Luther Burbank Corporation (LBC) CEO Simone Lagomarsino on Q3 2019 Results - Earnings Call Transcript

Oct. 26, 2019 10:04 AM ETLuther Burbank Corporation (LBC)
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Luther Burbank Corporation (NASDAQ:LBC) Q3 2019 Earnings Conference Call October 26, 2019 11:00 AM ET

Company Participants

Simone Lagomarsino - President and Chief Executive Officer

Laura Tarantino - Chief Financial Officer

Conference Call Participants

Bob Shone - Piper Jaffray

Luke Wooten - KBW


Good morning, and welcome to the Luther Burbank Corporation Third Quarter 2019 Earnings Conference Call. [Operator Instructions] Before we begin, I would like to remind everyone that some of the comments made during this call may be considered forward-looking statements. The company's Form 10-K for the 2018 fiscal year, its quarterly reports on Form 10-Q and current reports on Form 8-K identify certain factors that could cause the company's actual results to differ materially from those projected in any forward-looking statements made this morning.

The company does not undertake to update any forward-looking statements as a result of new information or future events or developments. The company's periodic reports are available for the company or online on the company's website or the SEC's website. I would like to remind you that while the company's management thinks the company's prospects for continued growth and performance are good, it is the company's policy not to establish with the markets any earnings, margin or balance sheet guidance.

I would now like to turn the conference over to Simone Lagomarsino, President and CEO. Please go ahead.

Simone Lagomarsino

Thank you, Andrew. Good morning, everyone and welcome to the Luther Burbank Corporation 2019 third quarter conference call. This is Simone Lagomarsino, President and CEO, and with me are Laura Tarantino, our Chief Financial Officer, and John Cardamone, our Chief Credit Officer. Today we'll discuss last quarter's financial results and I'll begin with a high-level overview of the quarter.

Several market dynamics occurred during the quarter and provided us the opportunity to better position the bank. These include: first, the inverted yield curve allowed us to enter into two pay fixed swap transactions that provided a positive carry for the quarter. Second, the two rate reductions by the Federal Reserve provided the opportunity to lower our cost of deposits toward the end of the quarter, the impact of which will be reflected in future results.

Third, the lease rates for retail space and office space have dropped in some of our markets, due to increases in online purchasing, which resulted in excess inventory due to the shakeup of some of the large box retailers. This provided us the opportunity to enter into two new leases at substantial future savings.

Fourth, as a result of continued equity market volatility driven by uncertainty caused by the threat of trade wars, Brexit and the potential for an economic downturn, we were able to repurchase additional shares under our share repurchase plan at a discount to our book value bringing total repurchases since inception of the plan to more than 1 million shares.

I will discuss each of these items and their impact to our results in more detail below. Let me start now with an overview of our earnings. Net income for the quarter was $12.7 million or $0.23 per diluted common share, compared to $11.7 million or $0.21 per diluted common share in the prior quarter.

Our third quarter earnings contained three non-recurring items. The first and most significant item was a $1.1 million write-off of unamortized tenant improvements for two leased facilities. The two other adjustments were $480,000 FDIC deposit insurance credit and a $78,000 gain on sale of loans due to the sale of loans.

I will discuss each of these items in more detail in a few minutes. Excluding these three nonrecurring items, the adjusted third quarter 2019 earnings would have been $13.1 million with an EPS of $0.23 per share, as compared to our linked-quarter adjusted earnings of $11.2 million or $0.20 per share.

The $1.9 million or 17% increase in adjusted net earnings, compared to the linked quarter was primarily due to a $2 million improvement in net interest income further supported by $950,000 in reduction in our provision for loan losses and partially offset by higher noninterest expense.

The $2 million improvement in net interest income in the third quarter as compared to the linked quarter was largely attributed to the $1.4 million in interest income from our two more recently executed pay fixed interest rate swaps, and secondarily, a [$569,000] interest in loan prepayment fees.

The swap transactions offset a portion of the interest rate risk in our loan portfolio, as well as took advantage of the inverted yield curve by immediately yielding positive interest carry. The increase in loan prepayment fees was due to accelerated prepayment speeds in our multi-family loan portfolio, which increased to a speed of 13.9% in the third quarter from a rate of 10.3% in the second quarter.

