Hope Bancorp, Inc. (HOPE) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the Second Quarter 2012 BBCN Bancorp, Inc. Earnings Conference Call. My name is Deeana, and I'll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, today’s conference is being recorded for replay purposes. I would now like to turn the call over to your host, Ms. Angie Yang, Senior Vice President, Investor Relations. Please go ahead.

Thank you, Deeana. Good morning, everyone and thank you for joining us for the BBCN Bancorp 2012 second quarter investor conference call. Before we begin, I'd 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 reflect our expectations based on information currently available 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, as well as the Safe Harbor statement in the press release issued yesterday. These documents contain important risks factors that could cause actual results to differ materially from the forward-looking statements. BBCN assumes no obligation to revise any forward-looking projections that may be made on today's call. The company cautions that the complete financial results to be included in the quarterly report on Form 10-Q for the 3 months ended June 30, 2012 could differ materially from the financial results being reported today. We have allotted one hour for this call. BBCN's President and CEO, Alvin Kang, will begin today with an overview of the quarter; and our Chief Financial Officer, Phil Guldeman, will discuss the financial results in more detail. Then Al will wrap up the presentation with closing remarks before we begin the question-and-answer session. Also joining us this morning from management are Chief Operating Officer, Boni Lee; Chief Credit Officer, Mark Lee; and Deputy Chief Financial Officer, Doug Goddard. With that, I'd like to turn the call over to Al Kang. Al?

Thank you, Angie. Good morning and thank you for joining us today. I’m going to start off by providing an overview of the quarter and then Phil will walk through our financial results in more detail. We executed well in the second quarter as we successfully completed the remaining steps in our merger integration and at the same time, we ramped up our business development effort with a substantial increase in loan production over the first quarter. We’re also very pleased to have exited the government’s Capital Purchase Program on June 27, 2012, having redeemed all $122 million of TARP with existing capital. For second quarter 2012, we generated net income available to common stockholders of $15.6 million or $0.20 per diluted common share. It’s important to note that the variance between net income and net income available to common stockholders for the current quarter was significant relative to past quarters. As part of our TARP redemption, we incurred additional discount accretion of $1.9 million. This adversely impacted our bottom line by $0.02 per diluted common share. Our pre-tax pre-provision earnings amounted to 3.03% of average assets for second quarter 2012, underscoring the strong earnings power of the new BBCN organization. Our return on average assets was 1.52% and our return on average equity was 9.40%. One of the key highlights for second quarter 2012 was a significant increase in loan production. New loan originations amounted to $241.5 million and contributed to a 4% increase in loan balances from March 31, 2012. I'm pleased to report that the loan growth came from both existing and new relationships. This and our ongoing focus on commercial lending drove a 5% increase in our commercial loan portfolio from the preceding quarter. In particular, we are making steady progress, winning new business from Korean national corporations operating here in the U.S. We believe the success in expanding our commercial lending platform is one of the factors behind the growth in the average balances of non-interest bearing deposits, which grew 3.8% compared to the first quarter. SBA loan production for the quarter was also strong. We funded $67.1 million in new SBA loans during the second quarter, nearly doubling the production of the preceding quarter; of this, approximately $50 million is attributed to salable SBA 7(a) loan. During the quarter, we opened our fourth loan production office, this one in Atlanta and we also assigned a dedicated SBA loan officer to lead our efforts in the Northern California market. Further strengthened by these additions, we believe BBCN’s SBA platform is by far the strongest in the nation among our peers and expect it to continue to be important contributor to our earnings growth through gains on sale or to generate interest income. Overall, our loan pipeline remains relatively strong. In spite of the numerous economic headwinds, we believe we are on track to achieve mid single-digit loan growth for the year. Notwithstanding the strong loan growth in the quarter, total assets declined to $5.05 billion at June 30, 2012 from $5.17 billion at March 31, 2012. This was due to the TARP redemption, which reduced cash and equity on the balance sheet. Given the positives that we have seen in our business development activities, we would expect our loan growth will return growth to the balance sheet. Finally, as provided in our earnings release, all of our capital ratios post-TARP redemption are well in excess of regulatory definitions for a well-capitalized institution. At June 30, 2012 our Leverage Ratio was 12.97%, Tier 1 risk-based capital ratio was 15.4% and the total risk-based ratio was 16.80%. Also tangible common equity was 12.49% of tangible asset. With that, let me turn the call over to Phil. Phil?

