Hope Bancorp, Inc. (HOPE) Q2 2017 Earnings Report, Transcript and Summary

Good day, and welcome to the Hope Bancorp Second Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Angie Yang, Director of Investor Relations. Please go ahead.

Thank you, Nicole. Good morning, everyone, and thank you for joining us for the Hope Bancorp 2017 second quarter investor conference call. Before we begin, I would like to make a brief statement regarding forward-looking remarks. The call today may contain forward-looking projections regarding the future financial performance of the Company and future events. In addition, certain statements regarding the proposed transaction between Hope Bancorp and U&I Financial Corp including the expected timeline for completing the transaction, future financial and operating results, benefits and synergies of the proposed transaction and other statements about future expectations, beliefs, goals, plans and prospects of the management are statements that may be deemed to be forward-looking statements. These statements are based on current expectations, estimates, forecast and projections. Management's assumptions about the future performance of the Company, as well as the business and markets the Company does and is expected to operate. These statements constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. We wish to caution you that such forward-looking statements reflect our expectations based on current expectations, estimates, forecast and projections and management's assumption about the future performance of Hope Bancorp. These statements are not guarantees of future performance. Actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. The closing of the proposed transaction is subject to regulatory approvals, the approvals of the shareholders of U&I Financial and other customary closing conditions. There is no assurance that such conditions will be met and the proposed transactions will be consummated within the expected timeframe or at all. If the transaction is consummated factors may cause actual outcomes to differ materially from what is expressed in integrating the two organizations and in achieving anticipated synergies, cost savings and other benefits from the transaction. We refer you to the documents the Company files periodically with the SEC as well as the Safe Harbor statements in the press release issued yesterday. Hope Bancorp 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 quarter ended June 30, 2017 could differ materially from the financial results being reported today. As usual, we have allotted one hour for this call. Presenting from the management side today will be Kevin Kim, Hope Bancorp's President and CEO; and Doug Goddard, our Chief Financial Officer; Chief Credit Officer, Peter Koh is also here with us today and will participate in the Q&A session. With that, let me turn the call over to Kevin Kim. Kevin?

Thank you, Angie. Good morning, everyone and thank you for joining us today. In the second quarter, we had our strongest quarter of business development since the completion of our merger of equals last year, reflecting the progress we are making in integrating the two companies and improving our execution at all levels of the organization. We generated $40.7 million in net income during the second quarter or $0.30 per diluted share compared with $36.2 million or $0.27 per diluted share in the preceding first quarter. Excluding merger-related expenses, the increase in earnings per share was $0.02. During the second quarter, we originated $725 million in new loans, an increase of 23% from $587 million in the prior quarter. This drove a 2.5% linked quarter increase in our end of period loan balance and brought us back to the high single-digit annualized loan growth that we are targeting. Much of the loan production came in later in the quarter and our average loan balances were up just 1.5% from the prior quarter. So we should see a stronger pickup in the net interest income heading into the third quarter. Importantly, we were able to generate the higher level of loan production without compromising on our pricing or credit quality. During the second quarter, the average rate on our new loan originations was 4.56%, an increase of 31 basis points from the preceding quarter. Our current focus in business development is producing the more balanced loan mix that we are targeting. Commercial real estate loans comprised 63% of total production, commercial loans accounted for 27%, and residential mortgage loans 10%. We had 2% growth in our commercial real estate portfolio on a linked quarter basis. We saw very balanced growth across this portfolio with every major property type of between 2% to 4% with the exception of multifamily, which was down 2% in the quarter. We are very pleased that we continue to see higher levels of commercial loan production. We had $178 million in new C&I originations by our commercial lending teams in the second quarter, up from $152 million in the prior quarter. This resulted in a 5% increase in the commercial loan portfolio on a linked quarter basis. We saw good balance within our Commercial Lending Groups including our West Coast, East Coast and Corporate Banking Group all making significant contributions to the total production. Overall, we now have $2.39 billion in total credit commitments outstanding to commercial customers and the utilization rate on our lines of credit was 50% at the end of the quarter. We had a strong pick up in SBA originations in the quarter as well. Although the production of 504 loans as a percentage of total SBA originations was higher than usual. Since it is the 7(a) originations that comprised the sellable portion of SBA loans and the majority of the originations in a given quarter, a sold in the next quarter, the strong SBA production had more of a positive impact to our portfolio growth this quarter than it did to our gain on sale for the quarter. We funded $109 million in SBA loans during the second quarter with nearly $66 million being sellable 7(a) loans. This compares with $80 million in the originations in the preceding first quarter with $52 million being sellable 7(a) loans. Our Residential Mortgage Group also saw a higher level of production, consistent with the seasonally stronger second quarter. We had $71 million of direct mortgage originations, up from $58 million last quarter. At this point in the interest rate cycle, most of our production continues to come from the purchase market rather than refinancing. As a result, we expect our consumer residential mortgage originations maybe at lower levels than our historical performance due to the current market trends. Given the preferences of the customer base that we serve in the purchase market, our current production is heavily weighted towards the 51 and 71 adjustable rate mortgages that we retain on our balance sheet. So as with our SBA production, our residential mortgage production this quarter had more of an impact on our portfolio growth than our gain on sale. Our overall consumer portfolio, which includes a residential mortgage loans increased 10% on a linked quarter basis. With that, as an overview of our business development effort. Let me turn the call over to Doug to provide additional details on our financial performance in the second quarter. Doug?

