Hope Bancorp, Inc. (NASDAQ:HOPE) Q1 2024 Earnings Conference Call April 29, 2024 12:30 PM ET

Company Participants

Angie Yang - Director of IR
Kevin Kim - Chairman, President and CEO
Julianna Balicka - CFO

Conference Call Participants

Gary Tenner - D.A. Davidson
Chris McGratty - KBW
John Deysher - Pinnacle Value Fund

Operator

Good day, and welcome to the Hope Bancorp 2024 First Quarter Earnings Conference Call. All participants will be in 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, Nicholas. Good morning, everyone, and thank you for joining us for the Hope Bancorp 2024 First Quarter Investor Conference Call. As usual, we will be using a slide presentation to accompany our discussion this morning, including an earnings call presentation and a merger-agreement presentation, both of which are available in the presentations page of our investor relations website.

Beginning on Slide 2, let me start with a brief statement regarding forward-looking remarks. The call today contains forward-looking projections regarding the future financial performance of the company and future events, as well as statements regarding the proposed transaction between Hope Bancorp and Territorial Bancorp, including the expected timeline for completing the transaction, future financial and operating results, benefits and synergies of the proposed transaction, and other statements about the future expectations, beliefs, goals, plans, and prospects of Hope Bancorp, as well as the combined entities.

These statements constitute forward-looking statements and are not guarantees of future performance. Actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. The closing of the proposed transaction is subject to regulatory approvals, the approval of the shareholders of Territorial Bancorp, and other customary closing conditions. If the transaction is consummated, we may not achieve anticipated synergies, cost savings, and other benefits from the transaction as a result of higher than anticipated transaction costs, deposit attrition, operating costs, customer loss, and business disruption following the merger, including difficulties in integrating the two operations.

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 this morning.

Hope Bancorp assumes no obligation to revise any forward-looking projections that may be made on today's call. Now we have allotted 1 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. Kevin?

Kevin Kim

Thank you, Angie. Good morning, everyone, and thank you for joining us today. Let us begin on Slide 3 with a brief overview of the quarter. For the first quarter of 2024, we earned net income of $25.9 million or $0.20 per diluted share compared with net income of $26.5 million or $0.22 per diluted share for the fourth quarter of 2023. Excluding notable items, our net income was $27.4 million, and our earnings per share were $0.23.

Notable items this quarter comprised merger-related costs of $1 million, or $752,000 after tax, an incremental FDIC special assessment of $1 million or $721,000 after tax, and the restructuring cost of $143,000 or $103,000 after tax. Last quarter, net income excluding notable items was $38.3 million or $0.32 per diluted share. Notable items in the fourth quarter comprised restructuring charges and an FDIC special assessment. Moving on to Slide 4. This morning we announced a definitive agreement to acquire Territorial Bancorp, the parent company of Territorial Savings Bank, a $2.2 billion in assets institution based in the state of Hawaii. This transaction creates the largest U.S. Regional bank catering to multi-ethnic customers across the continental United States and the Hawaiian Islands.

Founded in 1921, Territorial has been supporting their local communities and providing personal financial services to their customers for over a century. Hope is excited to be partnering with a bank that shares our values, and we intend to preserve and continue to build on Territorial's long and [storage] (ph) legacy. To ensure continuity of service for the customer base and employees after the close of the transaction, the legacy territorial franchise will continue to do business under the Territorial Savings Bank brand as a trade name of Bank of Hope.

The partnership with Territorial expands our footprint into the attractive Hawaii market which has a large Asian American and Pacific Islander community. It will contribute a stable low-cost core deposit base to the combined company. The spot cost of Territorial's total deposits was 1.61% as of December 31, 2023 or 1.2% excluding public fund deposits. Pro forma, Territorial’s residential mortgage loans would more than double the size of Hope's residential mortgage portfolio, greatly enhancing our loan mix diversification. We believe the transaction will strengthen Territorial Savings Bank for the long term and create meaningful opportunities to grow customer and market share by being part of a larger organization with greater resources and an expanded array of banking products and services.

The transaction is expected to close by year end 2024 and is expected to be immediately accretive to earnings after the close at a double-digit percentage growth rate, sustainably strengthening our profitability. On Slide 5, you can see that we ended the quarter with strong capital, and all our capital ratios expanded from December 31 of 2023. As of March 31, 2024, our total capital ratio was 14.19%, up 27 basis points from December 31. And our common equity ratio was 12.47%, up 19 basis points quarter-over-quarter.