Thank you, Al. Operating results for the 3 months ended June 30, 2012 include a number of pre-tax acquisition accounting adjustments and expenses related to the merger, as well as certain other significant expense items. In total, these had a positive impact of $7.9 million on our pre-tax income for the 2012 second quarter. This compares with a positive impact in the 2012 first quarter of $10.2 million, which was adjusted upward from the originally reported $9.6 million. Starting off with the income statement, net interest income for the second quarter came in at $59.5 million and included approximately $7.7 million of loan interest income from the accretion of the acquisition accounting discount on Center's loan portfolio. Our net interest margin was 5.02% in the second quarter of 2012. Excluding the impact of acquisition accounting adjustments, our net interest margin was 4.15%, 11 basis points higher than the comparable ratio for the preceding first quarter. We attribute the expansion of the margin to a reduction in our cost of funds, coming from both the lower cost of borrowings and a lower cost of deposits. The yield on our loan portfolio including loan discount accretion was 6.53%. The yield excluding loan count accretion was 5.59%, a decrease of 2 basis points from the 2012 first quarter. The reduction in yield is primarily attributable to new loans being booked at lower rates than the existing portfolio. The cost of deposits decreased by 1 basis point linked quarter to 55 basis points for the second quarter. Excluding amortization of premium on time deposits assumed in the Center merger, the weighted average cost of deposits was 63 basis points for the second quarter of 2012, reflecting a 6 basis point decrease from the preceding first quarter. The improvement was driven by reductions in the cost of interest-bearing demand deposits, as well as a favorable shift in the mix of deposits to higher concentrations of non-interest-bearing demand deposits, driven by our expanding base of commercial customers. Non-interest-bearing demand deposits accounted for 27% of total deposits at June 30, 2012, up from 26% at March 31, 2012. As Al indicated, average DDA balances increased 3.8% or $37 million on a quarter-over-quarter basis. The weighted average cost of FHLB advances increased 3 basis points to 1.95% from the preceding quarter. Excluding acquisition accounting adjustments, the weighted average cost of FHLB advances decreased 33 basis points to 3.08%. The improvement over the preceding quarter reflects the addition of $105 million in new FHLB borrowings at 0.76%, which is a rate substantially lower than the weighted average rate of the rest of the borrowing portfolio. Moving onto non-interest income, our non-interest income was $10.2 million in the second quarter, a decrease of $1.4 million from the preceding first quarter. This is primarily due to 2 factors: First, you may recall that we posted a net gain on sale of securities available for sale of $816,000 in the first quarter. There was no equivalent sale of securities in the second quarter. And secondly, our net gain on the sale of SBA loans were $2.5 million or $500,000 less than last quarter. We sold $27 million of SBA loans in the quarter compared with $33.4 million sold last quarter. At June 30, 2012, we had approximately $29.6 million of SBA loans available for sale. During the second quarter, we completed an analysis comparing the alternatives of recognizing a one-time gain on the sale of SBA loans versus the recognition of interest income over the life of the loan. Due to BBCN's strong capital and liquidity position, we believe recognizing interest income on SBA loans will provide greater long-term economic benefits than selling the loans into the second market -- secondary market in the current environment. As such, we will likely retain all or a majority of the SBA 7(a) loan production in the portfolio for the foreseeable future. However, this decision will be revisited on a quarterly basis after reviewing prevailing factors including but not limited to: capital adequacy; liquidity requirements; SBA premium trends; estimated loan payments speeds; prepayment speeds; and the availability of alternative investments. Our non-interest expense in the second quarter was $31.1 million, an increase of 2% from the prior quarter. Our salaries and benefits increased $716,000 or 5% from the prior quarter due to the effect of annual salary increases, and higher vacation and bonus accruals. Our occupancy expense increased $586,000 from prior quarter; $375,000 of this increase was attributable to a non-recurring expense associated with the re-negotiation of a sublease. Our professional fees increased $456,000 from the prior quarter, which was an unusually -- rather an unusually low level for the bank. These increases were offset by a decline in our FDIC assessment, which totaled $51,000 in the second quarter, compared with $1 million in the prior quarter. The unusually low assessment this quarter reflects the recognition of a $650,000 assessment rate reduction for the fourth quarter of 2011, as a result of an upgrade in our risk rating. For the third quarter, we would expect our quarterly assessment to be approximately $900,000 to a $1 million. We also incurred $1.2 million in merger-related expenses in the second quarter, which came in lower