Hope Bancorp, Inc. (HOPE) Q3 2010 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the third quarter 2010 Wilshire Bancorp Incorporated earnings conference call. My name is Eric. I will be your audio coordinator for today. At this time, all participants are in a listen-only mode and we'll facilitate the question-and-answer session at the end of the presentation. [Operator Instructions]. I would now like to turn your presentation over to Edward Han, First Vice President of Investor Relations. Please proceed

Thank you and good morning everyone. We appreciate you joining us today for our third quarter 2010 earnings conference call. Again, my name is Edward Han and joining me are Joanne Kim, company's President and Chief Executive Officer, and Alex Ko, Executive Vice President and Chief Financial Officer. Earlier this morning, Wilshire Bancorp issued its third quarter 2010 earnings results, which can be accessed either through the Investors Relations tab at wilshirebank.com or from the various financial news websites. This call is being webcast and will be available in archive for one-year on the company's website. Before we begin, I must remind you that during this call, we may make certain statements concerning Wilshire's future performance or events. Any such comments constitute forward-looking statements and are subject to a number of risks and uncertainties that might cause actual results to differ materially from stated expectations. These factors include but are not limited to the ability to grow market share in our markets, including New York and Los Angeles, success of new branches, marketing costs, loan growth and balance sheet management, credit quality, our ability to collect on past due loans, deposit generation, net interest margin expectations, interest rate exposure, global and local economic conditions, and other risks detailed in the most recent reports on Form 10-K and Form 10-Q as filed with the Securities and Exchange Commission. Given these uncertainties, undue reliance should not be placed on such forward-looking statements. Wilshire Bancorp is under no obligation to update this information as future events or developments take place that may change these forward-looking statements. First, Ms. Kim will provide an overview of our principal operations as well as an update on the loan portfolio. Following that, Mr. Ko will review our financial results. Following his remarks, Ms. Kim, will provide additional perspective and closing comments. We will then commence the question-and-answer portion of the call. With that, I will now turn the call over to Joanne. Joanne?