And our tangible common equity ratio was 9.33%, up 47 basis points from year-end 2023. Adjusting for the allowance for credit losses and including hypothetical adjustments for investment security marks, all our capital ratios remain high. Our Board of Directors declared a quarterly common stock dividend of $0.14 per share payable on May 23 to stockholders of record as of May 9, 2024.

Continuing to Slide 6. At March 31, 2024, our total deposits were $14.8 billion, essentially stable quarter-over-quarter. Our line of business groups exceeded their customer deposit growth goals for the quarter, offsetting a planned reduction of broker-time deposits. As of March 31, our gross loan-to-deposit ratio was 93%. Moving on to Slide 7. At March 31, 2024, our loan portfolio totaled $13.7 billion, a decrease of 1% quarter-over-quarter. Commercial and commercial real estate loans decreased partially offset by growth in SBA and residential mortgage loans. The negative rate of change in our loan balances has decelerated from recent quarters with our teams regaining momentum following the reorganization, our pipelines are increasing.

On Slides 8 and 9, we provide more details on our commercial real estate loans, which are well diversified by property type and granular in size. The loan-to-values remain low across the portfolio with a weighted average of approximately 46% at March 31, 2024. The vast majority of our commercial real estate loans have full recourse with personal guarantees. Asset quality remains strong with 98.2% of the commercial real estate portfolio being past graded at March 31, 2024.

With that, I will ask Julianna to provide additional details on our financial performance for the first quarter. Julianna?

Julianna Balicka

Thank you, Kevin, and good morning, everyone. Beginning with Slide 10. Our net interest income totaled $115 million for the first quarter of 2024, a decrease of 9% from the fourth quarter. This largely reflects a decline in average loans and a higher cost of interest-bearing deposits, partially offset by a decrease in average CDs and wholesale borrowings.

Net interest margin for the 2024 first quarter contracted 15 basis points to 2.55%. At the end of the first quarter, we paid off $1 billion of our bank term funding program borrowings and the remaining $695 million was paid off in early April. We used interest earning cash for the payoff. The positive spread earned on BTFP borrowings contributed approximately $3.6 million to net interest income in the first quarter. All else equal, the payoff of the BTFP should be a positive to our net interest margin going forward.

Moving on to Slide 11. Our average loans of $13.7 billion decreased 2% linked quarter. The average yield on our loan portfolio increased 1 basis point to 6.25%. As Kevin referenced, our lending team's momentum is rebuilding and loan growth trends are improving. Average deposits of $14.9 million decreased 3% quarter-over-quarter and the weighted average cost of interest-bearing deposits increased 19 basis points.

In the first quarter of 2024 we absorbed the renewal of promotional CDs from the year ago first quarter. I’d like to highlight that month-to-date in April 2024, the spot cost of our deposits has decreased slightly as we benefit from an improved pricing approach following our line of business focused reorganization.

On to Slide 12. Our non-interest income was $8 million for the first quarter compared with $9 million for the fourth quarter of 2023. Growth in deposit service fees was offset by a decrease in other non-interest income. Similar to prior quarter, we did not record any gain on the sale of SBA loans in the first quarter. Secondary market premiums have improved by April 2024 compared with the beginning of the year, and we’re likely to resume a small volume of SBA loan sales in the second quarter.

We are continually -- we continually evaluate market pricing conditions for selling or retaining SBA loan originations. Moving on to expenses on Slide 13. Our first quarter 2024 GAAP non-interest expense was $85 million compared with $99 million in the fourth quarter of 2023. Excluding notable items from both quarters which Kevin outlined, our first quarter non-interest expense of $83 million was down 2% quarter-over-quarter from $84 million in the fourth quarter of 2023 and is down 7% from $89 million in the first quarter of 2023.

First quarter 2024 salaries and employee benefits expense increased 1% quarter-over-quarter to $48 million, up from $47 million reflecting seasonal increases in payroll taxes and vacation accruals, partially offset by reduced salary and benefit costs following our restructuring in the fourth quarter. Year-over-year, our salaries and employee benefits expense is down 16%. For the first quarter of 2024, the effective tax rate was 28% compared with 25% for the full year 2023. For the full year 2024, we expect effective tax rate will be approximately 26%. Income tax provision for the first quarter was $10 million and included $1.1 million of true-up adjustments, which are not expected to recur.

