Hope Bancorp, Inc. (HOPE) Q4 2007 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Q4 2007 Nara Bancorp Earnings Conference Call. My name is Lisa and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of this conference. [Operator Instructions]. I would now like to turn the presentation over to your host for today’s call, Mr. Tony Rossi, with the Financial Relations Board.

Thank you, Operator. Good morning everyone and thank you for joining us for the Nara Bancorp Fourth Quarter 2007 Earnings Call. Joining us this morning from management are Ms. Min Kim, Chief Executive Officer; Mr. Alvin Kang, Chief Financial Officer; and Ms. Bonita Lee, Chief Credit Officer. Before we begin, I would like to make a brief statement regarding forward-looking remarks. The call today may contain forward-looking projections regarding future events and the future financial performance of the company. We wish to caution you that such statements are just predictions and actual results may differ materially as a result of risks and uncertainties that pertain to the company’s business. We refer you to the documents the company files periodically with the SEC, specifically the company’s most recent 10-Q and Annual Report on Form 10-K, as well as the Safe Harbor statement in the press release issued yesterday. These documents contain important risk factors that could cause actual results to differ materially from forward-looking statements. Nara Bancorp assumes no obligation to revise any forward-looking projections that may be made on today’s call. With that, I’d like to turn the call over to Ms. Min Kim.

Thank you, Tony. Good morning and thank you for joining us today. I am going to provide a brief overview of the fourth quarter of 2007 and then I will turn the call over to Al Kang, our Chief Financial Officer, who will review our financial results. Following Al’s remarks, I will conclude with a discussion of our outlook for 2008. We earned $0.32 per share in the fourth quarter compared to $0.35 in the same quarter last year. Excluding tax benefits in both the periods, our earnings per share was $0.31 in the fourth quarter of 2007 compared to $0.32 last year. The biggest obstacle to earnings growth continues to be the significant decline in our net interest margin. On a year-over-year basis our net interest margin declined by 6 to 7 basis points. It also declined 24 basis points from last quarter given the competition of our balance sheet, our net interest margin is negatively impacted in the near-term by each cut in interest rates by the Federal Reserve. In addition, the aggressive deposit pricing in our marketplace, coming from both Korean-American banks and mainstream banks has been a significant contributor to the net interest margin pressure. We are also starting to see some effects of the slowing economy on loan production and credit quality. Given the current economic conditions, we have tightened our underwriting criteria to reduce our exposure to certain industry and loans used for certain purposes. As a result, a lowered number of borrowers are meeting our standards. We will not compromise our strong credit culture to meet loan production goals, even if that has a negative or short-term impact on our financial results. Over the long-term we know that our discipline is in the best interest of our shareholders. We did have an increase in non-performing loans during the quarter, although a large majority of the increase was attributable to two loans that have fairly unique circumstances associated with them. Al will provide more detail on these loans later in the call. Aside from these two loans, we are seeing some increase in delinquency which we believe is more directly attributable to the weaker economic conditions. However, we have a strong collateral on these loans and we are being proactive in managing our problem credits and working out satisfactory resolutions. So, we believe we will be able to limit our losses to a very manageable level. Our success in controlling expenses has been a key factor in helping to offset the many challenges to earnings growth we are experiencing. During the fourth quarter, our operating efficiency ratio improved to 44.6% compared to 46% in the same quarter last year. We are very pleased with the commitment to controlling expenses that we have instilled throughout the entire company. During this challenging time, we believe we are well served by maintaining our strong capital ratio. We believe that our excess capital will allow us to effectively manage through any prolonged economic slowdown that may occur. It will also position the company to capitalize on any attractive opportunities that can enhance long-term value for shareholders. We view our capital position as a key competitive advantage in the current environment and we intend to be very prudent in how we choose to deploy it. At this time I am going to turn the call over to Al, who will review additional financial results for the fourth quarter.

