Hope Bancorp, Inc. (HOPE) Q4 2017 Earnings Report, Transcript and Summary

Good day, and welcome to the Hope Bancorp Fourth 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 for Hope Bancorp. Please go ahead.

Thank you, Phil. Good morning, everyone, and thank you for joining us for the Hope Bancorp 2017 fourth 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, projections and management’s assumptions about the future performance of the company, as well as the business 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-K for the quarter ended December 31, 2017 could differ materially from the financial results being reported today. In addition, some of the information referenced on this call today are non-GAAP financial measures. Please refer to our 2017 fourth quarter earnings release for the reconciliation of GAAP to non-GAAP financial measures. 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. 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 completed our first full-year of operations as the representative bank of the Korean-American community with a solid performance on numerous fronts and a quarter that reflects the consistency in our execution and business model. Relative to the preceding third quarter and looking at the core operating performance of the company, we had higher revenue, increased loan production volumes and positive trends in credit quality, although, this was somewhat offset by higher expense levels. We reported $80 million in net income during the fourth quarter, or $0.13 per diluted share. This includes a $0.19 per share impact from the revaluation of our deferred tax assets and our low income housing tax credit investments, or LIHTC, due to the recent reduction in federal corporate tax rate. Excluding this impact, our earnings per share would have come in at $0.32 for the fourth quarter. New loan originations topped the preceding quarter volume of $611 million, totaling $664 million for the 2017 fourth quarter. This resulted in net growth of $140 million in our end of period loan balances versus September 30, 2017. We continue to see an improved mix of loan production. Commercial real estate loans, including our SBA CRE originations comprised 58% of total production in the quarter. Consumer loans comprised primarily of residential mortgage loans accounted for 29% and commercial loans, including our SBA C&I production accounted for 13%. Overall, CRE loan demand continues to be softer than a year ago. The appreciation that has occurred in CRE assets has contributed to a lower level of inventory available in the market. Investors are also taking a more cautious stance in the current environment. As a result, the majority of our recent CRE loan production consist of refinancings. Turning to residential mortgage originations, we continue to successfully scale this business unit. In the fourth quarter, we had our highest level of loan production to date with $193 million in direct mortgage originations, up from $111 – $119 million last quarter. With additional loan production officers added in 2017, we are getting deeper penetration of the housing market in California. Most of our mortgage production continues to be weighted more toward the 5:1 and 7:1 adjustable rate mortgages that we retained on our balance sheet. Our consumable portfolio, which predominantly consist of the residential mortgage loans increased to 24% from the end of the prior quarter and 60% for the full-year. At the end of 2017, consumer loans accounted for nearly 6% of total loans, up from 3.8% at the end of 2016. And with the higher production volumes, the levels of gain on sale of residential mortgage loans ramped up nicely in the second-half of 2017, providing more diversification within our overall revenue mix. Looking at our C&I lending business, we had $75 million in new originations by our commercial lending teams in the fourth quarter. As of December 31, 2017, we had $2.34 billion in total credit commitments outstanding to commercial customers. The overall utilization rates on our lines of credit was 50% at the end of the quarter, which is at the same level as the end of the preceding quarter. In terms of commercial loans outstanding, we had a reduction of $58 million from September 30, 2017, due primarily to lower utilization of warehouse lines of credit. Looking at our SBA loan production volumes, which is included as part of the respective CRE and C&I volumes just discussed, we funded $66.7 million in SBA loans during the fourth quarter, which was relatively consistent with the preceding third quarter. However, in the 2017 fourth quarter, 100% production was sellable 7(a) loans. The average rate on new loan originations was 4.42% for the fourth quarter, up slightly from 4.40% in the preceding third quarter. Without going into specifics by product type, the average rate on new CRE commercial and residential mortgage loans all picked higher in the fourth quarter, reflecting the rising interest rate environment. However, the higher mix of lower yielding residential mortgage loans had the effect of mitigating the increase in our overall average rates on new loans. With that as an overview of our business development efforts, I will ask Alex to provide additional details on our financial performance for the fourth quarter. Alex?

