Hope Bancorp, Inc. (HOPE) Q3 2023 Earnings Report, Transcript and Summary

Good day, and welcome to the Hope Bancorp's 2023 Third Quarter 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. Please note, this event is being recorded. And I would now like to turn the conference over to Angie Yang, Director of Investor Relations. Please go ahead.

Thank you, Marlise. Good morning, everyone, and thank you for joining us for the Hope Bancorp 2023 third quarter investor conference call. As usual, we will be using a slide presentation to accompany our discussion this morning, which is available in the Presentations page of our Investor Relations website. Beginning on Slide 2, let me begin with 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 may differ materially from actual results due to certain risks and uncertainties. In addition, some of the information referenced on this call today are non-GAAP financial measures. For a more detailed description of the risk factors and a reconciliation of GAAP to non-GAAP financial measures, please refer to the company's filings with the SEC, as well as the safe harbor statements in our press release issued yesterday. Hope Bancorp assumes no obligation to revise any forward-looking projections that may be made on today's call. Now we have allotted one hour for this call. Presenting from the management side today will be Kevin Kim, Hope Bancorp's Chairman, President and CEO; and Julianna Balicka, our Chief Financial Officer. Peter Koh, our Chief Operating Officer is also here with us as usual and will be available for the Q&A session. With that, let me turn the call over to Kevin Kim.

Thank you, Angie. Good morning, everyone, and thank you for joining us today. Now, let's begin on Slide 3 with a brief overview of the quarter. For the third quarter of 2023, our net income was $30 million, or $0.25 per diluted share. Highlights of our third quarter results include net interest margin expansion of 13 basis points quarter-over-quarter, which led to a 4% linked quarter growth in net interest income. We maintained disciplined expense control, resulting in a 1% decline in non-interest expenses compared with the preceding quarter. However, the provisions for credit losses increased to $17 million for the third quarter and certain one-time gains in non-interest income from the second quarter did not reoccur. As a result, our net income decreased on a linked quarter basis. During the third quarter, we continued to strengthen our balance sheet, which positions us well to take advantage of profitable growth opportunities going forward. Total deposits grew 1% quarter-over-quarter, reflecting stronger customer deposit growth of 3%, partially offset by a planned reduction of brokered time deposits, all regulatory capital ratios expanded. Our liquidity continues to be ample. Continuing to Slide 4 for a more detailed review of our capital. Our capital ratios are strong and all regulatory capital ratios expanded quarter-over-quarter. As of September 30, our common equity Tier 1 ratio was 11.67%, up 62 basis points from June 30, and our total capital ratio was 13.23%, up 69 basis points quarter-over-quarter. Adjusting for the allowance for credit losses and including hypothetical adjustments for investment security marks all our capital ratios remained high. Our Board of Directors declared a quarterly common stock dividend of $0.14 per share payable on November 16 to stockholders of record as of November 2 of 2023. Moving on to Slide 5. At September 30, our cash and cash equivalents were $2.5 billion, up from $2.3 billion at June 30. At the end of the third quarter, our available borrowing capacity together with cash and cash equivalents and unpledged investment securities increased to $8.3 billion, or 53% of our deposits, and well exceeding our uninsured deposit balances. Continuing to Slide 6. At September 30, our total deposits were $15.7 billion, an increase of 1% quarter-over-quarter reflecting linked quarter growth of 3% in customer deposits, primarily in money market and savings accounts, partially offset by a $368 million reduction of brokered time deposits. Increasing core deposits is a key priority for the company and we saw excellent results from our front lines efforts during the third quarter. Our gross loan-to-deposit ratio was 91% at September 30, down from 95% at the end of the prior quarter and down from 100% at the end of the year-ago quarter. Moving on to Slide 7. At September 30, our loan portfolio was $14.3 billion, a decrease of 4% quarter-over-quarter, reflecting our prudent approach to loan growth and an intentional decrease in mortgage warehouse lending. Mortgage warehouse lines declined $126 million in the third quarter to $65 million at September 30 of 2023. We are in the process of winding down this business. In addition, payoffs and paydowns in a high-interest rate environment continue to hamper loan growth. On Slides 8 and 9, we provide more details on our commercial real estate loans, which are well diversified by property type and granular insight. The loan to values for these CRE properties are low across all segments and the vast majority of these loans have full recourse with personal guarantees. The weighted average LTV of our total CRE portfolio was 45% at September 30, 2023. Office commercial real estate of $455 million represented just 3% of total loans with no central business district exposure. With that, I will ask Julianna to provide additional details on our financial performance for the third quarter. Julianna?