Similarly, prepayment speeds in our single-family loan portfolio accelerated during the third quarter to rate of 35.6% from a level of 31.9% in the linked quarter. However, due to federal regulations, prepayment fees are generally not assessed on our single-family residential loans. Primarily, as a result of the aforementioned items, our yield on interest earning assets increased 11 basis points to 3.88%, for the third quarter, as compared to 3.77% during the prior quarter.

Excluding earnings from our interest rate swaps and the increase in multifamily prepayment fees collected, the yield on our loan portfolio for the third quarter expanded by 4 basis points to an adjusted yield of 3.96%, as compared to an adjusted yield of 3.92% during the second quarter of this year. This is generally due to the coupon on new loan originations exceeding the rate on loan payoffs. However, in more recent months the interest rate differential between originations and payoffs has narrowed, and the total coupon on the loan portfolio has remained relatively consistent.

Laura will provide more detail in her presentation later in this conference call. While our yield on real estate loans improved during the quarter, the yield on our cash and securities portfolios, which represents 11% of our interest earning assets declined 14 basis points to 2.31%, during the third quarter from 2.45% in the linked quarter. And this is as a result of lower short-term interest rates related to the Federal Reserve Board 50 basis point aggregate reductions in its target rate during the third quarter. Because the interest rates earned on our cash and securities portfolio adjust for short-term indices.

The short-term interest rate declines provided some relief from the cost of our interest-bearing liabilities, which increased only 1 basis points to 2.2% during the third quarter as compared to a cost of 2.19%, during the linked quarter. More specifically, the cost of our interest-bearing deposits increased 2 basis points to 2.07% for the third quarter from 2.05% during the second quarter. This is a significant improvement over prior quarter's trend, wherein our cost of interest-bearing deposits increased a 11 basis points between both the first quarter of 2019 and the second quarter of 2019 and from the fourth quarter of 2018 to the first quarter of this year.

During the third quarter, we began to reduce interest rates on our CD offerings, as well as some of our non-maturity deposits in response to the Federal Reserve's lead. For the third quarter, our net interest margin increased 9 basis points to 1.84% from 1.75% during the linked-quarter. We're very pleased with this performance as it marks the first increase in our net interest margin in more than one year. The market fully anticipates that the Federal Reserve will reduce its target rate again on October 30. While we would expect to see incremental benefits on the cost of our deposits with future short-term interest rate decreases.

The pace of the improvement in our cost of funds will lag the Federal Reserve's rate cut, particularly where their target rate dropped multiple times within a short period of time. Our ability to have our deposit repricing follow a short-term rate trend will be, in part, influenced by the timing of the maturities of our certificates of deposit, as well as the actions of competitors. Additionally, the benefit of short-term interest rate decreases may be offset by changes in the rate of our loan portfolio with that reprieve in loan prepayments fees and the steepening of the yield curve.

During the third quarter, we recaptured $500,000 in loan loss provisions, as compared to recording a charge for loan loss provisions in the prior quarter of $450,000 or a $950,000 change quarter-over-quarter. The recapture was primarily due to the collection of a $200,000 loan loss recovery and a $2.8 million reduction in our criticized loan balances since the end of the linked quarter. Our ALLL to total loans coverage ratio of 0.56% remains unchanged as of the end of the third quarter as compared to the prior quarter.

Non-interest income was $993,000 or $915,000 when adjusted for $78,000 gain on sale of loans during the third quarter of 2019, compared to non-interest income of $907,000 during the linked quarter when similarly adjusted for $581,000 of gains on the sale of loans and equipment recovery during that period. And the third quarter, we sold a $10.4 million pool of single family, 30-year fixed-rate mortgages with a weighted average loan-to-value ratio of 91%. Although no further loan sales are anticipated this year, we remain open to small transactions of this nature.

Non-interest expense was $16.1 million during the third quarter of 2019. And as previously mentioned, included a one-time $1.1 million write-off of capitalized tenant improvement related to our Manhattan Beach corporate office and our San Rafael branch. Although we have the option to renew both leases upon evaluating other available properties, the ability to reduce our annual occupancy expenditures by more than $1.1 million – by more than $1.1 million annually, was a compelling reason to relocate these facilities.

Additionally, we believe that the new premises have better accommodations and are generally better situated for our customers and employees. Non-interest expense for the third quarter also contained a $480,000 FDIC assessment credit. As I'm sure you're aware, the FDIC insurance fund reached its required minimum reserve level to allow banks to begin using their small bank credits.

