Hanmi Financial Corporation (NASDAQ:HAFC) Q1 2019 Results Earnings Conference Call April 23, 2019 5:00 PM ET
Richard Pimentel - SVP & Corporate Finance Officer
Chong Guk Kum - CEO
Bonita Lee - President, COO
Romolo Santarosa - CFO
Conference Call Participants
Gary Tenner - D.A. Davidson
Matthew Clark - Piper Jaffray
Chris McGratty - KBW
Don Worthington - Raymond James
Ladies and gentlemen, welcome to the Hanmi Financial Corporation First Quarter 2019 Conference Call. As a reminder, today's call is being recorded for replay purposes. At this time, all participants are in a listen-only mode. Following the presentation, the conference will be opened for questions.
I would now like to introduce Mr. Richard Pimentel, Senior Vice President and Corporate Finance Officer. Please go ahead.
Thank you, Dana. Thank you all for joining us today. With me to discuss Hanmi Financial's first quarter 2019 earnings are C.G. Kum, our Chief Executive Officer; Bonnie Lee, President and Chief Operating Officer; and Ron Santarosa, Chief Financial Officer.
Mr. Kum will begin with an overview of the quarter. Ms. Lee will discuss loan and deposit activities, and Mr. Santarosa will then provide more details on our operating performance. At the conclusion of the prepared remarks, we will open the session for questions.
In today's call, we may include comments and forward-looking statements based on current plans, expectations, events and financial industry trends that may affect our company's future operating results and financial position. Our actual results could be different from those expressed or implied by our forward-looking statements, which involve risks and uncertainties. The speakers on this call claim the protection of the safe harbor provisions contained in the Securities Litigation Reform Act of 1995.
For some factors that may cause our results to differ from our expectations, please refer to our SEC filings, including our most recent Form 10-K and 10-Q. In particular, we direct you to the discussion in our 10-K of certain risk factors affecting our business.
This afternoon, Hanmi Financial issued a news release outlining our financial results for the first quarter of 2019, which can be found on our website at hanmi.com. I will now turn the call over to Mr. Kum.
Chong Guk Kum
Thank you, Richard. Good afternoon, everyone. Thank you for joining us today to discuss Hanmi's 2019 first quarter results.
Our performance in the first quarter highlights the continued progression of our strategy to grow loans prudently, protect net interest margin and improve the bank cost structure. I will briefly summarize the key takeaways from the first quarter.
Net income per diluted share increased significantly from the prior quarter, which included onetime expenses, and was up more than 4% compared with the first quarter last year.
Through the end of the first quarter, our efforts to reduce costs and improve efficiencies have generated approximately $4.5 million in annual savings, and we are well on our way to achieving the $5 million net expense reduction target by year-end.
In what is traditionally our slowest quarter of the year for new loan and lease production, new origination volume in the first quarter nearly offset the normal loan and lease runoff. That said, we were very selective in adjudicating credits during the quarter.
And new origination activity in the period reflected continued loan pricing discipline and conservative underwriting standards. As a result, net interest margin has remained stable for 3 consecutive quarters.
In addition, total deposits were up 1.5% quarter-over-quarter and 10.1% year-over-year primarily driven by growth in time and noninterest-bearing demand deposits. Driven by the solid growth in deposits, along with our strategy to selectively grow loans and leases, our loan-to-deposit ratio stood at 95% compared with 101% a year ago.
And finally, subsequent to the end of the quarter, the Board of Directors appointed Bonnie Lee as Hanmi's next CEO upon my retirement next month. I'm very pleased with this decision, and I believe Bonita is uniquely qualified and deserving of this promotion.
Looking in more detail at our first quarter results. We reported net income of $14.7 million or $0.48 per diluted share. On a linked-quarter basis, net income per share increased by $0.11 or 29% compared to the fourth quarter of 2018, which included a onetime income tax adjustment totaling $2.7 million that reduced fourth quarter net income by $0.09 per share.