Thank you, Kevin. Beginning with Slide 10. Our net interest income totaled $135 million for the third quarter of 2023, up 4% from the second quarter, driven by a 13 basis point expansion in our net interest margin to 2.83%. The linked quarter increase in our net interest income and expansion of our net interest margin was driven by higher yields on interest-earning assets, a reduction in average borrowings and debt and, an increase in the average volume of interest-earning cash and deposits at other banks, partially offset by higher cost of interest-bearing deposits and a reduction in average loan balances. In the third quarter, we executed on $1 billion of one-year forward start receipt fixed pay float swaps that have a three-year term and will go into effect mid-year next year and continuing on after that. Moving on to Slide 11. Our average loans of $14.6 billion decreased 4% linked quarter. The average yield on our loan portfolio increased to 6.27%, up 28 basis points in Q3. Our average deposits of $15.7 billion were essentially stable, decreasing by only $45 million in the quarter. The average cost of deposits increased to 2.98%, up 19 basis points from the second quarter. The rate of change in the cost of deposits decelerated from the second quarter. Moving on to Slide 12. Our non-interest income was $8 million for the third quarter compared with $17 million in the second quarter of 2023. Last quarter's non-interest income included a one-time $6 million cash distribution related to an investment -- in an affordable housing partnership and $2 million of gains on SBA loan sales. In the third quarter, we elected to retain SBA 7(a) production on balance sheet. Excluding these two Q2 gains, non-interest income decreased $1 million quarter-over-quarter. Moving on to Slide 13. We continued to maintain expense discipline. Our non-interest expense of $87 million decreased 1% quarter-over-quarter. Salaries and benefits expense of $51 million decreased 2%. Our efficiency ratio was 60.5% as of September 30, up slightly from 59.1% as of June 30. The change in the efficiency ratio was primarily due to the decrease in non-interest income. Now, moving on to Slide 14, I will review our asset quality. Our non-performing assets at September 30, 2023, decreased 20% quarter-over-quarter to $62 million, or 31 basis points of total assets. The linked-quarter decrease reflects charge-offs of non-accrual loans, payoffs and work accounts, partially offset by new inflows. Net charge-offs for the 2023 third quarter totaled $31 million which included an idiosyncratic full charge-off of $23.4 million related to a borrower that entered into Chapter 7 liquidation in August 2023. As of June 30, 2023, we have recorded $9.6 million in impairment reserves related to this credit. For the third quarter, our provision for credit losses was $17 million reflecting the increase in charge-offs. At September 30, 2023, our allowance for credit losses was $159 million, representing 111 basis points of loans receivable. The allowance coverage as of June 30, was 116 basis points. However, excluding the $9.6 million of impairment reserves related to the idiosyncratic charge-offs, the allowance coverage as of June 30, was 110 basis points. Year-over-year allowance coverage is up from 104 basis points at September 30, 2022. Special mentioned loans at September 30, 2023 decreased quarter-over-quarter to $187 million. Substandard loans increased to $174 million during the same period. $21 million of the linked quarter increase in our substandard loans were completed multi-family residential projects. These projects are well secured and are awaiting the issuance of temporary certificates of occupancy by their local jurisdictions. Overall, we're not seeing any broader systemic issues within the loan portfolio. With that, let me turn the call back to Kevin.

