Hope Bancorp, Inc. (NASDAQ:HOPE) Q1 2021 Earnings Conference Call April 28, 2021 12:30 PM ET

Company Participants

Angie Yang - Director, IR
Kevin Kim - Chairman, President and CEO
Alex Ko - Senior Executive Vice President and CFO
Peter Koh - Chief Credit Officer

Conference Call Participants

Chris McGratty - KBW
Matthew Clark - Piper Sandler
Gary Tenner - D.A. Davidson

Operator

Good day, and welcome to the Hope Bancorp 2021 First Quarter Earnings Conference Call. [Operator Instructions]

I would now like to turn the conference over to Angie Yang, Director of Investor Relations. Please go ahead.

Angie Yang

Thank you, Sarah. Good morning, everyone, and thank you for joining us for the Hope Bancorp 2021 first quarter investor conference call. As usual, we will begin with the 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 March 31, 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 first 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, who is recently promoted to Senior Executive Vice President in recognition of the significant contributions as Chief Financial Officer since 2017. Chief Credit Officer, Peter Koh 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. 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. During the first quarter, we continued to deliver solid financial performance, while making additional progress on the strategic initiatives to enhance the long-term value of our franchise, most notably, improving our loan and deposit mix, while maintaining disciplined expense control.

Given the significant reserve we built last year and with our loan portfolio performing consistent with our expectations, we expect considerably lower levels of provision expense this year, which will positively impact our level of profitability.

For the first quarter of 2021, we generated net income of $43.7 million or $0.35 per diluted share, representing an increase of 54% when compared with net income of $28.3 million or $0.23 per diluted share in the preceding fourth quarter.

Throughout 2020, we made significant progress on improving our ability to gather lower costing transaction deposit accounts from commercial customers, and we've continued this momentum as we started 2021.

During the first quarter, our non-interest-bearing deposits increased 13% quarter-over-quarter. The strong inflows we are seeing in transaction deposits have enabled us to continue to reduce our dependence on higher cost time deposits, improve our deposit mix and reduce our overall cost of deposits.

At the end of the first quarter, our non-interest-bearing deposits increased to 38% of total deposits, up from 24% a year ago, while our time deposits declined to 25% of total deposits, down from 30% a year ago. The continued improvement in our deposit mix lowered our average cost of deposits by another 12 basis points in the first quarter, which has helped us to continue to expand our net interest margin by more than offsetting the pressure on earning asset yields that we have experienced.

Aside from continuing to grow transaction deposits, another strategic priority we set forth for 2021 was to increase our residential mortgage originations business and generate higher levels of fee income. In that context, we observed notable improvement in our performance during the first quarter.

Although mortgage rates have increased somewhat recently and impacted demand for refinancing, our renewed focus on purchase transactions and improved execution in this business helped increase our mortgage originations by 12% over the preceding fourth quarter, and compared with the first quarter of last year, originations were up 87%. As a result of the higher origination volume, our net gain on sale of loans increased 30% over the preceding quarter.

Moving on to Slide 4. We had another robust quarter of loan production, which included $305 million of PPP loan originations. Our focus on assisting new and existing customers to access the second round of PPP funding as well as the seasonally slower loan demand we see early in the year, resulted in our loan production in other areas coming in below the levels we saw during the second half of 2020.

Excluding PPP loans in the first quarter, we funded $278 million in commercial real estate loans, $157 million of C&I loans and $71 million of consumer loans, primarily consisting of residential mortgages. SBA loan production, which is included in the CRE and C&I fundings just discussed, totaled $37 million, which was up from $26 million in the preceding fourth quarter.

With the progress we are making in originating a more diversified mix of new loans, we are seeing a meaningful shift in the composition of our loan portfolio. Commercial real estate loans have decreased as a percentage of total loans from 69% at March 31 of 2020 to 64% as of March 31 of 2021. And C&I loans have increased from 24% a year ago to 32% of total loans as of the end of the first quarter of 2021.