Thank you, Min. Let me first provide some color on our net interest margin. On a GAAP basis, our net interest margin was 4.43% in the fourth quarter of 2007, compared to 4.67% last quarter. In the declining interest rate environment, we have seen a steady decrease in the yield on our loan portfolio. At the same time we have not been able to reduce deposit costs at the same rate, due to the highly competitive pricing in the marketplace. During the fourth quarter, the yield on our loan portfolio declined by 32 basis points from 8.87% to 8.55%, while our cost of total deposits only declined by 9 basis points from 3.94% to 3.85%. We also saw a slight decline in average non-interest bearing deposits during the quarter, which contributed to the decline in net interest margins. The decline in the yield on the loan portfolio is attributable to adjustable rate loans re-pricing lower following the 100 basis points of rate cuts in 2007, as well as the continued customer preference for fixed-rate loans within our new loan production. During the fourth quarter, fixed rate loans represented 68% of loan originations. As a result at December 31, 2007, fixed-rate loans comprised 52% of the loan portfolio, compared to 48% at September 30, 2007. The recent 75 basis point cut on January 22 will also have a negative impact on our portfolio yield. However, with fixed-rate loans now comprising a larger percentage of our loan portfolio, interest rate cuts won’t have quite the same impact on our overall yield as they have in the past. At December 31, 2007, the yield on our fixed-rate loan portfolio was approximately 7.70%. Despite the decline in our net interest margin, our strong growth in assets helped us to still achieve a 4% year-over-year increase in net interest income before provision for loan losses. This was also helped by higher interest income on securities. As you may recall, we took advantage of the market turmoil during the third quarter to pre-fund expected cash flows from prepayments or maturing securities in the portfolio by using FHLB advances to purchase other investment securities that we believe were available at attractive prices. Given our long-term balance sheet management strategy to maintain a certain percentage of our assets in the securities portfolio, we believed that it was a good time to increase our purchases prior to interest rates declining. So far, this has proven to be a good investment strategy for the company, as these securities have risen in value and the yields on our securities portfolio have increased 57 basis points from 4.69% in the fourth quarter of 2006 to 5.26% in the fourth quarter of 2007. Our non-interest income was $6.0 million in the fourth quarter, an increase of 10% from the same period last year. Within our non-interest income categories our service fees on deposit accounts were $1.9 million, an increase of 21% from the fourth quarter of 2006. The increase is primarily due to a new fee structure we put in place for certain deposit services, based on our market surveys. Our net gain on sales of SBA loans and other loans declined 29% to $1.7 million in the fourth quarter of 2007. Most of the $675,000 decrease in gains was attributable to a $503,000 decrease in SBA gains. We sold $24.9 million of SBA loans during the fourth quarter of 2007, compared to $19.4 million in the same period last year. However, this higher level of sales was offset by a decline in the average gross premium that we received as the market is pricing in expectation of faster prepayment rates. As such, our average gross premium was 5.23% in the fourth quarter of 2007 which compares to 7.54% last year. Other income and fees increased $940,000 primarily due to a $329,000 increase in income from interest rates swaps and a non-recurring write-down of $230,000 in 2006, relating to our headquarters move. We had certain other increases also in loan servicing and BOLI income. Our non-interest expense increased just 1.5% over the prior year. Reductions in our advertising and marketing expenses and a decrease in legal fees as well as the use of outside consultants, helped us to keep our overall expense growth minimal. Our operating efficiency ratio improved to 44.6% in the fourth quarter from 46.0% in the same period last year. This was driven by a 4.8% increase in revenues compared to a 1.5% increase in total non-interest expense. Moving to the balance sheet, our gross loans were $2.00 billion at December 31, 2007, an annualized increase of 10% from the $1.96 billion at September 30, 2007. The most significant growth occurred in our commercial real estate loan portfolio, which increased at an annualized rate of 13% during the quarter. Our SBA loan originations were $29.0 million in the fourth quarter of 2007, compared to $39.2 million last year, and $58.5 million in the third quarter of 2007. The sequential quarter decline reflects the weaker economic conditions impacting both demand for loans and the number of borrowers that can meet our underwriting criteria. Our total deposits were $1.83 billion at December 31, 2007, an increase of 4% annualized over the $1.81 billion at September 30, 2007. The increase was attributable to higher balances of brokered and State Treasurer CDs. This increase was offset by declines in non-interest bearing demand, money market, and savings deposits. As Min mentioned, we did see an increase in non-performing assets and delinquencies during the quarter. Our non-performing assets were $17.4 million or 72 basis points of total assets at December 31, 2007. This compares to $6.1 million or 26 basis points at September 30, 2007. The $11.3 million increase in non-performing assets is largely attributable to two loans that were placed on non-accrual status during the fourth quarter. The first credit is a $7.5 million commercial real estate loan which is collateralized by a car wash business property. This business has been affected by a legal dispute between co-owners of the property over a buyout agreement, which has prevented them from continuing to service their debts. Both owners have indicated their intent to bring the loan current once the legal dispute is resolved. The underlying business is performing well and there is sufficient cash flow to service the debt. However, in the meantime, in order to protect our interests, we have initiated foreclosure proceedings on the property. Given a current appraisal of its value, we do not expect to incur any loss. The second credit is a $3.5 million commercial loan in which the borrower has experienced a severe adverse impact on their business due to the discovery of a misappropriation of funds by employees. The borrower has been cooperative in providing additional collateral and liquidating assets to reduce the loan balance. However, we determine that a charge-off of $1.5 million related to this loan was prudent to reduce the carrying value of the loan to $3.5 million. These two credits also contributed to the increase in delinquencies during the quarter, which is defined as any credit that is 30 or days past due. Total delinquencies were $34.7 million at December 31, 2007 compared to $10.0 million at September 30, 2007. Aside from the two loans that I have discussed, we also had fixed commercial real estate loans totaling $12.2 million that contributed to the rise in delinquencies. Providing a little more color on these fixed-loans, three of the loans totaling $7.8 million are expected to be brought current. The borrowers for the other three loans totaling $4.4 million have all listed their respective underlying collateral properties for sale. Because of the strong collateral we have on these credits, as well as our earning recognition of issues and proactive steps to work with the borrowers, we do not anticipate that these loans will result in a material loss, if any, for the bank. Our provision for loan losses was $3.6 million. This higher provision was driven primarily by the higher charge-offs that we had this quarter. At December 31, 2007 our allowance for loan losses was 1.00% of gross loans receivable compared to 0.99% at September 30, 2007. The allowance coverage to non-performing loans was 121% compared to 354% at September 30, 2007. When evaluating our allowance coverage ratio it’s important to keep two things in mind; first, we are very aggressive in immediately charging off losses that are expected to materialize at a later time. It is our policy to recognize the loss immediately rather than reserving for the loss and charging it off later, which has the impact of inflating the allowance to total loans ratio prior to the actual charge-off. Second, we do not expect to see any material loss on the new loans that went into the non-performing category this quarter. Due to the low probability of loss in these non-performing loans, the allowance to non-performing loans coverage ratio is typically restored to higher levels as the problem loans are resolved. Our net charge-offs were $3.0 million in the fourth quarter, representing 61 basis points of average loans on an annualized basis. In the third quarter of 2007, net charge-offs were $1.2 million or 25 basis points. The increase in net charge-offs is primarily attributable to the one credit I discussed earlier, that resulted in a $1.5 million charge-off. Going forward, we expect that our levels of non-performing assets will remain elevated relative to our experience over the past few years. However, due to the conservative underwriting criteria that we have maintained; the strong collateral that we hold, and our aggressive approach to resolving problem credits, we believe that any losses we experience will be manageable. Now, I will turn the call back over to Min.

