Hope Bancorp, Inc. (NASDAQ:HOPE) Q3 2022 Earnings Conference Call October 25, 2022 12:30 PM ET

Company Participants

Angie Yang - Director, Investor Relations
Kevin Kim - Chairman, President and Chief Executive Officer
Alex Ko - Senior Executive Vice President and Chief Financial Officer
Peter Koh - Senior Executive Vice President and Chief Operating Officer

Conference Call Participants

Gary Tenner - D.A. Davidson
Matthew Clark - Piper Sandler

Operator

Good day and welcome to the Hope Bancorp 2022 Third Quarter Earnings Conference Call. [Operator Instructions] Please note this event is being recorded today. I would now like to turn the conference over to Angie Yang, Director of Investor Relations. Please go ahead.

Angie Yang

Thank you, Joe. Good morning, everyone and thank you for joining us for the Hope Bancorp 2022 third quarter investor conference call. As usual, we will be using a slide presentation to accompany our discussion this morning. If you have not done so, please visit the Presentations page of our Investor Relations website to download a copy of the presentation or if you are listening in through the webcast, you should be able to view the slides from the – from your computer screen as we progress through the presentation.

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 are based on current expectations, estimates, forecasts, projections and management 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 our press release issued yesterday. Hope Bancorp assumes no obligation to revise any forward-looking projections that maybe 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, 2022 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 2022 third quarter earnings release for the reconciliation of GAAP to non-GAAP financial measures.

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 Alex Ko, Senior Executive Vice President and Chief Financial Officer. Peter Koh, Senior Executive Vice President and Chief Operating Officer, is 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. Kevin?

Kevin Kim

Thank you, Angie. Good morning, everyone, and thank you for joining us today. Let’s begin on Slide 3 with a brief overview of our financial results. We delivered a strong performance in the third quarter, which reflects the improved earnings power of our franchise and ability to perform well in a variety of economic environments.

Despite the macroeconomic headwinds of inflationary pressures, and concerns about a potential recession, we generated an increase in earnings per share and pre-provision net revenue compared with the prior quarter, with all of our PPNR profitability metrics improving as well.

We reported net income of $53.7 million or $0.45 per share in the third quarter, up from $0.43 in the preceding second quarter while our pre-provision net revenue increased 12% to $82.6 million, a record level for the company. Most importantly, due to strong loan production, margin expansion, enhanced efficiencies and meaningfully improved asset quality, we are generating profitable growth with our pre-provision net revenue return on average assets increasing to 1.79% from 1.65% in the preceding quarter, while our pre-provision net revenue return on average equity increased to 16.26% from 14.66% in the prior quarter.

Moving on to Slide 4. In the third quarter, we funded $1.35 billion in new loans, which was 5% higher than the preceding quarter, a 34% increase over the third quarter of 2021 and another record level for the company. Our strong loan production in the third quarter resulted in 6.5% loan growth quarter-over-quarter or 11% year-to-date. As expected, given the investments we have made to build our corporate banking group, commercial lending was the largest contributor to our overall loan production, accounting for 55% of our total loan funding in the third quarter. We disbursed a record $747 million in new commercial loans during the third quarter and the average rate of new commercial loans increased 97 basis points over the preceding quarter.

Within the corporate banking group, we are getting strong contributions across industries and geographies, resulting in well-diversified loan production. In the third quarter, we had particularly strong contributions from our Texas region, which focuses on general middle market lending, our health care group, which joined us in mid-2021 and our teams that focus on financial institutions and telecom industry.

In terms of commercial real estate, while we expected to see a softening in demand due to higher interest rates. It did not soften as much as we thought. We had $534 million of commercial real estate loan production in the third quarter, which was down slightly from the preceding second quarter and accounted for 40% of total originations, but the average rate of new CRE loans increased 99 basis points over the preceding second quarter. Overall, we saw increasing trends in loan pricing in all asset classes during the third quarter. Combined with the higher mix of commercial loan production, this resulted in our average rate on total loan production increasing by 111 basis points compared with the preceding second quarter.

Moving on to Slide 5, the investments we have made over the years to build our corporate banking group, and establish expertise in new asset classes and vertical markets have resulted in a material transformation of our loan portfolio to a significantly lower risk profile. If we look back to us 3 years ago at September 30, 2019, commercial loans represented 22% of our total loan portfolio. As of September 30, 2022, commercial loans have increased by $2.5 billion, nearly doubling in volume and now represent 33% of our total portfolio.

