Hanmi Financial Corporation (HAFC) Q3 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, welcome to the Hanmi Financial Corporation's Third Quarter 2012 Conference Call. As a reminder, today's call is being recorded for replay purposes. [Operator Instructions] I would like to introduce Mr. David Yang, Vice President and Corporate Strategy Officer.

Thank you, Erin, and thank you all for joining us today. With me to discuss Hanmi Financial's third quarter and first 9 months 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 details on our financial performance and review credit quality. At the conclusion of the prepared remarks, we will open the session for questions. In today's call, we will 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 of certain risk factors affecting our business. This morning, Hanmi Financial issued a news release outlining its financial results for the third quarter and first 9 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, David, and good afternoon, everyone. For the third quarter of 2012, we continue to build profitability from our core banking operations and made a substantial progress with the successful turnaround strategy we put in place more than 2 years ago. We tripled our earnings in the third quarter compared to a year ago generating $13.3 million in net income, or $0.42 per share. As noted last quarter, our success in returning to profitability started the reversal of the deferred tax assets valuation allowance in that period. Additional DTA valuation allowance of $4.9 million was released in the quarter, which accumulates to a total $57.9 million for the 9 months for the year. Year-to-date, net income totaled $76.4 million or $2.42 per diluted share, including our net tax benefit of $47.2 million, which added about $1.52 per share to earnings. Our return to profitability over the past 2 years is a significant accomplishment, and the reversal of the DTA valuation allowance is the final constant in our future ability to generate earnings and to continue building franchise values. Our pretax income for the third quarter was up 47% to $12.6 million from the $8.6 million on -- in the second quarter, and triple the $4.2 million on the third quarter a year ago. Pretax net income was $28.7 million in the first 9 months of 2012, up 23% from the same period last year. We are pleased with the steady improvement in our profits, as well as the ongoing improvement in asset quality, improving all paid [ph] efficiences and contributions from our SBA loan originations and sales. Asset quality continues to improve with nonperforming assets dropping to $45.1 million from $78.3 million a year ago. As a percent of the total assets, nonperforming assets were at 1.59% compared to 2.91% a year ago, and 1.62% at the end of the second quarter. We are continuing to make excellent progress on credit quality and remain focused on resolving the problem assets we still had. To summarize, Hanmi had a really good quarter and an excellent year so far. We remain focused on maintaining strong capital levels, producing quality core earnings and improving credit metrics. We appreciate the hard work of the Hanmi team and the support of the investment community. 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 good afternoon, everyone. With strong operating profits augmented by the net tax benefit, our third quarter and year-to-date results were pretty good. Last quarter, we reversed $53.1 million for our DTA valuation allowance with an offsetting tax spend of $5.9 million, which generated a net tax benefit of $47.2 million. This quarter, we took another $4.9 million in DTA valuation allowance reversal and generated a tax benefit of $644,000 as a result of a provision to return and other adjustments and certain tax credits. The next quarter, we expect to reverse another $5.4 million, which will basically offset the fourth quarter tax provision and will bring the total DTA valuation allowance reversal to $63.4 million for the full year. The net result is that we will recover a total of $2.01 per share in book value for the year. At the end of the third quarter, our tangible book value per share was $11.52, up 8.1% from a year ago. As Jay said, this event is important not just for it's addition to profits and book value, but also as an indicator that our turnaround is sustainable. And as I said last quarter, in 2013, we will expect to have a normalized tax provision at approximately 39% of pretax income. Our core operations continue to show improvement, particularly in asset quality and efficiencies. We saw some compression in our net interest margin in the quarter, reflecting the excess liquidity we have on the balance sheet. Asset quality has really come a long way this year. Our ratio of classified assets to Tier 1 capital plus loan loss reserves improved again this quarter coming down to 28.6% at the end of September from 32.2% at the end of June and 83.2% a year ago. Both our operations and balance sheet are steadily improving. We ended the quarter at $2.84 billion in total assets, $1.89 billion in net loans and $2.36 billion in total deposits and an eighth consecutive quarterly profit. Our SBA loan originations were $34.8 million for the quarter and $111.2 million for the year. Because we sell most of our SBA loans in the secondary market to generate fee income, we sold $21.3 million with a $1.8 million gain in the quarter compared to the sale of $65.2 million, with a $5.5 million gain in the second quarter and an $18.1 million with a $1.6 million gain in this -- in the year-ago quarter. During the second quarter, gain of sales magnified from the sales of previous quarter's production of $30.9 million with a $2.6 million gain. Year-to-date, SBA sales totaled $86.5 million, generating a gain of $7.2 million. We sold $23.6 million in other notes for the quarter and $96.6 million year-to-date. Note sales generated only $515,000 in losses in the third quarter compared to $5.3 million in losses in the second quarter and $3.1 million in the losses in the year-ago quarter. Year-to-date, note sales generated $8.2 million in losses compared to $3.5 million in losses a year ago. In the past 3 years, we have sold more than $358 million in notes, which allowed us to reduce nonperforming loans, keep foreclosed real estate balances low and improve credit metrics very quickly. Our deposit mix is also continuing to improve, with core deposits growing to $1.73 billion, up $2.8 million from a year ago. Year-over-year, core deposits increased with a $73.2 