In terms of the average rate on new loans, as interest rates increase, we are beginning to see some firming up of loan pricing. In the first quarter, the average rate on CRE loan originations increased 14 basis points from the preceding fourth quarter, while the average rate on new C&I loans increased 17 basis points.

Overall, excluding PPP loan originations, the average rate on new loans increased 17 basis points quarter-over-quarter. We are however still seeing pay-offs on higher yielding loans, which is having the effect of reducing the average yield in the overall portfolio.

Now moving on to Slide 5, let me provide an update on the loan modification program that we implemented to assist our borrowers manage through the pandemic. We continued to see a steady decrease in the balances of our active loan modifications. At March 31, modified loans decreased to 6.9% of total loans, down from more than 10% as of December 31 of 2020. Generally, we have provided for the modifications under the CARES Act since the end of 2020.

Based on our COVID-19 modifications expiration schedule, we expect active modifications to decrease to approximately 2% to 3% of total loans by the end of the second quarter of this year. Hotel/motel and retail properties remain the two sectors of our portfolio that have been most impacted by the pandemic with hotel/motel properties representing 56% or $535 million of all active modifications at March the 31 of 2021, and retail properties accounting for 20% or $189 million.

So moving on to Slide 6, we have provided updated information on the modification program for our hotel/motel and retail CRE properties. At March 31, the level of loan modified in our hotel/motel portfolio decreased to 33% of the portfolio from 45% as of December the 31 of 2020.

We have approximately $381 million of modifications in this portfolio maturing by the end of the second quarter. So this percentage will be reduced by a significant amount within the next three months. And of the hotel/motel modifications that have already expired, I'm pleased to report that substantially all are current and performing.

The deferrals we provided in Phase 2 of our modification program have helped support our borrowers manage through the seasonally slower winter season, and this portfolio is performing consistent with our expectations. We are now starting to see improvement in bookings and cash flows as we move into the spring season with more of our borrowers now operating at or above breakeven.

And this is consistent with the occupancy and revenue per available room industry data that demonstrates meaningful improvements for this main - for the main regions where we have hotel/motel borrowers. As the vaccine rollout continues and business and leisure travel increases, we expect to see a steady decrease in active loan modifications as the year progresses.

Looking at our retail CRE portfolio, at March 31, we have $189 million of retail CRE loans that are currently operating under modified terms, representing 8% of our retail CRE portfolio. This is down from approximately 13% as of December 31 of 2020. For this portfolio, we have approximately $115 million of modifications expiring during the second quarter.

So we expect retail CRE modifications will be minimal by the end of the second quarter. And of the retail CRE modifications that have already matured, as with our hotel/motel portfolio, substantially all are current and performing. With more cities is continuing to lift pandemic-related restrictions, we expect business activity at our strip center type of retail properties will accelerate, leading to further stabilization for these borrowers.

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

Alex Ko

Thank you, Kevin.

Beginning with Slide 7, I will start with our net interest income, which is total $122.6 million, an increase of 2% from $120.8 million in the preceding fourth quarter and representing our third consecutive quarter of increasing trend. The growth in net interest income this quarter was due to a 25% reduction in interest expense as a result of the lower cost of deposits.

In the first quarter, our net interest margin increased 4 basis points to 3.06%, which represents our third consecutive quarter of margin expansion. This continued improvement in our net interest margin was driven primarily by lower deposit costs. Excluding purchase accounting adjustment, our net interest margin increased by 5 basis points quarter-over-quarter during the first quarter of 2021.

The success we are having with gathering lower costing deposits has provided additional opportunities to bring our deposit costs down as we have $1.6 billion in time deposits maturing in the second quarter at a weighted average rate of 65 basis points. This will provide an opportunity to continue to expand our net interest margin through the next quarter.

Now moving on to Slide 8. Our non-interest income was $8.8 million for the 2021 first quarter, down from $11.4 million in the preceding fourth quarter. The primary driver of this decrease was lower swap fee income, which was $1.5 million lower in the first quarter. We also recognized a $1.2 million decrease in service fees on deposit accounts, which was largely attributable to our risk management decision to discontinue working with customers in the check cashing industries.