Excluding these items, net income per share increased by approximately 4% or $0.02 per share compared to the prior quarter. On a year-over-year basis, net income per share increased by $0.02 or approximately 4%.
Net charge-offs declined to $200,000 or 2 basis points for the first quarter. We recorded a $1.1 million loan loss provision in the quarter, and our allowance for loan losses increased slightly to 72 basis points of loans and leases at quarter end.
However, nonperforming loans increased in the quarter due to a $25 million commercial loan relationship primarily secured by business assets and, to a lesser extent, commercial real estate, which experienced an interruption to their business activity subsequent to the end of the first quarter.
As a result, we have established a specific allowance of $3 million for this relationship, and we are working closely with the borrower to achieve a resolution as soon as possible.
That being said, our commitment to conservative disciplined underwriting is part of the fabric of Hanmi's credit culture. For the first quarter of 2019, the weighted average loan-to-value and debt coverage ratio on new commercial real estate loan originations were 43.2% and 1.7x, respectively.
For the entire commercial real estate portfolio, the weighted average loan-to-value and weighted average debt coverage ratio as of the end of the first quarter were 49.5% and 2.1x, respectively.
I'd like to now provide an update on our strategic goals for 2019, which are predicated on being more selective in new loan production, protecting net interest margin and enhancing profitability through expense reduction. As evidenced by our first quarter results, we have made measurable progress in these key areas.
In moderating our loan growth expectations for the full year 2019 to a range of 5% to 7%, we are very focused on growing areas of the bank that generate lower-cost deposits and/or higher spreads, such as C&I loans and equipment leases. C&I loans, which include our specialty lending division that focuses on mainstream businesses along with commercial equipment leasing division, were much larger portion of our overall loan production in the quarter than they have been in previous periods. Bonnie will expand on this in her remarks.
In addition, we are much more selective in adjudicating credits with greater emphasis placed on pricing discipline. As a result, the average loan and lease yield for the first quarter is up 16 basis points to 5.22%. Additionally the weighted average interest rate for the newly originated loans in the first quarter increased 8 basis points.
And importantly, weighted average interest rate for the newly generated CRE loans increased 25 basis points during the quarter. As a result, first quarter net interest margin was 3.52% and has increased slightly during the last 2 quarters.
In addition to the selective growth initiatives, we also made progress in our efforts to reduce costs and to improve operational efficiency, which are expected to be reduce noninterest expenses by at least $5 million on a net basis or approximately $0.12 per share by the end of 2019.
The rationalization of our branch network is a component of this effort and takes into consideration branch profitability, dependence on time deposits and strategic importance to the franchise. During the first quarter, we completed the consolidation of 4 branches including 2 branches in Illinois, 1 branch in Texas and 1 branch in Southern California.
This is in addition to activities from the fourth quarter last year that included the closure of 2 branches and opening of 1 new branch, all of which were in Texas. With the rationalization process now complete, we have successfully consolidated approximately 10% of the Hanmi branch network.
We are also making investments in technology and systems to ultimately reduce costs through improvement in operational efficiency. We are taking steps to centralize and streamline certain back-office activities to improve processing fee, along with enhanced consistency across the enterprise in adjudicating credits.
With that, I'd like to turn the call over to Bonnie Lee, our President and Chief Operating Officer, to discuss the first quarter loan and lease production results and deposit-gathering activity. Bonnie?
Thank you, C.G. I'll discuss loan and lease production and deposit-gathering activities and then turn it over to Ron Santarosa for additional details on our first quarter financial results.
During the quarter, loan and lease production totaled $179.8 million, which decreased 27% from the year ago. As a result of elevated level of payoffs in the quarter, our portfolio of loans and leases is essentially unchanged from the prior quarter. Our first quarter production activity continues to reflect our strategic shift towards the higher-yielding asset categories, such as C&I loans as well as equipment leases, while we reduce our exposure to lower-yielding asset classes, such as single-family residential loans. In fact, equipment leases comprised 39% of our first quarter production compared to 22% a year ago. Similarly, 19% of our first quarter production was C&I loans versus 11% in the first quarter last year.
