Hanmi Financial Corporation (HAFC) Q3 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, welcome to the Hanmi Financial Corporation Third Quarter 2013 Conference Call. As a reminder, today's call is being recorded for replay purposes. [Operator Instructions] I would now like to introduce Mr. David Yang, first Vice President of Investor Relations and Business Development. Please go ahead, sir.

Thank you, Cheryl. And thank you, all for joining us today. With me to discuss Hanmi Financial's third quarter highlights are C.G. Kum, our President and Chief Executive Officer; Bonnie Lee, Senior Executive Vice President and Chief Operating Officer; and Mark Yoon, Executive Vice President and Chief Financial Officer. Mr. Kum will begin with an overview of the quarter, and Mr. Yoon will then provide more details on our operating 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 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 2013, which can be found on our website at hanmi.com. I will now turn the call over to Mr. Kum.

Thank you, David. Good afternoon, everyone. I would like to welcome and thank our investors, research analysts and others for your interest in Hanmi Financial Corporation. I'm pleased to be here today to talk with you about our third quarter results, which has been my first full quarter leading the Hanmi team. Our goal is to transform Hanmi to be the premier Korean-American financial company. This goal will be realized by building an organization with the foundation of strong risk management and customer service to support a growth-oriented, relationship-based, banking philosophy that not only emphasizes asset generation, but also generation of core deposits. To fulfill these objectives, we will continue to make investments in technology, infrastructure and talented bankers. As you know, I joined Hanmi in June and shortly thereafter, we welcomed Bonnie Lee to our senior management team. Bonnie is one of the most respected bankers in this region, and I am very pleased to have her on our team. In the third quarter, we augmented our lending team with 4 of the top lenders in our market. These lenders have strengthened our lending platform and in particular, have provided the necessary expertise and contacts to safely increase our portfolio of middle market C&I loans. I believe we are building a robust lending capability that will help us to diversify risks in our loan portfolio and strengthen our ability to attract core deposits. To further enhance relationship banking with our business customers, we have hired an experienced banker who has a proven track record in cash management sales and service with a regional mainstream bank. This banker will lead the newly created cash management department that would deliver a broad array of cash management services to business customers. We will be the only Korean-American bank to actively market this business service. During the quarter, we opened our Dallas, Texas SBA loan production office with a seasoned banker in that market. Texas is the sixth largest Korean-American market in the U.S., making inroads in this growing market is strategically important to us. With that said, Hanmi generated solid profitability in the third quarter and first 9 months of 2013. Our net income was $10.3 million or $0.32 per share for the third quarter of 2013, and $29.9 million or $0.94 per share for the first 9 months of the year. For the last 12 months our loan portfolio has grown 11.1% to $2.1 billion from $1.89 billion a year ago. Solid loan growth is one of the key drivers of our year-to-date results. The loan pipeline at the end of the quarter remained strong, and I'm pleased to report a very healthy pipeline of C&I loans. I'm also pleased to report that we are one of the few banks that have seen its net interest margin grow in the third quarter. Finally, the lower efficiency ratio of 53% for the third quarter reflects our focus on improving efficiency throughout the company. With that, I will turn the call over to Mark Yoon, our CFO, to discuss the operating results in more detail. Mark?

