Hope Bancorp, Inc. (HOPE) Q3 2017 Earnings Report, Transcript and Summary

Good day, and welcome to the Hope Bancorp Third 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, Andrew. Good morning, everyone, and thank you for joining us for the Hope Bancorp 2017 third 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. These statements are based on current expectations, estimates, forecast and projections and management's assumptions about the future performance of the Company, as well as the businesses and markets in which 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. 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. 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 September 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 Alex Ko, our Chief Financial Officer; Chief Credit Officer, Peter Koh is also here with us today and will participate in the Q&A session. Now, before I turn the call over to management, I would like to announce that our CEO Kevin Kim has been appointed to the CSBS Banker's Advisory Board. The Conference of State Bank Supervisors or CSBS, its a nationwide organization of banking regulators from all 50 states, the District of Columbia, Guam Puerto Rico and the U.S. Virgin Islands. The CSBS has a longstanding bankruptcy advisory board to benefit from the perspective and experience of state chartered banking institutions. Members of the banker’s advisory board are recommended by their home state commissioners and appointed by the CSBS Chairman in consultation with the CSBS executive committee. Kevin Kim will be the only banker representing the state of California on behalf of everyone at Bank of Hope. We congratulate him on his appointment to the banker’s advisory board. 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. We had a solid quarter with positive trends across most areas of the company. Relative to the preceding second quarter, we had higher revenue, improvements in our net interest margin and stable expense levels. This was partially offset by higher provision expense. We generated a record $44.6 million in net income during the third quarter or $0.33 per diluted share. This represents a 10% increase when compared with $40.7 million or $0.30 per diluted share in the preceding second quarter. While revenue trends were positive, our overall new business development in the third quarter was lighter than expected considering the strength of our pipeline as we entered the third quarter. The volume of commercial real estate transactions in our markets has softened a bit with growing uncertainty about the administration's deregulation and tax reform, geopolitical concerns and the adverse impact of asset inflation, all of which seem to be pressuring the inventory of potential transactions, as well as negatively impacting the completion of deals. We booked $728 million dollars in new loan commitments during the 2017 third quarter and funded $611 million in new loans. This resulted in organic loan growth of $147 million in our end of period loan balances versus June 30th 2017. I'm pleased to report that the overall mix of production continues to trend toward the higher level of diversification that we are targeting. Commercial real estate loans comprise 59% of total production in the quarter. Commercial loans accounted for 21% and consumer loans comprised primarily of residential mortgage loans accounted for 20%. With the lower contribution of commercial real estate production this quarter, the size of our CRE portfolio was relatively unchanged from the prior quarter. Substantially all of the growth we had in the total loan portfolio in the third quarter came from commercial loans which increased 4% and mortgage loans which increased 15%. We had $190 million in new C&I originations by our commercial lending teams in the third quarter. Overall, we now have $2.37 billion in total credit commitments outstanding to commercial customers. The utilization rate on our lines of credit was 53% at the end of the quarter, which is up from 50% at the end of the preceding second quarter. Looking at our SBA business, we funded $67.9 million in SBA loans during the third quarter with nearly $50 million being sellable 7(a) loans. While the pipeline for our SBA business was very strong entering the third quarter, we saw a good deal of borrower hesitation in light of growing economic uncertainties and concern about asset inflation. This had an adverse impact on the volume of loans that closed during the quarter. On the other hand, our residential mortgage group had its most productive quarter since the merger. We had $190 million of direct mortgage originations, up from $71 million last quarter. We have added some new members to our loan production team which contributed to the higher production levels. With the larger team in place, we believe this higher level of production is sustainable, although we still expect to see the typical seasonality in the fourth quarter. Most of our mortgage production continues to be weighted more toward the 5:1 and 7:1 adjustable rate mortgages that we retain on our balance sheet, which drove the strong growth we saw in our residential mortgage portfolio this quarter. And given the overall higher level of production, we also recognized an increase in gain on sale of residential mortgages this quarter. Our leverage rate on new loan originations has been steadily increasing over the last year. The decline from the preceding quarter to 4.40% primarily reflects a shift in the mix of new originations with an increase to contribution from our lower yielding to residential mortgage loans and lower contribution from our high yielding SBA loans. While loan pricing continues to be very competitive in our markets, the overall yield at which we are adding new CRE and commercial loans have been consistently positive over the last year, compared with the third quarter of 2016 our average rate on new originations increased by 37 basis points despite the high mix of consumer loans in 2017. On our last call, we discussed the formation of our Institutional Banking Group or IBG, which targets loan and deposit relationships with larger commercial enterprises. We are pleased to report that we are seeing positive initial results from this group. During the third quarter, the IBG brought in more than $250 million in new deposits, primarily flowing into money market demand accounts. The success in their deposit gathering allowed us to positively shift our mix of deposits toward lower cost categories in the quarter. That completes my overview of our business development efforts for the quarter. Now, as previously announced, our former Chief Financial Officer Doug Goddard retired at the beginning of this month. Fortunately for us we had the benefit of having two experienced financial executives during our first year following the merger. Alex has been an integral member of our financial team from the beginning and we are fully confident in his ability to lead our team through the next phase of our growth. With that, I would like to welcome Alex to provide additional details on our financial performance for the quarter. Alex?

