Hope Bancorp - Q2 2024

Transcript

Operator (participant)

Good day, and welcome to the Hope Bancorp 2024 Q2 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, please press star, then two. 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 (Head of Investor Relations)

Thank you, Megan. Good morning, everyone, and thank you for joining us for the Hope Bancorp 2024 Q2 Investor Conference Call. As usual, we will be using a slide presentation to accompany our discussion this morning, which is available in the presentations page of our IR website. Beginning on slide two, 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. The closing of the proposed transaction is subject to regulatory approvals, the approval of the stockholders of Territorial Bancorp, and other customary closing conditions. Forward-looking statements are not guarantees of future performance. Actual outcomes and results may differ materially. Hope Bancorp assumes no obligation to revise any forward-looking projections that may be made on today's call.

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 the 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. 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; 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 (Chairman, President and CEO)

Thank you, Angie. Good morning, everyone, and thank you for joining us today. Let us begin on slide three with a brief overview of the quarter. For the Q2 of 2024, we earned net income of $25.3 million or $0.21 per diluted share. Excluding notable items, our net income was $26.6 million, and our earnings per share were $0.22. Notable items this quarter included merger and restructuring-related costs and a partial reversal of a prior accrual for the FDIC special assessment. Our results this quarter reflect continued progress in improving our financial performance following our strategic reorganization late last year. During the Q2 of 2024, our net interest margin expanded, our operating expenses decreased, and our return on assets improved. We are diligently working on our merger integration planning with Territorial Bancorp and look forward to closing the pending transaction by year-end.

Territorial will contribute stable and low-cost deposits to our franchise, and their loans will more than double Hope's residential mortgage portfolio. On slide four, you can see that we ended the quarter with strong capital and all our capital ratios expanded from March 31, 2024. As of June 30, 2024, our total capital ratio was 14.42%, and our tangible common equity ratio was 9.72%. Our high capital ratios are a strong base with which to support emerging growth opportunities. Our Board of Directors declared a quarterly common stock dividend of $0.14 per share payable on August 22 to stockholders of record as of August 8, 2024. Continuing to slide five, at June 30, 2024, our total deposits were $14.7 billion, essentially stable quarter-over-quarter.

Our front line continued to execute well with an increase in our non-interest-bearing demand deposits and other customer deposits, largely offsetting a planned run-off of brokered deposits. Moving on to slide six, at June 30, 2024, our gross loans totaled $13.6 billion, a decrease of $87 million or less than 1% quarter-over-quarter. $30 million of this decrease was from SBA loans sold in the Q2. Overall, loan production improved this quarter. Residential mortgage growth was, once again, robust, and commercial real estate loans were stable. However, this was offset by elevated payoffs and paydowns within C&I loans. Based on our strengthening pipelines, we are looking forward to positive loan growth in the Q3. On slides seven and eight, 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, with a weighted average of approximately 47% at June 30, 2024, and the profile of our CRE portfolio has not changed. Asset quality is stable, and 98% of the commercial real estate portfolio was pass-graded at June 30, 2024. With that, I will ask Julianna to provide additional details on our financial performance for the Q2. Julianna?

Julianna Balicka (CFO)

Thank you, Kevin. Beginning with slide 9, our net interest income totaled $106 million for the Q2 of 2024, a decrease of $9 million from the Q1. Approximately $4 million of the sequential decrease was attributable to the net impact of the payoff of our Bank Term Funding Program borrowings in late March and early April, which we paid off in full with interest-earning cash. Quarter-over-quarter, our net interest margin expanded by seven basis points to 2.62%. A notable highlight is the deceleration in the quarterly increase of our cost of deposits. Quarter-over-quarter, our average cost of total deposits increased by only three basis points, the lowest quarterly rate of change since the Q1 of 2022. On slide 10, we show you the quarterly trends in our average loan and deposit balances and our weighted average costs and yields. Onto slide 11.