After recognizing the current quarter's credit, we have a remaining small bank credit balance of $914,000, which we expect will be fully utilized by the first quarter of 2020 assuming that there is no significant change in the FDIC insurance fund levels.

Non-interest expense as adjusted for those two unusual items increased by $710,000 in the third quarter, as compared to the linked quarter, predominantly due to a decrease of $740,000 in capitalized compensation expense directly related to a $75.1 million or 16% reduction in loan origination volume during the third quarter, as compared to the linked quarter.

Our noninterest expense to average assets ratio and efficiency ratio continue to compare very favorably to the industry and measured 0.9% and 47.9% respectively for the third quarter of 2019.

Now, let's turn to the balance sheet. Our assets at the end of September 30, 2019 totaled $7.2 billion, an increase of $224 million or 3.2% year-to-date. The growth in assets was primarily attributed to $128.9 million increase in real estate loans and a $76 million increase in cash from the prior year-end. During the third quarter, our loan portfolio decreased by $7.2 million, chiefly due to elevated loan prepayment.

During the current quarter, we originated $382 million of loans, as compared to volume of $457 million and $312 million in the second and first quarters of 2019 respectively. However, our annualized prepayment for all loans increased to 20.7% for the third quarter from 17.7% and 13.7% for the second and first quarters, respectively.

Based upon feedback from our single family and income property loan sales teams, we believe that the increasing trend in prepayment activity is attributed to the continued low long-term interest rates, as well as competition for loan growth in our markets. Based on the loan repayment activity experienced year-to-date and the prolonged period with a flat and/or inverted yield curve, we have revised our growth expectations since the prior quarter and now expect asset growth of 3% to 5% for the 2019 calendar year.

Our credit quality remained strong with non-performing assets to total assets of 0.18% and non-performing loans increased by $1.3 million in the third quarter, compared to the linked quarter. The increase in non-accrual loans was represented by four small single-family loans made to two borrowers. Based on original appraisals no losses are currently anticipated on these four loans.

Of our non-performing loans totaling $12.9 million at September 30, 2019, 21% by balance are paying as agreed. We routinely evaluate our delinquent loans for indications of potential negative credit trends. At September 30, we had five accruing loans with a total principal balance of $2.6 million that were 30 days behind and no accruing loans that were 60 days delinquent. Of these five loans three have already made their payment or paid off and are now current.

During the third quarter, our retail deposits increased by $251.6 million, while our broker deposits declined by $124.1 million. Approximately 80% of the current quarter's growth in retail deposits was achieved in our business accounts, particularly within our 1031 Exchange protocol, while 20% or $49 million of the growth was gathered by our 10 West Coast branches. The decline in our wholesale deposit balance was purposeful as we ran off some of the excess liquidity resulting from strong retail deposit growth.

At September 30, 2019, our loan to deposit ratio was 116.7%, as compared to a level of 119.7% at the end of the linked quarter. Both the bank's and company's capital ratios remain strong and are well above the minimum levels required for bank regulatory capital purposes. The company's ROA and ROE during the current quarter were 0.71% and 8.45% respectively, compared 0.66% and 7.83% during the prior quarter. Excluding the impact of non-recurring items discussed above our current period ROA and ROE, would have been 0.73% and 8.71% respectively, compared to prior quarter adjusted amounts of 0.64% and 7.55% respectively.

We're pleased to report on – on October 23, 2019, the Board of Directors declared a quarterly cash dividend of $5.75 per common share, the dividend is payable on November 14, 2019 to shareholders of record as of November 4, 2019. Also, on October 23, 2019, the Board of Directors approved a one-year extension for the term of our stock repurchase plan, which will allow the company to continue its share repurchase activity through December 31, 2020.

Since the inception of the stock repurchase plan, which began in August of 2018, we have repurchased [1.044 million] shares at an average price of $9.85 per share, reflecting an 8% discount to our tangible book value. We have approximately $4.7 million remaining of the $15 million that was originally set aside for share repurchases, and we will continue to evaluate repurchase opportunities as appropriate.

Finally, given our bank's specialty in multifamily lending, I'd like to touch briefly on the California statewide rent-controlled ordinance that was passed in September of 2019. The new law, which goes into effect January 1, 2020 for most multifamily housing built 15 years or more ago, makes it illegal for a landlord to increase of tenants rent by more than 5% plus inflation or 10% whichever is lower on an annual basis.

