Hanmi Financial Corporation (HAFC) Q4 2022 Earnings Report, Transcript and Summary

Ladies and gentlemen, welcome to the Hanmi Financial Corporation's Fourth Quarter and Full Year 2022 Conference Call. As a reminder, today's call is being recorded for replay purposes. [Operator Instructions] I would now like to turn the call over to Larry Clark, Investor Relations for the company. Please go ahead.

Thank you, Doug, and thank you all for joining us today to discuss Hanmi's fourth quarter and full year 2022 results. This afternoon, Hanmi issued its earnings release and quarterly supplemental slide presentation to accompany today's call. Both documents are available on the IR section of the company's website. I'm here today with Bonnie Lee, President and Chief Executive Officer of Hanmi; Anthony Kim, Chief Banking Officer; and Ron Santarosa, Chief Financial Officer. Bonnie will begin today's call with an overview and Anthony will discuss loan and deposit activities. Ron will provide details on our financial performance and then Bonnie will provide closing comments before we open the call up to your questions. Before we begin, I would like to remind you that today's comments may include forward-looking statements under the federal securities laws. Forward-looking statements are 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 may differ materially from those contemplated by our forward-looking statements, which involve risks and uncertainties. Discussion of the factors that could cause our actual results to differ materially from those forward-looking statements can be found in our SEC filings, including our reports on Forms 10-K and 10-Q. In particular, we direct you to the discussion of certain risk factors affecting our business contained in our earnings release, our investor presentation and in our Form 10-K. With that, I would now like to turn the call over to Bonnie Lee. Bonnie, please go ahead.

Thank you, Larry. Good afternoon, everyone. Thank you for joining us today to discuss our third quarter 2022 results. 2022 was a year of solid execution and record earnings for Hanmi. We continue to strengthen and diversify our business by executing our well defined strategies, enabling us to finish the year with a strong momentum. This strategic model, coupled with our ongoing dedication to customer service, underscores our proven ability to navigate dynamic macroeconomic conditions and deliver strong results. For the year, we generated record net income and loan production and an improved net interest margin, all while diligently managing our operating expenses and improving our asset quality. Let me review the highlights. Net income for the year was a record $101.4 million, or $3.32 per diluted share. Loans grew by 15.7% in 2022, driven by record new loan production of $2.1 billion. Net interest income for the year increased by 21.8% as a result of a higher average earnings assets and a 42 basis point increase in our net interest margin to 3.50%. Our deposits grew by 6.6% for 2022, which helped fund our loan growth, and the mix of non-interest bearing deposits remained strong at 41.2% of total deposits. We managed our non-interest expenses diligently. They increased by less than 5% for the year, and we recorded a full year efficiency ratio of a 47.93%, a 608 basis point improvement from 2021. Importantly, asset quality improved significantly in 2022 as we continued our focus on high quality loans, disciplined underwriting and vigilant credit administration practices. As a result, nonperforming assets declined 29% to $10 million or 0.14% of total deposits. Criticized loans were down 20%, and net charge-offs were negligible over the course of the year. Last, our 2022 return on average shareholder equity was strong at 14.83%. We increased our shareholder dividend twice this past year 25% year-over-year in recognition of our improved performance and our capital ratios remained very strong, positioning us well for continued growth in a safe and sound manner. Our team delivered meaningful progress on each of our strategic growth initiatives. We further diversified our loan portfolio, strengthened our relationships with existing customers, expanded our customer base, bolstered our core deposit franchise. Our commitment to exceptional customer service is the hallmark of our community banking approach, and in tandem with our focus and hard work, enabled us to achieve these results. As we have discussed in the past, diversifying our loan portfolio has been a key priority over the last two years, and we made excellent progress in 2022. For example, our residential mortgage loan production was a record $421 million for the year and represented approximately 20% of our total loan production, well exceeding our ramp-up targets of 10% to 15%. Our SBA group also generated another strong year of production originating $209 million of loans for the year, driven by a keen focus on expanding market reach and securing new talent and we continue to gain solid traction with our Corporate Korea initiative, where both loans and deposits grew meaningfully. As a reminder, this initiative focused on the needs of US divisions of South Korea-based businesses and serves to diversify our portfolio with high quality loans. Here, loan balances were up $145 million or 23% for the year, and deposit balances grew $230 million or 59% and now representing just over 9% of our total deposits. In addition to the diversification achieved in our loan production and loan categories, nearly 12% of new commercial real estate and C&I loan production for the year came from outside California, up from 7% last year. We saw strong growth in Texas in our Eastern region, reflecting both the healthy market conditions as well as our continued success in attracting new customers in these markets. The results are clear; our loan diversification strategies are working. Our asset quality remains very strong as we have been proactive in communicating with our customer about their businesses. We want to understand the challenges they may see on the horizon and work together to help them navigate this uncertain macroeconomic environment. Communication with our customers is a critical part of our approach, both in gaining new business and in maintaining existing relationships. With that, I'll turn the call over to Anthony Kim, our Chief Banking Officer, to discuss fourth quarter loan production and deposit gathering in more detail.