Our non-interest income was $11 million for the Q2, an increase of 34% from $8 million in the Q1. We resumed sales of SBA 7(a) loans as secondary market conditions improved. We sold $30 million this quarter and booked a $2 million net gain on sale. We plan to continue selling SBA loans in the second half of the year. Moving on to non-interest expense on slide 12. Our Q2 2024 GAAP non-interest expense was $81 million compared with $85 million in the Q1. Excluding notable items, non-interest expense for the Q2 was $79 million, down 4% quarter-over-quarter and down 9% year-over-year. The largest component is salary and employee benefits expense, which was down 7% quarter-over-quarter and 16% year-over-year. You can see the positive impact of the restructuring in the year-over-year comparisons.

Now, moving on to slide 13, I will review our asset quality, which continues to remain stable. Non-performing assets at June 30, 2024, were $67 million, down 37% quarter-over-quarter. The non-performing asset ratio improved to 39 basis points of total assets at June 30, down from 59 basis points as of March 31. Net charge-offs for the 2024 Q2 were $4.4 million, or annualized 13 basis points of average loans, compared with 10 basis points annualized in the Q1. Net charge-off levels continue to be low and manageable. For the Q2, the provision for credit losses was $1.4 million, compared with $2.6 million last quarter. At June 30, 2024, our allowance for credit losses was $156 million, representing 115 basis points of loans receivable.

The reserve coverage ratio has been essentially stable, comparing with 116 basis points as of March 31, 2024, or 115 basis points as of December 31, 2023. With that, let me turn the call back to Kevin.

Kevin Kim (Chairman, President and CEO)

Thank you, Julianna. Moving on to the outlook on slide 14. In terms of our Q4 2024 outlook relative to the Q4 2023 actual results, we have the following updates. Q4 to Q4, our outlook for average loans to grow at a percentage rate in the low single digits remains unchanged. Residential mortgage loan growth continues to be robust. Commercial loan production continues to strengthen, and we expect the pace of paydowns and payoffs to moderate. Accordingly, we are looking forward to positive loan growth in the second half of the year. We now expect net interest income for the Q4 of 2024 to decline approximately 10% from $126 million in the Q4 of 2023.

Approximately 3% of this decrease comes from 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 Q4 of 2023. Relative to our initial budgeting, our net interest income expectations are lower, reflecting the cumulative impact of payoffs and paydowns in the first half of the year, market-wide loan spread compression on new originations, and the year-to-date shift in deposit mix. We successfully controlled deposit costs in the Q2, but deposit pricing remains very competitive as long as the interest rates remain high. In our outlook, we are factoring in one Fed Funds target rate cut of 25 basis points in September of 2024.

Overall, we expect the Q2 of 2024 to be at or near the trough in terms of net interest income, with quarterly growth by the Q4 of 2024 mainly driven by loan growth. In the Q2, we resumed SBA loan sales and expect to continue to sell SBA loans in the second half of the year. We remain very focused on disciplined expense control. We now expect our Q4 2024 operating expenses, excluding notable items, to decrease by more than 7% from $85 million in the Q4 of 2023. This is an update compared with our prior outlook for an expense decrease of over 5%. Lastly, we continue to assume an essentially stable asset quality backdrop and stable reserve coverage, which was 115 basis points of loans as of June 30, 2024.

Overall, as you see on slide 15, we are right on track toward realizing our medium-term financial goals, namely high single-digit loan growth plus revenue growth over 10% and efficiency ratio under 50%, leading to a return on assets over 1.2%. Following our reorganization in the 2023 Q4, 2024 is a building year as we focus on core deposit initiatives, operating efficiencies, and process improvements to support scalable and profitable growth. We are excited about our pending merger with Territorial Bancorp, whose contribution will accelerate the achievement of our medium-term targets. With that, operator, please open up the call for questions.

Operator (participant)

We will now begin the Q&A session. To ask a question, you may press star, then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then two. Please limit yourself to two questions, and if you have a follow-up question, please press star, then one. Our first question comes from Matthew Clark with Piper Sandler. Please go ahead.

