Hanmi Financial Corporation (HAFC) Q1 2014 Earnings Report, Transcript and Summary

Ladies and gentlemen, welcome to Hanmi Financial Corporation's First Quarter 2014 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.

Thank you, Lira, and thank you, all, for joining us today. With me to discuss Hanmi Financial's first quarter 2014 earnings 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 company's future operating results and financial position. Our actual results could be different from those expressed or implied by 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 our financial results for the first quarter of 2014, 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 want to thank all of you for joining our earnings call today. This morning, we reported that our first quarter 2014 net income grew 10% to $11 million or $0.35 per diluted share from the fourth quarter of 2013. During the first quarter 2014, we achieved solid growth in both loans and deposits year-over-year. We generated year-over-year loan growth of 7.3%, with our loan portfolio reaching $2.3 billion and deposits growing 7.4% from a year ago. Core deposits now make up 81% of total deposits, with non-interest bearing deposits accounting for 33% of the total deposits. With stable credit quality, we recovered $4.3 million in previously charged-off loans in the first quarter, which allowed us to record a negative provision for loan losses of $3.3 million. Even with this negative provision, our allowance for loan losses remains strong at 2.49% of gross loans. We continue to transform Hanmi with our investment in our people and technology to be the financial institution people want to work for and to bank with. As part of our commitment to strengthen our employee base, the training curriculum at Hanmi banking school continues to expand to cover not only technical and compliance training, but also training in customer service and English language proficiency. To provide leadership to better align our investment in technology with our strategic initiatives, a Chief Information Officer position was created. On March 24, a highly qualified Chief Information Officer joined our management team as well. We are also revitalizing our SBA lending program. As the first Korean-American bank to offer SBA loans, Hanmi has a long history of serving small business customers as a SBA lender. Yesterday, we announced that Anna Chung has joined us to lead our SBA Lending Division. Anna is one of the nation's best SBA lenders with more than 30 years in banking and SBA lending. She has the superior reputation for success in the industry. According to data from the U.S. Small Business Administration, her former bank was ranked ninth in the nation in lending volume for SBA 7(a) loans in the first quarter of fiscal 2014. I am confident that under her leadership, our SBA lending group will quickly become a force in small business lending. On April 17, 2014, Central Bancorp held a special meeting of its shareholders to vote on the merger with Hanmi Financial. I am pleased to report that the shareholders voted overwhelmingly to approve the merger with Hanmi. We believe the merger will create great financial and strategic values. As we said when we announced the deal, we anticipate strong earnings accretion and minimal dilution to book value for our shareholders. The transaction will also enable us to expand into several new markets, including Texas, Illinois, New York, New Jersey and Virginia. All of these markets have significant Korean-American population with potential for further penetration. But even more importantly, Central Bancorp's subsidiary, United Central Bank, has solid penetration into other communities, including Indian, Pakistani and Chinese-American and mainstream. The management team at Central Bancorp continues to make significant progress in lowering its classified assets. As of year-end 2013, Central's classified assets totaled $405 million. By end of April, the management at Central Bancorp believes that the classified assets will be down to approximately $245 million without material reduction in its capital base. Given this progress, it is highly likely that Central Bancorp will reach the classified asset target of $160 million in the second half of the year to close the transaction. In conclusion, as reflected in our first quarter results, I'm pleased to report continued improvement in our core earnings capacity. I'm also pleased with additions to our management team to strengthen our infrastructure and position Hanmi for future success. With that, I'd like to turn the call over to Mark Yoon, our Chief Financial Officer, to discuss operating results in more detail. Mark?