In line with our longer-term objective to diversify our loan and lease portfolio, CRE loans comprised 70.6% of our portfolio at the end of the first quarter compared with over 75.8% 2 years ago. First quarter production consisted of $46.5 million of commercial real estate loans, $30 million of SBA loans and $33.6 million of C&I loans.
We also originated nearly $70 million of commercial equipment lease. Newly generated loans and leases for the quarter had a weighted average yield of 5.97%, an improvement from the previous quarter's weighted average yield on new production of 5.89%. As a result, average loan and lease yields for the portfolio improved to above 5.22%, an increase of 16 basis points from the prior quarter.
Looking ahead to the second quarter and the remainder of 2019, our loan and lease pipeline is strong, and we continue to expect full year growth of loans and leases in the range of 5% to 7% as noted by C.G.
Moving on to deposits. We continue to operate in a highly competitive Asian-American banking landscape for deposit-gathering activities. Total deposits of $4.82 billion increased 1.5% during the first quarter on a linked-quarter basis and 10.1% from a year ago.
Growth in the quarter was driven by increase of 4.1% in time deposits and an increase of 2.5% in noninterest-bearing demand deposits from the prior quarter. As a result of the first quarter loan production and deposit-gathering activities, our loan-to-deposit ratio for the first quarter was 95%, down from 101% in the first quarter last year.
I would now like to turn the call over to Ron Santarosa, our Chief Financial Officer. Ron?
Thank you, Bonnie, and good afternoon, all.
Looking at our top line revenue results, net interest income for the fourth quarter was $44.9 million, down from $45.6 million for the fourth quarter, principally due to 2 fewer days period-over-period. We did see yields improve during the quarter and an increase in loan prepayment fees, which led to increases in income on loans and leases as well as securities and deposits placed in other banks.
Offsetting this was an increase of $1.2 million in total interest expense, mostly driven by a 10.9% increase in deposit expense. Continuing our trend of replacing borrowings with deposits, our interest expense for borrowings fell 83.1% to $71,000 for the quarter, and there were no borrowings at the end of the first quarter.
Net interest margin ended the quarter at 3.52%, up 1 basis point from 3.51% at the end of the year. Competition remains robust within our markets for deposits, and this is reflected in the 15 basis points sequential increase in our cost of deposits to 1.35%.
There are a couple of factors offsetting this. First, there was a 16 basis point increase in the average yield for loans and leases with balances remaining relatively stable from the prior quarter combined with the shift from borrowings to deposits. Net interest margin, adjusted for loan prepayment penalties and the special FHLB dividend, was 3.46% for both the first and fourth quarters.
Turning to noninterest income. We had a 0.7% decrease from the linked quarter to $6.3 million. Decreases of $290,000 for service charge on deposit accounts and $273,000 for servicing income drove the decline, with servicing income reflecting a higher level of prepayments affecting this line item. Offsetting those declines were the sale of $69.2 million of municipal bonds, resulting in a gain on sale of $725,000.
SBA trading premiums rebounded in the first quarter and averaged 7.4% compared with 6.5% for the fourth quarter. As a result, we continued our sales practices and sold $15.5 million of the guaranteed portion of our SBA loan volume.
Noninterest expenses fell 0.8% to $29.1 million from the fourth quarter primarily due to a $362,000 decrease in other operating expenses, chiefly from the change in our off-balance sheet allowance, and a $556,000 decrease in advertising and promotion. Partially offsetting these decreases was a $459,000 swing in other real estate owned expense and a $416,000 increase in occupancy and equipment, of which approximately $300,000 was related to onetime expenses associated with the consolidation of 4 branches during the quarter.
