Hope Bancorp, Inc. (NASDAQ:HOPE) Q3 2021 Earnings Conference Call October 26, 2021 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 – Deputy Chief Operating Officer

Conference Call Participants

Chris McGratty – KBW
Gary Tenner – D.A. Davidson

Operator

Good day, and welcome to the Hope Bancorp’s 2021 Third Quarter Earnings Conference Call. All participants will be in a listen-only mode. [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.

Angie Yang

Thank you, Matt. Good morning, everyone, and thank you for joining us for the Hope Bancorp 2021 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 already, 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 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’s assumptions about the future performance of the company, including any impact as a result of the COVID-19 pandemic, 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 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, 2021 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 2021 third quarter earnings release for the reconciliation of GAAP to non-GAAP financial measures.

Now, we have allotted one hour for this call as usual. 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 our Deputy 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 had a very productive quarter with increased profitability record high loan originations, further enhanced deposit trends and a significant improvement in our asset quality metrics. We generated net income of $55.5 million in the third quarter or $0.45 per diluted share up 3% from the preceding quarter.

Pre-provision net revenue of $65.4 million represented an increase of 1.4% over the preceding second quarter. And our return on tangible common equity increased to 21 basis points to 13.71% quarter-over-quarter.

New loan production reached a record high and exceeded $1 billion for the first time in our history, up 13% quarter-over-quarter. Our deposit mix continued to shift favorably to lower cost deposits with noninterest bearing deposits increasing 7% quarter-over-quarter and accounting for 40% of total deposits, which is also a record high. As expected our efforts to de-risk the portfolio impacted growth in our total loans this quarter, although we continue to increase owning assets, which is driving higher net interest income.

Our third quarter results included a $10 million release of our reserve for loan losses reflecting the progress we have made in moving higher risk loans of our balance sheet and the improved performance we are seeing in our hotel/motel and retail CRE portfolios combined with an improving economy.

During the third quarter, we sold $29.6 million of loans and moved another $131.6 million of potentially higher risk loans to help for sale at the end of the quarter, contributing to the larger decline in substandard loans during the quarter. At this point, we believe the process of de-risking the loan portfolio has been largely completed, and we are not anticipating a material amount of additional strategic loan sales in the fourth quarter. Given what has occurred, we believe, we are well-positioned to drive organic loan growth and enhance operational profitability in the quarters ahead.

Moving on to Slide 4. As we indicated on our last call, we expected to see an acceleration of loan production, as we entered the seasonally stronger second half of the year and economic conditions continue to improve. While the resurgence in COVID-19 cases and supply chain disruptions impacted the pace of the economic recovery we were still able to have an exceptionally productive quarter of business development leading to a record $1 billion in new loan production in this quarter.

Compared with the prior quarter, our overall loan production increased by 13% with strong performances occurring in all areas of our business. And in each segment, we achieved a higher level of production than we had in the preceding second quarter. In particular, commercial loan production increased 14% quarter-over-quarter to $344 million. Our corporate banking group continues to gain traction and develop new relationships with larger corporate clients, which is driving the higher level of commercial loan production, excluding PPP loans and strategic loan sales and transfers, our commercial loans outstanding balance would have grown 6% quarter-over-quarter.

Over the last year, our corporate banking group has further expanded into telecom and healthcare with the addition of the experienced business development and specialized the credit teams in each of these verticals. And we are pleased to see the positive impact these teams are making to our overall loan production volumes. This production has been a significant driver of the diversification we have achieved over the last few years, and we will continue to opportunistically add experienced teams to supplement our growth.

Our SBA loan production, totaled $116 million in the third quarter, which is a record level of non-PPP production. Excluding the impact of PPPs and strategic loan sales and transfers, SBA loans in our portfolio would have increased an 11% quarter-over-quarter.

Our CRE loan production increased 14% quarter-over-quarter. As we have mentioned previously, we are looking to create a more diversified, lower risk profile commercial real estate portfolio, and have been increasing our focus on multi-family loan origination over the last year. The stronger CRE loan production this quarter is largely attributable to the success we are having with this effort. New multi-family loans, more than doubled quarter-over-quarter and accounted for approximately 12% of our total loan originations in the third quarter. This resulted in 20% growth in this portfolio from the end of the prior quarter.