Thank you, Mr. Kum, and good afternoon, everyone. I will discuss our financial results for the first quarter of 2014 in more detail, including income statement, loan and deposit growth, net interest margin and asset quality. We generated $28 million in net interest income before credit loss provision for the first quarter of 2014 compared to a $27.6 million in the preceding quarter and $25.6 million in the first quarter a year ago. This was mainly driven by continued growth in average loan balances, high utilization of a low end no cost funding sources and the improved net interest margin. As we discussed in the release, we recorded $3.3 million negative provision for loan losses in the first quarter, reflecting higher recoveries on loans that were previously charged off. In the first quarter, gross recoveries were $4.3 million, more than offsetting gross charge-offs of $1.6 million, resulting in net recoveries of $2.6 million. With the reserves at 2.49% of gross loans, our reserve position continues to be well above the average of 1.9% reported for the first quarter by SNL Financial for the 325 banks that make up its U.S. Bank index. Noninterest income in the first quarter was $7.2 million compared to $7.6 million in the preceding quarter and $8.4 million in the first quarter a year ago. The reason for the drop in the quarter compared to the preceding quarter and the year-ago quarter was mainly from lower gains from selling SBA loans, offset by higher gains from selling securities. We are able to harvest the gains from our securities portfolio following the favorable movement in the U.S. curve during recent international events. On the expense side, noninterest expense in the first quarter was $19.8 million, down 1.8% from $20.2 million the preceding quarter and up 3.3% from the first quarter a year ago. Professional fees declined due mainly to the lower cost associated with the merger process, strategic reviews and litigation costs. In the first quarter, we did see normal increase in compensation costs, reflecting higher salaries and benefit costs. Our provision for income taxes has been somewhat variable over the past few years. Our first quarter effective tax rate was 41%, which is higher than effective tax rate of 35.6% for the full year in 2013. As we noted last quarter, the California EZ programs have, for all intents and purposes, expired, and we are paying higher rates this year. Moving on to the balance sheet. As part of our liquidity management strategy, our securities portfolio was up by $101.1 million year-over-year at $521 million, or to compare to the preceding quarter, it was down about $10 million. We continue to deploy assets liquidity into mostly short-duration GSE amortizing bonds to be better positioned for a rising interest rate environment. Gross loans increased 7.3% to $2.28 billion from $2.12 billion a year ago and increased 1.9% from $2.23 billion at the end of preceding quarter. First quarter new loans totaled $159.9 million, consisting of $79.7 million of CRE loans, $36.9 million of C&I loans and $34.2 million of purchased residential mortgages and $8.4 million of SBA loans. We sold $6 million of guaranteed portion of SBA loans for our $547,000 gain in the first quarter of 2014. In the first quarter, the gain on SBA loan sales totaled $1.9 million for selling $25.1 million of guaranteed portion of SBA loans. On the deposit side, core deposits were $2.03 billion or 81% of deposits, up by $254.1 million or 14.3% compared to a year ago. Year-over-year, our core deposit growth was fueled by $117.5 million increase in demand deposits and $115.1 million increase in non-jumbo CDs. Our overall deposits were up by $173.6 million from a year ago, with core deposit growth more than offsetting the $80.5 million decrease in jumbo CDs. Our net interest margin improved 4 bps to 4.02% from 3.98% in the preceding quarter and by 16 bps from a year ago. This increase was mainly generated from higher-yielding assets and a lower overall cost of fund. And as you may recall, we paid off our trust preferred securities last year, which eliminated interest payments on those securities and contributed to the year-over-year improvement in margin. On the asset quality side, total classified assets at quarter end were down 35.9% to $51.4 million compared to $80.3 million at the end of the fourth quarter and were down 45.9% from $95.1 million a year ago. The decline in the first quarter of 2014 mainly resulted from $20.3 million in loan upgrades and $8.8 million in repayments. NPLs were $25 million compared to $32.9 million a year ago, a reduction of $7.9 million year-over-year. Now I'd like to turn the call back to Mr. Kum.

Thank you, Mark. I want to thank Hanmi team for their hard work and dedication this quarter, and to welcome the new employees who have joined our team. I'm proud of the effort and the results we have accomplished together. The short- and long-term strategies we are implementing will enable Hanmi to become the premier Korean-American financial institution. 2014 will be an exciting milestone year. Thank you. David?

Lira, let's open the call for questions.

[Operator Instructions] And our first question comes from the line of Julianna Balicka with KBW.