than our expectations. Combined with the $1.8 million in merger-related expenses incurred during the first quarter, our total merger-related expenses came in at $3.0 million for the first half of the year below the $4 million to $5 million range that we had been anticipating. While we expected most of our merger-related expenses would be incurred in the second quarter, approximately $800,000 to a $1 million is now expected to be expensed in the remainder of the year. We are pleased that our merger-related costs will come in at the lower range of our estimate. As Al mentioned, with the major integration elements completed, we are on pace to achieve the cost savings that we anticipated from the merger. If you compare certain expense items on a pro forma basis from the time the merger was announced in the 2010 fourth quarter to the current second quarter and look at those both on an annualized basis, you'll see that item and data processing costs have decreased by approximately $2.6 million. Merger-related expenses have decreased by approximately $2 million and furniture and equipment expense have decreased by approximately $500,000. In addition to these reductions and expenses on an annualized basis, we have reduced salaries and benefits by approximately $2.4 million per year since December 2010. This has been accomplished through a combination of natural attrition during the more than year long merger process and layoffs. However, it is difficult to see true reductions in the compensation line item as those savings have been offset over the last 1.5 years by 2 years of salary increases; the restoration of a performance-based incentive bonus program; the implementation of a long-term equity incentive program; and investment in additional staff to support a larger and more sophisticated organization. I would just add that the salary and benefit increases followed a prolonged period of salary freezes at both the former and Nara Center banks. Overall, we believe the wisdom of these investments is manifested by our efficiency ratio which was less than 45%, our ratio of non-interest expense to average assets, which was 2.32% and the return on assets, which was 1.52%. For the remainder of this year, we anticipate that our non-interest expense will stabilize in the $29 million to $31 million range per quarter. Moving to our balance sheet, our gross loans were $3.6 -- $3.87 billion at June 30th, up from $3.74 billion at March 31, 2012. New loan originations of $241.5 million were offset by aggregate loan payoffs, paydowns, amortization and other adjustments, which totaled $107.3 million during the second quarter. Our total deposits fell slightly to $3.88 billion at June 30, 2012 from $3.9 billion at the end of the prior quarter. The decrease came from what appears to be normal operating fluctuations in money market accounts and a continuation of the strategic runoff of our higher rate non-jumbo time deposits. These decreases were partially offset by the continued growth in our non-interest-bearing deposits as previously discussed. Moving to credit quality, we were pleased with the stability we saw in the loan portfolio this quarter. Our total watch list loans, which is the sum of Special Mention and Classified loans declined to $314 million at June 30th, down from $324 million at the end of the last quarter. It's worth noting that approximately 54% [ph] of our Classified loans are marked to fair value. Our non-performing loans worth $83.3 million at June 30th; a slight increase in $81.9 million at the end of the prior quarter, but down a bit as a percentage of total loans. The increase in non-performing loans is primarily attributable to 3 acquired credit-impaired CRE loans, aggregating $3.8 million which were placed on 90 days past due. Because these loans were mark-to-market at acquisition date, they remain on accrual status. As a side note, approximately 61% of non-accrual loans are current on their payments. Combined with accruing restructured loans, which are also current, approximately 56% of our total non-performing loans as we define them are current and paying as agreed. Our non-performing assets were $90 million at June 30, compared with $87.6 million at March 31st. On the percentage basis, non-performing assets were 1.78% of total assets at June 30th compared with 1.69% at the end of the prior quarter. Our net charge-offs were $4.0 million in the second quarter, up from $2.2 million last quarter but still within our expected range. We recorded a provision for loan losses of $7.2 million in the quarter. To briefly walk through the major items that comprise our provision this quarter: approximately $5.1 million was relating -- was related to increasing the allowance for loan losses for new loan production and acquired loans that matured and were refinanced; and then there was approximately $2 million of provision required as a result of credit deterioration in the acquired portfolio. On June 30th, we had an allowance for loan losses of $65.5 million or 1.69% of total loans. The coverage ratio of the allowance for loan losses to non-performing loans, excluding acquired loans past due 90 days or more on accrual status, increased to 105% at June 30th from 98% at March 31%. In general, we are comfortable with the trends we are seeing in the portfolio. With that, let me turn the call back to Al. Al?