million increase in demand deposits and $108.3 million increase in money market in NOW accounts. Hanmi ended the third quarter with 29.4% in DDA accounts and over 58% in low-cost transaction deposits. Focusing on the income statement, we generated $24.9 million in net interest income for the third quarter of 2012. While average interest-earning assets were up slightly, year-over-year, our yields were down 22 basis points end of quarter and 38 basis points year-over-year. While our cost for interest-bearing liabilities is also down 11 basis points in the quarter and 38 basis points from a year ago, it is not enough to offset the decline in yields. Our net interest margin for the third quarter was 3.69%, which was down 15 basis points from the preceding quarter and 6 basis points from the year-ago quarter. For the first 9 months of the year, margin improved 5 basis points to 3.74% from 3.69% in the first 9 months of 2011. With the overall cost to deposits at 61 basis points in the third quarter, there's still a little room for improvement. It will just not be as dramatic as we have seen in the past few quarters. Yields on interest-earning assets were 4.35% in the third quarter and 4.49% year-to-date. Over the coming quarters, we should maintain or nominally expand them as we continue to improve the mix of core deposits and with less drag on yields with the improvement in asset quality. We also believe we can boost yields as we better -- as we see better growth in the loan portfolio and as we begin to deploy excess liquidity. As we discussed in the release, we did not take a credit loss provision for the third quarter, reflecting continuing improvement in asset quality. Our loan loss provision year-to-date was $6 million compared to $8.1 million in the first 9 months of 2011. With reserves at 3.38% of gross loans, our reserve position continued to be well above the average of 2.71% reported for the second quarter by SNL Financial for the 328 banks that make up it's U.S. Bank Index. Noninterest income in the third quarter of 2012 was $6.5 million, which was down from the $7.2 million in the preceding quarter and up from the $6 million earned in the third quarter a year ago. Year-to-date, noninterest income was relatively flat at $17.3 million compared to $17.5 million in the year-ago period. The biggest component of the quarterly differences was in gain from SBA loan sales, loss from other note sales and gains on sale of investment securities. Going forward, we anticipate that the loss from the note sales will decline while gain from SBA loan sales will continue to contribute to revenues. Noninterest expense in the third quarter of 2012 was $18.8 million, down 5% from the $19.8 million in the second quarter of 2012 and down slightly from the $18.9 million in the third quarter a year ago. Year-to-date, noninterest expense fell 9% to $57.3 million from $62.8 million in the same period of 2011. Salaries and employee benefits, our largest overhead cost, they were down 3% in the quarter and up 12% year-over-year. Year-to-date, compensation expenses rose 6% to $27.7 million, which reflects severance paid in connection with workforce reduction and increased bonus accruals for this year. We also are seeing significant savings in our deposit insurance premiums and regulatory assessments, as well as lower cost of directors' and officers' liability insurance. The combined savings year-to-date in these 2 categories totals $1.7 million and is directly related to the improvement in our balance sheet and asset quality. In the other category where we had big cost savings, is our OREO-related expenses, which were down $1.2 million in the first 9 months of this year compared to the same period last year. And last year, we had a $2.2 million expense associated with the unconsummated capital-raising efforts in 2011. The efficiency ratio for the third quarter of 2012 was 59.81%, an improvement from 61.07% in the second quarter and 60.55% a year ago. For the first 9 months of 2012, the efficiency ratio was 62.32%, down from 66.63% in the first 9 months of 2011. Let's talk about the loan portfolio and credit quality now. Total classified assets at September 30, 2012, were $131.2 million compared to $143.7 million at the end of the second quarter and $317.1 million a year ago. The continuing improvement in this metric is probably one of the most significant items for measuring our turnaround. JH and his team deserve a lot of credit for the hard work, and smart work too, that they have put in to improve our asset quality. Nonperforming assets, including loans held for sale, decreased 48% to $49.5 million compared to a year ago. This is a reduction of $46.3 million from $95.8 million a year ago. Our nonaccrual loans include $19 million or 38% of which are performing restructured loans that are current and paying on a modified agreement. Our net charge-offs were $5.9 million compared to $13.4 million during the second quarter of 2012 and $15.5 million during the same quarter a year ago. The allowance for loan losses totaled $66.1 million or 3.38% of total gross loans at the end of September compared to $100.8 million or 5.06% of total gross loans a year ago. As I mentioned earlier, we still have an ALLL that is well above the 2.71% of average reserves held by all U.S. banks and 2.04% average reserves held by banks in the $1 billion to the $5 billion asset size according to SNL Financial. The allowance for loan losses to nonperforming loans was 148% at quarter end compared to 159% in the preceding quarter and 129% a year ago. Again, based on SNL data for June 30, 2012, our reserve levels far exceed the 61% coverage ratio for U.S. banks and the 47% ratio for banks in our size range. To recap, we are pleased with the accomplishments our team has achieved in the past few years, and this quarter is further evidence of our success in returning Hanmi bank to our health. We still have some work to do on asset quality, but the heavy lifting is pretty much behind us. We are now fully focused on growing high-quality earning assets and improving efficiencies to further build our earnings capacity. We know we could not have accomplished all that we have done without the hard work of our people and especially without the support of our investors. If you're in the Los Angeles area and you would like to meet with us, please give me a call. Lastly, we will be ringing the closing bell for the NASDAQ exchange on December 17 this year in celebration of our 30th anniversary. Thanks again for your attention and support.