Thank you, Bonnie. I'll begin with additional details on our loan production where fourth quarter volumes were $474 million, down modestly from the third quarter and, we believe, reflecting the current environment of higher interest rates and economic uncertainty. We achieved higher sequential production in commercial and industrial, SBA and equipment finance and while our residential mortgage production was down from its record volume in the third quarter, we originated $107 million of loans during the fourth quarter, a very good result in a challenging mortgage environment. Our focus in the residential mortgage division is on the non-QM market, and our correspondent lenders in this market remain active. A large portion of our production continues to be for home purchases rather than refinances. The purchase market remained relatively healthy in the fourth quarter as many homebuyers were eager to close on their homes and lock in their rates. However, we do expect mortgage originations to moderate in 2023 as higher interest rates are having an impact on both the purchase and refinance markets. C&I funding was $138 million during the quarter. Total commitments on commercial lines of credit increased to $1 billion at quarter end, up $56 million or 5.7% from the prior quarter and up 34% year-over-year. Outstanding balances on these lines increased by 6% between quarters, resulting in a fourth quarter utilization rate of 40%, consistent with the third quarter. Equipment finance production was strong again at $89 million for the fourth quarter, up from $86 million in the third quarter. And SBA 7(a) loan production was $53 million for the fourth quarter and continues to perform in line with our expectations. Our investment in loan production personnel over the last year and half has enabled us to continue to service this key market. With respect to our Corporate Korea Initiative, as Bonnie mentioned, we delivered strong loan growth for the year, which was driven by $187 million of new production. We did see a decline in production for the fourth quarter given the higher level of economic uncertainty that is impacting our customers. However, we remain optimistic about this important line of business and expect 2023 to be another good year for us. Our Corporate Korea portfolio is well above the level we had expected for this business as loan balances were $781 million at year-end, representing 13% of our total loan portfolio. The average rate on all new loan production for the fourth quarter was 6.85%, up 130 basis points from the third quarter. Payoffs were $121 million for the quarter, down from $140 million for the third quarter. The average rate on loan payoffs was 6.27%, up 101 basis points from our third quarter payoffs. This is the second quarter in a row where new origination yields have exceeded the yields on loan payoffs, which should benefit our future average loan yields. In summary, our efforts to further diversify our loan portfolio by industry, geography and loan type is working, which we believe will drive incremental growth and profitability. Now turning to deposits; excuse me, deposits remained relatively stable during the fourth quarter, down less than 1% from the prior quarter. We did see a shift in the composition of our deposits during the quarter, as some deposits in DDAs, money markets and savings accounts moved understandably into time deposits given the rapid increase in interest rates. Notwithstanding these moves, noninterest-bearing DDAs represented just over 41% of our total deposits at year-end, which we believe validates our strong customer service and local market expertise. We also had continued success with our deposit gathering efforts with our new and existing Corporate Korea clients as those deposit balances grew modestly in the fourth quarter. At year-end, our Corporate Korea deposits were $575 million, up 59% from the prior year and represented just over 9% of our total deposits. And now I'll hand the call over to Ron Santarosa, our Chief Financial Officer, for more details on our fourth quarter financial results.