Our corporate banking group has been the primary driver of increasing volumes of commercial loan fundings and a continued shift in our client base towards larger, stronger commercial enterprises as well as a more diversified C&I portfolio. We have also seen a significant transformation of our CRE portfolio during this same time period. Commercial real estate loans accounted for 71% of our total portfolio at September 30, 2019, having increased by less than $1 billion over the course of 3 years, CRE loans as a percentage of total loans declined to 61% as of September 30, 2022.

More importantly, we are making good progress in creating a more diversified, lower risk portfolio. We continue to see solid results from the multifamily lending team we have built, which accounted for 46% of our total CRE loan originations in the quarter. As a result, multifamily continued to grow as a percentage of our total CRE loans, representing 13% as of September 30, 2022. In contrast, our hotel-motel portfolio at the end of the third quarter represented just 11% of our CRE portfolio, down significantly from 19% 3 years ago.

Now I will ask Alex to provide additional details on our financial performance for the third quarter. Alex?

Alex Ko

Thank you, Kevin. Beginning with Slide 6, I will start with our net interest income, which totaled $153.2 million for the third quarter of 2022, an increase of 8.2% from the preceding second quarter. The strong growth in net interest income was largely driven by a 4% quarter-over-quarter increase and average loans receivable, a 59 basis point increase in the average loan yield and expansion of our net interest margin.

Our net interest margin increased 13 basis points quarter-over-quarter to 3.49%. The expansion in our net interest margin was driven by a favorable shift in our mix of earning assets as well as higher loan yields resulting from the repricing of variable rate loans and higher pricing on new loan production. Overall, the yield on interest-earning assets increased by 56 basis points quarter-over-quarter. These benefits were partially offset by an increase in deposit costs, resulting from higher rates paid on interest-bearing deposits. With the lag in deposit cost catching up to the increase in yield on interest-earning assets, we may see flat to slight margin compression in the fourth quarter potentially offsetting to a small degree to the year-to-date margin expansion.

Moving on to Slide 7, we remain in an asset-sensitive position as of September 30, 2022 and are positioned to benefit from higher interest rates. Of our new loan production in the third quarter, 57% represented variable rate loans and as of September 30, 2022, variable rate loans increased to 46% of our total loan portfolio.

Now moving on to Slide 8. Our non-interest income was $13.4 million for the third quarter, an increase of 5% over the preceding second quarter. We had a lower gains on sale of SBA loans, reflecting a lower volume of loans sold and the lower net premiums on SBA loan sales. We also recorded lower gains on sale of residential mortgage loans due to a lower volume of loans sold. These decreases were mostly offset by higher deposit account service charges, an increase in swap fee income and reduction in fair value losses on equity investment.

Moving on to non-interest expense on Slide 9. Our non-interest expense was $83.9 million compared with $80.4 million in the preceding second quarter. We have decreases in most expense areas, but these were offset by increases mainly in two areas. First, we had an increase in salary and benefit expense, largely reflecting higher incentive compensation accruals in light of our strong financial performance. And second, other non-interest expense trended higher, reflecting an increase in earnings credit expense on deposit accounts. With our strong revenue growth outpacing our increase in expenses, our expense efficiency ratio improved to 50.4% from 52.1% in the preceding second quarter.

Now moving on to Slide 10. I will discuss our key deposit trends. Our total deposits increased 3.1% from the end of the prior quarter, while our business development efforts continue to result in the consistent addition of new commercial deposit relationships. We had one particularly sizable outflow from a large corporate client as they capitalize on a significant acquisition opportunity to expand their business. Given that much of our loan pipeline included in the low-risk variable rate commercial loans, that we have been targeting. We determined that the longer-term benefits of adding these loans and the new commercial relationships outweighed the consideration of time deposits that were utilized to support the strong loan growth in the quarter.

Overall, the cost of our interest-bearing deposits increased by 71 basis points quarter-over-quarter due to higher rates across all of our deposit categories. This resulted in a 46 basis point increase in our overall cost of deposits. At this point in the rising rate cycle, management of our deposit costs and mix is a top priority as we remain focused on generating profitable growth. We have a number of deposit strategies in place, which we expect will help in increasing our core deposits and mitigating the pressures of rising deposit costs.

Now moving on to Slide 11. I will review our asset quality. Our enhanced credit administration processes and tightened underwriting criteria contributed to a continuation of positive trends in our portfolio in the third quarter, with reductions in all categories of non-performing assets and criticized loans. Total non-performing assets at September 30, 2022, decreased to $97 million and reflected reductions in non-accrual loans. Delinquent lost 90 days or more on our status, accruing TDRs and other real estate owned. At quarter end, total non-performing assets represented 51 basis points of total assets, down from 61 basis points at the end of the second quarter. Total criticized loans declined by another 17% in the third quarter and represented our fifth consecutive quarters of steady reduction.