Matthew Clark (Managing Director covering Western Banks)

Hey, good morning, everyone. Just the first one on the loan growth outlook, backing into what you need to do to get to low single digits on average for the Q4 implies a decent step up in the second half here. Just can you just talk through what's going to drive that growth and what the pipeline looks like at this stage?

Kevin Kim (Chairman, President and CEO)

Well, Matthew, as you may remember, excuse me, historically, we have been very strong in terms of our new loan originations. Our loan production engine was the main driver for our organic growth at a much faster pace than most of the peers in the pre-COVID times. But when we had industry-wide challenges, such as what we saw in the past two years, most of the issues we had were deposits in the liability side of the balance sheet. So when we had a strategic reorganization in October of 2023, it was designed to support high-quality loan and deposit growth. Obviously, we wanted to focus more on enhancing our deposit franchise before we strive to achieve a meaningful loan growth.

Our 2024 Q2 numbers indicate that we began to see the results of our priority on deposit front, such as meaningful reduction in brokered deposits, growth in customer deposits, very nominal quarter-over-quarter increase in our average cost of deposits, expansion of NIM, and so on. Now we expect our loan balances to grow in the second half of 2024 as we focus high-quality growth in both loans and deposits. Our loan pipeline has been nicely building up, actually. I think our loan growth, when we have a better deposit environment, will be accelerated. We feel pretty confident, as we had shown in the past, that our loan production will be the engine for the growth in the second half of the year.

Julianna Balicka (CFO)

Matthew, this is Julianna. If I can add just a couple more comments. Quarter to date, for example, our commercial loans are up. And when we look at the Q2, the issue for us in the Q2, or the headwind for us in the Q2, has been the elevated payoffs and paydowns as opposed to production meeting budget to actuals. And our commercial real estate was able to beat budget. So we feel comfortable when we look out into the second half of the year that the drivers are aligning well.

Matthew Clark (Managing Director covering Western Banks)

Okay, great. Then on the loan yields, they were down this quarter. Not sure if that was just due to the SBA loan sales or not. Just any commentary there and the related outlook?

Julianna Balicka (CFO)

It does reflect to the mix of the loans that were being originated vis-à-vis just kind of what was running off. In terms of the commercial loans, there has been spread compression this year in terms of origination. So that does kind of factor into the loan yields. And plus, of course, you have the accounting-related items, not accounting-related, but the non-yield items, such as quarter-over-quarter changes in prepayment fees and/or quarter-over-quarter changes in non-accrual income reversals. But also, when you look at the origination yields of, say, commercial real estate compared to 2023 or for commercial loans compared to 2023, there has been market-wide spread compression. And that does factor into the outlook, which is part of the reason why we did lower the NII outlook in our outlook slide.

Matthew Clark (Managing Director covering Western Banks)

Got it. Then on the margin, do you have the average for the month of June and the spot rate on deposits at the end of June?

Julianna Balicka (CFO)

I have the spot rate for the end of June, which is at 3.43.

Matthew Clark (Managing Director covering Western Banks)

Okay. And then on the SBA loan sales.

Julianna Balicka (CFO)

Sorry. 3.43, just to make sure we're talking about the same number, 3.43 spot rate of total deposits.

Matthew Clark (Managing Director covering Western Banks)

Yep. Got it. And then on the SBA loan sales, should we assume a similar amount gets sold in the second half here per quarter?

Kevin Kim (Chairman, President and CEO)

Yeah, I believe so. We began to sell the SBA loans in the Q2, and we are currently selling more loans in the Q3. I expect the total loans to be sold in the Q3 will be more than the number that we had in the Q2.

Matthew Clark (Managing Director covering Western Banks)

Great. Thanks again.