Thank you, Kevin. As I begin the review of our second quarter results, I will limit my discussion to just some of the more significant items in the quarter, since we provide quite a bit of detail in our press release. I'll start with a net interest margin. On a reported basis, a decline by 2 basis points to 3.75%. With the recent increases in the prime rate as a result of two Fed rate increases since December, we had a 9 basis point increase in our loan yields when compared to the preceding quarter. However, this was not sufficient to offset the impact of the higher funding costs, a large part of which was attributable to the runoff of the beneficial impact of purchase accounting adjustments on our liabilities. This accounted for approximately 9 basis points of the increase in our funding costs relative to the preceding first quarter or roughly two-thirds of the increase. In the next few quarters, we do expect some continued pressure on our net interest margin from declining purchase accounting, but we believe we will be able to offset deposit pricing pressure with improving loan yields. Moving to non-interest income most of the major items were relatively consistent with the prior quarter with the most significant variances coming within the other income line item. Last quarter, our non-interest – other income included higher than usual swap income of $963,000 versus $481,000 in the current second quarter. In addition, we recognized as other income recoveries from pre-merger fully charged-off acquired loans of $1.1 million in the preceding first quarter versus only $210,000 in the current quarter. As Kevin mentioned, we had stronger production of both SBA loans and residential mortgage loans. But due to the mix of production, our net gain on sale income was fairly similar to last quarter. We sold $46 million of SBA loans in the quarter with an average premium of 9.2% before broker commissions. This compares with $45 million of SBA loan sales in the preceding quarter with an average premium of 8.85%. Turning to non-interest expense. We had a few notable variances from the prior quarter. Our advertising and marketing expense declined by 30% primarily due to the impact of our new LPGA title sponsorship that was fully recognized in the first quarter this year. Going forward, these expenses are being accrued throughout the year, so we would not expect a significant swing as we saw in the preceding quarter. Our data processing and communication expanse declined 26% from the preceding first quarter. This was attributed to a number of factors including we recognized a credit in the current quarter of approximately $380,000, which is a one-time event following the renegotiation of a contract with the former Wilshire vendor. And two, we had decreases in item processing in ATM debit card processing expense is largely related to our branch consolidations in 2017. Excluding the impact for the one-time credit, we believe our current data processing and communications expense represents a fair quarterly run rate for the foreseeable future. Our professional fees declined by 21% from the first quarter, as you may have noticed from our Form 10-Q for the first quarter, which was filed with the SEC on July 20, 2017. The amount of professional fees for the first quarter was higher by approximately $1.3 million compared with what we reported previously on our earnings release and conference call. This was due to the recognition of audit fees that were finalized and received late in the second quarter, but for services in earlier periods. And lastly, our credit related expanse swung to the recognition of $88,000 of income this quarter. This is always a volatile line item with this quarter being positively impacted by the timing of REO related expenses and valuations. Now that we are substantially through all of the MOE integration, we believe we have achieved the cost saves that we projected for the combination of the two companies. However, we continue to invest a portion of these cost savings to strengthen our infrastructure as well as support our new business development initiatives. We have a number of projects in the second half of 2017 much of which is related to the meeting of the higher regulatory requirements and we would also expect an uptick in merger-related expenses for the upcoming U&I Financial transaction. Despite the recent branch consolidations, our FTE account increased to 1,378 as of June 30, 2017 from 1,352 as of March 31. This is just one example of the investments we continue to make in our workforce. As a result, we expect our non-interest expenses will run higher in the second half of this year before moderating back down to levels that will help us meet our targeted efficiency ratio goal of mid-40s in 2018. Moving on to asset quality. We saw some increase in our problem loan categories, but a low level of credit losses in the quarter. Our non-performing assets increased by approximately $19 million in the quarter. However, earlier this month, we received a full payoff of a little more than $5 million on a non-performing loan, so we've already seen an improvement of NPAs during the third quarter. Out of the new non-performing assets roughly half of this new inflow is coming from two larger credits. One of the hotel commercial real estate properties that is on non-accrual and one is a C&I loan that is a TDR. We believe we are properly reserved for both of these loans. Beside from these two larger credits, the remaining inflow of NPAs are much smaller credits. Our total criticized and classified assets increased by approximately $30 million, but the increase was predominately in the special mentioned category. We don't see anything systemic in the loans that were downgraded to indicate any broader issues within the portfolio. And we believe that the longer term trend will continue to be towards a lower level of problem assets. We had just $1.3 million in net charge-offs in the quarter. Due to the low level of credit losses, our quantitative reserve requirements dropped a bit in the quarter which had a favorable impact on our level of provision expense. We recorded a provision of $2.8 million in the quarter which kept our allowance to total loans ratio were essentially unchanged from the prior quarter. With that, let me turn the call back to Kevin.