Our loss experience remains minimal. We had just $219,000 in net charge-offs during the third quarter or 0.01% of average loans receivable on an annualized basis. Year-to-date, we have net recoveries of $18.6 million. We recorded a provision for credit losses of $9.2 million, which primarily reflects the strong growth in the loan portfolio during the third quarter and addresses future economic headwinds. At September 30, 2022, our allowance for credit losses coverage ratio remained at 1.04% of loans, while our coverage of non-performing assets increased to 166% from 137% at June 30, 2022.

Now moving on to Slide 12. Let me provide an update on our capital position and returns. To accelerate interest rate hikes during the third quarter continued to result in unrealized losses in our investment security portfolio, which negatively impacted tangible common equity to tangible asset ratio by approximately 35 basis points in the 2022 third quarter. Our tangible common equity to tangible asset ratio remained strong at 8.09% as of September 30, 2022, and changes in unrealized losses do not have an impact on regulatory capital ratios.

As announced yesterday, our Board of Directors declared a quarterly cash dividend at $0.14 per share, which remains the same as last quarter. During the quarter, we did not repurchase any stock and continue to have available $35.3 million of our $50 million stock repurchase program. As of September 30, 2022, all of our capital ratios remain at strong levels to support our continued balance sheet growth.

With that, let me turn the call back to Kevin.

Kevin Kim

Thank you, Alex. Now moving on to Slide 13. I will wrap up with a few comments about our outlook. While the operating environment has certainly become more challenging, we expect to continue benefiting from the significant shift we have made to a more relationship-focused commercial banking model over the past few years. With the growth we had in the third quarter, commercial loans now represent one-third of our total loan portfolio, which reflects the success we have had in building our corporate banking group. This has had a positive impact on our loan production volumes, our deposit gathering and the diversification of our franchise.

With each passing year, our CBG Group has made a larger contribution to our growth and diversification strategies, accelerating our progression to a lower-risk, high-performing regional bank. With the success we have had with the CBG initiative, we have also steadily built Bank of Hope’s reputation as an attractive destination for experienced commercial bankers, which in turn has enhanced our ability to recruit banking talent to continue our expansion and target new industries and geographic markets. More recently, we have added teams in Florida, Chicago, Boston and San Francisco with the Boston team focused on private banking and the San Francisco team focused on the tech industry.

We expect to continue to see growth in commercial loans and deposits, further diversification and stronger asset quality over the longer-term, given our reduced CRE concentration and the stronger, more liquid commercial enterprises that now comprise a larger percentage of our client base in due – in part due to the stronger commercial banking capabilities that we have built, we have been able to effectively manage through the macroeconomic headwinds that have accelerated throughout the year. Through the first 9 months of 2022, we generated a loan growth of 11% or 13% excluding SBA, PPP loans, which has helped produce the margin expansion, efficiency improvements and increases in profitability that we have seen, while we continue to maintain strong capital levels and asset quality.

As we look forward to the final quarter of the year, we expect a higher rate to have an increasingly larger impact on CRE loan demand. And while the fourth quarter tends to be a seasonally slower quarter for commercial loan production, our commercial loan pipeline continues to be relatively strong as the more recent additions to the CBG team ramp up their business development efforts, particularly as the expected recession draws nearer, we are being ever more selective with the loans that we are adding to our portfolio and focusing on those that are more recessionary resistant, have greater ability to absorb interest rate and macroeconomic risk and ultimately contribute to profitable growth for the company.

So while we fully anticipate continued growth through the balance of the year, it would be prudent for us to expect loan growth to moderate meaningfully from the very strong third quarter given all of these factors, mitigating the impact of the accelerated interest rate hikes on our deposit costs will remain a top priority for our leadership. And even with moderated loan growth expected in the near-term, together with improved efficiencies that we are realizing as we continue the balance sheet growth and the ongoing improvements in our asset quality, we believe that we are well positioned to continue generating strong financial results for our shareholders.

With that, we would be happy to take your questions and add any additional color as requested. Operator, please open up the call.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question here will come from Clark Wright with D.A. Davidson. Please go ahead.

Gary Tenner

Hi. Sorry. This is Gary Tenner actually from D.A. Davidson. A quick question in terms of what the September 30, deposit spot rates were interest-bearing or total?

Alex Ko

Sure, Gary. Deposit spot rate as of 9/30, total interest-bearing deposit spot rate was 1.84%. And if you want to have a total deposit spot rate was 1.21%.

Gary Tenner

Thank you. And so the commentary in terms of the NIM compression for the fourth quarter, as you think about kind of ongoing deposit growth and costs going higher, does that NIM compression potentially accelerate in the first half of 2023 or maybe just characterize how you see the margin first half of next year.