For the same quarter comparison, total noninterest expenses are 2.3% less than the first quarter last year. Despite these expense savings this past quarter, lower revenues caused our efficiency ratio to increase slightly to 56.8% from 56.4%.
Return on average assets for the first quarter increased to 1.09% from 0.83% last quarter, while return on average equity increased sequentially to [10.62%] from 7.92%. Our tangible book value increased by $0.42 to $17.89 per share from year-end, and our tangible common equity ratio was strong at [9.93%]. With that, I will turn it back to C.G.
Chong Guk Kum
Thank you, Ron.
Hanmi's first quarter results represent a solid start to a new year and reflect the positive results of decisions we made last summer to protect net interest margin and to reduce expenses.
During the quarter, we closed 4 additional branches to improve our cost structure. In addition, our net interest margin continues to show signs of stabilization and in fact also has started to show some upward momentum that bodes well for the balance of the year.
As you are aware, this will be my last earnings call as the CEO of Hanmi. I want to take this opportunity to thank our shareholders, customers and employees for their loyalty and support. I also want to thank the analyst community for their support and keeping me on my toes.
The Hanmi that I leave behind is very different than the one I joined in 2013. Today, our infrastructure is strong, and the management team is top-notch. Under Bonnie Lee and Ron Santarosa's leadership, the future of Hanmi is bright. Thank you, and God bless.
Dana, that concludes our prepared remarks. We would now like to open the call for questions.
Thank you [Operator Instructions] Our first question comes from the line of Gary Tenner with D.A. Davidson. Please proceed with your question.
Hey, good afternoon I have just a couple of questions. I guess first on the branch consolidation, can you remind us what the quarterly savings from that particular exercise will be starting in the second quarter?
It should be approximately $1 million. It's roughly a $4 million annual save, so about $1 million per quarter. But recall, Gary, we were also going to be making investments. We also had some merit increases that are coming into effect in the second quarter.
So as we mentioned, the $5 million idea is a net notion. And while the branches will contribute more than just about $4 million per year, there will be some other offsetting ideas for that. So said slightly different, not the entire $1 million will show in the second quarter.
Okay. Great. And then with the 5% to 7% loan growth coming off flat loans this quarter, I understand the comment about the strength of the pipeline. I'm just wondering what type of assumptions does that make around the pace of prepayments for the remainder of the year.
Chong Guk Kum
Well, I'll let Bonnie talk about the pace of the growth that she expects for the remaining three quarters. But the prepayment penalties -- or the prepayments that we experienced in the first quarter was not unusually high. It kind of falls in line with the levels of prepays that we've had over the last 2 years, albeit maybe a little bit on the higher end. But the prepays are, I would say, somewhat within the range of what we have experienced over the last couple of years.
Yes. I mean so therefore what [we have said] prepays are hard to predict. But during the first quarter, we had two relationships that customers had actually sold the business. Property and lease, they're recognized as income. And so looking at the rest of the year, starting in the second quarter, the pipeline going into the second quarter is about 20%, 25% higher than the first quarter that we experienced.
First quarter was - going into the first quarter, I think that we saw lesser purchase transactions. And hopefully that for the remainder of the year, there will be more activities in terms of purchases as well as refinance activities.
Chong Guk Kum
Also in the specialty lending division as well as the commercial equipment leasing division, the momentum that they generated in the first quarter is significant in that as we have said before, the first quarter is typically a very slow quarter.
But notwithstanding that, some of the things that they have done to put them in motion as far as maybe closing them in the second quarter and beyond, I think, are what bodes well for us to hit that 5% to 7% target for this year.
Okay. Well, actually I do have one more question, if I could. You talked a lot about the margin. With the fed looking to be on pause, let's assume the rest of the year, does that give some extra, I guess, opportunity for you to expand the margin from here versus if they change the rate?
Chong Guk Kum
Yes, for us, and particularly operating in our market, the pace of the rate increases by the fed, albeit I should say that, that slowing down is a definite positive to us, in that it gives us opportunity to have our customer base on the lending side get used to the higher interest rates. I mean we just could not increase rates fast enough last year with the fed's decision every quarter to increase rates.