Thank you, Doug. Looking ahead to the remainder of 2017, we are optimistic that we can continue our momentum in business development. Over the past few months, we have made some adjustments within the organizational structure to enhance our focus on generating new business. And we anticipate seeing the impact of these changes not just in the coming quarters, but for years to come supporting our continued growth. We are also actively adding new talent to the Bank that can positively impact our growth and diversification. The most significant recent step was the addition of Steven Canup to head our new Institutional Banking Group. The ability to attract Steven to the Bank and to form an Institutional Banking Group was a direct benefit of the increased size and scale we have following the MOE. We now have the capital base lending capacity and treasury management capabilities to effectively service the larger commercial enterprises that comprise the target customer base of this group. We anticipate that the formation of the Institutional Banking Group will provide a number of benefits for us. It provides an incremental source of balance sheet growth. It will be focused on supplementing our efforts to lend to larger commercial credit, which should improve our overall diversification and reduce our CRE concentration, and it will generate lower cost transactional deposits that should reduce our reliance on more costly CDs. We anticipate the Institutional Banking Group will make a meaningful contribution to both deposits and loans over the second half of the year. With this contribution and the healthy pipeline we have in our traditional lending areas, we believe we are well-positioned to maintain high single-digit annualized growth rate in loans that we are targeting. With regard to the previously announced acquisition of U&I Financial Corp., as a result of our delayed 10-K filing, we expect the completion of the transaction will also be delayed towards the end of the year over early 2018. As most of you should have noticed, the Company filed its Form 10-Q for the first quarter of 2017 on July 20. As a result, we have received confirmation from NASDAQ that we are now back in compliance. And as previously guided, we expect to be timely with our quarterly SEC filings going forward. And finally, we announced last week, an increase in our quarterly dividend from $0.12 to $0.13 per share. This represents our fifth consecutive annual increase in our cash dividends and exemplifies our Board's commitment to continuously enhance shareholder returns. This dividend increase also underscores our Board’s confidence in the long-term growth prospects of the Company as the only super regional Korean-American bank in the U.S. As both organic and acquisitive growth strategies add quality assets to the Bank, we anticipate a positive impact on our level of profitability going forward. With that, let's open up the call to answer any questions you may have. Operator, please open up the call.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Matthew Clark of Piper Jaffray. Please go ahead. Matthew your line is now open.

First question just on the loan growth, nice pickup at quarter end and fairly broad base. It sounds like high single-digit is what you anticipate to sustain going forward, is that fair?

Yes. That is true. As you saw in the second quarter, it has grown nicely in the double-digit range and I think it should support the high single-digit annualized growth that we are targeting.

Okay. And then in the gain on sale revenue, how much of that was single family residential if any?

It’s the other gain on sale, so roughly little under 400…

I see it. Thank you. Sorry about that. And then I guess the upward pressure on expenses in the second half of this year, can you suggest maybe a run rate that you think we might gravitate into before we see some moderation next year?