Thanks, Al. At this point, we would like to provide our guidance for 2008. For the full year we expect fully diluted earnings per share to range between $1.11 and $1.15 with the second half of the year expected to be significantly stronger than the first half. The two biggest challenges to earnings growth will be continued pressure on our net interest margin and a larger provision for the credit losses to reflect the deterioration in credit quality that we expect. On a near-term basis, we will continue to be negatively impacted by reduction in interest rates. Once the interest rates stabilize for a prolonged period of time, our net interest margin tends to benefit, as a lag-effect of the deposit re-pricing downward runs its course. However, at least for the first half of the year we expect that out net interest margin will remain under pressure. With those considerable headwinds and uncertainty about the strength of the economy, we are taking a conservative approach to year 2008. Our primary goal during the year will be positioning the company to prosper when economic conditions become more favorable. To accomplish this we’ll be focusing on the following areas: First, we do not intend to pursue asset growth at the expense of our profitability. We must improve our balance sheet flexibility and fund our loans with lower cost resources. In 2008 we plan to more closely match our assets and deposit growth and we expect both areas to grow in the single digits. Second, we will continue to be aggressive in managing the current loan portfolio to identify potential problem credits and minimize losses. Third, we will maintain tight control on expenses while also continuing to invest in technology and new product development that will enhance our ability to attract commercial deposit customers. Fourth, we will prudently continue to the expansion of our East Coast franchise. Through 2008 we expect to open two new branches on the East Coast; one in New Jersey and one in New York. And fifth, we will maintain our strong capital position. As we successfully execute on these strategies, we believe that we can position the company to generate higher levels of earnings in 2009. Now, we will be happy to take any questions you might have.