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

[Operator Instructions] Our first question comes from the line of Gary Tenner with D.A. Davidson.

It's actually Matt filling in for Gary. How are you guys looking at the excess liquidity on the balance sheet in terms of -- what sort of strategies do you have going forward into the next quarter, as well as 2013?

Matt, that's a good question. One of the things is we've not -- we've actually lowered our deposit pricing and then we're still maintaining ample levels of liquidity. Our goal is -- for the last 3 quarters, we've been selling notes, obviously, to clean up the asset quality issue on our balance sheet. We expect those levels to tail off. We're not looking for -- if I was going to pick a number for net sales in the fourth quarter, we have got a couple of situations we're looking at, but it's probably going to be about $10 million. So it's going to be a lot less than what we've done historically. We did have some little higher payoffs this quarter than we had expected, but again, we're looking at some elevated levels of loan production, origination going into the fourth quarter and into 2013. So our goal here is to really take the excess liquidity and deploy it in higher-yielding loans. So obviously, if we can effectively do that, that would obviously have a more positive impact on our net interest margin, and so that's our strategy. We're expecting to probably originate about $160 million in the fourth quarter in loan production. And going forward in 2013, I think we talked about this last quarter, we're expecting about a 10% growth in our loan portfolio. So we think if we're successful doing that, that should help us with our liquidity situation.

Okay, that's helpful. And then going on with the loan production guidance, any particular loan categories where you're seeing some pockets of growth going into the rest of the year, as well as 2013?

Well, obviously, we are -- our bread and butter business is commercial real estate lending. There's some movement there. We'd like to see a little more of a diversification. We are looking at C&I. We're exploring mortgage possibility. We like the SBA loan originations, but that's more to sell in the secondary market. The premiums on that products are still pretty strong, and we think that's a good place to monetize that particular investment, taking the gain on sale. But for the most part, it's probably going to be still commercial real estate. We'd like to do more C&I, but that's still a tough business out there. But overall, we are exploring a couple of avenues there.

Our next question comes from the line of Joe Gladue with B. Riley.

Just wondering if you could give us a little bit of color on sort of what the types of loans are that are flowing into the classified category, and I guess there's a little bit of an uptick in enclosed this quarter versus last quarter. Is that -- is there any trend there or just 1 or 2 sizable loans? Just -- I'm looking for a little detail.

Well, we've seen over the last couple of quarters, a nice reduction in our classified loans. I'm not sure exactly if there was any one particular item that was a trend or anything. We do expect to see lower levels of classified loans coming into the classified category, going forward. But I mean, JH, is there any particular item that you're seeing?

This is JH Son, CCO of the bank. Of the total classified loans, motor [ph] has $19 million, which is 15% of the total classified loans; and followed by college [indiscernible], $8.8 million, 10%; and also is the land-based at $12.7 million, 10%. So it is the most heavily on business property loan and land loan.

We're still seeing mostly the business property and in the concentrations that we've seen historically, Joe.

Okay. And just wondering again, with your strong reserve levels and declining levels of classified assets, is it possible we'll see some further quarters with no provisioning?

Well, I can't say for certain that there'll be no provisioning, but we do expect to have lower levels of provisioning. I mean, I think last quarter, we were at $4 million, $6 million year-to-date. We're thinking that it's going to be lower levels going forward. As we mentioned -- to your previous question, we expect to see lower levels of downgrades in loans going forward. Charge-offs have been relatively low, $5.9 million. Most of those charge-offs were related to the note sales that we did in the third quarter. We're not expecting doing a lot of note sales in the fourth quarter, probably less than $10 million. So we expect lower charge-offs, probably nominal provisioning, could possibly be 0. But it's going to be much lower than what you've seen in the first 2 quarters.