Thank you C.G., and good afternoon, everyone. Our third quarter profits reflect the overall improvement in our operations. Our pretax income increased 9.7% quarter-over-quarter and 33.2% year-over-year. For the first 9 months of the year, pretax income grew 63.9% compared to a year ago. The highlight for the quarter was our net interest margin, which improved to a 4.28%. This is an 18 basis point expansion from the second quarter and a 59 basis point improvement from a year ago. For the first 9 months of the year, NIM increased 34 bps to 4.08%. Credit quality continued to improve. Loan growth for the year is good, although higher payoffs in the third quarter reduced our loan portfolio slightly from the last quarter balance. Overall, we are pleased with our third quarter results. We generated $28.5 million in net interest income before credit loss provision for the third quarter of 2013, up from $27.2 million in the preceding quarter and $24.9 million in the third quarter a year ago. For the first 9 months of the year, net interest income before credit loss provision increased 8.9% to $81.2 million from $74.6 million a year ago. Average interest-earning assets were down by $12.8 million in the quarter and $49.7 million from a year ago. Average interest-bearing liabilities were also down $33.3 million in the quarter and $136.1 million year-over-year. Both these declined balances boosted net interest income before credit loss provision in both the quarter and the year-to-date period, reflecting the shift in the asset from low-yielding cash and securities into loans, the complete payoff of EPS and the shrinking of high-cost time deposits. Third quarter loan yields improved 12 bps in the quarter, and it went down 16 bps year-over-year. Our yield on average interest-earning assets improved 16 bps in the quarter and 40 bps year-over-year. Our constant deposits was down a single basis point in the quarter and fell 9 bps year-over-year. We had a few weeks during the quarter when we had to match our competitors promotional CD rates to retain good customers. The markets have settled down and interest costs are stabilizing. As we discussed in the release, we did not take a credit loss provision for the past few quarters, reflecting continuing improvement in asset quality. With the reserves at 2.67% of the gross loans, our reserve position continued to be well above average of 2.15% reported for the second quarter by SNL for the 325 banks that make up its U.S. Bank index. Noninterest income in the third quarter of 2013 was $7.3 million, which was slightly down from $8.2 million in the prior quarter, and up from $6.5 million in the third quarter a year ago. The main reason for the slight decline in the third quarter was the lower gains from selling SBA loans. SBA loan sales were down in the quarter and premiums for these loans were also declined. For the first 9 months of the year, noninterest income increased to a $23.8 million from $17.3 million, which was mainly attributable to a $7.7 million decrease in net loss from selling NPLs. On the expense side, noninterest expense in the third quarter of 2013 was at $19 million, down 5% from $20 million in the prior quarter and up 1% from the third quarter a year ago. For the first 9 months of 2013, noninterest expense increased 1.4% to $58.1 million from $57.3 million in the first 9 months of 2012. Higher compensation costs in the quarter were more than offset by low professional fees. As discussed in the release, we did not incur additional cost from a loss we prevailed on and received the $640,000 reimbursement from insurance company for legal expenses incurred for another lawsuit. We expect our professional fees will vary due to expenses we may incur for strategic reviews in the future and of course, future litigation is never something that is easy to predict. The efficiency ratio for the third quarter improved to a 53% from 56.6% in the second quarter, and 59.8% a year ago. Moving on to the balance sheet, our interest-bearing cash balances are up significantly from the second quarter, but down 47% from a year ago at $115 million. The increase was due mainly to higher loan payoffs and retail deposits. Our investment portfolio decreased to $17.8 million in the third quarter, due mainly to a $26.1 million sales, $11.9 million principal pay downs and $10.6 million fair value adjustment, partially offset by $31.4 million purchases. In the third quarter of 2013, we generated $136 million new loans, mainly consisting of $27.9 million SBA loans; $84.6 million CRE loans; and $22.8 million C&I loans. We sold $15.5 million of guaranteed portion of the SBA loans for $1 million gain in the third quarter of 2013. Last quarter, the gain on SBA loan sales totaled $2.4 million, and it was $1.8 million in the third quarter a year ago. Two factors influenced the lower level of gains in SBA loans. First, we're transitioning our lending focus to C&I loans, and that process will take time. The second factor is that the premiums for SBA loans have fallen dramatically. Last quarter, we saw a decline in premiums from 12.2% to 8.5%. One other factor to note on SBA loans right now is that as a preferred lender, we're able to continue to approve loans during the government shutdown, but all our loan production will still need to be reviewed by the SBA. We anticipate that, now the SBA is back in business, there'll be some delays as they work through the backlog in the first week -- first few weeks of October. We are very glad that this particular budget crisis has been resolved and hope that it does not recur. On the deposit side, core deposits were $1.94 billion or 79.7% of deposits, up by $208.6 million or 12.1% compared to a year ago. Year-over-year, our core deposits increased with $84 million increase in demand deposits and $147 million increase in non-Jumbo CDs, partially offset by $25 million decrease in MMDA and NOW accounts. Finally, our credit quality continues to improve, and I like to briefly review these metrics. Classified loans at quarter end were down to $83.7 million, compared to $89.6 million at the end of second quarter, and $130.9 million a year ago. Nonperforming assets decreased 53% to $23.1 million, compared to $49.5 million a year ago, a reduction of $26.4 million year-over-year. Our net charge-offs were $2.2 million compared to $1.62 million during the second quarter of 2013 and $5.9 million during the third quarter a year ago. Now I turn the call back to C.G.