Thank you, Kevin. As I review our financial results, I will limit my discussion to just some of more significant items in the quarter. I will start with our net interest margin, which increased by 1 basis point to 3.84%. Similar to last quarter, we had additional income related to acquired loans that was one-time in nature and resulted in additional discount accretion income of approximately $3 million in the fourth quarter, which helped to keep our reported margin relatively stable. We do not present any meaningful one-time events that would impact our interest income in the first quarter of 2018. Without this positive impact and since we are expecting deposit cost to continue increasing in a rising interest rate environment, we would expect to see some pressure in our net interest margin in the next quarter. Moving to non-interest income. Our most significant variance linked quarter was a decline in the net gain on sale of SBA loans, which was $1 million lower than in the third quarter. We entered the fourth quarter with a lower inventory of SBA loans held for sale of $4.9 million, and the holiday season limited the time in which we could complete our execution of sales during the quarter. These two factors accounted for a lower level of SBA loan sales. During the fourth quarter, we sold $36.6 million of SBA loans, down from $49.9 million in the preceding third quarter. As a result, we ended the year with a higher inventory of SBA loans held for sale of $27.6 million. We believe this positions us well to deliver increased levels of loan sales and SBA gain on sale revenue for 2018. The lower gain from SBA loan sales was partially offset by $461,000 increase in gain on sale of residential mortgage loans, reflecting the higher level of production. During the fourth quarter, we sold $48 million of residential mortgage loans, up from $29.1 million in the preceding third quarter. The other significant variances in the quarter was $648,000 increase in our other income line item in non-interest income. This is due to a gain we recognized from the sale of a building and land, partially offset by low levels of swap income. Turning to non-interest expenses. Our non-interest expense increased by $11.2 million compared with preceding third quarter. A number of factors led into increase, many of which are one-time for non-recurring in nature. The largest factor was our salaries and employee benefit expenses, which increased by $3.9 million. $1 million of this increase was due to higher than usual BOLI expenses this quarter, resulting from an annual assessment of our fully liability conducted at year-end. Other significant factors that led to the higher compensation expense in the fourth quarter included an increase of $1.1 million in salary due to additions to headcounts we had during the third and fourth quarters. We actually had a much higher headcount increase during the 2017 third quarter than the fourth quarter. But the majority of the hires occurred late in the third quarter. As a result, the impact of these additions does not fully show up in our salary expense until the fourth quarter. In addition, we had an increase of $650,000 in the insurance costs, as well as an increase of $400,000 in commissions. We also had a few other significant variances from the prior quarter within non-interest expenses. Our other expense line item increased by $2.9 million. This was mainly due to a $3.3 million impairment we reported on our LIHTC investments from our annual valuation study. This is separate from $1.6 million LIHTC impairment that we ran through our tax provision expenses this quarter, which was purely a result of the reduction in corporate tax. Notably, we had a $3.6 million swing in our credit-related expenses. In the third quarter, you may recall that, we had a $2.8 million reversal in our off-balance sheet provision for unfunded loan commitments, which more than offset all of our other credit-related expenses that quarter. We had no such reversal benefit in the fourth quarter, and we recognized $1.1 million of credit-related expenses. And finally, our professional fee has increased by $1.3 million, which was largely driven by a variety of special project costs. Although, approximately $60 million in aggregate that we have guided was special project-related costs from the 2017 third quarter through the 2018 first quarter, we incurred $2.2 million in the fourth quarter, or $3.8 million to-date. Moving on to our tax provisions. Our tax expense this quarter included a $23.8 million write-down in the value of our DTA, as well as a $1.6 million reduction in the value of future expected tax benefit from our LIHTC investment, due to the passage of Tax Cuts and Jobs Act on December 22, 2017. Excluding this $25.4 million incremental tax charges, our effective tax rate for the 2017 fourth quarter would have been 34.4%, which predominantly reflect higher levels of tax exemptions on municipal loans in the 2017 fourth quarter. As a result of tax reform, which lowered the corporate federal tax rate from 35% to 21%, we’re projecting our effective tax rate for 2018 to be in the range of 25%. Now looking at our balance sheet. Kevin already discussed our major trends we saw in the loans, so I will start with our deposits. Our total deposits at year-end declined by $147 million from the end of the preceding quarter. This was largely driven by reduction in the amount of brokered money market accounts, as well as late quarter fluctuation in the balances of some of our large deposit customers. While our end of year deposit balances were lower at December 31, 2017 when compared with September 30, 2017, our average deposit balances both noninterest bearing and interest bearing were higher in the fourth quarter versus the third quarter. Given the volatility in our deposit balances late in the year, we increased our borrowings by $210 million before the year-end. Moving on to asset quality. We’re pleased to see the positive trends across our portfolio. Our non-accrual loans declined by approximately $10 million, or 23% and included the payoff of $4.2 million loan relationship. Other real estate loan was reduced by $6.4 million, or 37% and reflects the solid progresses that we have made in working through this portfolio. Our nonperforming assets to total assets declined by 10 basis points to 79 basis points during the quarter. Our total loss experience continued to be very low. We had $2.7 million of net charge-offs in the quarter, $2 million of which was related to one commercial loan relationships. Net charge-offs for the fourth quarter on an annualized basis represented 10 basis points of average loans in the quarter. We recorded a provision for loan losses of $3.6 million in the quarter, and our allowance to total loss ratio at December 31, 2017 was 76 basis points, which was unchanged from the preceding quarter. With that, let me turn the call back to Kevin.