Thank you. Thank you, Julianna. Moving on to Slide 5. Today, we announced a strategic reorganization that is designed to enhance shareholder value over the long term. Accordingly, the company realigned its structure around lines of business and product delivery channels, optimized its production capacity and reduced headcount. Since its inception, Bank of Hope has made great progress in growing from a traditional community bank into a diversified regional bank. However, our industry continues to undergo secular changes and adapting our business model to meet these challenges is essential to long-term success. With this reorganization, we will have four distinct business groups instead of our prior region-based structure namely, retail banking, commercial banking, corporate and institutional banking and fee-based business group. This will enable us to expand our client relationships, empower deposit growth, enhance revenue generation and run our bank more efficiently. As part of this transformation, we are planning to rationalize our branch network over the next six months, subject to customary notices and approvals and a winding down certain non-core businesses. We understand this action has a human component and thus, we have not made this decision lightly. We are making every effort to support those employees affected by the reorganization. These decisions are never easy and we deeply value their contributions to our franchise. We believe these changes will benefit customers, employees and shareholders in many ways over the long term, and allow us to sustainably expand our profitability. Upfront we expect to realize more than $40 million in estimated annualized cost savings, largely related to the staffing reduction, the branch rationalization and operational process improvements. Related to the reorganization, we expect to recognize one-time charges of approximately $12 million in the fourth quarter of 2023. In light of the organizational restructuring, we will dispense, providing you with an outlook for the remaining two months of the year, and we will provide a full-year outlook for 2024 when we report earnings in January. With that, we would be happy to take your questions and add any additional color as requested. Operator, please open up the call.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Chris McGratty from KBW. Chris, please go ahead.

Yeah. Good morning. Hey, Kevin. Hey, Julianna. Kevin, I wanted to start with the strategic reorganization. In the past, you've talked about managing the Company to an expense-to-asset ratio. I'm interested in kind of what the bogey will be for judging success. Will it be that metric? Will it be the ROE, the efficiency ratio, which has its limitations because of the rates? I'm trying to understand how we should be thinking about capturing this $40 million into the numbers.

Well, the main purpose of this restructuring is obviously, to obtain sustainable profitability on a longer-term basis. And we have been really trying to operate and run this Company with the existing structures that we inherited from the predecessor organizations and which turned out to be vulnerable in an economic situation where interest rates were fluctuating very rapidly at an unexpected pace. And we really took time to reassess the whole structure how we can be a more profitable, more sustainable organization. And obviously, ROE and ROA and profitability efficiency ratio, all those metrics are very relevant, but the baseline is how we can provide better services to customers, how we can motivate our employees for a better opportunity in their career and how we will have a better return to our shareholders. It's all stakeholder consideration. And this is a very painful process in that, we have to let go a certain level of people much higher than the level that we had in the past. But I think this is a fundamental change of this organization, which will ultimately bring to a better profitability over a long term in a very sustainable manner.

Thank you for that. That’s good color. If I could ask a follow-up on the metric. Is this -- given the environmental pressures you spoke about, is this to capture certain metrics, whether it's expense to asset or efficiency for moving further, maybe higher, or is it an outright reduction? I guess is your goal to outright reduce these metrics [Multiple Speakers]

Yes. The reduction reflects the realignment around our business -- lines of business, which minimize redundancies in both frontline and back office support staff. In our prior region-based structure, a lot of resources have been fragmented and we have redundancies because the regions were kind of independent in their operations. And so as a result of this alignment, I think we will be a lot more effective bankers providing our customers with a more consistent level of excellence in service. So this is not just a cost savings measure. This is a more fundamental change in how we do our business and how we drive our profits from our businesses.

Maybe, if I could get one more on capital, Kevin, we ask you every quarter about how you're thinking about capital return, certainly shrinking some of these businesses that are not core, we'll free up some capital. How are you thinking about buybacks given the value of the stock and the outlook for '24?

Yeah. We believe capital preservation and capital expansion, they are very important in this current environment. In terms of shareholder return, I think we are maintaining a strong dividend payout ratio. And eventually, our robust capital base will give us opportunities to more effectively take advantage of growth opportunities going forward. So if you are asking more specifically where – whether we will be beginning to share our – beginning to repurchase our shares, I think that is not likely.

Okay. That’s exactly. Thanks, Kevin for the color.

And our next question comes from Matthew Clark from Piper Sandler. Matthew, please go ahead.

Hey. Good morning, everyone.

Good morning.

First one for me around the reorg and that $40 million of savings you expect to extract. Can you give us a sense for the realization or timing of those savings and whether or not there might be some reinvestment necessary to realign these businesses? Trying to get a sense for whether or not that $40 million will fall to the bottom line or not?