Thank you, Mark. I want to thank all the people on the Hanmi team for their hard work this quarter and for the warm welcome they have given those who have recently joined us. The culture here at Hanmi is very rich and the dedication of our people is quite strong. With everyone working hard and smart, we have started to execute on a strategy to be the premier Korean-American financial company. David?

And now let's open the call for questions.

[Operator Instructions] And our first question comes from Julianna Balicka with KBW. Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division: I was wondering if you can elaborate a little bit more on the higher payoffs that you saw in the third quarter and discuss that in context of any seasonality that you may normally see in the third quarter. I know a lot of the hiring will come, and the benefit from the hiring you've done will come through next year, but the 1% in quarter loan balances being decreased was a little bit surprising. So maybe if you can elaborate a little bit more than that.

Okay. Julia, this is Bonnie. I'll take the first part of the question. On average, looking at a couple of quarter, past quarters, we averaged about $50 million per quarter payoff. During the third Q, we actually made a business decision to demand the payoff from our customers, from our existing customers. And it is actually 6 loans. Either they have -- the loans are in the watch list or to be downgraded or, although it's a past loan, that we saw increased risk, credit risk. So we asked at the beginning of the quarter, that we ask a customer to pay us off. So altogether, 6 loans, we made a business decision to get the loans paid off, in total over $44 million. In terms of the slight decline in the quarter end balances in terms of the loans, looking at, again, past quarters' level productions, we averaged about $160 million per quarter production. And since we haven't done a whole lot of C&I loan, it's actually the commitment and then outstanding disbursements were about the same balance. In the third Q, we did have a buy commitment about $160 million, but actual disbursements were a little over $130 million. So that's under production level. So if you look at just quarter-end to quarter-end, the balances that you may see there's a little bit slight decline. But we expect to have the production to pick up and just looking at the -- going into the fourth quarter, looking at the projections and pipelines, we have increased our projection compared to the third Q, beginning of the third Q.

Bonnie, this is C.G. Kum. Just to kind of expand on Bonnie's comments a little bit. When you have the kind of transition that we have had in the third quarter, there will be some, I would say, choppiness as far as production is concerned in most organizations. But here at Hanmi though, I was very pleased to see the production level be maintained at a relatively high level, even with the all the changes that were taking place in the third quarter. So as Bonnie mentioned, to kind of sum it up, the part that was extraordinary in the third quarter was the higher-risk loans that we strategically asked out of the organization. Except for those loans, we would probably have maintained the kind of production level that we had in the past. To look further out, and we don't provide any future guidance on any specific parts of our income statement or the balance sheet. But to elaborate or to kind of flesh out a little bit further what Bonnie just mentioned about the higher production expected in the fourth quarter, we're right now on a very preliminary basis seeing projections -- and this is very, very preliminary, so you really can't put a lot of stock to it, but I just want to give you a frame of reference. We're looking at over $300 million of potential production for the fourth quarter. And of which, we're looking at about $128 million of that being in the C&I category. So the new team have kicked into gear, as well as the other Hanmi bankers who have been here and who have been loyal and dedicated and hardworking. They continue to work extremely hard to generate the loans for us. And so I'm looking forward to a very productive and exciting fourth quarter. Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division: That's very good to hear. Great color. And if I can follow up then on the loan topic, you're increasing loan yields? Could you discuss a little bit more that's -- whether there was something unusual with minus -- there's something unusual in the second quarter or whether there was something that allows you to increase your loan yields this quarter?