As part of our efforts to increase this loan segment, we recently recruited a highly experienced multi-family team led by an executive who joined us from a large money center bank. This is an attractive product that complements our existing portfolio and improved the diversification and lower level of risk associated with this lending segment are in line with our longer term strategic initiatives of the enhancing franchise value.

Overall the excluding PPP loans and the impact of the loan sales and transfers, we would have had total loan growth of 3% quarter-over-quarter or 12% on an annualized basis. This level of loan production is more reflective of the stronger business development capabilities of our franchise.

In terms of our loan modification program granted under the CARES Act, we continue to see a steady decrease in the balances of our active loan modifications. At September 30, modified loans decreased to below 1% of total loans down from 2.4% as of June 30, 2021. Our COVID-19 modifications have been maturing as scheduled and we expect they will wind down to nearly zero by the end of the year.

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 5. I will start our net interest income, which totaled $130.3 million for the third quarter of 2021, an increase of 3% from $126.6 million in the preceding second quarter. This increase was due to 2% increase in interest income and 8% decrease in interest expense.

During the third quarter of 2021, $236 million of PPP loans were forgiven versus $164 million in the preceding second quarter. The net fee realize from PPP forgiveness was $3.2 million in the third quarter versus $1.8 million in the second quarter of 2021.

Our net interest margin decreased four basis points quarter-over-quarter to 3.07%. The increase in our net interest margin reflect an eight basis point negative net interest margin impact from the excess cash, as a result of our strong deposit growth. If not for the excess liquidity, we would have had a margin expansion this quarter, given the reduction in our cost of deposits and increase in average yield on investment securities, which it together had a net positive impact of six basis point to our net interest margin.

Looking ahead to the fourth quarter, we expect our net interest margin to remain fairly stable with relative stability in both loan yield and deposit cost. So at this point, we are not expecting to see much margin pressure in the fourth quarter.

Moving on to Slide 6. From a longer term perspective, and looking at the potential for higher interest rates next year, we are well positioned to benefit from higher interest rate environment. Variable rate loans as a percentage of total loans have been trending higher due to our increase in commercial lending and accounting for 41% of our portfolio as of September 30, 2021. Together with a higher trending non-interest bearing demand deposits, we have steadily become more asset sensitive each quarter of this year.

Now, moving on to Slide 7. Our noninterest income was $10.6 million for the 2021 third quarter down from $11.1 million in the preceding second quarter. Looking at our customer-related fee income and net gain on sale of loans. Noninterest income decreased by $300,000. The primary drivers of the decrease included lower loan service fees as a result of the higher level of SBA 7(a) loan payoff and a lower level of net gain on sale of mortgage loans, due to a lower volume of loan sold in the quarter.

Moving on to noninterest expense on Slide 8. Our noninterest expense was $75.5 million representing an increase of 3% from the preceding second quarter. The largest factor contributing to this increase was $4.7 million increase in salaries and employee benefit expense. This was caused by a number of factors, including increase headcount and associated increase in base salaries. This largely reflects a new frontline hires, including the multi-family chain that Kevin mentioned, as well as wage increases that were necessary to retain existing employees.

Second, higher group insurance expense and finally an increase in the bonus accrual for the year to reflect the higher than expected financial performance. This increases an employee costs were partially offset by a lower level of professional fees, primarily resulting from a decline in legal fees, along with a non-recurring software impairment charge in the preceding quarter. Looking into the fourth quarter, we expect noninterest expense will trend downward from the third quarter to our more normalized range of $72 million through $74 million.

Now, moving on to Slide 9. I will discuss our deposit trends. We continue to run off higher costing time deposits and replace them with lower cost deposits through our business development efforts. During the third quarter, our non-interest bearing deposits increased 7% from the end of the prior quarter, while our time deposits decreased 4%. The increase in our noninterest bearing deposits exceeded the runoff and time deposits resulting in a 2% increase in total deposits quarter-over-quarter. The cost of our interest bearing deposits declined six basis points quarter-over-quarter and our total costs of deposits decreased four basis points. These decreases represents, our eighth consecutive quarters of declining deposit cost.