Yes. There's a lot of moving parts in there obviously and as a result of all the moving parts went through sort of reforecasting internal process and I'll break into two pieces. We do have the U&I merger coming up, so merger-related expenses will probably cause a spike of maybe 2% of the efficiency ratio in the quarter that closes. Borrowing that the current run rate of expenses and efficiency ratio are actually pretty close that where we are in the second quarter. And the reason it's not getting down to what we’ve previously guided in terms of mid-40s as soon as we thought is a lot of one-time projects we’re identifying that are going to hit the second half of the year. And those relate to not always some new business units that are starting up, which Kevin referred to, but some more expenses related to things like – it had stress testing related to DFAST and credit modeling and some of the infrastructure. So an extra $4 million or $5 million of sort of project related expenses that are going to hit the second half of the year, we believe we're going to hold that efficiency ratio up closer to the current level excluding merger expenses, delaying when we get back to the mid-40s to the start of next year.

Okay. And then [indiscernible] on the core margin and the increase in deposit costs, it sounds like obviously purchase accounting contributed two-thirds of the increase. But as you think about your deposit promotions and kind of the competition in and around you, how should we think about the upward pressure on deposit costs. And it also looks like new production is coming in and around the core – right on top of the core loan yield. So you know probably some additional benefit of repricing, but just trying to get a sense for what the incremental change in assets and deposits might be?

Yes. I'm going to answer those in a reverse order. On the asset side, we are seeing some upward tick in loan yield as things reprice and as we have some inflow of loans are higher than the coupon rate in the portfolio. That spread is a little higher than that in the investment portfolio with a new purchases and repricing to the investment portfolio are noticeably higher than our current portfolio. On the deposit side, the good news on the purchase accounting benefit we're losing, we have very little left to lose there. We will lose about another 3 basis points in the third quarter for purchase accounting benefit and then that's it on the Wilshire deal it's gone and that will then be able to stabilize. With the other cost of deposits where we're seeing the most movement is on retail CDs. On that piece of it, we’re definitely seeing repricing full under $600 million or so of retail CDs that will reprice in the quarter. We'll see a definite uptick of anywhere from 15 basis points to 20 basis points in some of those. Overall that drives the increase in overall cost of deposits in the neighborhood of 2%. We think we can offset. And if I factor in the rest of the liabilities – liability side of the balance sheet, I'd say the cost of funding could go up 2 basis points to 4 basis points in the next quarter. And we expect to be able to offset a fair amount of that on the offset side such that the core NIM excluding the purchase accounting is really fairly unmoved right now. Hope that wasn’t too long an answer?

And I guess how much in accretion on the deposits is left [in coming quarter]? You said 3 basis points. I can calculate it.

It's about $800,000 we’ll get. Well, how much is left for the third quarter? There's about 250 left for the third quarter.

Got it. Thank you.

Our next question comes from Chris McGratty of KBW. Please go ahead.

Hi, thanks for taking the questions. Doug just following up on the margins, the 3.75%, can you for an apples-to-apples comparison compare that to last quarter, what the purchase accounting – I think the disclosure changed a bit. The purchase accounting benefit in both quarters were – just so we can have [that data]?

Roughly [indiscernible] basis we don't break it out into as much detail. There are very touchy rules about non-GAAP disclosures about things like margin, but currently we're running at 3.75% of which about a quarter is purchase accounting, I'm rounding a little bit. That cores up from about 3.48% last quarter.

Okay. In terms of the 30 basis point improvement in new production that's all the kind of core, that's not inclusive of any movements in purchase accounting, is that right?

No, purchase accounting was comparatively flat between quarters. The Wilshire deal is still new enough that that number is not moving very fast, it will bounce around a little bit. We will start to see that decline particularly in 2018, but I think we're in good shape to have a growth offset that.

And then maybe finally for Kevin, year into the merger, I am interested in your kind of observations both positive in areas for improvement with respect to the integration, the cost savings, the growth opportunities. Just say how you think you've done over the past year and maybe how you are going to expect to perform in the next six months? Thanks.

Well, I think the integration between BBCN and Wilshire during the past 12 months was a quite successful one. And we pretty much achieved all the cost saves that we anticipated and represented to the investment group at the beginning of the deal, but we had a lot of projects going on which resulted in higher than expected expense levels at least in the year of 2017. So I see those more like an investment for the future of this organization. And it will eventually benefit the Bank of Hope and its shareholders, and I feel very positive about that. Once we complete those investment types of expenditures, I think our efficiency will be achieved as originally expected. And for the next six months, our revenue will continue to grow, but at the same time our expenses will be there. But from 2018, I think we begin to see the real benefits of all the investments in the deal that we did during the past 12 months.