Yes. We've -- during the third quarter, we made a decision to hold the line as far as Commercial Real Estate interest rates are concerned at about -- at 4.5%. I mean, as you know, the long end of the curve started to move up in the third quarter. And so consistent with that, we decided to, internally, to require 4.5% minimum interest rate for the -- our typical, most prevalent product, which is our 25-due-in-7 commercial real estate loan. That product, historically, or I should say over the last year or 2, have been priced somewhere between 4.25% to 4.5% to maybe a little bit higher. But starting in third quarter, we basically had decided that we want those pricing to come in at a minimum 4.5%. Of course, for good customers, we have made some exceptions to that. Good customers being defined as not only from an asset-quality standpoint, but from also a higher-deposit standpoint. So that contributed to the overall higher yield for our portfolio.

If there is one, I guess, extra benefit we realized from the strategic decision we made to let go of some of the problem loans toward the quarter end, was that we realized about $480,000 of the recapture of income from non-accrual status and also classified loans that the -- paid off during the third quarter. So that -- even without those, the recapture of income from problem loans, our loan yield probably go down very little, maybe a 5 point, maybe to 5% or 5.2, 2% [ph]. So it wouldn't really move the needle. Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division: Okay. That make sense. And then if I can ask about efficiency. Some of the expense reduction that we saw this quarter were some of the less normal expenses reducing such as strategic review, et cetera. From the $19 million operating expenses this quarter, how should we think about the run rate going forward, balancing out some cost efficiencies versus investment in the business?

Well, the -- there's -- that number is still in a state of flux, in that the third quarter includes onetime expenses associated with some of the executives -- executive departures from Hanmi. And obviously, it includes new expenditures associated with additional personnel coming on board. So from a personnel side of it, we're monitoring that a bit. And during the fourth quarter, by the end of fourth quarter, we'll have a much better feel for what the future run rate should be. As to the other expenses in the noninterest expense category, the -- what you're seeing is probably a pretty good indicator of at least another quarter or 2, as it relates to noninterest expenses. And that is primarily due to the fact that -- while we continue to make inroads in terms of reducing the professional expenses, in particular, relating to litigation, the real benefits are not going to come until next year when we will have completed some of the litigation matters. And also, some of these what we call strategic reviews, evaluating some of the acquisition options, those things will have calmed down a little bit more, hopefully, next year. And so the -- I guess, the short answer is, the third quarter number is not what I would consider to be a predictor of the future run rate of expenses for Hanmi. But I think we're heading in the right direction as far as not only expenses are concerned, but the managers of Hanmi becoming more and more focused on the issue of expenses. Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division: Okay. That make sense. And then final question now. The last quarter, when you first joined the bank, you started to preliminarily discuss capital management plans. And I was wondering whether there is anything that you can update us on that's a little bit more tangible?

Yes. I mean the -- I guess a quick answer is, that the -- as you know, we have implemented the cash dividend program which we will be continuing. The other significant element of the capital planning side of it is to better leverage the capital and the balance sheet of Hanmi. And that's where the issue of strategic reviews come in and the cost associated with them. We are actively looking at opportunities to leverage and to better use -- utilize our capital. And hopefully, we'll have some good news to report to the marketplace within the next quarter or 2. Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division: And what about buybacks?

I'm sorry? Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division: What about buybacks?

Well, the buyback issue will be dependent upon how successful we are in terms of deploying our capital for expansion purposes. If the -- if we are not able to do that as quickly or as much as we would like, then we would definitely look at the buyback program. But based on the potential uses of capital, I think it's premature to think about a buyback at this point. But that's on the table and the board is aware of that, and the board is supportive of it if we are not able to utilize that capital for expansion purposes in the near term.

Our next question comes from the line of Tim Coffey with FIG Partners.

C.G., I was wondering if you can kind of walk me through your expectations for cash and equivalents. Obviously, it was pretty high this quarter, higher than I think you typically would like it. Do you plan to hold onto that for -- to fund new loans or do you think you can maybe put it in kind of like a piggy bank for, in case there's deposit runoff for any reason?