Thank you, Anthony. Beginning with net interest income at $64.6 million for the fourth quarter, we saw a 2.3% sequential growth from the third quarter. This increase primarily reflected the increase in average loans, while the increase in the cost of interest-bearing deposits essentially offset the increase in average loan yields. Average loans reached $5.88 billion for the fourth quarter, up 3.2%. The cost of interest-bearing deposits rose 92 basis points to 1.7% and the yield on loans was 5.21%, up 54 basis points. Turning to our net interest margin, which was 3.67% for the fourth quarter and up one basis point from the prior quarter; we saw the increase in loan yields benefited our net interest margin by 48 basis points, while the increase in the cost of interest-bearing deposits reduced that benefit by 46 basis points and there was a negative one basis point differential between the increase in yields on other interest-earning assets and the cost of borrowings and debt. During the fourth quarter, we saw a 125 basis point increase in the federal funds rate, 425 basis points for all of 2022 and extraordinary acceleration of interest rates in a very short period. Expectedly, the interest rates offered on our loan and deposit products have also increased and as we saw, depositors renewed their interest in time deposits. Turning to our various betas for the fourth quarter; our interest-bearing deposit beta for the fourth quarter was approximately 62%, while our loan beta was approximately 37%. As we have previously noted, the beta in any particular quarterly period can vary significantly given the amount of the change in the federal funds rate for that period as well as differing market conditions for that period. As such, we continue to remain cautious as to the quarterly trajectory of the net interest margin given the current uncertainty in interest rates and the economy. That said, we are very pleased with the performance of our net interest revenues and net interest margin through this stage of the rising rate cycle, especially given the support from our high level of noninterest-bearing demand deposits. Moving on; noninterest income was $7.5 million for the fourth quarter, down from $8.9 million for the prior quarter, due primarily to a $600,000 decline in other operating income and a $300,000 decline in our SBA gain on sales. The decline in other operating income was primarily due to a $500,000 decrease from the third quarter where we had a gain on the disposition of a lease residual. The volume of SBA 7(a) loans sold for the fourth quarter decreased modestly to $40.9 million, and trade premiums, as expected, declined 10% to 5.99% for the quarter. Last, we recognized a $300,000 valuation adjustment to our bank-owned life insurance asset. With respect to expenses, noninterest expenses for the fourth quarter were up $600,000 from the third quarter, with some categories increasing and others declining. Salaries and employee benefits increased by $900,000, reflecting primarily adjustments to incentive compensation from our strong loan production and financial performance, changes in activity levels contributed to the $500,000 increase in professional fees and a $200,000 decrease in advertising and promotion. Occupancy and equipment expenses was $1 million lower in the quarter, largely due to adjustments to real property taxes on leased and owned premises. In addition, other operating expenses were higher by $300,000 due to a valuation adjustment on our servicing assets. As a result, our efficiency ratio for the fourth quarter increased slightly to 46.99%. We recorded a provision for credit loss expense of $52,000 for the fourth quarter, down from $600,000 for the third quarter. Fourth quarter expense reflected a positive loan loss provision of $200,000 and a negative off-balance sheet provision of $100,000. The allowance for credit losses was $71.5 million at year-end, representing a coverage ratio of 1.2%. Compared with the third quarter, our specific allowances increased $1 million, while the allowance for quantitative and qualitative considerations decreased by $1.1 million. In summary, we delivered another strong quarter with net income of $28.5 million or $0.93 per diluted share, a return on average assets of 1.56% and a return on average equity of 15.9%. For the full 2022 year, our return on average assets was 1.44% and our return on average equity was 14.83%. The company and the bank exceeded minimum regulatory capital ratios, and our ratio of tangible common equity to tangible assets was 8.5%, up from the prior quarter because of net retained earnings for the quarter as well as a positive adjustment to the unrealized after-tax loss on our securities portfolio arising from a decrease in longer-term interest rates. Consequently, our tangible book value per share was up 4.8% from the third quarter to $20.54. With that, I will turn it back to Bonnie.