Now moving on to Slide 14. I will review asset quality. Our non-performing assets at March 31, 2024 increased to $107 million compared with $46 million as of December 31 and $80 million as of March 31, 2023. The quarter-over-quarter increase was largely attributable to one relationship consisting of three commercial real estate loans that were accruing in 90 days past due as of March 31, 2024.

The exposure is fully secured and sales agreements are in place for the collateral properties with no expected loss. Net charge-offs for the 2024 first quarter were $3.5 million or 10 basis points of average loans annualized compared with 5 basis points in the prior quarter. For the first quarter, our provision for credit losses was $2.6 million compared with $2.4 million in the prior quarter.

At March 31, 2024, our allowance for credit losses was $159 million, representing 116 basis points of loans receivable compared with 115 basis points as of December 31, 2023, and up from 109 basis points as of March 31, 2023.

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

Kevin Kim

Thank you, Julianna. Moving on to the outlook on Slide 15. Our pending transaction with Territorial Bancorp is expected to close by year-end 2024 and does not impact our fourth quarter 2024 outlook. In terms of our fourth quarter 2024 outlook, relative to the fourth quarter 2023 actuals, we have the following updates. Fourth quarter to fourth quarter, we still expect average loans to grow at a percentage rate in the low single digits, up from $14.05 billion in the fourth quarter of 2023.

In terms of net interest income, we utilized the current implied forward interest rate curve in our baseline. Therefore, we’re factoring in one Fed fund's target rate cut of 25 basis points in September. This compares with five Fed fund's target rate cuts implied by the forward curve in January of 2024. Accordingly, we now expect net interest income for the fourth quarter of 2024 to decline between 5% and 7% from $126 million in the fourth quarter of 2023. This includes the net impact of the payoff of the bank term funding program, which contributed a positive $4 million to our net interest income in the fourth quarter of 2023.

Year-to-date, secondary market premiums for SBA loan sales have improved, and we are likely to resume SBA loan sale activity, with a small volume in the second quarter. Fourth quarter to fourth quarter, we still continue to expect operating expenses to decrease by over 5% from $85 million in the fourth quarter of 2023. Our outlook translates into positive operating leverage when comparing the fourth quarter of 2024 with the fourth quarter of 2023 with the decrease in expenses, plus the gains from the [resumption] (ph) of SBA sales, exceeding net interest income pressure.

Finally, in our 2024 outlook, we continue to assume an essentially stable coverage ratio of allowance for credit losses to loans which was 116 basis points of loans as of March 31, 2024, and 150 basis points of loans as of December 31, 2023. With that, I will proceed to discuss our pending merger with Territorial Bancorp and switch to the transaction related slide deck available on our Investor Relations website.

Beginning with Slide 3 of the merger presentation, the transaction with Territorial Bancorp is strategically compelling and financially attractive, bringing together two culturally aligned organizations. I reviewed the key highlights in my opening remarks and will now review some of the details. The aggregate consideration of $79 million based on the closing price of April 26, 2024, is equivalent to 31% of Territorial's December 31 tangible book value.

The exchange ratio is fixed at 0.8048 Hope shares per Territorial share. The estimated earn-back period for Hope's tangible book value dilution is approximately 3 years. We expect the transaction to be immediately accretive to earnings after the close at a double-digit percentage growth rate. No capital raise will be needed to complete the transaction, and the combined company will have strong capital and capital ratios to support growth after the close.

On Slide 4, we provide a closer look at Territorial Bancorp. Headquartered in Honolulu, Hawaii, Territorial Savings Bank has the fifth largest market share in the state, operating 28 branches on the island of Oahu, Maui, Kauai and Hawaii. With $2.2 billion in total assets as of December 31, 2023, Territorial had gross loans of $1.3 billion and total deposits of $1.6 billion. Territorial has very strong capital and its tangible common equity ratio was over 11% as of December 30, 2023.