Actually, definitely no, as to the latter. One of the core emphasis of Hanmi, on a go-forward basis, will be emphasizing the degeneration of core deposits through relationship banking, whether that's through the lending side or augmenting that with the cash management side. So the focus on the deposit generation, core deposit generation, will continue to, I think, increase that cash balance. It's then -- it's incumbent upon the lending side to put those to -- put those dollars to good use. And as my answer reflected in the -- as it relates to the noninterest expense side, there's a bit of uncertainty as to how much of that cash is going to be consumed by the new lending activities. As I mentioned, the pipeline at this point in the quarter, seems very healthy. And if that pipeline does become real and manifests on the balance sheet, that cash position should shrink materially. So that's the hope at this point in time.

Okay. And then one other question about the operating expenses. The advertising line item's been over $1 million for 2 consecutive quarters. Given the hiring that you're doing in L.A. and also the new loan production office in Texas, would there -- should there be an expectation that, that line item would stay about where it is for the foreseeable future?

Yes.

Our next question comes from the line of Gary Tenner with D. A. Davidson and Co. Gary P. Tenner - D.A. Davidson & Co., Research Division: Just a couple of questions. Want to make sure I heard the number right on the interest reversals, was that $480,000? Is that correct?

Yes. Gary P. Tenner - D.A. Davidson & Co., Research Division: So the $44 million that you effectively worked out of the bank. Does that get you, in terms of that kind of pool of loans, does that get you where you want to be or is there another kind of leg or -- of loans that you want to work out?

It's an ongoing process, Gary. I'm very comfortable with the asset quality of Hanmi as it stands right now. We continue to work through what's becoming a smaller, smaller pool of problem credits. So the answer at this point is that -- we went through a very extensive credit review process shortly after I arrived. And we have identified risks, we dealt with them and we managed some of them out of the bank, we took some hits and whatnot. And so the -- what we see or what you see in terms of our asset quality matrix, which is on the balance sheet today, is a pretty good -- pretty accurate depiction of the quality of the loans in our portfolio. Having said that though, it's a continuous process as you know. And so we have a credit team that is very diligent in working with the lending team to make sure that we identify problem loans as early as possible. And if need be, work them out of the organization in a cooperative fashion. Gary P. Tenner - D.A. Davidson & Co., Research Division: Okay. That's helpful. And then just a quick question on the SBA business. You mentioned that with a focus on C&I that, that production on SBA may -- it sounds like you're saying it may stay a bit lower for a period of time. Is this -- if you assume that premiums stay where they are right now, is $1 million a quarter run rate of fees about what you'd expect or does it go lower than that?

Well, I think -- well, let me kind of explain -- provide a slightly different perspective or color on the issue of SBA. I probably was the cause of the lower production in the third quarter. And the reason for that is the SBA loans on a proportional basis, have generated higher level of classified loans than any other loan category at Hanmi, and that's probably true for most of the Korean-American banks. I needed to understand why that was the case and what the offsetting benefits are, which, obviously, involves the premium income from the sale of the 7(a) loans. And so what we did was we assessed the -- our objectives relative to the SBA lending program. And what we decided was that we want a little bit tighter, I would say focus as to the SBA loan generation. We decided, from a geography standpoint, we're going to stay primarily to the Western United States, including state of Texas. We're not going to do one-off deals in Delaware or Florida or whatever. So we're going to stay primarily to a geography that we have some familiarity with. Secondly, as much as possible, and we will do some of the gas station loans and business loans, but we like collateral to back the SBA loans, to lower the risk profile, if you will. And so the SBA team and management have come to a better understanding as far as what we need to do on a go-forward basis. But to support our continued commitment, my continued commitment to not only be active in the SBA but to expand the SBA program, we opened the Dallas office. We are about 90% done in terms of hiring a new SBA lending manager in the Northwest. We have had a SBA loan office in Seattle, that position has been vacant for a while with that person leaving. So we're pretty close to filling that position. And in addition to that, we're also close to filling a -- well, actually not filling, but creating and filling a SBA loan manager in the New York-New Jersey market. We're also actively looking for a SBA loan manager for the possibility of opening an office in Atlanta. And so overall, our commitment to SBA is very strong and probably, over time, it may create a volume that's even higher than what Hanmi has historically generated. And I think higher volume is going to be necessary because, as Mark mentioned earlier, we expect that the premiums paid for the 7(a)s are going to continue to go down. And so we're going to have to make it up in volume. And so with that thought in mind, we're going to continue to make the investment in SBA to enable us to generate the volume necessary. But at the same time, do it a little bit smarter and a little bit less risky.