Thank you, Kevin. As it has been the practice in the past, I will limit my discussion to just some more significant items in the quarter. I will start with our net interest margin, which increased by 8 basis points to 3.83%. The increase was mainly due to an 18 basis point increase in our average loan yield. The increase in loan yields was due to the following three factors. First, the fourth quarter impact of June Fed rate increase. Second, an increase in merger related accretion income of $1.3 million, due to an increase in pay off of acquired loan. And third, recognition of $2.6 million of interest income relate to the recovery of an acquired loans that had been charged off. The benefit of increases in loan yield on our margin was partially offset by a 9 basis point increase in our cost of interest bearing deposits. The increase in our cost of interest bearing deposit was mainly due to the run off of the beneficial impact of purchase accounting adjustments on our time deposits. Excluding the impact of purchase accounting estimate, our net interest margin increased 9 basis points in the quarter, mainly due to the higher average loan yield. Moving to non-interest income. Most of the major items were relatively consistent with the prior quarter. The largest variance on the positive side was $495,000 increase in gain on sale of residential mortgage loans, due to a higher volume of loan sold in the quarter. On the flip side, the largest variance was 700,000 decline in our other income entities. This was mainly due to a lower level of a swap income and a lower level of recoveries from pre-merger fully charged-off acquired loans relative to preceding second quarter. Turning to non-interest expenses. We had a few notable variances from the prior quarter. Our salaries and employee benefits expenses increased by $1 million due to mainly an increase in a full time equivalent of 85 people. These hires were spread across the company both in the back office support and customer facing roles, such as build out of the Institutional Banking Group and our residential mortgage production chain. Our data processing and communication expenses increased $545,000 as [indiscernible] will normalized level after the recognition of a large credit last quarter. We have a 510,000 decline in ORE [ph] expenses due to a decline in valuation allowances. And the largest variance was in our credit related expenses. As we reduced our off balance sheet provision for unfunded loan commitment by $2.8 million dollars, the reduction was mainly the result of updated information for our estimation of off balance sheet unfunded commitments. Now, I would like to update our guidance on expectations for higher non-interest expenses related to special projects that we discussed last quarter. We now expect the product related fee will be approximately $6 million in aggregate and will be realized for three quarters through the 2018 first quarter. The current third quarter, our non-interest expenses included approximately $1.6 million in cost associated with these projects. Looking at our balance sheet. Kevin I've already discussed the major trend we saw in loans and deposits. But I would like to just note that we have made slight modification to how we are reporting origination volumes. The $611 million in new originations include $38 million in construction loans that were previously committed to in previous quarters funded this quarter. In the past we had only included in our reported construction origination volumes that were booked and funded in the same quarter. However, construction loans are also funded in the subsequent period. This resulted in construction loans not being adequately reflected in our origination volume. While the construction lending is not a sizable portion of our overall businesses, we did want to make it clear to you that we are making this change beginning this quarter. Now moving on to other areas of our financial results. Our FHLB borrowings increased $225 million from the end of the prior quarter. This was mainly due to overnight funding we took on to manage period end fluctuations in our warehouse line of credit. Moving on to asset quality, our non-performing assets to total assets declined by 1 basis point to 89 basis points during the quarter, while we saw small variances in non-accrual loans and the critical loans, I'm sorry criticized loans, as well as delinquent loans are nothing particularly meaningful. Our total loss experience continues to be very low. With net charge offs representing just 7 basis points of average loans in the quarter. We've recorded a provision for loan losses of $5.4 million in the quarter, which was largely driven by our qualitative adjustment. As a result of increase provision for loan losses s is this quarter, our allowance to total loss ratio increased 2 basis point to 76 basis points from the end of the prior quarter. With that, let me turn to call back to Kevin.