Thank you, Ron. I believe this past year and in the years before that, we have demonstrated our ability to navigate volatility, and we'll continue to do so with a keen focus on the execution of our strategic plan. We entered 2023 with a strong balance sheet. Looking ahead, we anticipate that loan production will moderate from the levels we saw in 2022 due in large part to the current elevated interest rate environment and uncertain macroeconomic backdrop. We are approaching this dynamic environment with caution and discipline. We remain vigilant in our underwriting and credit administration. We remain focused on growing our core deposit base by continuing to win customers and expand our existing corporate relationships. And we remain committed to our communities and the Hanmi team, all with the goal of delivering attractive returns to our shareholders. With that, I want to thank the entire Hanmi team for their exceptional work this past year. We just celebrated our 40th anniversary, an important milestone for our company. Our teams reflect the communities we serve in enabling them to bring a deeper understanding of our customers' needs. They are our competitive advantage and with them, we look forward to many more decades of delivering personalized relationship-based service with a continued commitment to helping our customers reach their financial goals. This is how we intend to continue generating positive results for our customers, our communities and our shareholders. Thank you. We'll now open the call for questions. Operator, please open the line up to the questions.

[Operator Instructions] Our first question comes from the line of Kelly Motta with KBW. Please proceed with your question.

Hi. Good evening. Thanks for the question. I think I'll start with the deposit side. We've seen a few of your peers report so far, and betas are clearly accelerating, but you were still able to keep your margins pretty flat this quarter, which is great. Just wondering if you could provide some commentary on maybe spot deposit rates at 12/31 as well as what you're expecting for betas and vis-à-vis how that should read through into the margin in the next couple of quarters here.

Well, thank you, first of all. And I just want to acknowledge the hard work of Anthony and the team in managing our deposits, not only in their growth, but in the rates that we pay. It's a very competitive marketplace and I think our beta reflects the discipline and determination that Bonnie had mentioned. So with that, I can plainly tell you that the cost of our interest-bearing deposits through January, for the month, are about 70 basis points higher than the quarterly average that we experience. So how that translates into a beta, I truly don't know. We're going to be up against perhaps two more rate increases. What I can say is that I think we've demonstrated again over the past few quarters that we take to heart what our depositor needs are, but also what our financial performance needs are and we navigate the best we can through those hurdles and when we meet again in the first quarter, I'll let you know what our beta is.

Thanks Ron. Just stepping back on deposits, just at a high level; noninterest-bearing, you had some runoff this quarter, but they're still over 40% and pre-pandemic, you were more around 30%. Just on a high level, anything like structural that would dictate having a higher level of noninterest-bearing? Maybe it's Corporate Korea or -- and those sorts of initiatives, but just wondering on what you view as kind of the run rate of noninterest-bearing deposits as part of your mix here with what you've done in the past couple of years. And how much do you anticipate kind of sticking around as liquidity post COVID starts to run through?

Thanks. So let me try to answer that. So definitely, last couple of quarters, we did see outflow of DDA going into the interest-bearing deposit category. And I still think that speed of -- the velocity of the outflow will slow down. And our strategy has been very consistent that we go after -- we target market and the corporate deposit accounts, and we've been very successful, whether that has been Corporate Korea Initiative or corporations within the US. So that strategy will continue to stand.

Okay. Thanks. I will step back.

Our next question comes from the line of Matthew Clark with Piper Sandler. Please proceed with your question.

Hey. Good afternoon. Thanks. Maybe first just on running out the margin outlook discussion; Ron, if you had the average margin in the month of December?

I think we're within a few basis points, if I remember correctly, of what we did for the quarter.

Okay. Got it. And then maybe shifting to loan growth, held up pretty well this quarter and I know, Bonnie, you mentioned that you fully expect it to slow, which is not a surprise. But can you speak to the pipeline and then also, what drove the strength in C&I production this quarter with rates in the low 7s? Just trying to get a bit of better feel for the types of credits you might be booking in this environment.