Our first question comes from Brett Rabatin - FTN Midwest Research.

First, I just wanted to ask on the gain on sale of SBA loans and just that business going forward. Obviously the margins are lower and there’s been some lower production for many people that are in the business. Can you update us on fee income thoughts for 2008 and your intentions on SBA and how do you see that business in the near term?

Brett, we anticipate to have about 15% to 20% less production in the year 2008 and also we think that our premium may decline at least to 50 basis points or so. So definitely, we expect much less premium gain on sales on SBAs going forward.

Would they be calling the premium be off of the fourth quarter level?

We expect about 50 basis points lower than the fourth quarter of 2007.

And then, wanted to circle around on the margin just given the loan yield at the year end and what the Fed has done and your loan portfolio and the cost of funds. Would it be fair to assume in your guidance, you’re anticipating probably 20 basis points of pressure in the margin in the first quarter and then as we go through the year maybe it gets back to the fourth quarter level? Or can you give us some thoughts on how you see the margin progressing this year?

Yes, now it depends on what the Fed is going to do, but we are anticipating further rate cuts. Perhaps another 75 basis points, most of it, in fact all of it coming in the first quarter, so we are taking a pretty conservative view of it, so there will be margin compression. Your estimate of 20 is probably not too far off from where we think we will be. We expect maybe a little bit better than that. But we do expect that in the second half with the deposit pricing catching up that we should show some improvement. I think interestingly just this month, given the 75 basis point cut, we’ve seen our competitors really reducing rates as we did pretty significantly and even Countrywide has reduced their rates although not as much, so that is very encouraging. The other thing is on the wholesale side, broker deposit rates and the rates for the state treasury deposits are coming down pretty significantly. So while we do expect continued margin compression, we are hopeful that it won’t be as severe.

And then just lastly, wanted to get some clarity on this one $7.5 million car wash loan that you have. Is that essentially a bridge type facility?

What do you mean by bridge?

The loan is to one customer that is going to buy a business from another individual or business and your loan is to essentially facilitate the short-term financing of the acquisition of the business.

No, actually this particular business, it’s owned by two partners, and they are disputing over the buyout amount. And once they agree to the buyout amount, I think that the credit will be resolved.

[Inaudible] bridge loan.

And so your loan is to the individual partners who own the business?

Right.

And it’s on non-accrual because they’ve essentially been trying to sell it and they’ve stopped paying interest or why...?

Since they couldn’t agree upon a buyout amount, both of the partners decided not to service the loan and they filed a complaint to the court. So, it’s up to the court to decide as to the future of this business.

So, they are fighting over the price of what they will sell their business for, and they’ve stopped servicing the loan. If the loan is sold at either of their wishes, does that pay you off? Let’s just say it sells at the lower end of what they expect. Does that pay you out of the credit?

No, it’s actually one partner is trying to buy out the second partner.

Oh, okay.

In front of the buyout amount.

So, it’s not a third party buying the business?

No.

Okay, I understand.

Our next question comes from Aaron Deer – Sandler O’Neill. Aaron Deer - Sandler O’Neill : A few questions also related to the margin in a roundabout way. In the release, you pointed out that loans are now 57% fixed?

52%. Aaron Deer - Sandler O’Neill : I’m sorry, 52%. Of the remaining 48%, what percentage of that re-prices immediately versus something that’s more periodic in nature?

About 75% is re-priced immediately out of a 48% variable. Aaron Deer - Sandler O’Neill : Okay. And then the rest would re-price....?

Quarterly basis. Aaron Deer - Sandler O’Neill : Quarterly, okay. What is the average duration of your time deposits?

Less than 6 months, about 4.5-5 months. Aaron Deer - Sandler O’Neill : And then lastly what are your thoughts on what you’re going to do with the securities portfolio at this point given where the old curve is and where rates stand?