And Joseph, JH Son. And if I may add a little bit more color on that. Over the past 8 quarters, we have seen continuing improvement in all quantifiable measure of our asset quality. As we maintain strict internal control and proactive solution to managing of problem assets, we expect to see a steady and gradual progress towards a strong loan portfolio. As such, we expect to see subsequent improvements in the figures for our total allowance, as well as the loan loss provision in the future.

Okay. I'll ask one more and that's just -- in terms of your net interest margin and the cost of funding, do you -- what do you see going forward there? Do you still have any levers to pull to help bring down the cost of fundings? And I guess, are you considering anything like redeeming some of the subordinated debt early or anything like that?

Well, one of the things -- redeeming subordinated debt is something that we would like to entertain because that -- those borrowings are fairly expensive today. But I mean, that's something we're exploring. We're not really in the position to do that considering we're still under our order with FRB and with the MOU at DFI. As far as funding costs, we're probably -- got a couple of more basis points to go, and that's probably about it. Our goal would be to obviously, take our liquidity, deploy it in higher-yielding loans and that would be possibly a way that we can expend the NIM. But like I said in my prepared text here is that we need to probably focus more on working on the asset side and growing the yields by redeploying the excess liquidity. I think we'd have more success in an expansion that way.

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

To kind of continue the conversation about the excess liquidity, you had mentioned that you would like to target 10% loan growth next year. Now, in the event the loan growth is slower, say, 5% for argument's sake, what is your philosophy towards maintaining the cash and equivalents versus redeploying them into securities? And what is your thoughts about securities portfolio management?

Well, I guess from a security standpoint, we do have some room that we could add some securities to our portfolio in that regards. I think overall, it's -- it would probably -- we don't get the 5% -- or we'd get a 5% versus 10% loan growth, we would deploy a higher percentage of that in the securities portfolio going forward. The average yield of our securities portfolios is about 2.2% to 2.5% -- to 2.25%. We do more of that. But again, we -- as I mentioned earlier, we did -- we have reduced some of our deposit rates, so we're not really trying to really grow that liquidity at this point. We want -- we believe that we can be successful in growing our loan portfolio 10% next year and that's obviously going to be our target. If we're not going to -- we see that, that's not happening, we would deploy some of that in the investment portfolio, but might let some of it run off too.

That makes sense. And then in terms of your securities portfolio, you shifted securities from health to maturities to AFS. So are you planning on selling some of those down or is there any other plans there?

No. It wasn't the intent to sell these particular securities. The held-to-maturity securities were predominantly municipals. And we've made a strategic decision here that in the event that these municipals got into a credit situation -- obviously, some of the municipalities in Southern California have run into some financial problems. We wanted to have the flexibility to sell these securities in the event of a credit situation. Having them in held-to-maturity created some hurdles for us. And so we'd made the decision to take all the securities held out of maturity and put them in available-for-sale and keep as much of our investment portfolio liquid in the ability to sell in the event of a credit situation with a particular security or what have you. It was a consciously discussed situation here. Obviously, from an accounting standpoint, we really can't do much with held-to-maturity securities in the near future. It's not our intent or philosophy to really have held-to-maturity securities going forward. So it was more driven not by the intent to sell securities because we have a lot of liquidity to begin with based on just seeing the numbers that we have, but it was more to react to a potential credit situation that may occur in the municipal portfolio. And I'm not saying that any of the municipal securities are in a credit situation that would require us to sell them today, it was just we wanted to provide additional options on that particular portfolio.

That makes sense. And then finally, in terms of the excess liquidity, what are your thoughts about portfolio-ing SBA loans and such in order to redeploy the security versus selling it for the gain?

Yes. I mean, that's -- that is definitely discussions that we're having in our ALCO and our strategic sessions. That's something we can look at. But one of the compelling arguments that we like about selling into the secondary market and monetizing those gains is that the premiums right now are very strong and actually have improved even from the second quarter into the third quarter. And I mean, that's obviously something that we could do. We are talking about it. But at this point in time, we have preferred to go with the gain of sales versus portfolio-ing.

That makes sense. And then I'll step back, but just final question, what are the premiums then in this quarter? What was the improvement?

Premium improvement is currently over 11%. We generated average premium rate of 11.1% last quarter.

Right. But we've seen premiums on various products as high as 14%, 15% on the various buckets on the pricing. But the pricing sheets that we've seen recently are showing stronger bids out there.

[Operator Instructions] If there are no other questions in the queue, I would like to turn the call over to David for his remarks.

Thank you for listening to Hanmi Financial's third quarter conference call. We look forward to talking to you next quarter.

Ladies and gentlemen, thank you all for your participation in today's conference call. Thank you, David.

Thank you.