Sure. In terms of our strong production in the C&I, which has been -- diversification has been one of the key strategy. So in the 4Q, the contribution was from the new commercial lines of credit to the corporate type of customers. And then in terms of industry, it's fairly broad various industries, including manufacturing companies that we extended the C&I.

Okay. Great. And then maybe just on the SBA outlook. Premiums continue to come in. What's your expectation around premiums and production and your comfort level with originating SBA 7(a) going through a recession?

Sure. I think in terms of production, first of all, production, I think we are expecting about $45 million to $50 million per quarter. And then I think that has been fairly consistent. In terms of the premium market, I think it's been -- this quarter -- past quarter was a little shy of 6%, 5.99%. So I think it's pretty much holding at that rate. So thanks to some of the new markets that we went into and then the additional marketing people that we hired, that we were able to have a really good production. And hopefully, that momentum stays throughout 2023.

Okay. And then just on the -- maybe for Ron on the noninterest expense run rate. I think there's a couple of moving parts this quarter. It sounded like there was an MSR adjustment that hurt a little bit. But just your overall thoughts on expense growth in terms of that run rate and with wage inflation and all the other things we need to consider.

Yes. We're clearly prepared for the pressure that we will see probably starting the second quarter with wage inflation. That's in the marketplace. We will address that prudently. So I would look at noninterest expenses just subject to general inflationary pressure with, as we pointed out, which is just a function of a period, we seem to be fortunate with activity levels in certain categories going up and down, offsetting each other. But generally so, inflationary pressure I would just think about.

Okay. And then last one for me. Just any updated thoughts around buyback activity. Capital turned a corner here. Obviously, rates have helped. But just your appetite to maybe reconsider the buyback given your -- where your stock trades and obviously a recession on the horizon.

I think we've been patient with capital, which I think has served us well, particularly through this volatile rate environment that we've had here in the second half of 2022. So we'll continue to be patient. There's a lot of things that have yet to play out in the interest rate side of life. And then I think you'll see -- I think we're all anticipating, I'll say, a pent-up expectation of how will economic activity actually play out in this new environment. So we'll continue to be patient.

Our next question comes from the line of Tim Coffey with Janney Montgomery Scott. Please proceed with your question.

My first question is about the new CDs that were brought on in the quarter. I'm wondering if you have kind of what the average rate on those were and what the average life of those are.

Usually, where average life of CDs are a term of 12 months. I don't have average rate for the quarter.

I would just say I think what I would look to in the earnings release slide deck, we show the CD maturities. And so you'll see about $1.2 billion, if I remember correctly, that will mature 4 quarters forward. And the average rate of that was 3.83%.

Okay. Great. Yes. Sorry. Okay. And then my next question is kind of looking at your loan-to-deposit ratio, is your expectation that you'll be funding the loan production off of deposit growth?

Yes. Certainly, gathering deposits going forward, this environment will be a challenge. But we feel that whether it's a Corporate Korea Initiative and as well as expansion -- successful expansion into outside of California regions, that we can bring the additional deposits into -- to fund our loans. So we are mindful, and we are looking at those numbers very closely when we build our loan pipeline.

Okay. And then just a -- so we have heard from a number of competitors the last couple of days. And they've been talking about significant headwinds to margin expansion in 1Q and perhaps even first half of 2023. Do you think you're immune to those headwinds or maybe just not going to face them at the same strength of those -- your competitors will?

Not at all. We're not immune whatsoever. So again, you saw a magnificent 1 point expansion. So I know a conversation previously about are we at the apogee yet? We tried to signal in the third quarter, looking back at our second quarter earnings, that it's probably going to happen. We'll continue to debate that. But at what point differential right now, I think we might be cresting.

Our next question comes from the line of Gary Tenner with D.A. Davidson. Please proceed with your question.

So my questions were largely asked and answered already. But just in terms of the tax rate, Ron, bounced around a little bit. It was lower this quarter. Where do you project at this point the full year tax rate for '23?