Thanks, Alex. Although the 2017 fourth quarter included several non-core items that impacted our bottom line results, most notably the tax reform, we expect to recover the incremental tax charge by approximately the end of the third quarter of 2018 through lower quarterly tax provision expenses. Looking back at 2017, it was a year of important achievements in terms of successfully completing the integration and making progress toward our vision to build upon our Korean-American heritage and national presence to be a top performer for our shareholders, customers, staff and communities. At the same time, however, and admittedly, 2017 was also a challenging year for Bank of Hope, as we stood amongst a new and broader peer group of mainstream banks. Having crossed the $10 billion threshold by just a small margin, we’re subject to higher regulatory standards and requirements, and higher levels of investments in our risk infrastructure and DFAST preparedness weighed against our financial performance. We also modified our front-line organization to enhance our progress with diversifying our revenue streams and to accelerate our transformation to be a diversified financial institution. And I believe this transformation will eventually lead to stronger and healthier growth for Bank of Hope for the long-term. All of these events contributed to what I would describe as growing pains in our first full-year as a regional bank. But this growing pains are temporary in nature and to be expected at the beginning stages of new development. Importantly, we believe these changes create greater opportunities and are critical and ultimately shaping a stronger future for Bank of Hope. Constant change is the new norm in today’s business environment. What was the possibility of dramatic tax reform just a few months ago has now become reality, and one which we believe creates even greater opportunity for Bank of Hope to enhance its shareholder value. Now, I would like to take a few minutes to discuss just a couple of our strategic priorities for 2018. First, core deposit gathering will be a key priority for Bank of Hope this year, and I suspect, it will be for many of our peer banks. I expect the deposit gathering market will become even more competitive than it has been recently and will be an ongoing challenge for banks in the next few years. More than ever, we recognize that the ability to successfully maintain or attract lower cost core funding will be a critical determinant of profitable growth in the years ahead. And so we are planning to dedicate some resources to enhance our capabilities in this area of our business. And second, we will be focused on driving efficiencies throughout all levels of the organization through non-interest expense control measures. We certainly expect to see improvements in our efficiency ratio once we have passed the costs associated with our special projects. But with the constant change in the banking environment, including increasing regulatory requirements, our baseline continues to be pressured higher. With that said, I also believe we have room to improve our cost control measures, so this will be another area that we will focus on in 2018. Now, I would like to provide some thoughts on our business for 2018. In 2017, we added significant headcount to our organization. The majority of which was focused on strengthening our back office and infrastructure. In 2018, our hiring will be more focused on front-line staff and revenue producers. One area that we will be investing in is our SBA group, as we are opening a loan production office in New York City during the 2018 first quarter and are planning to open additional LPOs in other areas of the country later this year. In terms of our loan production for 2018, during the second quarter – during the second-half of 2017, we were able to generate a significant increase in the productivity of our residential mortgage business. We expect this trend to continue in 2018, and this business to become an even larger contributor to fee income with a projection for loan origination volumes to increase in the double-digit range over our 2017 production. For our SBA business, we are projecting loan origination volumes to increase over 2017 production in the range of low to mid-teens, which will of course contribute to an increase in gain on sale of SBA loans for 2018. Overall for 2018, we expect net loan growth to exceed the growth achieved in 2017, but we will refrain from providing more definitive guidance at this point in time. While we are optimistic about our pipeline for new loans heading into 2018, we believe it is appropriate to take a more cautious stance for now and wait for more clarity as to the ultimate impact of the significant tax reform on the competitive market for lending and deposit gathering. Given this more cautious stance and increasing regulatory requirements, we believe it will be prudent to update our projections for our efficiency ratio for 2018. While we are still targeting an efficiency ratio in the mid-40%s longer-term, we are budgeting for our efficiency ratio this year to be in the range of 46% to 48%. In summary, while we are taking a cautious – cautiously optimistic stance, we’re making significant enhancements to our overall enterprise risk infrastructure, and the tax reform creates potentially significant opportunity for our organization to enhance returns. Overall, we believe Bank of Hope is well positioned to further increase the value of our franchise and deliver even more to our shareholders, customers, employees in 2018 and beyond. With that, let’s open up the call to answer any questions you may have. Phil, please open up the call.