I think we’re going to continue to manage that portfolio. It provides us a pretty healthy yield right now compared to where we were before. It also is a source of liquidity should we need it, and a number of the securities have embedded gains in them now whereas before we had pretty significant unrealized losses. We do have additional callable agencies that are probably going to be called away. So, we’ll be able to get some cash flow off that portfolio. Aaron Deer - Sandler O’Neill : So would you expect to see that portfolio run down or if you could just see yourselves add into that portfolio?

I think it really depends on our cash flow situation from the liability side but we’re just going to remain flexible and use it to our advantage.

Our next question comes from James Abbott – Friedman, Billings, Ramsey & Co.. James Abbott - Friedman, Billings, Ramsey & Co.: I was wondering if you could give us what your provision for the year and what your outlook is and then how that breaks down between what your rough expectation of charge-offs are and then also your expectation of building the reverse ratio.

The provision is probably going to be a little bit higher than 2007, around $2 million a quarter. In terms of the charge-offs, Bonnie?

We expect that about the same level as 2007. James Abbott - Friedman, Billings, Ramsey & Co.: And that includes that $1.5 million – I forget what you called it in the press release – misappropriated something or other?

$1.5 million was already charged off during the fourth quarter. We built that into the 2008 projections. James Abbott - Friedman, Billings, Ramsey & Co.: Yes, okay, so if you strip that out as a non-recurring item or at least unlikely to, or hopefully not likely to recur, then you would expect charge-offs to rise somewhat during 2008 then?

Yes.

James, hold on for a minute. Operator, can you turn up the volume on the callers, please? We’re having a tough time hearing them. James Abbott - Friedman, Billings, Ramsey & Co.: I will try to speak up too. Another question is on the margin in the first quarter, I am trying to understand if the Fed has lowered basically by 100 basis points assuming that they do 25 tomorrow and have roughly half of the earning assets reset down. Wouldn’t that be closer to 50 basis points of margin compression; you’re going to have some of the funding cost that comes off and I understand that, but it seems to me that 20 basis points would be a little optimistic. Maybe I’m not doing something right?

There are a lot of things that go into it. And there are a lot of offsets, but you’re right, it’s 50% of our bulk portfolio that re-prices immediately, but I think you have to look at the liabilities side; we have deposit re-pricings and in the first two quarters it will be about $350 million a quarter that re-prices. We’ve cut our deposit pricing just 75 basis points just recently and also as I indicated the wholesale deposits are re-pricing pretty substantially. We have a lot of callable brokered CDs and we’ll achieve pretty significant cost savings there and the state treasurer deposits that price off treasuries are really coming down substantially. So, all of those things lead us to believe that the compression won’t be as severe as it was in the fourth quarter. And the other thing is the yield on our securities portfolio has been going up, so I think you just have to take all of those things into account, and one other thing that affects it a little bit is the level of loan prepayments that generate prepayment penalty income, so that has some affect on it. James Abbott - Friedman, Billings, Ramsey & Co.: And one housekeeping thing I forgot to ask earlier was the reserve for performing loans, so past grade loans, what is the reserve allocation to that in terms of basis points?

Past loans? James Abbott - Friedman, Billings, Ramsey & Co.: One of your competitors last quarter mentioned that was about 10 basis points and I was wondering if that’s comparable for you?

We have several past grade categories, but we haven’t given the range. Can you give us a minute to look that up and once we find it we’ll say it on the call a little later? James Abbott - Friedman, Billings, Ramsey & Co.: Sure, sure.

It looks like the range is probably 10 to 15 basis points. Depending on the type of loan and whether it’s a past loan or a higher level past graded credit.

Our next question comes from Christopher Nolan – Oppenheimer & Co.. Christopher Nolan – Oppenheimer & Co.: There was a phrase in the press release indicating that the company seeks to position itself to capitalize on attractive opportunities that create long-term value for shareholders. Is this boiler-plate or should we be reading that there might be some consolidations with [inaudible]

We are always certainly keeping an eye on opportunities, so we would like to just reserve and capitalize it when the opportunity comes. Christopher Nolan – Oppenheimer & Co.: Do you think more of these types of opportunities could prevail themselves as credit quality, for the banks in general, continues to deteriorate?