Thank you, Edward. Thank you all for joining us today for our call. We were pleased to deliver a quarter of strong profitability, improving credit quality and increasing capital ratios. We recorded net income available to common shareholders of $4.1 million while $0.14 per share in the third quarter compared to a net loss of $1.7 million or $0.06 per share in the same period last year. We have yet to see a significant improvement in the economic activities in our market and loan demand remains relatively weak. At the same time, we continue to have success in attracting new low cost deposits to the bank. Given these market dynamics, we have implemented a strategy to reposition our balance sheet. The strategy is to reduce cash equivalents and lower yielding investment securities to fund outflow from high cost deposits. We have reduced higher cost money market and time deposits and rolled off borrowing as they mature. A portion of the high cost deposits outflow is being replaced with new non-interest bearing demand deposits, which has increased by more than $25 million in the third quarter. This balance sheet reposition strategy has had a positive impact on our net interest margin which increased 22 basis points from last quarter. Expansion in our net interest margin enabled us to still slightly increase our net interest income compared to the second quarter of 2010, despite the decline in average interest earning assets caused by the reduction in the securities portfolio. Another benefit from the repositioning of our balance sheet is an improvement in our capital ratios. Due in part to this strategy our TCE ratio increased to 6.28% at September 30th, from 5.8% at June 30th. Our regulatory capital ratios were also increased by at least 38 basis points from the second to the third quarter of 2010. As I mentioned earlier, loan demand continues to be somewhat weak, which in addition to our problem loan sales, contributed to a slight decline in our total loans during the third quarter. Total originations were $113 million in the third quarter compared to $186 million in the second quarter. SBA loan originations were also down during the quarter to $17.6 million from $32.6 million last quarter. The third quarter SBA loan originations were impacted by the then pending passage of small business job act, which included SBA guarantee waivers and 90% guarantee. Since this new rule will be effective as of October 1st, 2010, customers delayed their closing of their loans to take advantage of fee waivers. Our fourth quarter SBA loan origination is strong and is expected to return to the previous production level. The one area that we did see some growth in was the construction portfolio which increased by $11 million. The increase was a result of increased funding of existing construction loans of affordable housing projects, mostly located in the Los Angeles County area. Turning to our asset quality, we were pleased with the improvements we saw in the portfolio of this quarter. We recorded a provision for loan losses of $18 million, down from the $32.2 million that we recorded in the second quarter of 2010. The loan provision reflect reduced levels of non-accrual loans, delinquent loans, criticized and testified assets and net charge-offs in the third quarter relative to the second quarter of 2010. We continue to be aggressive in disposing of problem assets, and we sold another $17.4 million in non-accrual and delinquent loans during the third quarter. We continued to be disciplined in the pricing that we accept and these loans were sold at an average discount of approximately 15% to their carrying value. The average discount based on the contractual outstanding balance for these loans were approximately 28%. All of these loans were commercial real estate loans, primarily secured by gas stations, hotel, motel, and shopping center properties. Our focus will remain on credit quality and the timely resolution of problem loans. We will continue to take an aggressive approach to dispose of and reduce our non-performing loans, especially through continued note sales into the fourth quarter. In the third quarter, we did not rush to sell more loans in an attempt to get better pricing. However, in the fourth quarter, we will be a bit more aggressive and I expect the problem note sales to be substantially greater than the amount sold in the third quarter. These note sales helped to reduce our total non-accrual loans to $76.3 million at September 30 from $83.1 million at the end of second quarter. The new inflows into non-accrual loans during the third quarter were $25.6 million, which compares to new inflow of $10.7 million last quarter. The outflow of non-accrual loans were $32.2 million, down by $200,000 compared to outflows for the second quarter. Our OREO increased to $16 million at September 30th from $6.5 million at the end of second quarter. The increase reflects a more aggressive approach in remediating non-performing assets, as we believe we can dispose of these properties fairly quickly, as we double prices compared to note sales. We have already sold two properties in September 30th and we are in contact on five other properties currently in OREO totaling $5.6 million. Our total delinquencies decreased to $34.8 million at September 30th from $37 million at June 30th. A positive sign of improving credit quality was the large decrease in inflow into total delinquencies which decreased by $59.7 million to $26.6 million in the third quarter of 2010. Delinquency outflows decreased from $79.8 million in the second quarter to $28.8 million in the third quarter. We made enhancements to our allowance or loan loss methodology during the third quarter, which expanded the scope of loans evaluated for individual impairments. We reviewed the entire modified loans during the third quarter. Even though these loans were performing under their modified contractual terms, we reevaluated the loans on an individual basis, and aggressively transferred additional loans at TDR, resulting an increase in impaired loans. Examples of such additional TDR classifications include multiple notifications and loan model modification. This expanded scope of impaired and TDR loans resulted in TDRs increasing to $115.5 million at September 30th from $53.1 million at the second quarter end. All of our TDR loans are performing at less than 90 days past due and $108.6 million or 93.7% in TDR were less than 30 days past due. Approximately $40.2 million of the increase in TDR is directly attributable to the expanded scope. All TDRs are considered as impaired loans and effective valuation allowance as allocated. Absent to this enhancement the impaired loan would have decreased to $160 million. Our allowance for loan losses increased to 4.04% of total loans at September 30, 2010 from 3.72% of total loans at the end of the prior quarter. Coverage of Legacy Wilshire loans was increased to 4.44% at the end of third quarter. Our coverage of non-performing assets increased to 107% from 101% at the end of prior quarter. Although, we have improvements in virtually all of our price matrix this quarter, the adoption of the more conservative interpretation of [TDRs] toward the increase in our loans ratios. Now, let me turn the call over to Alex for further review of the third quarter financials, after which I will provide some commentary and outlook before opening the line for questions. Alex?