Alex Ko

Yes, Gary, that’s a good question. Actually, we are trying to evaluate that hard. But given there is a lot of uncertainties and the variables, we are not actually giving a guidance for NIM for 2023. We kind of limited given our guidance for Q4 with a flat or small compression as the lag in deposit pricing for our CD, it will catch up. So, I don’t think it will continue, but there is a lot of variables for 2023.

Gary Tenner

Great. Thank you. And then just last question, if I could. Just in terms of capital, total risk-based capital under 12%. It was up over 13%, probably a year ago. Any thoughts on doing anything to augment the total risk-based capital number in terms of sub debt or otherwise?

Alex Ko

Yes, sure. We believe this capital ratio as of today is a strong. And obviously, we will assess the need for any augmentation of the capital as we move forward, especially, there is a convertible bond that is scheduled, can be potentially to be put, but we are well aware of that. But given our strong core earnings power, we maintained our dividend at $0.14 per share. Even though we started repurchasing our shares, but again, we believe our capital ratios in all measures remains strong. But again, we need to assess on a regular basis for any augmentation of the capital going forward.

Gary Tenner

Thank you.

Operator

[Operator Instructions] Our next question here will be from Matthew Clark with Piper Sandler. Please go ahead.

Matthew Clark

Good morning everyone. Just following up on the interest-bearing deposit costs and I think your interest-bearing deposit beta this quarter is 50%, 40% so far for the cycle? What are you guys assuming for your deposit beta through the cycle on either interest-bearing or total basis?

Alex Ko

Yes. Matthew, it’s really difficult to have a 2023 deposit beta. Again, given volatilities and in the interest rate hike that we recently saw. So, we will try to give data guidance for next 2023 in the next quarter when we have a conference call.

Matthew Clark

Okay. And then just – go ahead.

Alex Ko

No, go ahead.

Matthew Clark

Okay. Understood. And then just shifting to your outlook on the loan-to-deposit ratio crept up a little bit to 100%. It does sound like loan growth is going to slow pretty dramatically here. But what are your plans for managing the loan-to-deposit ratio going forward and what’s your limitation?

Alex Ko

Yes. Matthew, let me start with kind of some sort of assessment of our increased net loan-to-deposit ratio to 3, and we will give you some sort of guidance as well. As we mentioned during the earlier remarks, there was one kind of isolated large outflow. it was in excess of around $600 million of deposit. So, without that – if we didn’t have that outflow because we believe that is isolated, and we expect – we still maintain a good relationship with that particular large depositor, and we expect that will come back even though it was run out due to their investment opportunity that they had in Q3. So, if we didn’t have that outflow, our loan-to-deposit ratio would have been in the neighborhood of 96%. So, the bank, we have been managing our loan-to-deposit ratio, 96%, 95% level throughout the quarter. So, that is still our target loan-to-deposit ratio going forward, even though later on, we might even further lower, but it will take a longer time perspective. So, I think higher loan-to-deposit ratio for Q3 was relatively temporary basis.

Matthew Clark

Okay. And then on expense growth, I think we can easily back into your guidance for the upcoming quarter. It looks like there was an uptick in earnings credits within other expense, which would probably continue here in 4Q. But I guess how are you thinking about inflationary pressures as we get into next year and whether or not the rate of increase in terms of comp is higher than years past or not?

Kevin Kim

Matthew, let me respond to that. First of all, on the loan demand side, obviously, the fourth quarter is seasonally soft quarter. But in addition to that, the significant pace of rate increases and also uncertainties about the timing and depth of the recession, we believe that a lot of investors will be more reluctant to move forward with their planned investments. So, that goes to the result of softer loan demand. And in addition to that, higher interest rates make it more challenging for them to meet our stringent underwriting criteria. So, the loan growth in the third quarter was pretty robust. And our fourth quarter loan production will be at a lower volume relative to the fourth quarter. In terms of non-interest expense side, as you mentioned, the ECR expense will be higher in the fourth quarter than in the third quarter. And I think that is pretty predictable. So, our non-interest expense in the fourth quarter will be higher than the non-interest expense of the third quarter, and we expect a little uptick in the total non-interest expense in the fourth quarter. If I add one more thing, Matthew, in terms of loan demand side in connection with that, our loan growth for the year will be at the higher end of the high single to low-double digit range as we previously guided. But there is a good chance for us to even to exceed that range on an ex PPP basis for full year 2022.

Matthew Clark

Okay. Thanks again.

Operator

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

End of Q&A

Kevin Kim

Once again, thank you all for joining us today. We hope everyone stays safe and healthy, and we look forward to speaking with you again next quarter. Thank you everyone.