Territorial's asset quality is excellent and non-performing assets represented just 10 basis points of total assets at the end of the year. 97% of Territorial's loan portfolio are residential mortgages, which have a low weighted average loan-to-value ratio of 63%. On Slide 5, we show the pro forma loans and deposits of the combined company. You can see that the transaction accelerates the prudent diversification of our loan portfolio with Territorial's contribution more than doubling Hope's residential mortgage loans to approximately 15% of total loans outstanding of the combined company. Pro forma, Hawaii will become the combined company's third largest market in terms of deposits by state.

On Slide 6, we highlight territorials low-cost, stable and granular core deposit base. The cost of total deposits was 1.61% as of December 31, 2023, and 1.2%, excluding public funds deposits. The average account size is $30,000 and the median account size is a little over $4,000. 73% of Territorial’s deposit balances excluding public funds are from accounts equal to over less than $250,000 in size, 93% of the non-CD deposit balances at Territorial are from consumer accounts.

Slide 7 recaps the financial details of the transaction, which I have already covered in my remarks, but are presented here for your easy reference. The merger will require the approvals of regulators, the approval of Territorial shareholders and the satisfaction of customary closing conditions.

Moving on to Slide 8. Upon completion of the transaction, we intend to continue operating in Hawaii under the Territorial Savings Bank brand. With an merger, cultural integration is a very important aspect that must be addressed with great care. We are pleased that Hope and Territorial organizations share similar corporate and cultural values that emphasize a strong commitment to employees, customers and the communities that we serve. We look forward to building on the long-standing legacy and positive impact that the territorial franchise has made to the Hawaii market.

We have a deeply experienced Board and management team with proven histories of successfully completing and integrating M&A transactions with diverse business models. We fully expect to have a smooth and seamless integration process which will enable us to quickly begin realizing the benefits of this combination for our shareholders, our customers and our employees. With this transaction, we are taking another strong and purposeful step to fortifying the long-term growth prospects of Hope Bancorp and ensure the success of the franchise for many, many years to come.

With that, operator, please open up the call for questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] First question comes from Gary Tenner with D.A. Davidson. Please go ahead.

Gary Tenner

Thanks good morning. I wanted to ask for some more color, if possible in terms of some of the financials around the deal, including what your expectations are for one-time merger expenses, thoughts around credit marks and projected cost saves and timing of those.

Julianna Balicka

Hi Gary, this is Julianna. The deal marks, as you know are something that is going to reflect the forward rate curve or the valuation at that point in time. So those will shift. But right now, we are assuming deal marks of approximately about 15% on the loans, approximately 17% change on the securities. And on the loans, we are assuming that accretion and that will be lower in the first couple of years, accretion income because this is a residential mortgage portfolio, right? It’s going to be a little bit more longer-dated. The average life of it will be seven years, but we expect to prepay to be back-end loaded when interest rate changes -- change in life events. So we're not assuming a front-loaded accretion.

In terms of the deal expenses, we are assuming deal expenses – and we're still working out some of the related expenses as we go through our integration planning process will be in the $25 million to $30 million range. And the cost saves, we're assuming 75% in the first year. And then 100% in the subsequent year. I will say that this is not necessarily a cost saves transaction. This is a strategic market expansion transaction that provides us an excellent high-quality core deposit base. And the and -- and we are focused on making sure that the customer experience and transition period is seamless. So unlike maybe in-market transaction, the cost saves are going to be the number that I just told you about.

Gary Tenner

Okay. I appreciate that. And then just more broadly, as it relates to the territorial franchise and how you're thinking about that market longer term, I know if you go back several years, growth of territorials deposits have lagged the state of Hawaii in total. I wonder if you guys could provide any kind of color in terms of why that may have been the case? And kind of how you're thinking about approaching that market longer term?

Kevin Kim

Well, we believe that territorial's long legacy in the State of Hawaii has established a very good market presence in Hawaii. And with our larger balance sheet and our broader array of banking products and services, I think, we have really good market share expansion opportunities in Hawaii. And this will also become a very beneficial experience for the customers of Territorial.

Gary Tenner

Yeah, thank you.

Julianna Balicka

Gary, if I can just add real quick to -- that you asked about the transaction expenses. What I quoted to you was the pretax number. So I just want to make sure that's clear.

Kevin Kim

Did you share that 27.5% of Territorial interest expenses will be the expected cost savings.