Hi, Matt. This is Julianna. Thank you for that question. A substantial amount of the cost savings that we are expecting of that $40 million, namely $34 million of that is going to come from the staff reduction that we executed last week. So that is already in place and will start to manifest itself in our operating results beginning now. Then in the next six months, we have plans to consolidate some branches and the cost savings from that will roll in over the first half of the year. And then lastly, some cost savings from process improvements will continue and be phased in throughout the whole of the next 12 months. So then the $40 million that we are providing to you on Slide 15, that's the fully loaded number. That being said, near-term actions around operational process improvements will continue to generate benefits that are not yet necessarily identified and quantified. And that's an important consideration to think about when you are reorganizing an organization and removing redundancies and streamlining operations for more efficient, simpler banking. And in terms of how much of this is going to drop to the bottom line, the second part of your question, needs to be considered is that this organizational restructuring was designed to position our bank for high-quality, well-balanced growth regardless of cycle and to promote total relationship banking through collaboration between our business groups and the expansion of our fee-based business products. And to succeed, we need to continue to invest in our franchise, and we've talked to you in the past. So this isn't anything new about investments that we've been making in treasury management solutions. And for example, we recently opened a new branch in Bellevue, Washington. So investing in people, processes and technology to strengthen our bank is going to be ongoing. However, what is important to point out is that the investments that we have been making have not caused large fluctuations in our expenses because we do practice disciplined expense management, and we do not expect that approach to change. So to state firmly, the restructuring was not designed to extract cost savings just so we could redeploy into some new large scale, not yet unveiled projects. That's not the case. However, one thing that I would say for your modeling purposes is that the cost savings are improvement to your existing 2024 baseline, and we will share our outlook in January. And your 2024 baselines will naturally have assumptions around typical business as usual expense growth in an organization and so that's where the cost savings would be applied to.

Got it. Great. And then on the mortgage warehouse business, just remind us of the balance there at the end of the quarter? And then, I think I can answer the question myself, but just the rationale to exit that business.

Yeah. This is Peter, Matt. The balance is actually $65 million, and we've been continuing to wind that down. I think as you know, the mortgage business has had a big slowdown. And overall, I think pricing and risk profile of that line of business, we thought that winding down that business made more sense for us at this point.

Okay. And then, your SNC (ph) exposure. Can you just update us there on the size of that portfolio and whether or not you went through a recent exam, and whether or not there are any upgrades or any downgrades there?

There were downgrades related to the Shared National Credit exam and the syndicated lending portfolio that we have the Term Loan B type portfolio, it's approximately $300 million, and that's down from approximately $600 million at the beginning of the year.

Okay. And then just last one for me on the deposit costs, if you have the spot rates at the end of September?

One second, let me get you the spot rates. 370 -- excuse me, 310 was the spot rate. That's for total deposits just to be clear.

[Operator Instructions] And for our next question, we have Gary Tenner from D.A. Davidson. Gary, please go ahead.

Thanks. Good morning. A couple of questions. First, in terms of the loan yields in the quarter, was there anything unusual that kind of drove some of that loan yield expansion this quarter? Or was it more of a mix change quarter-to-quarter?

It's a combination of three things. The mix change quarter-over-quarter (ph). The accumulation of interest rate increases and interest rates moving higher on our variable loan portfolio and interest rate -- interest income recoveries. And one thing, I'd like to add to Matt's prior question was into my answer. Our spot rate on deposits was 310 at the end of the quarter, up from 297 at the end of the prior quarter. So the spot moved 13 basis points quarter-over-quarter.

Julianna, the interest income recoveries that you just mentioned. Could you quantify that, I guess, maybe relative to the prior quarter, how much of an impact that was?

This quarter, the interest income recoveries were $3 million.

Versus any meaningful amount in the second quarter?

There wasn't a meaningful amount in the second quarter

Okay. Thank you. And then, in terms of the swaps…

Your question, in terms of kind of our net interest margin expansion, even with the net interest income recovery when we back that out, our net interest margin still expanded from the improvement on the liability side.

Okay. I appreciate that. And then on the swaps you mentioned, what is the received fixed rate on those?

367 over SOFR.

Thank you.

And we do have one more question from Chris McGratty from KBW. Please go ahead, Chris.