Going forward, we expect our deposit service fees to remain in the range we recognized during the first quarter. These decreases were partially offset by a higher level of net gains on loan sales during - resulting from the increased mortgage originations that Kevin discussed as well as an increase in loan servicing fees, primarily related to our SBA servicing portfolio. During the first quarter, we sold $67.8 million of residential mortgage loans compared with $52.6 million in the preceding fourth quarter.

Moving on to non-interest expense on Slide 9. Our non-interest expense was $70.4 million in the 2021 first quarter, representing a decrease of 1% from the preceding fourth quarter. The primary reason for this variance was the expected future benefit associated with the $2.4 million branch restructuring charge recorded in the fourth quarter.

Our salaries and benefit expense increased $25,000, reflecting seasonally higher payroll taxes and the 401(k) contribution expenses. This was partially offset by a $1.4 million in deferred loan origination cost resulting from our PPP loan production in the first quarter. Our occupancy expense decreased $233,000, which is reflective of the initial benefits of our branch consolidations completed only in first quarter.

Now moving on to Slide 10, I will discuss some of our key deposit trends. We continued to run off higher costing time deposits and replaced them with lower costing transaction deposits through our business development efforts. During the first quarter, our non-interest-bearing demand deposits increased 13%, while our time deposits decreased 11%, resulting in total deposits remaining relatively unchanged from the end of preceding quarter.

Now moving on to Slide 11, I will review our asset quality. During the first quarter, we recognized an increase in criticized loans, which primarily reflects downgrade in the hotel/motel portfolio to a special mentioned category from our COVID watch grade that we originally established during 2020 for loans impacted by the pandemic and modified under the CARES Act.

While we are not seeing any unforeseen issues with these borrowers or any more deterioration than we had expected, and they remain current and performing under the modified terms, based upon a protracted recovery for these borrowers, we believe it was prudent to adjust the risk ratings for these loans, under which we will receive additional monitoring as special mention loan.

The updated financials that we have received from these borrowers to date confirms that their performance was relatively consistent with our expectations at the time we built up our allowance for credit losses. As we continue to receive updated financials for the first half of 2021, we expect the performance of these borrowers will reflect greater benefits from an improving travel industry and ultimately lead to upgrades beginning in the second half of the year.

Our non-accrual loans increased $25 million from the end of the prior quarter. This was mainly due to the addition of a $24 million retail CRE loan to a single borrower in the Fashion District. This is a unique situation with the borrower being involved in a legal dispute and is not reflective of any broader deterioration in this property types. Overall, we continued to experience minimal losses in our total loan portfolio. We had net charge-offs representing 6 basis points of average loans in the first quarter.

Now moving on to Slide 12, we have recorded a provision for credit losses of $3.3 million in the first quarter. The provision maintained at our allowance for credit losses at 1.52% of total loans, which we believe is sufficient given the performance of the portfolio. Excluding PPP loans, our coverage ratio was 1.6%.

Within the various buckets of our allowance for credit losses, the improving economic forecast drove a substantial level of release in our general reserves, while we had an increase in specific reserves associated with impairments identified on loans that went into non-accrual in the first quarter. We also made some qualitative adjustment in the hotel/motel portfolio to increase our coverage just a bit, which we believe is prudent until we start to see the improved performance we expect as the economy strengthens in the coming months.

Now moving on to Slide 13, let me provide an update on our liquidity position and capital ratios. Our overall liquidity position remains very strong as of March 31, 2021. Our primary source of funds continue to be customer deposits and we continue to see significant increases in non-interest bearing demand deposits.

We maintained a robust capital position with our total risk-based capital ratio, Tier 1 common equity ratio and Tier 1 risk-based capital ratios are increasing from the prior quarter. As of March 31, 2021, we continued to maintain a meaningful amount of excess capital above the amount required to be considered well capitalized. And given our strong capital and liquidity positions, we maintained our quarterly dividend at $0.14 per share.

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

Kevin Kim

Thank you, Alex.