Thank you, Alex. Looking ahead, we expect to see a continuation of the positive trends we experienced in the third quarter. Although the commercial real estate market remains somewhat sluggish, our pipeline looks strong heading into the fourth quarter. We expect our C&I and residential mortgage lending to continue to drive growth in our loan portfolio. Our expense levels will increase a bit due to our project related costs in the next two quarters before we see a return to a lower efficiency ratio during 2018 and given the general stability in our asset quality, our credit costs should remain well-controlled. Collectively, this trend should result in a consistent level of earnings performance going forward. A full year following our transformational merger Bank of Hope has surpassed $14 billion in total assets. I'm confident that the investments we are making in our organization today will support sustainable growth and profitability for many years to come. And I look forward to keeping you apprised of our progress. With that, let's open up the call to answer any questions you may have. Operator, please open up the call.

[Operator Instructions] The first question comes from Aaron Deer of Sandler O'Neill & Partners. Please go ahead.

Good morning, everyone.

Good morning.

I'd like to start on the question on the deposit costs. Alex, could you repeat where was the core deposit costs for the quarter and how did that compare to the prior quarter and to the extent that you guys are feeling any deposit pricing pressure, are you seeing an increase in the beta's [ph] and would you anticipate that deposit cost increases could accelerate from here?

Yes. Let's start with beta, we have a FHL – I am sorry, the FASB [ph] rate increase about 75 basis points for the last - since December last year and our actual deposit cost increased from 76 basis point to 103, which is about 27 basis point increase or around 36 beta. So we actually increased our deposit cost. However, there was actually accretion impact for this quarter just compared to prior quarter and this quarter, there was about 9 basis point increase in the interest bearing deposit cost. However because of the purchase accounting the discount accretion of a time deposit disappeared. We historically had about a $1 million and that had a 7 basis point impact on the increase of dollar deposit cost. But also I would like to note that there is a significant competition amongst our community. So I would expect that deposit cost will increase slightly going forward.

Okay. And then relatedly I guess on the other side of the balance sheet, I was hoping if you could provide the specific yields on new production on each of your three primary loan categories and how those are comparing quarter-over-quarter?

Yes. Our loan yield actually increased by 18 basis point and there is a kind of purchase accounting related, as well as a one time nature embedded in that 18 basis point increase. First of all non-accrual loan from former center bank that's about $1.3 million. We had a impact on the interest income and also purchase accounting adjustment, we did have a pay off of former center and [indiscernible] loans, we have about $2.6 million. That did have actually impact on the loan yield about 10 basis point. And also actually at the core wise, we have a full impact of the churn rate increase, those actually helped about $2.3 million or 9 basis point increases. So you know, just adding all those together you know, purchase accounting related and also non-accrual income we expect about 9 basis points increase out of the 18 basis point increase comes from. And the remaining, we believe is a core increase comes from the rate increase that we observed in June.

Okay. That's helpful. And in terms of the average on a portfolio, like I guess, what I'm more curious about is in terms of new production or just particularly given the mix shift that you guys are seeing as you are doing more on the C&I and the residential side, what kind of impact that's going to have on the average yield going forward based on the production. I am curious how did the production in the third quarter if you could give what the new loan yields were rates on that new production for each of the three categories, so commercial real estate, C&I and residential?

Sure. Let me start with mortgage loans that we originate for the third quarter. It does have about 3.36% of the loan. For the quarter, we have a higher increase on the mortgage loans, which did have actually lowered a little bit of our overall average loan yield. Going forward, considering that we have added more people in mortgage department, we expect the mortgage loans will continue to increase. And the CRE actually - we have about $350 million of a CRE loan origination which is obviously higher than our mortgage rate about 4.73% rate. And SBA we have the highest rate of 5.6%. So in the mixture of the loan portfolio, as we expect more C&I loans and mortgage loans, we might see a little bit loan yield decrease going forward.

Okay. That’s helpful. Thank you.

This is Peter. Aaron, I just wanted to add on that as well. I don't know if you're still there, the C&I part, I think most of those rates are going to be variable as well versus the CRE which is relatively more sided with the fixed rates. And so even that the initial yields are a little bit lower, I think there is some benefit there for having more variable rate loans.

Understood. That's helpful. Thanks, guys.

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

Good afternoon, everybody. I just wanted - if I could just follow up on the margin questions, if we kind of balance the one timer in terms of the interest reversal and the purchase accounting benefit with the benefits of the Fed. How should we be thinking about – I know disclosures have changed a bit, kind of the margin for the fourth quarter when you kind of boil it all down?