Thank you, Joanne, and hello, everyone. Let me begin with a review of our balance sheet. Total assets were $3.23 billion at September 30th down from $3.44 billion at the end of last quarter. The decline is primarily due to a $139 million reduction in our investment portfolio, as part of our repositioning our balance sheet. During the third quarter, we sold 115 million and in securities at a gain of $2.7 million. In addition to the securities sales, $139 million in securities matured or were called. Our total deposits declined to $2.71 billion at September 30th, down from $2.9 billion at June 30th. The decline came from our money market and time deposit accounts. These declines were offset by $25.5 million or 6% increase in our non-interest bearing demand deposits. During the first nine months of 2010, we have opened 1,960 new DDA accounts; as a result core deposits represented 73% of core deposits at September 30th, compared to 65.3% on the same date a year ago. In the third quarter, we experienced an improvement in all of our capital ratios. Specifically, our tangible common equity to tangible asset ratio increased 48 basis points to 6.28% at September 30th from 5.8% at June 30th. All of our capital ratios are well above the minimum of well capitalized institutions and at September 30th, we should have a list of 131 million in access capital before any of the ratios reaches to regulatory advantage of a world capitalized institutions. Turning to our income statement, our net interest income before provision for loan losses were $29.7 million in the third quarter of 2010, compared to $29.4 million in the same period of the prior year. On a sequential quarter basis, our net interest margin increased 22 basis points to 3.93%. The increase was primarily due to a reduction in our cost of funds resulting from the improvement in our deposit mix. Our total cost of funds declined to 1.24% in the third quarter from 1.43% in the second quarter. Interest income there was a reversal from non-accrual loans accounted for $1.1 million for the third quarter 2010. Without this reversal net interest margin is 4.07%, a difference of 14 basis points from the actual net interest margin. We have a 10 million in non-interest income in the third quarter 2010 compared with 7.4 million in the same period last year. The increase is primarily due to two factors, first, we have $2.6 million gain on sale of investment facility, and second, we have $2.7 million gain on sale of SBA and residential mortgage loans, which was 22% higher than last year. The gain primarily reflects our sale of approximately 19.6 million in SBA loans. Our total non-interest expense was $14.8 million in the third quarter of 2010, unchanged from the same period of the prior year. 5% increase in salaries and expenses benefits were offset by 35% decrease in data processing costs. On a sequential basis, our non-interest expense declined by 8%, this was primarily due to reduction in professional fees and expenses related to [REO] Now, I will turn the call back to Joanne. Joanne? Now, I will turn the call back to Joanne. Joanne?

Looking ahead, we expect to see continued improvement in credit quality, and further declines in non-performing assets partially driven by additional note sales. However, we will continue to take an aggressive posture in respect to selling our non-performing assets. Why we're not expecting any meaningful growth in the loan portfolio, there are two areas of our lending that we are optimistic about in the near-term. The first is our SBA lending business. We have built a very strong platform for this business that has gained excellent momentum in the past several quarters. In fact, I'm proud to announce that we were ranked 11th overall in the nation in total SBA originations for fiscal year ended September 30th, 2010. I believe this trend will continue and our business should get a further boost from the recent changes to the SBA programs that were enacted with the small business jobs and credit act. The second area that we see good growth opportunities near-term is our residential mortgage lending business. We have had good initial results with our testing of a warehouse lending program for residential mortgages, and we intend to increase our wholesale and warehouse lending activity going forward which could provide a new source for loan growth. However, absent a significant increase in commercial and CRE loan demand, we intend to continue shrinking the balance sheet for at least another quarter which should further improve our funding mix and capital ratios. We also believe, we still have opportunities to improve our net interest income through the repositioning of our balance sheet. We expect that this strategy will also enhance our ability to capitalize on growth opportunities once a stronger economic recovery materializes, as we will have an improved capital position to support that growth. Thank you for being with us this morning. Edward.

Thank you, Joanne. That concludes our formal presentation. At this time, we would like to open the call for questions.

(Operator Instructions). Your first question comes from the line of Jonathan Elmi with Macquarie. Please proceed.

Just a couple of follow-up questions on the NPL sales. Curious, who some of the underlying buyers are? And then also whether or not you guys financed any of the sales?

The buyers are primarily individual investors who happen to be in the same line of business. For example, for gas station sales, we are primarily selling those to another gas station owners. And typically, we do provide financing, and we are using the finance income to get the better pricing in note sales. The average financing term is with 30% to 40% down payment and we provide basically two years interest-only terms at a market rate. And what was your second question?