I have a few questions about the quarter. Very nice results to see. In terms of the loan growth, which was coming through nicely, I see there's an increasing amount of loan commitments, which suggest increasing C&I loan growth. So could you talk about your outlook for the rest of the year as the teams and the lenders have come on ramp-up? And how are the -- how has their books of business been moving over, et cetera, in terms of your expectations for increased loan growth in the future?

Yes. The -- as you noted, our base of C&I customers, as reflected in the loan totals, continue to go up. And if you look at the commitment side, it's even more impressive. That's as a result of the new members to Hanmi joining us from another institution. The -- as we talked in the past, the -- it takes about 6 to 9 months for a new team to be fully on track in terms of being productive, and we're certainly on target, if not a little bit ahead of initial expectation. First quarter, as typically the case for most banks, tend to be a little bit slower for whatever reasons. The -- our customer seems -- customer base is not as willing to be active on the borrowing side. And so, I would suggest that the -- starting in the second quarter on, we should continue to see upward trajectory as far as the growth of our C&I loan totals are concerned. Also, one of the elements that will help us grow even more on the C&I side is that we have transitioned our cash management capabilities or technology into -- to another vendor. And we are in the process of doing the conversion to what will be latest technology as far as cash management services are concerned. The actual transition will be completed by September. And once we are fully online, that will give us additional lever to pull as we go after the lower middle market business clients. So I expect that with that element, along with the talented team that we have, we will continue to be a force in the C&I lending business.

Very good. And in terms of your SBA platform, you referenced reforming your SBA platform. So other than bringing over management-level changes, what are some of the other reforms you're instituting? And what are going to be the practical implications once those are in place?

Well, the -- with the arrival of management or the key person in Anna Chung, she's bringing -- she has brought with her already significant number of other personnel on the SBA side. The most significant changes that you'll see as far as our SBA program is concerned is that our volume will go up, and the average size of loans will probably go down. That's just the way Anna has done it in the past, and Anna has done that safely wherever she has been in terms of taking on lower risk profile, SBA loans and just generating a lot more of them. So it's our expectation that she will fully kick into gear in the third quarter of this year. And with that, I know that the next question is going to be, well, what kind of volume do we expect. And I think it's safe to say that $25 million to $30 million is a good number per quarter on a steady, repeatable basis, for 7(a)s, by the way.

Sorry?

For 7(a)s.

Okay. And then in terms of -- so the implication is she kicks in -- she and her team kick into gear in the third quarter, then shall we expect some more securities gains in the second quarter to kind of bridge the income gap?

Well, I think that depends also on the interest rate environment. As Mark mentioned, we were fortunate in that the rate environment worked in our favor. It's not to say that the -- our SBA pipeline is bone dry, but I think what you're saying is that we probably will not have the $25 million to $30 million in volume for the second quarter, which is probably likely. But we'll see what happens during the quarter in terms of other opportunities to generate additional income. And if the rate environment cooperates, yes, there could be some more mining of opportunities in the securities portfolio.

Our next question comes from the line of Gary Tenner with David & Company (sic) [D.A. Davidson & Co.]

That's D.A. Davidson. A couple of questions, first, on the personnel line. Obviously, there tend to be some seasonal impact on the comp side. Is there -- how much additional was there this quarter in terms of new hires brought on board? Were there any sort of one-time-ish stock grant compensation in there? Anything that you could give us on that line item would be helpful.

Yes. Mark and I will tag-team on this one. Yes, there were onetime costs associated with issuing a restricted stock. That involved the issuance of restricted stock to our Board of Directors, pursuant to our compensation program, along with some issuance of restricted stock for some new additions to our management team. So those are onetime events, and I'll let Mark speak to the other components.

Right. As I discussed the last quarter, we had one nonrecurring adjustment we made to a bonus accrual in the last quarter, fourth quarter of 2013. And also, there was also 8% increase in health insurance cost because of ObamaCare, so that increased our employee benefit cost by $160,000. And then we have also a slight increase in the bonus provision for this quarter. So the increase of $1.3 million consist of many elements. So we believe the quality run rate for the rest of this year would be in the range of about $10.5 million to $10.7 million.