Now, moving on to Slide 10. I will review our asset quality. Nonaccrual loans and substandard loans decreased significantly by 51% and 36% respectively from the prior quarter. Nonaccrual loans decreased by $57 million quarter-over-quarter due to three primary factors. First, we charge it off a large relationship that had to move to nonaccrual status in the first quarter of this year. Second, we had a couple of large payoffs of nonaccrual loans this quarter. And finally, the transfer of the loans to held-for-sale also contributed to the decrease in nonaccrual loans.

Substandard loans decreased by $137 million quarter-over-quarter, as a result of the loan sales and transfers as well as the charge-off and the payoff mentioned above. So charge-off relationship combined with the loans that we sold and transfer it to the loans held-for-sale resulted in an elevated level of charge-offs in the third quarter of 2021, totaling $42.7 million.

As previously discussed, during our first quarter conference call this year, the relationship there was charged-off this quarter is a unique situation with a borrower being involved in our legal dispute. With regard to the loans transferred to held-for-sale in the third quarter, as of today we have completed our sales of the $69 million of this sale alone, since the quarter end and anticipate that the remaining loans transferred through a held-for-sale will be sold during the fourth quarter. So loans transferred to a held-for-sale, we’re already contracted for sales at quarter end and therefore the impact of this future sales have already been reflected in our financial results for the third quarter of 2021.

Now, moving on to Slide 11. We recorded a credit for credit losses of $10 million in the third quarter. This reflects our significantly improved asset quality combined with improving economic forecast. So allowance for credit losses as of September 30, 2021 was 1.05% excluding PPP loans compared with 1.47% as of June 30, 2021. The decrease in our ACL coverage ratio mainly reflects an improved macroeconomic forecast, asset quality improvements and a meaningful reduction of problem loans.

Our coverage ratio as of September 30, 2021 was slightly higher in comparison with our CECL day one coverage ratio of 0.98% at January, 2020. Notwithstanding, the meaningful shift to a lower risk loan portfolio. But the other hand, our allowance for credit losses, as a percentage of nonaccrual loans, nonperforming assets and nonperforming assets all increased significantly quarter-over-quarter.

Now, moving onto Slide 12. Let me provide an update on our capital position and returns. As of September 30, 2021, we continued to maintain a meaningful amount of excess capital to be utilized for future growth. Tangible common equity per share increased 23 basis points from the quarter, prior quarter and the 63 basis points year-over-year.

Based on our strong capital and the liquidity positions, we maintained our quarterly dividend at $0.14 per share. With a continued strength of our financial performance and capital position, as well as the significantly reduced credit risk in our loan portfolio, we resumed stock buybacks and repurchased $47 million of common stock during the third quarter. This reduced our shares – sorry, this reduced total of common stock outstanding by approximate 3.5 million shares compared with the end of the prior quarter.

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

Kevin Kim

Thank you, Alex. Now, moving onto Slide 13. Let me provide a few comments about our outlook. Our loan pipeline remains robust and we expect to maintain a higher level of production. Particularly as many of the new bankers we have added this year, continue to gain traction. We also have a good pipeline of new banking talent, and we expect to continue making additions on a consistent basis that will further strengthen our commercial banking capabilities, add expertise in new areas and contribute to the further diversification of our loan portfolio in the coming years.

With more of our energies, focused on growth and business development, we are also investing in geographic areas that we believe can become largest sources of organic growth in the future. We have had a loan production office in Atlanta for many years and late in the fourth quarter, we will be opening our first full service branch in the heart of a rapidly expanding Korean community in Duluth, a nearby suburb of Atlanta.

We believe that our larger presence will enable us to better capitalize on the economic growth being experienced in this region, as well as the expand our efforts to bank the Korean national corporations in the Southeastern region of the United States. This should all lead to higher levels of loan growth going forward and more opportunities to remix our balance sheet toward higher yielding earning assets, which will positively impact our profitability. Throughout this year, we have steadily reinvested a portion of the cost savings from efficiency initiatives, such as our branch consolidations into strengthening our business development capabilities. And we are seeing very positive results from these efforts.