Yes. I think for the full year of 2022, we ended up on the, I'll say, the low end of 28%. And the year prior, we were at the high end of the 28%. So I still think the 29% is about right, spot me plus or minus, like 50 basis points, if you will. But I feel comfortable for judgment matters to use 29%.

Okay. And then just one more question on that Slide 14 that you just referenced a moment ago on the NII sensitivity. On the deposits where you've got the footnote #2, that cost of CDs as of December 2022 was 2.68%. I assume that's the average for the month of December as opposed to the period end because the period end seems like it will be over 3%. Correct?

Yes. For the month, yes. We will work on propositions.

And I just wanted to make sure I was looking at it correctly.

Our next question comes from the line of Jason Stewart with JonesTrading.

This is Matthew Erdner on for Jason. Good quarter all around. It's good to see that credit quality is holding up well. But loans 30 to 89 days past due was up 52% quarter-over-quarter. Can you guys talk about where you're seeing stress build there?

There's a little bit of seasonality to -- in the smaller loans, too. So we haven't -- in terms of data metrics, we haven't seen anything that's potential problems. Having said that, though, in this environment, I think the typical small businesses, whether it's SBA or equipment finance, they could get impacted. So what we did in the fourth quarter -- during the fourth quarter, we actually scrubbed the top 20% of our SBA loans and contacted every customer to see how they are doing and try to gauge and be in front of them as to any potential problems that they may have coming down in the next couple of quarters. So -- but we haven't seen anything alarming as of yet.

Awesome. That's good to know. And then from people we've talked to in the commercial real estate space, demand there is slowing pretty quickly. How has demand been for you guys and your product? And then when do you think we'll see an uptick in originations in that space?

That's a difficult question. So definitely, we have seen slowdown in the inbound inquiries and the commercial real estate loans. And we are being cautious in certain -- whether markets or certain type of properties definitely within the CRE, we are mindful of -- the situation is the office properties in selected markets and then also try to stay away from the retail type of CRE loans that is near big-box retailers. So we follow that in terms of CRE market very closely and as well as some of the health care industries to see commercial real estate as well.

Got you. And then what -- could you give an example of a couple of markets where you would be hesitant to originate?

As I just said, I think in terms of offices, I think it's different factors. I think it varies. And for the health care properties as well, I think that particular industry is experiencing higher rise in the labor cost and the average increase in the labor market.

Next question is a follow-up question from the line of Kelly Motta with KBW.

I just wanted to follow up on credit. You continue to release reserves at this point. I think you're at 120 basis points at this time. I understand the reserve levels are driven by the CECL model. But just given where we are heading into what could be a credit cycle, do you think this is the bottom? Or do you think there's still room to release reserves as we get into 2023?

So again, a little bit difficult to respond definitively. But if the color of expectations relative to the economy actually start to play out in the first quarter, then you can anticipate that we're at the low level, if you will. But just like it's hard on the margin where are rates going to be, et cetera, it's difficult, but I would -- there, I would bet more concern and say, okay, you're probably at the low end. But if it should drift down, it's not going to drift down that much. You're not looking at huge ideas where we were like $140 million at the top of the year, $120 million at the bottom of the year. So there's not that much more bottom left.

Got it. Sorry, I know I'm trying to ask you to look in your crystal ball with that. Last question for me. I apologize if you already addressed this. But Ron, with the occupancy and equipment line, it looks like there was some reversal that you called out in the release. Do you -- is that supposed to come back to more like 2Q, 3Q levels of like 4.6, 4.7? Or is that kind of 3.7 run rate on that line a good projection on a go-forward basis?

Yes. I would look to the previous quarter for your run rates. And then they should kind of match again the aggregates because we have -- as was pointed out, we have some other things that went against that notion. So bottom line, the total of noninterest expense, I think, is a fairly good idea. So if in your modeling, you're coming too far away from that, then I'd ask you to go back and look at your model.

There are no further questions in the queue. I'd like to hand the call back to Bonnie Lee for closing remarks.

Thank you for participating in our call today. We appreciate your interest in Hanmi and look forward to sharing our continued progress with you throughout the year. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.