Sure. You have some onetime nature or and high accretion income in Q3 compared to normal quarters assuming there is such one time and higher accretion income in Q4, the report is net interest margin will decrease slightly maybe. However the core in that interest margin we expect to be stable or slightly increased concerning the rate that we currently offer and I don't think that there will be a December – as expected December Fed rate increase we will have a significant impact in our margin going forward because it's in December expected.

That’s helpful. Thanks. If I could on the expenses too, obviously the control – the cost control is pretty good this quarter. You talked about the $6 million I think last quarter was like 4 or 5, as you kind of look through what's already been in the run rate, just to make sure I got the comments appropriate. The level of dollars of expenses from here over the next couple of quarters. Can you just help frame a little bit better in terms of you know, are we going to be in the mid to high 60s, $60 million a quarter and then kind of levelling off to get [indiscernible] maybe back half of next year, I am just trying to be correct or right?

Yes, this quarter actually we have about $1.60 million included as special project. We would expect to continue next two more quarters. That kind of aggregate above like a $60 million of the total project related. Here what I mean by the product related is our investment to make it fast and either compliance and expenses that is related to the $10 billion plus cost and we are actually working on to be prepared. So we are investing those in expenses. However, starting the second quarter of next year we expect those investments will be substantially completed. So about like a $3 million reduction expected starting second quarter of 2018. However we will have some increase on the salary and the benefits as we grow. So I think the run rate for the fourth quarter and Q1 2018 will be around like $65 million to $66 million and starting second quarter of next year it was down so about like $64 million to $65 million.

Okay, that's helpful. Thank you very much. And then maybe on the tax rate going forward. Obviously this is good - is this a good run rate for the future aspect, assuming we don't get anything out of Washington?

Yeah. Obviously unless the corporate rate substantially decreases 20% our expected tax rate for 2018 will not be substantially decreased, but we are actually doing some analysis of what kind of tax saving strategy we can come up with. So from the 38.4% or three percent currently I would expect that will decrease a little bit, but it depends on the actual tax strategy that we come up with. But I would expect to slightly reduce in 2018.

All right. Thank you very much for the color. I appreciate it.

The next question comes from Matthew Clark of Piper Jaffray. Please go ahead.

Hey, good morning. I wanted to follow up on your commentary around the commercial real estate environment and the related growth and thinking about loan growth overall. You know, I think in the past you guys have targeted high single digits. But it seems like things may have changed particularly since the deal was announced. Just curious if I can get your updated thoughts on loan growth.

Okay. Matthew this is Kevin. Let me first talk about the high single digit loan growth guidance that we gave you last quarter. We had given guidance for high single digit loan growth going forward basis from the second quarter and over the past 2 quarters including the second and third quarter of 2017, we have had approximately 4% growth in our loan portfolio, which can be annualized to 8% percent. So we believe we are on target or we are on track with the annualized pace of high single digit loan growth that we target. And going back to the question of CRE concentration and how it would impact our CRE loan production. I don't think there is any impact on our CRE production coming from our CRE concentration. Our new CRE loan production is driven mainly by our credit decisions and I don't think it is driven by any effort to manage our CRE ratios. With the proactive monitoring and risk management programs we have put in place, we feel comfortable continuing to grow see our CRE portfolio.

Okay, great. And then on the provision a little higher than expected, it looked like it's partly related to that migration and criticized. Can you talk to them what migrated this quarter and your outlook from here?

Sure. This is Peter. The provision expense came out a little slightly higher, but I think if you look at the last two quarters, the second quarter and third quarter of this year, I think we're kind of on track in terms of what we would expect from an annualized basis. We did have some increase in substandard loans this quarter, but none of that was really from any new loans. These are all previously identified loans which we had already identified as special Mention. So we did have some migration from Special Mention to substandard and a majority of those loans are actually real estate secured loans which have well secured collateral. So we see very low loss potential from that migration. And ultimately I think overall asset quality looks pretty clean still. So we are proactively monitoring and managing the portfolio and I think we're looking good.

Great. Thanks.

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

Thanks. Good morning.

Morning.