Of the new hires this quarter, approximately 75% of frontline employees, which represents a shift in our workforce more towards revenue generating personnel. Notwithstanding these investments in our organization, we expect to maintain our noninterest expenses within our normalized range. Following the significant reduction of potential problem loans this quarter, we believe our asset quality will continue to improve in the near term as the U.S. economy, as well as our borrowers continue to recover from the pandemic.

All together with relatively stable loan yields, deposit costs and net interest margins, we believe we are well-poised to drive improved profitability in the coming quarters. And the end result of our efforts will be a stronger franchise with a more diversified high-quality loan portfolio, reduced concentration risk and a lower cost deposit days, which will drive profitable growth and create additional value for the shareholders in the years to come.

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

We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Chris McGratty with KBW. Please go ahead.

Chris McGratty

Hi, good morning.

Kevin Kim

Good morning, Chris.

Chris McGratty

Kevin, maybe a question on growth and capital. You guys are very aggressive with the buyback at good valuations. Can you help us with the outlook for additional buybacks given what sounds like an improving growth outlook?

Kevin Kim

Well, as we discussed, we we’re quite active with our current buyback program and the third quarter, and we have less than $3 million remaining in that program. So at current valuations, along with our strong capital position of Tier 1 common equity ratio in excess of 11%, I think it would be a good idea for us to consider another authorization sometime soon.

Chris McGratty

Okay. And then could you, I appreciate the color Alex, on the expenses near term. Could you help us kind of more broadly we’ve heard from a lot of banks about the kind of wage pressure given inflation and investment. So more broadly beyond the quarter, how should we be thinking about the cadence of expenses from here?

Alex Ko

Yes. As we reported this quarter we had our little bit increase on noninterest expense due to the salary and bonuses, which also included a increase on bonus accrual that was a more kind of catch off for the first nine months. And I don’t expect same level of accrual for the bonus is necessary for the Q4. So, even though we have a little bit in the higher salary expenses due to the retention of the employees for the – what’s going on with hiring environment. Anyhow, I would expect salary and benefit expense will be decreasing compared to Q3 and all other items I would expect, it will be a pretty simple level as we have seen in the Q3. So that’s why, we believe about $72 million to $74 million of run rate is what I would expect.

Kevin Kim

Chris in connection with that subject, I think it is worth mentioning that the current job market is an employee market and the cost of hire an employee is ranging conservatively 10% to 15% higher than our current base salaries for the same position. So the cost to retain and attract employees in the current market is far greater than it was, over a year ago. So there will certainly be some upward pressure in terms of compensation and benefits. But as Alex mentioned we will continue to look at other areas, where we can enhance efficiencies so that we can manage our noninterest expenses within our more normalized range of $70 million to $74 million.

Chris McGratty

That’s great color, Kevin. If I could just sneak one in to clarification, the $43 million of charge-offs in the quarter, I’m interested in how that kind of mapped to the large nonaccrual with, I think it was around 23 or 24 in the first quarter, and then the loan sale of 30 in the transfers of 131. I’m just trying to figure out, where the loss content was within the three things that you call that. Thanks.

Peter Koh

Hi, this is Peter. I can address that one for you here. So, we did have an elevated level of charge-offs this quarter, and it really was a combination of various factors, the loan sales, we had the one large relationship as well, and a couple of large payoffs. We are in the process of multiple workouts with current customers. So, we can’t shared a lot of detail in terms of that breakdown, but we will say that the discounts on the loan sales side actually were still very reasonable. We felt that we had a significant amount of reserves attached to those discounts and a good portion of the larger elevator charge-off was due to the larger relationship that we discussed.

Chris McGratty

Okay. Thank you.

Operator

[Operator Instructions] Our next question will come from Gary Tenner with D.A. Davidson. Please go ahead.

Gary Tenner

Thanks. Good morning. I’m a bit of a follow-up, I suppose, to the last question, but in terms of the property types, that were sold in the quarter. If I looked at your data, you provide on your tables in terms of the real estate loans by property type, other than, it appearing that there was some hotel/motel involved in the sales and transfers that, I can’t, it doesn’t quite jump out at me in terms of what other property types were represented there. So, could you talk from that point on?

