd like to turn the conference back over to management for any closing comments.

Thank you for listening to Hanmi Financial Second Quarter Conference Call. We look forward to talking to you next quarter. Thank you.

Thank you, ladies and gentlemen. If you'd like to listen to a replay of today's conference, please dial 1(800) 406-7325 or (303) 590-3030 using the access code of 4550848 followed by the pound key. This does conclude the Hanmi Financial Corporation Second Quarter 2012 Earnings Conference Call. We'd like to thank you all for your participation, and you may now disconnect.