Operator (participant)

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

Christopher McGratty (Head of U.S. Bank Research)

Oh, great. Kevin and Julianna, slide 15, the medium-term targets, which are 26 and beyond. If I look at current profitability, I mean, that's basically a doubling of your ROA. You talked about the expenses. What rate outlook is incorporated into this medium-term target?

Julianna Balicka (CFO)

It's based on the current forward curve. Although for the rate cuts for the rest of this year, as you can see, we're only factoring September just because things near-term, there's so much variability. But in the longer term, we are factoring in the current forward curve on Fed Funds, which eventually settles at 3.75. But hold on. Let me get you the 2026 and 2027 numbers in a second. Go on to your next question.

Christopher McGratty (Head of U.S. Bank Research)

Okay, great. I guess the follow-up would be, what betas are you assuming in the down rate for both deposits and for your assets?

Julianna Balicka (CFO)

Well, the variable rate assets, floating rate assets, as you know, that is loans, those are going to have a high beta because those reprice automatically. It's just a matter of timing within the month of when the kind of rate cuts happen. And for deposits, we are assuming a lagged beta, a low beta upfront for the first several cuts before we kind of get to a more normalized beta over time.

Christopher McGratty (Head of U.S. Bank Research)

Okay. But.

Julianna Balicka (CFO)

We lower in the second half. One thing I will point out.

Go ahead.

Matthew Clark (Managing Director covering Western Banks)

No, no. Go ahead, I just.

Julianna Balicka (CFO)

One thing I'll point out is in this quarter, we have gone through an exercise of reviewing our deposit pricing and making sure that all the exception pricing and exceptions are warranted to start to control our deposit costs ahead of rate cuts. And so we're not assuming a high deposit beta upfront, but we are assuming that we will be able to continue to be disciplined in how we approach deposit pricing post our reorganization. That is a change to our practice vis-à-vis before and an improvement.

Christopher McGratty (Head of U.S. Bank Research)

Okay, great. And then just the last one I had would be just tax rate. How should we be thinking about the tax rate from here?

Julianna Balicka (CFO)

We are assuming 26% for the full year. So that does have a lower tax rate in the second half of the year based on when certain tax credit investments and their amortizations kind of hit our P&L.

Christopher McGratty (Head of U.S. Bank Research)

Okay. Thank you very much.

Operator (participant)

Again, if you have a question, please press star, then one. Our next question comes from Gary Tenner with D.A. Davidson. Please go ahead.

Gary Tenner (Research Analyst focusing on Financial Sector)

Thanks. Good morning. Hoping you could provide the CD maturity schedule for the back half of the year with the rates that are coming off.

Julianna Balicka (CFO)

One second. Let me just answer it back to finish Chris's question. For 2026, we've got the terminal Fed Funds at the end of 2026 at 4.25 and 3.75 the following year in 2027. The maturity of our CDs maturing in the second half of the year, we've got the rates that are coming off are 5.10, 5.12 kind of neighborhood. The maturities that are coming off in the Q3, we've got $1.56 billion. In the Q4, we've got $2.1 billion.

Gary Tenner (Research Analyst focusing on Financial Sector)

What's your sense when we're going to the Q3, what the renewal rate outlook would be?

Julianna Balicka (CFO)

I think the renewal rate outlook will be hopefully lower than the current one for the simple reason that we have recently reduced pricing.

Gary Tenner (Research Analyst focusing on Financial Sector)

Okay. Thanks. And then my other questions were mostly answered. But I noticed in your kind of walkthrough of the non-recurring items in the quarter, the tax provision was different on the press release versus the deck. I'm assuming the one on the press release is the correct one, but just wanting hopefully you could confirm that.

Julianna Balicka (CFO)

I would use the earnings release and the tables as your primary source document.

Gary Tenner (Research Analyst focusing on Financial Sector)

Sounds good. Thank you.

Operator (participant)

This concludes our Q&A session. I would like to turn the conference back over to management for any closing remarks.

Kevin Kim (Chairman, President and CEO)

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

Operator (participant)

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