Okay, thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Aaron Deer with Sandler O’Neill. Please go ahead.

Hi, good morning, everyone.

Good morning, Aaron.

Good morning, Aaron.

I appreciate the guidance on a number of curious or that was helpful. The one area where I’d like to explore a little deeper is on the expectations for deposit pricing, and I guess, the net interest margin in general. It seems like the deposit cost ticked up a good deal here in the fourth quarter, and you’re obviously very focused on that as a priority for 2018. So I’m just curious what kind of further cost increase do you see on the deposit side as we head into 2018? And what kind of impact do you expect that to have on the margin?

Sure, Aaron. Yes, as you see, we do have a sizable increase on deposit costs, and we would expect to actually continue to increase our deposit pricing based on the overall interest rate environment, as well as competition in deposit arena. So in terms of how much it will increase, let me give you a little bit more colors of our CDs maturing next year. But we have a total sizable CDs maturing next year, about $3.8 billion, because our CD is mainly like a 12-month CD. And the rate that we see varies from 1.15% to as high as 1.5%. So it depends on the market rates going forward, let’s say three times rate increases based on our current deposit beta above overall 35, but our higher deposit beta on CD. So I would expect to have a double-digit increase of our deposit cost in terms of a basis point. And relate to that impact to net interest margin, let me give you net interest margin overall and also include the deposit component. As I mentioned, due to the reasons the cost on the deposit will have a negative impact on the pressure to the margin. But we do see, there will be an increase on our pricing on the loan side, given the rate increases, our pricing will increase slightly. And also, we do have a accretion impact for the purchase accounting, and obviously, that will be a decreasing trend. So on a reported net interest margin basis, we might see slightly reduction. But on a core basis of net interest margin, mainly increase on the loan yield offset by the deposit price increases, we would expect the core net interest margin will be kind of constant like a 3.5% or 3.6% ranges going forward.

Okay, that’s very helpful. I appreciate that. And then on the expenses, I know you gave some guidance with respect to the efficiency ratio. But I guess, just given some of the non-recurring items in the fourth quarter, I’m just trying to also get at maybe a run rate in terms of what to expense on a dollar basis. And it looks like you’re probably running around $68 million, maybe $69 million per quarter. Is that kind of the right level to think about where you’ll be here as we head into the New Year? And then is some of these current investments drop off, I think, to about $2 million or so quarterly, it sounds as though, those are going to be offset by other planned investments that are going to be made as the year goes on, is that correct?

Yes, Aaron, you’re correct. So you touched two component, efficiency ratio and also run rate for the non-interest expenses, obviously, those efficiency ratio will be the function of non-interest expenses, as well as non-interest income and other sources. So as we discuss efficiency ratio, we gave you guidance for 2017 like a mid-40% ranges. But because of the investment and special projects, we would expect to increase like a 47% or 48%. And move on to non-interest expense component, clearly, 2017 fourth quarter, we have a lot of noises, and we do believe that’s not core or is one-time nature, such as LIHTC invest – impairment of $3.3 million and $1 at BOLI post-retirement benefit obligation and other special related fees. Excluding those one-time, we would expect, as you mentioned Aaron, around like $68 million would be our run rate. And also I also wanted to echo what you mentioned, we would expect to have additional investment on the professional fees in preparation for the enhancing our infrastructures. So that can be added and probably spread throughout the remaining quarters of 2018.

Okay, great. Thanks for helping me out there, Alex, and I’ll step back.

Thank you, Aaron.

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

Hey, good morning. Thanks for taking the question. The loan growth, Kevin, you talked – you didn’t give a specific number. You said, it was just going to be, I believe, stronger than 2017. What – given the inclusion of the deal, what is the – what was the full-year organic loan growth during 2017 to work with?

Our actual loan growth for 2017 was a little higher than 5%. And we believe, as I said, 2018 growth will be higher than that. How much higher will be dependent upon a number of variables. And we believe it will take a couple of quarters before we have more clarity as to the ultimate impact of tax reform on how the consumers and borrowers will behave, as well as how the competitors may react. And other variables include how the CRE transaction market trends, how successful we will be in gathering core deposits, and whether the strengthening economy will actually translate into more C&I loan demand and et cetera.

Great. Thank you for that. If I could on the accretion, kind of a modeling question on the accretion income. In the outlook, can you remind me, number one, how much accretion income is left in the plan in terms of timing for that to come into margin?