We believe that this law allows for reasonable annual rental rate increases. And unlike some rent control laws and other states does not place undue restraint on California multifamily property owners, and we do not believe that this will negatively impact the values or cash flows of the collateral underlying the loans in our multifamily loan portfolio. As it pertains to our loan portfolio, our originations – at origination, we underwrite our income property loans to lower our current actual rent or market as derived from the appraisal.

And now, I'll turn it over to Laura who will speak a little bit more specifically about some of the trends in our margin and other loan and deposit portfolios.

Laura Tarantino

Thank you, Simone, and I'll be relatively brief. As previously noted, the yield on our loan portfolio improved 4 basis points from the linked quarter, even when excluding the interest income from the swap transactions and the greater level of prepayment speeds, which was attributed to a growing coupon on our real estate loan portfolio where the rate on new loan origination volume has generally outpaced the coupon on loans prepaying.

As reported in our last quarter's earnings call, due to the decline in the five-year treasury rate during 2019, which is correlated to our real estate loan operates the spread between loan originations and payoffs continues to compress.

The weighted average rate on new loan volume during the quarter was 4.26%, while the weighted average rate on loan curtailments and pay off for the same period was 4.22% resulting in a spread of only 4 basis points. This compares to a second quarter weighted average coupon on loan originations of 4.44% and a weighted average rate on payoffs and paydowns of 4.33%, and a corresponding spread of 11 basis points.

Consequently, the weighted average rate on our loan portfolio increased by only 1 basis point at the end of the third quarter to 4.19%, as compared to a weighted average rate of 4.18% at the end of the prior quarter. Because 89% of our loans in the portfolio are fixed-term portion of their hybrid on period and given that our new loan origination rates are approaching the overall loan portfolio rates, absent any steepening in the mid-to-long-term treasury rate, our expectation is that the coupon our loan portfolio will remain relatively unchanged in the near term.

As we think about deposits recent reductions in short-term market rates have translated to improvements in the cost of our deposits. The ending rate on our retail deposit portfolio decreased by [8 basis points] to a level of 1.98% at September 30 versus a measure of 2.06% at June 30.

As would be expected with short-term brokered deposits, the cost of our wholesale deposits declined more rapidly and fell by 31 basis points to a rate of 2.10% at the end of the third quarter, as compared to a rate of 2.41% at the end of the second quarter. Our time deposits represent 67% of our deposit composition.

Looking forward on the quarter, 1.04 billion or 29% at the time deposit portfolio is subject to renewal during the next three months. 527 million of this balance is represented by wholesale deposits with a weighted average interest rate of 2.11% and were current pricing is in the 1.9% to 2% range. The remaining 516 million of this balance is comprised of retail term deposits with a weighted average interest rate of 2.21%. This compares to an average rate on new and renewed retail CDs of 1.98% during September 2019.

As Simone already noted, while additional short-term interest rate cuts may benefit the cost of our funding, it's anticipated that our deposit beta will slow if the Federal Reserve's target rate decreases in rapid and succession giving the CD concentration in our deposit portfolio and the difficulty of adjusting customer rates too quickly, while simultaneously growing deposit balances.

Additionally, all of our FHLB advances at September 30 totaling $977 million, our fixed rate term borrowing with an average interest rate of 2.3% and a weighted average term to maturity at 2.6 years. As a result of both short-term and long-term decreases in market interest rates at the end of the third quarter, as compared to the end of the prior quarter, as well as hedged instruments executed during that period, our interest rate risk has declined substantially.

Net interest income and the economic value of equity decline as a result of a 200 basis-point parallel interest rate shock have improved to decreases of 2.4% and 7.8% respectively, at the end of the current quarter from decreases of 7.4% and 13.5% respectively, at the end of the linked quarter. While the net interest advantage of the pay fixed interest rate swaps on our books will lessen, if and when short-term interest rates continue to decline, we anticipate that our liability sensitive balance sheet will benefit from the same market change.

That concludes our prepared remarks. And at this time, we'll ask the operator to open the line for questions.

Question-and-Answer Session


Thank you. [Operator instructions] And our first question comes from the line of Matthew Clark with Piper Jaffray. Your line is now open.

Bob Shone

Good morning, this is Bob Shone on for Matthew Clark. How are you doing?

Laura Tarantino

Great. How are you doing, Matthew? Oh! Bob?

Bob Shone

So, I kind of wanted to talk about the margin and the outlook, specifically around the swap income that we saw this quarter. Could you guys give some more color to the swaps that you put in place maybe the majority of them and what we can expect going forward?