And so what we're seeing and what's really, I would say, encouraging are the rate increases on the interest-bearing asset side for the fourth quarter of last year and the third -- first quarter this year. That is to say that the rate increases that we've been able to implement are keeping somewhat in pace with the rise in the funding costs.
And so I fully expect that the -- as we go further out, that the -- end of the year that the -- our team will be able to pass along higher and better pricing to our borrowing customers. And furthermore, as Bonnie mentioned earlier, the -- one of the significant production area for the bank was the commercial equipment leasing division.
That area contributed a proportionately higher percentage in the first quarter as compared to the rest of the bank. And as you may recall, that area generally generates a yield about 75 basis points higher than the rest of the portfolio.
So if we're able to keep up that momentum from the equipment leasing side, I think we've got a pretty good chance of maybe perhaps expanding the margin a little bit more.
Great. Thank you
Our next question comes from the line of Matthew Clark with Piper Jaffray. Please proceed with your question,
First question on share repurchase, I don't know if you've had any activity this quarter and some appetite going forward.
There were no share repurchases during the first quarter. We do have a share repurchase authorization or a share repurchase plan in effect. We will look at that from time to time and probably behave as I would characterize it as a traditional company when there's opportunity or where there's some strategic benefit to execute against that plan.
Okay. And then on expenses with the branch closures, it sounds like we're going to do a little relief in the occupancy and equipment line, just thinking about the merit increases and just the overall run rate of noninterest expense. Should we expect any more relief? Or have we found a bottom and maybe grow from this kind of level?
I don't -- again, as you pointed out, there are probably some relief in like the occupancy line. I'm just not sure of the timing as I go to the other lines of professional fees or supplies, data processing. Because again, we're going to be making certain investments and incurring certain costs.
So I just don't know quite yet how that would work. So I think sitting here, I would say the run rate that we have today at 29-some-odd million, I think that's a fairly good starting point for the second quarter.
Okay. Great. And then on the increase in non-accruals, can you just give some more color of the type of business underlying the loan, maybe what happens more specifically and then just the general trend in criticized/classified?
Chong Guk Kum
Yes. The -- this is a C&I relationship with a CRE component on an occupied factory that we took as collateral or we have as collateral. They experienced a labor issue that has caused a business interruption. And that is causing them to assess whether this is an ongoing business or should they accelerate their transition to a new business model, which was already in the works. And so that's an issue that they are evaluating right now. They're working very cooperatively with us as we speak.
And so as we sit and talk, we put some money away to protect our downside on this, but -- and we'll know within the next couple of quarters as to the ultimate resolution. But the positive here is that there's a borrower cooperation, and there seemed to be assets to potentially pay back some or all of the loans that we have.
And just the broader trend in criticized/classified assets this quarter?
Chong Guk Kum
It's stable to downward. There's no -- we've had this over the last couple of years. So we get this one-off kind of situation. So when you look at the overall portfolio, there's no systemic -- there's no portfolio-wide kind of a weakness or downgrade -- downgrades, if you will, or the higher level of criticized or substandards, if you will.
And so I would say once again, this is a -- as we said at this point in time, it's a one-off issue. And there are no other significant increases in the criticized or any other grade categories.
Our next question comes from the line of Chris McGratty with KBW. Please proceed with your question.
Thanks. Maybe just going back to Matt's question on the credit for a moment. The $25 million, I guess, help us with how large this is relative to kind of your largest handful of credit to the bank, whether this was self-originated than perhaps a purchaser's bank loan?
And then also, C.G., if the outcome doesn't go the way you think or hope, the loss content in kind of this relationship, you set aside $3 million on $25 million. I mean how confident are you in the collateral, I guess, is the question.