Now there's a caveat to that, and that is at the FTE level that we are currently at, that level of salary and benefit cost is reasonable. But we are evaluating the level of -- the employee level that's appropriate for the size of the organization that Hanmi is. We are evaluating ways by which to what I call rightsize Hanmi in anticipation of our merger with Central Bancorp, Inc. I want to make sure that we are as efficient as possible before we start the integration effort. So between now and the close of the transaction, if not as part of the integration efforts, before the integration effort, we want -- we're evaluating all the different options as far as what the rightsizing of Hanmi's employee base means in terms of headcount and things like that.

And just to add, in terms of total FTE headcount, we are at the same level. Actually, we are down by 1 FTE from the fourth quarter.

Okay. And then regarding the tax rate, would you contemplate any sort of engineering of sorts to reduce that tax rate at all, whether it be affordable housing or anything along those lines?

Well, actually, yes. We've been reviewing a couple of tax credit funds out there, affordable housing projects. And so, hopefully, we can make some investment in this year. And actually, we are probably going to make a couple. So that would probably reduce our effective tax rate maybe by 1 or 2 basis points -- I mean, percent, sorry about that.

Our next question comes from the line of Don Worthington with Raymond James.

In terms of the loan purchases, any detail in terms of maybe the weighted average rate and kind of where the collateral is located?

Yes. This is the variable residential mortgage rates. We cannot disclose the name of the seller, but it's -- the rate is reset every year based on the proprietary index, which is very -- closely mirrors the, of course, the 11 district. So -- and then most of the collaterals are located in Southern California and some in Northern California, too. And the floor rate that we are getting is 2.75%. And so -- and then, obviously, it has a recourse.

Yes. It has recourse to a legitimate entity with financial wherewithal from which we've bought loans in the past.

Okay, great. And then any more color on the recoveries? What I'm really looking for, was this kind of one loan or was it a number of loans that led to the recovery, the net recovery in the quarter?

It was a number of loans. I believe it was either 4 or 5 loans.

Yes, there are actually 4 relationships that contributed to the recovery.

[Operator Instructions] And we have a follow-up question from Julianna Balicka with KBW.

I have a follow-up on the UCB transaction. You said that by end of April that classified assets at the Central Bank are down to $245 million. Is that based on organic resolution of their loans or does that include any sales?

Yes, most of it organic. They just completed a bulk sale of $46 million, $46 million in classified loans, and the $245 million is a projected number to be achieved by end of this month. But all the signs are there's a high degree of confidence from CBI management that it will happen. It's -- there's not a lot of risk to not happening.

And that includes the -- this loan sale that you just referenced?

Yes. Yes, that's already finished.

Okay. And in terms of other than the $160 million classified loan hurdle that UCB needs to reach, are there any other hurdles that need to be met for the loan -- excuse me, for the transaction to be approved and completed?

Yes. I mean, there's typical -- the material adverse clause that cannot be breached. And then the other element is the -- as it relates to the loss share, we just want to make sure that there aren't any issues relative to FDIC in terms of a loss share certificate that have been filed. So far, since last year, with the new staffing that they have put together for the filing of the loss share certificates, everything seems to be working fine as far as that issue is concerned. So that's the only other meaningful caveat.

And then what about your -- the Chief Credit Officer search that's going on at Hanmi Bank?

We are close to extending an offer.

[Operator Instructions] And our next question comes from the line of Tim Coffey with FIG Partners.

So the question I have just had to do on the timing of closing the merger. You talked about this being a second half event. Is that still looking to be more of a fourth quarter event than a third quarter event?

Well, based on the information that we have, we think that we have a shot at getting the -- well, first of all, all of this is predicated upon whether or not CBI is able to hit the $160 million classified asset number. I personally believe that I think they're on the trajectory to hit that number sometime in the third quarter. And that is going to be one of the more significant matters that the regulators will look at as part of the merger application that we will file. Assuming that they do hit that target within that particular time frame, I'm hoping that we can get the regulatory approval to close either by end of third quarter or beginning of fourth quarter. So that's the best guesstimate that we have at this point.

And I'm showing we have no further questions at this time. Please continue.

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

Ladies and gentlemen, this does conclude our conference for today. We thank you for your participation, and you may now disconnect.