Simone Lagomarsino

Yes, thanks for asking. And so, during the quarter, I think actually started in late June and then we did another one in August, we – the two separate swaps, both notional amount of $500 million. They have a weighted average pay fixed rate of 1.438% and they have a two-year maturity from inception.

Bob Shone

Awesome. Thank you. And then shifting gears talking – looking at share repurchases this quarter, it looked like they slowed, a little bit slow. Was this a function of the stock price being higher? And can you talk about appetite for share repurchases going forward? Thank you.

Simone Lagomarsino

You're correct. It definitely was a result of higher stock prices. And as noted in our presentation, the Board recently extended our stock repurchase plan, so we continue to look forward to utilizing the remaining balance of our authorized share repurchase in upcoming quarters.

Bob Shone

Okay. Thanks. I'll step back.


Thank you. [Operator Instructions] Our next question comes the line of Luke Wooten with KBW. Your line is now open.

Luke Wooten

Hi, good morning, Simone and Laura. Thank you for taking my questions.

Laura Tarantino

Good morning.

Simone Lagomarsino

Good morning, Luke.

Luke Wooten

Just wanted to talk about kind of the deposit mix during the quarter. I saw you guys were able to lower the money market rates. It looked like about by 4%. But you guys are still able to grow those balances. I just wanted to see kind of the outlook for the non-maturity growth in the deposit portfolio kind of going forward?

Simone Lagomarsino

Most of our non-maturity deposits come in via our business line verticals. And during the quarter, we saw most of our growth in 1031 exchange account. As you know, those come in and go out a little bit, but we continue to grow that portfolio period-over-period. Is that referring to your question?

Luke Wooten

Yes, no, that's perfect. Thanks. And then just kind of – on the margin relative to that just you guys had said that looks like it's going to be a little bit more lagged in terms of the funding cost repricing. And I just want to make sure I got the numbers right for the – you said $1.04 billion should be renewing in the next three months. Correct?

Simone Lagomarsino

That's correct.

Luke Wooten

And the weighted average rate on that was, it was closer to the wholesale of the 2.11% versus the retail of the 2.21%?

Simone Lagomarsino

That's correct.

Luke Wooten

Okay. Got you. And I think you said that the new wholesales are coming on at 2.1%. So, there shouldn't be a major pickup in terms of.

Simone Lagomarsino

No. New wholesale is closer to 1.9, frankly, and dropping. As we're getting closer to this next Fed meeting, we may see that dropping.

Luke Wooten

Okay. Got you. And just kind of paring that with in terms of FHLB borrowings. Would you be more inclined to take on less kind of structure and shorter duration FHLBs then put – then kind of renew those time deposits or how do we, how should we look at that going forward just in terms of the mix shift on the balance sheet, considering it's a larger piece?

Simone Lagomarsino

I think we like to – we believe that retail deposits are far more valuable than FHLB wholesale borrowings, right? They're – you can see the utilized, but if we can continue to grow our retail relationship, we would prefer to do that. And I think with the higher level of prepayments that we're seeing. We should be able to keep the growth in loans and deposits equally balanced.

Luke Wooten

Okay. That's helpful. And then just lastly, just wanted to make sure that I got the numbers right. So, with the office relocation, you guys are expecting $1.1 million annually or is that kind of amortized over the life of the new lease?

Laura Tarantino

Yes, I've mentioned that. So, it is a little confusing. We took a $1.1 million charge, which is a one-time charge to vacate the two offices that we’re vacating and we will achieve a $1.1 million annual improvement in the expenses going forward. The two numbers are the same, but it is annual [kind of thing] going forward.

Luke Wooten

Got you. And then just one more on credit, you guys said you guys have, I think it was the approximately 900 remaining credit with the FDIC, so that you cover a couple more quarters if I'm not mistaken, and then we should kind of.

Laura Tarantino


Luke Wooten

Okay. And then that should return kind of back to normalized – well, expecting that the insurance fund is not still fall at that point.

Simone Lagomarsino

Yes, and it looks like based on the recent instructions at the FDIC release, that will probably recognize two quarters in the fourth quarter of this year.

Luke Wooten

Okay. Perfect. I'll step back. Thank you.

Simone Lagomarsino

Thank you, Luke.


Thank you. [Operator Instructions] And I'm showing no further questions at this time. So, with that, that completes our call today. A recorded copy of the call will be available on the company's website. Thank you for joining us.

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