Sure. We did have total accretion on a dollar amount wise $12.8 million in Q4, and that did have a 39 basis points reduction in Q4. And that accretion amount will decrease substantially starting Q1 2018. And reason for that is, $4.8 million of accretion include a one-time nature of reclassification of SOPs, loans, about $3 million. So, obviously, we do not expect that we’ll continue in 2018’s first quarter, plus about $1 million per quarter of reduction based on the scheduled amortization amount. So with that, 2018 Q1, we would expect about $9 million of accretion dollar impact.

Okay. Just so I’m clear, the $9 million was that delta year-on-year that you’d expect?

Yes.

…the chain on the reduction? Okay, great. And maybe last one, given – Kevin, given the comments of – about the competitive deposit environment. Can you – you’re obviously reflecting what’s happened with lower taxes and higher retained earnings? Can you remind us if acquisitions are something that, number one, you were able to be considering in 2018, or if that’s not on the table given what happened last year? Thanks.

Well, Chris, we continue to monitor the opportunities as they become available in the marketplace, and we would be interested in anything that would be a good fit with our growth strategies. And particularly, we would be interested in those targets, which would enhance our loan portfolio diversification, or enhance our deposit base. So, obviously, M&A can be a means to add liquidity in the form of a deposit-rich institution. And hopefully, we will be able to find a good viable target sometime in the future.

Okay. In terms of like where M&A ranks in the priorities, do dividends, or perhaps even a buyback makes sense, or is it organic growth first and then everything else is kind of secondary?

Well, everything is on the table actually. We always constantly look at the way to maximize our shareholder value. And given the additional equity or capital that we may have from the reduction of tax expenses, we are currently looking into the way to maximize our most positively impacted shareholder value. And at this point, I think, the majority of the benefits will accrue to the company and the shareholders with a relatively small portion being passed along to customers and employees.

Okay. Thank you very much for taking the question.

Thank you.

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

Hi, good morning.

Good morning, Matt.

Just on the mortgage gain on sale this quarter, it look like a better gain on sale margin. I’m curious what your thoughts are in terms of volume or the amount of production you expect to sell maybe in 2018, and within that, it might come at a better margin?

Yes, we would like to sell more, because we have hired more mortgage officers and it was reflected in our – actually Q4 production. And we are actually strategizing our portfolio to keep or to sell to maximize our fee and also increase our interest income as well. So we would expect to continue to sell all those – most of the loans except some loan duration portfolio that we will keep on a minimum basis. So I think, the actual – the gain on the sale, I think, it will be also around like a 2% premium ranges going forward in terms of the mortgage loan sale.

Matthew, this is Kevin, and let me add a few comments. And we are expecting a very strong year of growth relative to our mortgage business unit. As such, we will have a higher gain on sale of mortgage loans, as well as we will have a higher balance of mortgage loans on our balance sheet.

Great. And then on the core deposit front, the comment about adding some additional resources there, can you just talk about what maybe some of your plans are, I assume, that’s hiring-related? And also, where you see your kind of the biggest opportunities within your customer base to generate low-cost core deposits?

Well, we are actively evaluating a number of strategies that we intend to implement later this year. But for competitive reasons, we would not want to provide specifics as yet.

Understood. Thanks.

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

Thanks. Good morning. My question has largely been answered. But I guess, Kevin, for you just a broad question on sort of risk management and maybe geopolitical risk. How do you think about given tensions on the Korean Peninsula, et cetera, and to the degree that you’re working towards doing larger business with larger companies that are related to – that are subs of South of our Korean companies. What – how do you think about that and how is it working to how you kind of view the risk side of the business?

Well, the geopolitical uncertainties surrounding Korean Peninsula is an issue for us. And the most notable result from that geographic – geopolitical concerns is to delay of our plan to open up a branch in South Korea. Currently, we see the timeline for our Seoul branch opening will be delayed to late 2018 at the oldest. And we want to make sure that the Korean Peninsula will be stable politically and otherwise before we have a physical operating unit there. In terms of the domestic business in the U.S., it may have some impact. But I don’t think it has as material impact as we would expect for a branch operating in Korea. Hopefully, the Trump administration and Kim Jong Un region in North Korea will be wise enough to deal with the situation in a peaceful and constructive manner, and I think that will be best case scenario for us. But even if something happens, I do not think, it will be as damaging as some of the financial institutions based and headquarteredin Korea. Our main business is in the U.S., not main business, but entire business is actually in the U.S., although some of our customers have bases and connections with Korea.

Okay. I appreciate the thoughts on that, Kevin.

[Operator Instructions] I’m seeing no further questions in the queue. This concludes our question-answer-session. I would like to turn the conference back over to management for any closing remarks.

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

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.