Thanks, Phil. You can catch your breath now. Overall, this was a very solid quarter and we believe we are already seeing the synergies of our new organization coming through in our core operation. With the systems in office integrations and TARP redemption behind us now, we are fully focused on building the BBCN franchise for the long-term. Our core earnings power reflected by our pre-tax, pre-provision earnings gives us the ability to operate confidently even in uncertain times that seem to be facing us for the next several quarters. We expect net loan growth to continue, operating expenses to be more predictable and we have flexibility in our SBA loan strategy. We are committed to looking for ways to expand our market dominance as a use of capital, as well as considering reinstituting common dividends. While the overall economic and interest rate environment continue to access headwinds, we believe we are well-positioned to continue enhancing our level of profitability going forward. Now we would be happy to take any questions that you might have. Operator, will you please open up the call.

[Operator Instructions] First question comes from the line of Aaron Deer, Sandler O'Neill & Partners.

Phil, I've got a question on the expense guidance. I guess, if I back out the merger cost in the quarter, the FHLB pre-paid penalty, the lease negotiation expense and the FDIC benefit that you had, it looks to me like core expenses were up about 3% sequentially to about $29.5 million. Your guidance suggests that there is really not any additional savings to be had from the merger, that you are kind of already at your run rate. Is that right? Am I thinking about that correctly?

I think that’s fair to say we have some additional savings that are scheduled to come in over time. They will be offset by the need to support the growth of the bank as we move forward.

Okay. And then on the funding side, you’re obviously back booking some pretty strong loan growth. If that continues, what are your thoughts in terms of how to fund that? Do you let the securities come in some or do you use the CDs more? Obviously you've picked up some FHLB borrowings in the quarter. What’s kind of your preference and what do you expect here?

I don’t see significantly reducing the securities portfolio. The funding of that loan growth will come from a combination of longer term FHLB advances that are pretty cheap right now and broker deposits so that we can keep our loan deposit ratio at the acceptable level.

Next question comes from the line of Joe Gladue, B. Riley.

Yes. Wanted to touch base on the mix between fixed rate and variable rate commercial loans. Clearly the mix moved a little bit more towards fixed this quarter. Just wondering a, what the mix is of originations and b, how you are, I guess, incentivizing borrowers to do variable rate loans when rates were so low now?

The first question, the fixed versus variable in terms of origination out of our total production, 35% of the origination was from the fixed and the variable rates [indiscernible]. And most of the C&I business loan customers, obviously they'll stay with the variable rates. And then looking at the more of the long-term real estate investor types, they are still looking at the fixed rate. So it differs for each customer’s -- their investment strategy.

Okay. And I guess, just wanted to follow up a little bit on provisioning and reserve levels. Before the merger, I guess, there was some indication that following the merger there would be some rebuilding of reserve levels. And just wondering what the current thoughts are on what, maybe, a comfortable level for the loan loss reserve might be?

It’s always difficult to predict what the loan loss reserves are going to be or the provisions are going to be but I think what we saw this first -- this quarter, I think we have a better understanding of how all the dynamic works going forward. So I think we are comfortable with where we are today, the trend line.

Your next question comes from the line of Lana Chan, BMO Capital Markets.

Couple of questions on the margin. The loan interest income from the acquisition, $7.7 million this quarter, is that a good run rate to use going forward?

I’m sorry. Were you referring to the accretion from the discount?

Yes.

Yes. That is a number that will unfortunately decline as time goes on. As those loans are paid off, the accretion disappears. They hopefully are refinanced under BBCN standards and then require a provision expense.

Right. But I guess, how quickly would you expect that to decline at least for the back half of the year?

That’s really difficult to determine because it’s a function of prepayments and as you recall last quarter, we had a flood of unexpected prepayments, which brought in an unusually large amount of accretion. This quarter, it slowed down. I think it’s fair to say you can assume that it will be declining as time goes on, but very difficult to pinpoint.

I think, Lana, I think the accretion will be closer to second quarter, may be slightly less because of the shrinking portfolios loans pay-off and first quarter was kind of the unusual quarter.

Okay. And then on the other side, in terms of the cost of funds, are there other levers you are looking at to pull to lower the cost of funds further? CDs, borrowings?

Yes. We’ve been pushing as much as we think the market will accept in terms of lowering our deposit rates. Again, as you see in the press release, we are achieving some benefits from the acquired deposits and those, too, are going to diminish as time goes on. So I don’t see there being any significant opportunities there. Again, all the FHLB advances, for instance, that were assumed through the merger had been mark-to-market, so they're already at a pretty low rate.

Okay. And just if I could ask one more question on capital. I think you guys mentioned something about looking at restating the dividend going forward. I mean, given that your tangible common equity ratio is extremely healthy relative to peers, what are the priorities for redeployment of that capital? Dividends? Would stock buybacks be in the consideration as well?

Well, I think in terms of capital deployment, the first use would be a support growth whether that’s organic or acquisitive. But secondly, the Board is in the process of looking at reinstating the common dividend and I think stock repurchases would be behind that.

Your next question comes from the line of Scott Valentin, FBR Capital Markets.

Just with regard to loan originations, did you notice any -- or I guess, was there any change of pace over the course of the quarter? Was it stronger in the first part of the quarter, maybe tail off in the second part of the quarter? Or was it pretty consistent?