No, I think those were actually both of them. That's definitely very helpful. And then, I guess, the one other question on the sales, and I apologize if I missed this, but you gave the discount to the current book values of loan, and then were also reserves allocated to those credits as well? Just trying to get to what the total discount was there?

Yeah, actually, sometimes we do charge a portion of the principal balance, so based on the outstanding balance as of the sales date, after the charge-off our discount was 15% for third quarter. However, before, if we include that charge-off portion into that loan balance, our discount was about 28% for third quarter.

Next question comes from the line of Julianna Balicka with KBW. Please proceed.

I have a couple of questions to follow-up. One, very quickly. Could you discuss the lower effective tax rate, please?

Sure. The lower effective tax rate was because in the second quarter we have experienced net loss position and tax regulation. If there's a substantial fluctuation quarter-over-quarter basis, instead of using annualized tax rate, which is just estimation, we need to true up on each quarter. So that's why we trued up in the second quarter as well as third quarter. So that's why we have a substantial fluctuation and the lower than the statutory rate of 42.5% is because we have a permanent difference such as low income housing tax credit, which is a direct credit at lower dollar effective tax rate.

Thinking about next quarter, if you have the same level of earnings as this quarter, what would be your effective tax rate?

I think, it would be lower than obviously the statutory rate. I would target like a 30%, plus or minus.

30%?

Yes.

And then, I have some questions on the TDRs, the additional expansion of the methodology. So these TDRs, the ones that were identified in the expansion of the impairment, scope of impairment, were they downgraded from, I mean what was the change to their grading and things like that?

Ratings are basically similar because when our borrowers asked us to modify their terms, we generally, depending on the situation that a borrower is in, generally we downgrade to substandard credit in general, so I think that grading would not change much unless there is a, if the modification continues with a lot worse cases, but generally our majority of our modified or TDRs are in substandard categories.

So let me, if I'm understanding correctly, the new TDRs were already substandard loans.

Yes, majority of them, correct.

Let me give you more color. Our enhancement of our TDR however is not classification reason. It is revisiting our interpretation of the TDR and considering the credit quality, general credit quality, we expanded to broadening our interpretation of the TDR meaning by regulatory destination, borrower has a financial difficulty, and the bank could give concession. How we interpreted that concession, we kind of expanded, even it is performing and based on the contractual terms, if we gave them, like a multiple modification and if we believed the term was a little bit longer than the normal, we kind of aggressively classified as downgrade, as TDR. So that by definition those TDRs are impaired loans, so we look at all those additional TDRs, perform FAS 114 analysis. So, with that 114 analysis, I don't think it has anything to downgraded, in terms of classification are we strengthen the specific reserve based on those FAS 114 analysis.

What was the specific reserve increase based on that additional analysis?

About 5 million.

Okay. So, the additional required reserve was about 5. Were there any additional charge-offs related to this?

No, it was mainly the increase of the provision, based on specific reserve.

Okay. So that makes sense. And very good. And then, two quick questions. On the loan sales, I'm sorry if I missed that, were they mostly in the Los Angeles area or through geographic breakdown?

I think, primarily Los Angeles area.

And then finally, and I will step back, for the loans, for the security sales that you have had so far each quarter in 2010, how should we be thinking about that for the fourth quarter and also into 2011? Is this kind of an ongoing part of your fee income?

I think for the fourth quarter, I'm anticipating $2 million to $3 million, depending on market positions, and for next year, I do not anticipate anymore, further gains as we see interest rates go up.

Your next question comes from the line of Joe Gladue with B. Riley. Please proceed.

I just had one question left. In regards to the balance sheet repositioning and the funding costs, did have a nice reduction in cost of interest bearing deposits. Do you think there's much more of that you can get going through?