Now moving on to Slide 14, let me provide a few comments about our outlook for the remainder of 2021. We expect to deliver consistently strong performance, driven by our continued progress in reducing our cost of deposits, expanding our net interest margin, maintaining disciplined expense control and seeing reduced credit costs, in line with improving economic conditions.

As we progress through the year, we expect to see a higher level of loan growth, which should enable us to favorably remix the balance sheet towards higher yielding earning assets, generate more revenue growth, realize more operating leverage and produce further increases in our profitability.

Our loan pipeline is increasing and we are seeing more loan demand as our customers become increasingly confident in a stronger economic recovery in the second half of the year. This should lead to a higher level of loan production in the coming quarters.

Additionally, we have recently expanded our corporate banking group to include a team that will focus on the newly initiated healthcare vertical. The team we added is a highly experienced, highly productive group with expertise in developing full banking relationships with hospitals, assisted-living facilities, medical groups, outpatient centers and other healthcare-related businesses.

We are already seeing the pipeline in this vertical build and we expect to see it make meaningful contributions to our loan production and core deposit gathering in the second half of the year. And, as we grow this vertical in the future, it will provide another vehicle towards our strategic goal of continuing to improve the mix of our loan portfolio.

In summary, we are off to a great start this year. We are executing well on all of our initiatives to enhance the value of our franchise. We are seeing positive trends in business development efforts and our loan portfolio is performing as expected with the help of our modification program.

We expect the continuing economic recovery will lead to steady improvements in both loan growth and asset quality as well as support lower provision levels this year versus 2020. Accordingly, we believe we are well-positioned to deliver strong financial performance and enhanced profitability over the rest of the year.

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] Our first question comes from Chris McGratty with KBW. Please go ahead.

Chris McGratty

Kevin, maybe just starting with you, I mean, you guys have done a great job remixing the deposits almost 40% non-interest-bearing and running down the CDs. I guess, I'm interested, how much more you think you could remix going forward? And ultimately, I'm trying to solve for how much do we think net interest income is going to grow because of these efforts and the improving loan growth? Thanks.

Alex Ko

For sure. Chris, this is Alex. Let me start to respond to that. We have, as you mentioned, a pretty good improvement on especially non-interest-bearing demand deposits. That's from the institutions that we have been working for many, many years. And now, we are actually getting more and more deposits. So, I think it will continue and maybe in excess of 40%, I do not know exactly. But given the rate that we see, I mean, the interest rate and liquidity, I think it will continue a little bit to expand our non-interest-bearing income position.

And in terms of impact to net interest income, obviously that's almost kind of deposit cost fees, even though some of the non-interest bearing deposit we paid some ECR, but that's a relatively lower rate. So, I think it will definitely help to boost our net interest income going forward.

Chris McGratty

Okay. And then, your comment about the service charge run rate, the new run rate, I guess lower than $2 million a quarter. I know those are typically pretty high-margin businesses. How do we think - maybe the question is about expenses - how do we think about any potential offset on the expenses or what's a fair run rate on expenses? Thanks.

Alex Ko

Sure. I don't expect our run rate for the expense will materially different from what we have in this quarter. Given our salary and benefit-wise, I think it will be pretty much similar level. And we will have some, again, the gains on our savings on our previously announced branch rationalization, but it will be pretty much offset with others. So I would say, it will be pretty much similar level of what we have reported in this quarter.

Chris McGratty

Great. And then, if I could, just one more on the PPP fees. Could you just let us know what's yet to be realized?

Alex Ko

Sure. The PPP fees that we have recognized for this quarter was about $2.8 million. And still to be further recognized is remaining at March 31 is about $18.3 million.

Operator

Our next question comes from Matthew Clark with Piper Sandler. Please go ahead.

Matthew Clark

Just on that last question on the $18.3 million, how much of that is for round two? And then, what kind of amortization schedule are you using there?

Alex Ko

We are amortizing two years for those. You're talking about, Matthew, the PPP loan, right?

Matthew Clark

Yes, I'm asking about the $18.3 million of remaining PPP fees. How much of that is going to come from round two? And over how many years you are amortizing that?