Just maybe Julianna, coming back to the margin, net interest income comments. Normalizing for the recoveries, I guess, maybe a little help on the trajectory of net interest income. It feels like a smaller balance sheet but more profitable, but interested in your comments about whether the trough might be in NII.

I think in terms of our net interest income expectations and net interest margin expectations, obviously, we will talk about 2024 in January. But -- and we are pleased with the improvement that we saw this quarter even with the outside of the interest income recovery. One thing I will remind you all about is that we do have some $1.8 billion of CDs maturing in the fourth quarter from a promotion that we ran last year. So that will put some downward pressure or upward pressure rather on the cost of deposits in the fourth quarter. So in terms of the trough in the NII and NIM we'll talk about that in January. It's kind of curve dependent, right, higher for longer versus when the interest rate will be coming in. But we're pleased with what happened this quarter and our frontline continues to execute excellently on growing customer deposits, which gives us the flexibility to run off higher cost funding. And net-net positions us to have a more profitable balance sheet. And then on my prior answer just now, the fixed rate is 367. I said over SOFR, but I just left it at 367. So just for your clarification.

The $1.8 billion, Julianna that's coming up for renewal, what was the rate that was put on, I guess, probably last year sometime?

It was put on last year in the fourth quarter because these were 12-month CDs when it was put on. So the average rate that, that was put on was 4.43.

Okay. And then maybe last one, the SBA loan sale comments. Do you have any thoughts on retaining versus selling near term?

At the moment, it is more profitable, more economically profitable to FDA loans.

To be sure, maintain them, is that what you said?

Yes, to maintain balance sheet. So we evaluate that from a perspective of profitability.

Okay. Helpful. Thank you.

Our next question comes from David Chiaverini from Wedbush Securities. David, you may proceed.

Hi. Thanks. So I wanted to follow up, I guess, indirectly on the NII question. In terms of balance sheet growth and loan growth, any kind of figures or informal guidance in that regard?

No informal guidance at this time, we will provide guidance and outlook for 2024 in January, as you can imagine, we're going through our budgeting process, and we are going through a reorganization.

Yeah. Understood. And then, shifting gears over to credit quality. Any other kind of areas. You mentioned that you're not seeing any systemic risk, which is great. But can you comment on any areas that you're paying any more particular attention to? I like the slide you laid out with the commercial real estate exposure and the low LTVs, but any other areas that you're focusing in on?

No. Actually, as you may know, we went through a pretty substantial derisking process over the last couple of years, particularly related to some of our CRE concentrations in hotel areas. So at this time, outside of sort of the one-off case that we had seen this quarter really, we're not seeing anything systemic.

Got it. And that one-off case. I'm assuming that it was the shared national credit related to an oil company, but can you confirm what that was related to?

It was that participation. I think it was generally covered with lead bank. We do have a participation in that credit, and it was related to [indiscernible] gas industry. Yes.

Thank you. [Operator Instructions] Right now, we have a follow-up question by Matthew Clark from Piper Sandler. Please, Matt, go ahead.

Thanks. I just want to follow up on the office CRE portfolio and get an update on the reserve that you have against that portfolio and what amount is criticized?

We'll look at the reserve level right now. But as you know, we have a very small office CRE portfolio. So I think over 99% of our portfolio -- or around 99% of it is pass rated. We do not have any central business district exposure, and most of ours is really Class B in office properties in metropolitan areas. So we do understand the concern from an industry perspective, but really within our portfolio, we're not seeing any signs of concern at the moment and do we have any reserves?

Well, the reserves in our total book are 111 basis points, and that covers all of our portfolios office is very small. So the reserves that we have specifically on office is not a meaningful number, 111 basis point coverage. What I would go with for the [indiscernible]. Thank you.

Yeah.

And at this time, we have no further questions and this will conclude this session. I would like to turn the conference back over to management for some closing remarks. Thank you.

Thank you. I am confident that our strategic reorganization announced today will enable us to better serve our customers, expand customer relationships and operate our bank more efficiently, benefiting all our stakeholders through sustainably improved profitability. Once again, thank you all for joining us today, and we look forward to speaking with you next quarter.

And the conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Have a good day.