No, I think that we are well positioned in terms of building our loan loss reserve and building our capital, it will be a proven practice when the economy is so uncertain and we just like to preserve the capital for any type of opportunity going forward.

Chris, I think from the target perspective the smaller banks, it really depends on if they have losses or lower earnings that would give their directors probably a better view towards selling their banks. I think we’re going to have to see how earnings and credit losses and all of this plays out through 2008 and whether that’s going to change the minds of the boards of directors. They’re still probably in that denial stage where they think their bank represents an attractive opportunity, so there’s still is a disconnect between buyer and seller. Christopher Nolan – Oppenheimer & Co.: Al, going forward for 2008, given that your capital levels are already pretty strong does it make more sense to actually start more aggressively building the reserves given that loan loss provisions are tax deductible thus a more tax efficient way to actually fortify the balance sheet?

This is a continuing area of discussion. I think we are providing for reserves that we believe to the adequate given the inherent losses in the portfolio. We have a huge percentage of our allowance that really is based on subjective factors, the qualitative factors. If you just looked at our quantitative analysis, our reserve level is significantly lower. So, we don’t build reserves for the sake of building reserves, but I do think that we believe that our reserve positioning is appropriate and we are aggressive in charging loans off and taking very active steps in monitoring and collecting proper credit. So, there isn’t anything that we believe, notwithstanding the results of the quarter, that would lead us to believe that we need to build reserves. So, we just are going to continue our methodology. We think it’s served us well.

Our next question comes from Erika Penala- Merrill Lynch.

I was wondering what the underlying assumptions were on a specific portfolio basis behind the loss assumption for 20’08; essentially what are you assuming for CRE losses in 2008 versus C&I losses?

I’ll answer the second question first. It’s really difficult to determine the percentage of loss, the CRE and C&I. So far we haven’t had any loss in the CRE loans, but just for the period of fourth quarter with economy down-turning; it’s shocking. We’ll have to see and it depends on how well we manage the CRE portfolio, but typically most of the CRE portfolio is well collateralized. So at this point, we don’t expect to have a significant loss from the CRE, but as far as the charge-offs are concerned that’s based on our fourth quarter averages as well as what’s happening in the economy and definitely there is more retail businesses that are suffering from the economy. So, we took that into consideration. So a number of factors that we took into consideration. So aside from that $1.5 million charge-off that we have experienced in the fourth quarter we still expect that our charge-offs for the remaining 2008 would increase a little bit from 2007.

Okay and on the expense side, is the fourth quarter run rate something appropriate to assume as throughout 2008 or will the expansion in the East Coast bump that up a little bit?

We are budgeting for a little bit higher run rate probably $14.5 to $15 million.

Okay and my last question, I’ve heard that there have been articles in local Korean newspapers indicating that there is increased interest among the South Korean banks to enter the U.S. market. Do you have a sense on how interested these banks really are in doing that, and if so, would you consider engaging any of them in strategic partnerships?

There has been increase of the interest from the Korean banks in Korea concerning the lower stock price and they have been looking for an opportunity to expand their market share in the United States, but I think that at this point in time they are just trying to see if there is any interest or opportunity within this market and I don’t think there was any significant or serious conversations among any of the Korean American banks at present time.

Our next question comes from Don Worthington - Howe Barnes Hoefer & Arnett. Don Worthington - Howe Barnes Hoefer & Arnett: Getting back one more time to the margin, do you have floors on your adjustable rate loans approximately if you do have, the percentage of the portfolio that has floors?

No. Don Worthington - Howe Barnes Hoefer & Arnett: No, okay. And then on the six CRE loans they were not accrual status, any commonality among those loans in terms of location or type of property?

Mostly no. There isn’t any commonality and probably types are different, and it comes from various geographic locations, so we don’t have any commonality to report on. Don Worthington - Howe Barnes Hoefer & Arnett: Is it all Southern California or...?

Basically two of the loans are from eastern region. Out of those two, one borrower was out of country during the holidays, that was really a strong borrower. So he brought the loan current when he returned from his trip from overseas.

And I’ll now turn the call back over to management for closing remarks.

Once again thank you for joining us today and we look forward to speaking with you next quarter.

Thank you, operator.