Yes. Let me give you a little more color on our repositioning of our balance sheet. As we indicated that repositioning comes, A, from the run-off or not renewal of the high cost of deposit accounts, and we have about $317 million of CD at a rate of 1.74%, as expected to mature in Q4. And we have lowered the spot rate of our 25 basis points in the month of October, so that's about $113 million will be either re-priced about 25 basis points lower, or it might just run-off, because we continue to plan to have that repositioning, meaning let go of the high cost deposits. And on the other side of the non-interest, non-accrual loan kind of interest reversal, I do not believe, there will be a significant fluctuation of that non-accrual loan just reversal during the Q4. So with that, we expect minimum, like 10 basis point further margin expansion going forward in Q4.

Next question comes from the line of Aaron Deer with Sandler O'Neill. Please proceed.

I just wanted to follow-up on Julianna's question about the TDRs. Can you give us a sense of what your history has been with respect to TDRs moving back to performance status versus those that might have required additional modification and some other result?

I don't have the details statistics on hand. However, we are selling quite a few loans from TDR group as well. So, I think as far as, do you have that data?

Yes, maybe this can be a little bit helpful. It is just a historical trend. Let me give you first quarter, second quarter, and third quarter, actual TDR, and further migrated to non-accrual loans. The first quarter of our $7.9 million, or 8 million was further migrate to non-accrual out of total $64.6 million TDR. During the second quarter out of $54.6 million TDR, $1.1 million was migrated to non-accrual. During the third quarter, only $856,000 has migrated to non-accrual. So, it seems like it is definitely a decreasing trend.

Alex, that's helpful. How about in terms of, is there a bucket of, so to speak that will, based on their performance, move back to performing status at year end?

Move back to performing level?

Yes, whether it can be recharacterized as being performing loans versus TDR.

We have a few loans that are performing and there are scheduled to go back to performing, like a non-TDR level, but so far the dollar volume isn't that great, because the TDR, the definition of TDR is getting very tough. It's not lenient any more, so I guess, understanding that the top definition of TDR, I think, I don't expect a large amount of TDRs moving to performing level any time soon. However, I do anticipate some reductions through more of a note sale during fourth quarter.

Okay. And then lastly, given that a lot of your business is focused on small business lending, I was curious to get your thoughts on TARP and what you might be thinking about in terms of refinancing that under the small business lending funds program?

We have reviewed that program, and I don't think the detailed guideline has come out yet. So, we are actually looking into it and see whether we can take advantage of rate reduction. Again, we are looking at it. Anything that you want to add?

Right. In terms of our kind of captive usage, I think there's yet to receive regulatory detailed guidance, as to know how much it can be classified as Tier 1 and what kind of term for the refinancing existing TARP money in terms of captive, we will explore more the opportunities, but in terms of the actual loans, further origination, we definitely take advantage of that and government subsidized, and we are in the process of further, much more origination of those loans.

And then, if I might, just one last one on the SBA business. It seems like the gains are getting are pretty robust. As you kind of come in here to the fourth quarter, are you still getting those 10% plus gains on the note sales?

We have not seen any changes in the premium side, so I expect that similar level of premiums in the market.

You have a follow-up question from the line of Jonathan Elmi. Please proceed.

First on the TDRs, I appreciate that you guys expanded the scope of what you are classifying as TDRs this quarter, but do you have any sense or do you guys know what the linked quarter change would have been on apples-to-apples basis if you had used the same criteria in the second quarter?

Sure. I think about $40.2 million was incremental due to the changes. So, if we didn't change that TDR and impairment changes, impaired loans remain flat at $160 million. A TDR has a minor increase.

It sounds like you guys are going to somewhat significantly increase problem loan sales in the fourth quarter, at least that's your intention. Can you quantify that at all in terms of order of magnitude of what you might be looking to do?

I guess during the first half 2010, we sold closer to $70 million. Yes, our intention is to sell during the second half of 2010 the similar amount or a bit higher. That's our plan.

We're currently showing no more questions in queue at this time. I would like to turn the call over to Edward Han for closing remarks.

Thank you. That concludes our quarterly conference call. On behalf of our management team and Board of Directors, I would like to thank everyone again for your participation and continued interest in support of Wilshire Bancorp. If you have any further questions please feel free to contact us directly. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.