Great. Thank you for that.

Our next question comes from Aaron Deer of Sandler O'Neill. Please go ahead.

Hey. Good morning, everyone.

Good morning.

Good morning, Aaron.

Doug, I wanted to follow-up on the expense discussion here. The $45 million in additional expenses that you are talking about is that on an annualized basis or is that a quarterly number?

That's in the second half of the year.

Okay. And is that one-time in nature and is it going to dropout or is it just a – expecting that the revenues catch up to that and that's what brings the efficiency ratio…

A good part of that will dropout. I mean, I don't want to say 100%, because we do – are making some net investments on infrastructure that result in some higher headcount, but we're talking about some projects that really are kind of one-time help us finalize getting over that $10 billion hump and things like that in a variety of projects that I do believe are one-time. It's not just the efficiency ratio. That actual expense level should decline in the first part of next year.

Got it. That's helpful. And then Peter, can you maybe give us little bit more color on those two larger commercial credits that went to non-accrual. Specifically maybe what type of business it was in the C&I category and then with both of them maybe what their size was in the specific reserves carried against those?

Sure. I think about half of the NPLs are coming from those two large credits. They're actually both unrelated industries, one is a hotel CRE and there was a TDR loan of that about $5 million that was in the C&I area. So both I think I've had ample reserves and the actual calculations are coming off our impairment and basically those two loans combined are about $9.2 million, so pretty much half of it was based on those two unrelated customers. And as we noted in the third quarter, we already had some good recoveries or some collection activities on those non-accrual loans, not the two I just mentioned, but in the rest of the portfolio. So about $5 million of it already in the quarter we were able to make some progress. And just a touch upon I know on this special mention category, we also had a little bit of an uptick there as well. And there were two large CRE loans that drove that increase about $18 million of that increase in special mention category came from these two loans. And both of these loans actually are well secured and they're paying as agreed. And I think it's a reflection of just our proactive management of our portfolio.

Got it, that’s very helpful. Thank you, Peter. And maybe just one last question going back to the deposit pricing discussion. I'm just – it's interesting to see the kind of guidance to given on the CDs? Is any of that tied to some of the branch closures and just efforts to retain customers and keep them happy amidst some of the changes in the branch footprint?

Not really - I would – not even, not really, not at all, I would say. We've been in an environment where our customer base has been anticipating rate increases for the last six months and it's a bit of very competitive promotion pricing driven environment for the last six months and I haven't felt that change at all as a result of the branch closures, but it is, in fact they are still.

Okay. Good stuff. Thanks guys. Appreciate though.

Thank you.

Thank you.

[Operator Instructions] Our next question comes from Gary Tenner of D. A. Davidson. Please go ahead.

Thanks. Good morning.

Good morning.

Good morning.

I had given other follow-up I guess on the expense and efficiency question. My recollection from last quarter is that you all had talked about a low to mid 40% efficiency ratio in third quarter. Now I get why it's getting pushed out to 2018 given what you're talking about some investments for the back half of this year? In terms of not getting that efficiency ratio maybe down as low as you previously guided, is that an expense item or is that revenue item that's kind of keeping the number a little bit higher?

Well, little bit is revenue because we did have lower growth in the first half of the year than we would have hoped for just in terms of earning assets and so forth. But we've been thinking in terms of mid 40s for a while now and it really is mostly from what we're looking at in our internal forecasting the timing of some of these infrastructure expenses in the second half of the year.

Okay. Thanks. And Kevin I don't know if you build a comment at all on Steven Koh is stepping down as Chairman of the Board. Any kind of changes, what does that mean [in any sense?]

Well I don't know what I can say about that, it was Chairman close long hard decision to voluntarily step down from the leadership. But he will remain as a Member of the Board and I think that we will rely on his leadership in the future as the honorary Chairman of the Board and also as a Director of the Board. His influence in the community is really big and I think he will continue to serve as a good Ambassador of the bank in the community and I hope there will continue for a long time to come.

Okay. Thank you. End of Q&A

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Okay. Thank you, everyone. Thank you again for joining us today and we look forward to speaking with you again in three months. Thank you.