Alex Ko

Yes. It will be amortized over the three years, but vast majority - almost $14 million out of that $8.3 million is coming out of the second round of PPP and the rest, $4.4 million, coming out of the first round of PPP. And those are the net fees.

Matthew Clark

Great. And then, the average PPP balance in the quarter and end of period balance you had it?

Alex Ko

Yes. Average balance for Q1 was about $583 million and period end balance was $715 million.

Matthew Clark

Okay. Thanks. And then, on the pipeline, it sounds like it's increasing. Can you give us kind of order of magnitude how much that pipeline is up year-over-year or linked quarter?

Kevin Kim

Well, let me address that. We have a strong pipeline and obviously it is much larger than it was at the beginning of the year. And we gave the guidance of mid to high-single digit growth at the beginning of the year and we believe that is still a good projection as of today.

When we look at the strength of our pipeline, together with our initiatives to further expand our business development efforts by corporate banking group and SBA units as well as the launch of the portfolio mortgage products by our mortgage banking group at the end of March, I think the mid to high-single digit growth projection is still realistic.

Matthew Clark

Okay. And then, just on expenses, that $1.4 million from FAS 91 for deferred origination costs this quarter was round two. I'm assuming your comments about keeping the run rate similar to first quarter assumes that $1.4 million is offset by some savings to keep it around $70.5 million.

Kevin Kim

Yes. That's correct, Matthew.

Matthew Clark

Okay. Okay. And then, just remind us, do you guys have an SBA portfolio that you - within your portfolio that you retain? I can't remember if you sell all your production on the SBA front or not. And if you do, what is that - what's the health of that portfolio look like as some of these subsidies covering off in October?

Kevin Kim

Matthew, as of March 31, we have approximately $220 million in SBA loans held in our portfolio. And during the several quarters, we have kept all the SBA loans in our portfolio and have not sold during that time. And during that time, the premiums in the market have gone up significantly. And given the high premiums that have been available to us, I think we are in the process of re-evaluating our current strategy to portfolio SBA loans on our books, but we have not made the decision yet.

So, we are seriously considering selling some of the loans and we have not decided when we will begin to do that. And if we do that, we have not decided yet whether we will sell only new productions of SBA loans or we will sell some of the loans in our existing portfolio.

Operator

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

Gary Tenner

Thanks. Good morning. I just wanted to drill a little bit to the guidance on the provision level for the year, 160 times PPP the CECL day one, I think, brought you to about 98 basis points January 1 of last year. So, just - I know that you - obviously the provision came down quite a bit this quarter and you're projecting a year-over-year lower provision for the full year, which I think we'd all expect anyway. But just wondering what would kind of prevent you from maybe reversing a larger piece out over the next quarter or two, particularly as a lot of those hotel deferrals or modifications start to pay.

Peter Koh

Sure. This is Peter. I can address that. As we're looking at the next couple of quarters here, some of the trends that we're seeing where we had a few downgrades in Special Mention and the Hotel space, we will continue to assess the portfolio as it recovers. But as we know unexpected, there is point to be some spotty recovery rates for some of the hotel portfolio, which I think is reflected in the first quarter.

We may see some of that trickle into the second quarter just timing wise when we get the financials to be able to validate the information. But as you had mentioned, the economic forecast has drastically improved. And I think our models and our CECL methodology is also picking up on that.

So, assuming that the economic forecast continues at the current pace, I do think that we will see some level of release towards the second half of the year is our expectation. And I think, in terms of just a normalized run rate for our reserve coverage, I think we'll be closer to the day one CECL accounting that level as well. Obviously we have to go through the time period in terms of measuring the recovery rates, particularly as it relates to the hotel portfolio, but as we know in the current marketplace right now, March - February-March, we saw some very good improving trends.

We believe April will continue to show additional progress. And we are optimistic that through the spring and summer seasons, I think our borrowers in the hotel space particularly will be benefiting a lot from that. And I think that will be reflective of the - in the allowance reserve coverages eventually.

Operator

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

Kevin Kim

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

Operator

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