Julianna Balicka

And the cost savings will be 27.5%. It just happens to be in the same range as the [deal cost] (ph).

Gary Tenner

Got it. Thank you.

Operator

[Operator Instructions] The next question comes from Chris McGratty with KBW. Please go ahead.

Chris McGratty

Great, good morning. Kevin or Julianna, I just want to go to Slide three for a second, the double-digit earnings accretion that you referenced -- Julianna, you mentioned that accretable isn't going to be notably higher or front-loaded. If you were to kind of unpack the double digit, like how much is purchase accounting versus just core, I’d say.

Julianna Balicka

Well, I mean in the current interest rate environment, accretion is core. But between the 3, it's going to be mixed -- between the kind of three components of EPS accretion, it is going to be a combination of cost saves, right, which are going to be phased in over time, as we do the transition. The accretion on the balance sheet. And then the third component will be balance sheet restructuring, repositioning, Territorial does provide us balance sheet liquidity optionality with their securities and their cash position. So there will be some redeployment of that as well built into our earnings accretion and we are going through our transaction -- integration planning process right now. So as we kind of tighten up the model in the sense of going through this process, we will share more details.

Chris McGratty

Okay. Great. And if I could just add one more. The interest rate marks are understandably large. But aside from that -- maybe a little bit more color on just the perception of their credit portfolio, the diligence you did any portfolios that might not be core to the legacy Hope Bancorp.

Julianna Balicka

It's an excellent asset quality portfolio. We took a look at it in multiple ways through the due diligence process. Obviously, we needed to make sure that we had the marks on the balance sheet correctly estimated between interest rate and credit. I mean with NPA ratio of only 10 basis points. I mean, this is -- 97% of that is the residential mortgage portfolio at a low LTV. It's a clean asset quality portfolio.

Chris McGratty

Okay, thank you.

Operator

[Operator Instructions] The next question comes from John Deysher with Pinnacle. Please go ahead.

John Deysher

Hi, good morning. I was just curious if you could tell us how this deal came about -- how you found Territorial? And were there any other bidders for the bank?

Kevin Kim

Well, hi, this is Kevin. Well, my counterpart at Territorial and I have had casual interactions over the years. And in the current interest rate environment, both of us concluded that a strategic partnership between Hope and Territorial would be very, very compelling. So we had engaged a serious conversations from towards the end of 2023. And we came up with announcing the deal signing this morning. So I understand that Territorial has talked to other potential buyers. But from strategic perspective, they must have concluded that Hope would be the most ideal deal partner for this for this deal.

John Deysher

Okay. That's helpful. You're going to keep the franchise intact. What about the management team at Territorial – who is going to be --.

Kevin Kim

We plan to maintain most of the customer-facing and frontline employees at Territorial. And we believe that capitalizing on their very good reputation and traditionally good services and loyal customers at territorial would be very important for us to continue after the close. So we will retain most of the employees. And the cost savings will come from mainly [duplicative] (ph) corporate and public company expenses that will be redundant after the close. Like we said, this is not a deal for mainly cost savings or elimination of competition. This is more of a strategic merger to improve our market share growth opportunities in the new market.

John Deysher

Understood. Thank you very much and good luck.

Kevin Kim

Thank you.

Operator

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

Gary Tenner

Thanks. I had just a quick follow-up. Julianna, in terms of your comment regarding the deposit rates month-to-date April, were you referencing that relative to the full quarter average from the first quarter?

Julianna Balicka

Relative to March 31 spot. So from March 31 spot --.

Gary Tenner

Did you give us the March 31 spot? If I missed it, I apologize.

Julianna Balicka

No. Our March 31 spot was [367] (ph) for total deposits, and we're down several basis points from that as of right now in April.

Gary Tenner

Okay, thank you.

Operator

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

Julianna Balicka

Actually -- excuse me, may I make a comment. The spot that I just quoted to Gary at 367 excludes some cost benefits that we have from hedge accounting on our deposit book. So the hedge adjusted spot is present in our average balance sheet is [342] (ph), and we're down several basis points from that 342. So I just wanted to clarify that. Apologies.

Kevin Kim

Great. Once again, thank you all for joining us today, and we look forward to speaking with you next quarter. So long, everyone.

Operator

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