Starting off of the second quarter, we had a stronger pipeline to begin with, which we mentioned at the last quarter’s conference. And we are just -- at this merger -- after the merger, all business units are fully dedicating to the production and we were able to develop new relationships then, as well as generate loans from the existing relationships. And just to give you some colors that, out of our top new loans booked, 4 of them represented the renewed relationships that we acquired during the quarter, 4 out of 5.

Okay. Four out of 5, okay. And then you mentioned you opened the fourth LPO in Atlanta. Did that have any impact during the quarter, in terms of originations or just, it's too new to -- it was just too new to have any impact?

No. We just opened, so we will -- we are looking forward to see the production coming from the area.

Okay. And then just another question and I will step back in the queue. But on loan yields, I mean obviously the industry has seen some pretty low loan yields. Just wondering what you are seeing. I know it varies by product, but just maybe in 2 categories, maybe commercial real estate and C&I, just maybe how sharp your loan yields have dropped, maybe quarter-over-quarter on originations?

I think we experienced in the marketplace a competition quarter-to-quarter about 25 basis points drop in the originations. In the C&I, it’s mostly tied to the variable rate, so it hasn’t been that much affected. But in terms of the commercial real estate in the refinance as well as new production, it differs from the property types, but we see rates as competitive as 3.75 on the multi-family type of the properties. But it ranges on the -- overall commercial real estate market ranges from 4% to 5.5% and 5.75%.

[Operator Instructions] Next question comes from the line of Gary Tenner, D. A. Davidson.

Just a couple of questions about the SBA decision, I guess, as it relates to what’s in held for sale at the end of the quarter. Would you plan to sell that in the third quarter and then begin to retain your new production? Is that the way we should be thinking about it?

No. I think as we mentioned that we’re probably going to, because of our strong capital and liquidity position, have a tendency to hold those in portfolio, but we’ll look at that each quarter based upon current factors. But our leaning now is to use that in the portfolio.

Okay. And what’s -- what kind of rate are you -- are those SBA loans coming in at nowadays?

Overall, our SBA loan it’s averaging about 4.95%.

Okay. Great. That’s helpful. And just one last question with regard to the dividend, just in terms of philosophy about payout rates, what would your general view be, Al, in terms of how much of earnings you would want to be paying out in terms of dividend?

We’re kind of looking at that. We’re gathering information on what the industry does, our peer group and what we’ve done both center and narrow in the past. So we’re trying to make that determination to see what would be a reasonable payout ratio. And so all of those things are still under consideration by the Board.

Next question is from Don Worthington, Raymond James.

In terms of the acquired loans that may be refinanced into BBCN loans. How much more that is outstanding?

Right now, we have about $946 million of what we consider performing acquired loans and $165 million considered credit impair and still outstanding.

Okay. And then any plans to redeem any more trust preferreds?

No. Not in the short-term the one trust preferred that we redeemed had a very high interest rate. It was 10.18%. So we thought that, that was beneficial to redeem.

Okay. And then lastly, any more plans for additional LPOs beyond the Atlanta one?

Not in the immediate future. We’re always considering different locations around the country, but nothing on the drawing boards right now.

Your next question comes from the line of Julianna Balicka, KBW.

Just a quick follow-up, on the brokerage fees you've mentioned that you could potentially keep down to funding [ph] growth. What kind of rate would you be paying on those?

Depends on the terms that we go out on. Gosh, the shorter-term stuff is 20 basis points, 25 basis points.

Yes, but for modeling I'd considered 40s, as an average for the tenure you'd probably bring in 40, 45 basis point.

Because the SBA loans that we are likely to hold in the portfolio are, in essence, variable rates loans, we may decide to fund that portion of the loan growth with shorter-term CDs because we will not have any interest rate risk on that.

Or matching advances.

Or matching advances.

Your next question comes from the line of Aaron Deer, Sandler O'Neill & Partner.

Just a quick on follow-up question, one is following up on Lana's inquiry into the accretion. Where was the -- what would you estimate for the accretible discount that was still outstanding at June 30th?

I don’t have the exact number in front of me. It's $63 million or $64 million, low 60s…

It's in the low 60s as I recall.

We can follow-up with you, Aaron.

Okay. And then on the tax rate, it came down a little bit in the quarter. What are you looking for, for the remainder of the year in terms of an effective tax rate?

Well, I think if you look at the average of the first 2 quarters, somewhere in that range would be reasonable to expect.

There are no more questions at this time. [Operator Instructions]

Okay. Well, as the fire engines are telling us we have to cut this off. So once again, thank you for joining us today and we look forward to speaking with you next quarter. Thank you.

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation. You may now disconnect and have a great day.