Chong Guk Kum
Well, this credit at $25 million is one of the largest C&I credits, but we have a total relationship that exceeds $50 million all in. And so I'd say this is in the upper end of the range but on a C&I -- as far as C&I is concerned, certainly not anywhere near the largest relationships that we have in the bank. Information that we have in our possession today appear to indicate that we do not have a loss exposure.
But we are going through a detailed process right now to validate and to update the value of the collateral that we have, that we have accounts receivables, we have inventory, upon which we have lease and borrowing base certificate and audits -- excuse me, collateral valuation and, like I mentioned, equipment.
So we have relatively current appraisals on all of them, but with the disruption that we have had, we are obviously much more focused on getting a -- and as I mentioned earlier, I think with the possibility of this not being a going concern. So we're taking a really hard look at the actual current value of the collateral.
On the real estate side, we seem to be fairly well secured. Real estate comprises roughly the $5 million out of the $25 million. The other $20 million is comprised of equipment loans and accounts/inventory-funded line of credit.
It's really too early for us to say whether $3 million is sufficient or not. We believe that the best guess estimate from our standpoint is that $3 million should be more than adequate based on all the information that we have today.
But like in any credit situation, as we delve into the situation and as we get to understand the current value of all the collateral, that number may even go up or down. But it's premature for us to give you anything more than what we believe is the best guess estimate at this point, which is $3 million.
Great. That's great color. And this was self-originated, or is this a participation? Just want to be clear.
Chong Guk Kum
Okay. Great. Maybe going back to the margin, Ron, maybe to ask the question a little bit differently. You guys have been successful protecting the NIM given the strategy shift. How should we be thinking about growth in NII, right? If NIM stabilizes, you get the loan growth, you achieve the targets. Maybe a comment on investment portfolio strategy given the new structure and then kind of thoughts on growth in NII from here.
And just to be clear, so NII meaning net interest income or noninterest income?
Oh, I'm sorry. Net interest income.
Okay. So I would anticipate that net interest income could have a positive growth quarter-over-quarter. If you see -- our average earning assets were a bit flattish with respect to loans, but you did see the growth in securities. So you're going to see a little bit of a recomposition of the balance sheet, loans to securities, earning assets comprised of loans versus securities.
Within the loan book, as Bonnie mentioned and as C.G. mentioned, you're going to see the shift as a practical matter from resis into leasing assets, and we had kind of commented on that previously. So there'll be some recomposition, on the funding side, again, you see the shift.
Time deposits a little bit more than they were perhaps 2 years ago, 3 years ago, so the recomposition of the funding base. But we seem to be settling into the proportion of the mix where we are today. So I see the growth emanating partly because of just typical balance sheet growth, NIM stabilizing or some -- there could be some upward bias. But I won't -- I'm not as optimistic as C.G., but that's just the nature of our 2 personalities. And so I think it can grow a little bit.
And then could you help us on the tax rate going forward?
Sure. I think we probably will settle out closer to 29% for the year rather than 28%.
Our next question comes from the line of Don Worthington with Raymond James. Please proceed with your question.
Thank you. Good afternoon, everyone. Maybe just some thoughts on where you see the SBA production and sales going. This quarter, you sold some. Would you expect that to continue? Or I guess it depends on premiums and what's going on in the market, but any commentary would be helpful.
Sure. We experienced actually higher premium this quarter versus prior quarter. And I think that we -- it's pretty much we -- in terms of premium, it's been a little bit stabilized. In terms of our production, we expect to see a better production in the second quarter than the first quarter.
Okay. Good. And then in terms of the decrease in deposit service fees linked quarter, what drove that? Was it compensating balances or earnings credits or just...
Some of them are actually related to branch closures in Texas, some of the accounts from the particular branches in Texas that had components of a money service business. So that's what drove somewhat the decrease.
Okay, great. Thank you.
We have no further questions in the queue at this time. Please continue.
Thank you for listening to Hanmi Financial's First Quarter 2019 Results Conference Call. We look forward to speaking with you next quarter.