So Gary, if I add a little more color on your question, basically, you're asking for run rate for the next quarter or so for your modeling purposes. So we have a target volume for SBA loans, and if we achieve the target for Q4, then I think -- assuming that, obviously, the SBA premium is going to continue to stay at this level, the 8%. It looks like they're going to stay for the time being, as the treasury yield curve is going to stay kind of -- it just came down a little bit today and yesterday. I think it's going to be at this level. Then probably we're going to realize the gain from selling SBA loans around $1.3 million to $1.5 million for Q4, okay.

[Operator Instructions] And our next question comes from the line of Scott Valentin with FBR Capital Markets. James Ulan - FBR Capital Markets & Co., Research Division: This is James Ulan for Scott Valentin. I was wondering if you can give a better sense of run rate for the cost of the new C&I teams, as well as a quarterly run rate for their originations?

Well, the -- we're not ready to do so at this point in time. The -- as I mentioned earlier, it's somewhat early in the quarter, but it seems that, that team is -- not only that team, but the bank as a whole, because I want to emphasize that it's just not that group of people that came over but also the -- we have placed a focus on generating C&I throughout the company where there are opportunities, others are doing so. And so in a proportional sense, it's about $128 million on a $306 million projected production for -- excuse me, fourth quarter of 2013. And so the -- that's about the best I can do at this point. I -- really, I'm not in position to project out any further than that. James Ulan - FBR Capital Markets & Co., Research Division: Okay. And then a question about SBA premiums. You gave good guidance on fourth quarter premiums. Can you just talk about the economic factors that caused the gain on seller decline and give us some thoughts on how you think those factors might change or stay the same in the first quarter and second quarter of 2014?

Yes. As I mentioned earlier, the primary reason for the lower premium had to do with lower volume of SBA loans generated in the third quarter. That having to do with a kind of a reassessment, or me coming up to speed as to understanding the SBA lending business model, and then collectively revising the business model to limit the geography and to lower the risk profile in terms of types of SBA loans that we're more comfortable with. So those were the main parts contributing to the lower production. Going forward, however, as these new hires kick into gear, we should meet, if not exceed, the prior quarterly -- the volumes that were generated. Having said that though, from a -- how that translates into premium, we expect that it's going to be less on a go-forward basis to what it was in 2012, even though the volume is going to be equal to or higher, because of the fact that we expect that the premium income is going to be less. James Ulan - FBR Capital Markets & Co., Research Division: Okay. And what are you thinking for how that premium will trend and what are the primary drivers?

Well, we believe the primary driver is the market interest rate. So it's a function of treasury yield curve and spread. So as you can see that after the shutdown crisis resolved, we've been seeing that treasury yield curve has been kind of shifting downward. So considering that we've been underwriting SBA's with a weighted average of interest rate of a 4.5% or 4.6%, so because of the spreads are widening, we expect the spreads will be widening, so the premium is going to stay either at this 8% level or maybe higher premiums for the time being. But once we've reached another showdown early next year for budget debt ceiling and other budget issues, then probably we're going to see maybe a shrinking of the spread between the SBA yields and the treasury yield curves. Then we're going to have another premium decline. So that's kind of what we're seeing right now.

And there are no further questions at this time. I'd like to hand the call back over to management for closing remarks.

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

Ladies and gentlemen, this concludes the Hanmi Financial Corporation's Third Quarter 2013 Conference Call. We thank you for your participation, and at this time you may now disconnect.