Kevin Kim

Sure. I can add a little color. So if you recall, the second quarter, we really focused on the hotel/ motel space for the loan sales and in the third quarter a smaller portion of the hotel/motel we continued to address, but we’d actually looked at focused on the retail side as well. So, when you look at the overall composition on the CRE side, we looked at the two primary categories, where we felt that there was risk stemming from the pandemic, which is the hotel and the retail. So in combination with the loan sales from 2Q and 3Q, we feel confident that we have addressed all the significant kind of concerns.

As you know, as mentioned in the prepared remarks, we really do feel that with the improving economic conditions and monitoring our underlying borrowers financial performance, which is improving across the board, we felt comfortable, reducing levels of reserves and things like that. But to answer your question, yes, it was mostly from the hotel and the retail sectors.

Gary Tenner

Okay. And obviously a good portion of your commercial real estate funding’s this quarter, then we’re also in the retail property type as well. Just give me the kind of quarter-over-quarter growth. So, you’re still comfortable in this space. You just needed to kind of dearest some specific credits?

Kevin Kim

That’s correct. So we do, we still are finding good opportunities in the retail sector, but we are looking at that very closely. And I do think we will moderate the growth there where we feel that we can manage the levels. The retail sector has, is to us a more diversified as a category than say hotels. There are a lot of underlying cash flows that come from different sectors of the economy. And as you may know, we are focusing on the convenience store type of retail, where it is mostly internet resistant. And so we are looking at a sort of a recomposition play within the CRE and that I think applies to the retail sector as well.

Gary Tenner

Great. Thank you for that. In terms of loan sales going forward will you be continuing to solve both the SBA and single-family production?

Alex Ko

Yes, yes. We will continue to sell the SBA loans, at this point we are not expecting any dramatic change in the level of gain on sale of SBA loans, but we have on our books in excess of $280 million of guaranteed portion of SBA loans. So, we are keeping a close eye on the secondary market, and premiums available in the secondary market. So, but currently we don’t have any plan to have any dramatic change in the level of a gain on sale of SBA loans.

Gary Tenner

Okay. And then last question for me, in terms of the multi-family business that showed good strengths this quarter. Can you tell us specifically the yields in the production in that segment this quarter?

Kevin Kim

I think we will have to take a look at that. I think maybe we can get back to you with the yield there. Multi-family in general is, from a CRE perspective is a slightly lower yielding category, but a risk adjusted, I think it does make sense for us in terms of our strategic plan.

Gary Tenner

Okay, thank you.

Kevin Kim

Thank you.

Operator

[Operator Instructions] Our next question is a follow-up from Chris McGratty with KBW. Please go ahead.

Chris McGratty

Yes, thanks for the follow-up. The question is, you’ve had a lot of success on the deposit diversification over the last couple of years. I’m interested in kind of your thoughts about the sustainability of these really strong growth in particularly noninterest bearing, I know there’s some new verticals, but any thoughts on just deposit growth over the next several quarters?

Alex Ko

Yes. We had a great success, especially on the noninterest bearing deposits. And when we look at the composition of that the increases we see in two types, one from the institutional from CDC deposits, as well as lots of retail deposit increase. And we believe that retail deposit is mainly coming from the government subsidize or PPP, those loans maybe some – there is some temporary nature. So there will be some runoff. I don’t think there will be a dramatic runoff for those retail side and going back to the CDC or institutional noninterest bearing deposit, we see it’s a very stable. So, we do not expect a meaningful runoff for that institutional noninterest bearing deposits. So both two combined, we expect there might be some runoff, but we do not expect a substantial reduction of our deposit that we grew for the last 18 months or so in the near future.

Chris McGratty

All right. Great. Thank you.

Alex Ko

Maybe, Gary, can I get back to you the most family, the yield we just found out, it was around the 3.03% yield.

Operator

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

Kevin Kim

Okay. Once again, thank you all for joining us today. We hope everyone stay safe and healthy, until we speak with you again next quarter. See you everyone.

Operator

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