Kevin, I'm a little confused by your comments on loan growth. A moment ago you said that you know – on the second quarter call indicated you thought you'd hit 13% growth rate for the remainder of the year and now you're kind of using the second and third quarter combined growth rate to suggest you're on pace for that, but this quarter's growth was quite a bit less and it looks like the commercial real estate growth outlook is not quite as strong given what you had discussed in terms of some kind of a reduction in activity in that space. So if could you talk about given where we are now how things lay out for the fourth quarter and how maybe that is different from where you thought things were in July?

Well, we have a very strong pipeline entering into the fourth quarter. So we expect a solid fourth quarter in terms of loan growth. And when we discussed a high single digit loan growth in the second quarter, we were discussing the growth rate on a going forward basis not retroactively starting from the first quarter of 2017. And so, I believe the fourth quarter production although it is a seasonally less productive quarter, we believe the fourth quarter production will be much stronger than the third quarter production that we reported. So in terms of our loan growth on a going forward basis, the high single digit growth expectation is still good and we believe that is quite achievable number.

And you think is achievable for this year on a full year basis or no?

Yeah we were talking about on a going forward basis from the second quarter. So we had very little increase of loan growth from the first quarter to the second quarter. So - and that was a - that was not a typical quarter for us. So our discussion was on a going forward basis from the second quarter of 2017. So if you are talking about the whole 12 months of calendar year 2017, the high single digit number may not be applicable.

Right, fair enough. Okay. And then in terms of the change and in your disclosure on production or the origination levels, could you give us Alex based on the 6% [ph] I think you reported for this quarter, kind of what the apples-to-apples would have been last quarter on your new method?

Sure. We included subsequent draw down in our origination and Q3 we did have a $38 million construction loans just to apples-to-apples comparison. The second quarter we have a $44 million of construction loan. They could have included.

Right. So you would have that $44 million in the second quarter, to what you have previously disclosed of the 725? Is that the right way to think that?

Yes. That’s correct.

Okay. All right, thank you.

Sure.

The next question comes from David Chiaverini of Wedbush Securities. Please go ahead.

Hi, thanks. A question on the strong pace of new hiring, should we expect the ramp of new hires to continue at that - at this elevated pace over the next couple of quarters and is this related to the special projects that you're talking about?

David, in terms of a question whether we expect to continue to hire this many people in the coming quarters and the answer is no. We expect to continue to hire more people, but those people will be more likely to be the people in the frontline for business generation purposes. In terms of our people back in the support functions, I think we have pretty much hired the people that we would need to enhance our risk management infrastructure. Obviously there will be more people coming in the future. But that is not you know anywhere near the numbers that we hired in the third quarter.

Thanks. And then shifting gears to deposits. Can you talk about the outlook for deposit growth in any new strategies you may be implementing to drive growth there?

Sure. The deposit growth, as we discussed during the remarks, we do have a Institutional Banking Group in assets of $215 million this quarter and those deposits actually core deposits and we expect those deposit from Institutional Banking Group will continue the next several quarters. On top of that, we have fully utilizing our branch networks, kind of diversifying each different areas, offering different rates. So we would expect to see improvement from the retail, especially from the branch network in addition to Institutional banking Groups deposits. So the cost that we actually have on the Institutional Thinking Groups deposit was lower than the other broker CD or other race. So in terms of cost wise from the retail branch side we will offer a good way to our VIP or good customers, we’ll be competitive. So there might be a little bit of uptake on the deposit cost to retain and sustain our growth on the loan side. And we will also supplement that with the institution banking and also the funds available. So there will be a little bit increase on deposit cost of all.

One thing that I would like to add to what Alex just said, in addition to our retail banking efforts on Institutional Banking Group, we have increased our C&I productions and through the C&I relationships we hope to be able to bring in a lot more deposits, operating fund type of deposits with our enhanced capabilities and the Treasury Management Services. So hopefully that will be one of the contributor to enhance our deposit situation in the coming quarters.

Okay. And my last question is housekeeping, I think I may have missed it, but what was the core margin in the third quarter?

It will be more excluding those accretion and the other onetime nature. It was about 3.43% which was compared to previous quarters slight increases.

3.4. I thought last quarter it was about 3.5, in the first quarter I thought it was you know 3.49, so 3.43 sounds like it’s a bit of a decline?

Yeah, there is two different natures one time or exclusion, you know, just pure kind of purchase accounting exclusion versus there was excessive kind of pay off related. So you're correct, it was about 3.5, but you know, excluding other compared to like apples-to-apples comparison because Q3 we did have additional onetime nature, just purely apple-to-apples comparison. It will be 3.42% in the last quarter compared to a slight increase in this quarter.

Okay. Thanks very much.

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

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