Q3 2023 Hope Bancorp Inc Earnings Call
Participants
Angie Yang; Senior VP and Director of IR & Corporate Communications; Hope Bancorp, Inc.
Julianna Balicka; Executive VP & CFO; Hope Bancorp, Inc.
Kevin Sung Kim; Chairman, President & CEO; Hope Bancorp, Inc.
Peter J. Koh; Senior EVP & COO; Hope Bancorp, Inc.
Christopher Edward McGratty; Head of United States Bank Research & MD; Keefe, Bruyette, & Woods, Inc., Research Division
David John Chiaverini; Senior Analyst; Wedbush Securities Inc., Research Division
Gary Peter Tenner; MD & Senior Research Analyst; D.A. Davidson & Co., Research Division
Matthew Timothy Clark; MD & Senior Research Analyst; Piper Sandler & Co., Research Division
Presentation
Operator
Good day, and welcome to the Hope Bancorp's 2023 Third Quarter Earnings Conference Call. (Operator Instructions) Please note this event is being recorded.
And I would now like to turn the conference over to Angie Yang, Director of Investor Relations. Please go ahead.
Angie Yang
Thank you, Marliese. Good morning, everyone, and thank you for joining us for the Hope Bancorp 2023 Third Quarter 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 Investor Relations website.
Beginning on Slide 2, let me begin with a brief statement regarding forward-looking remarks. The call today may contain forward-looking projections regarding the future financial performance of the company and future events. These statements may differ materially from actual results due to certain risks and uncertainties. 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 yesterday. 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 Sung Kim
Thank you, Angie. Good morning, everyone, and thank you for joining us today. Now let's begin on Slide 3 with a brief overview of the quarter. For the third quarter of 2023, our net income was $30 million or $0.25 per diluted share. Highlights of our third quarter results include net interest margin expansion of 13 basis points quarter-over-quarter, which led to a 4% linked quarter growth in net interest income. We maintained disciplined expense control, resulting in a 1% decline in noninterest expenses compared with the preceding quarter. However, the provision for credit losses increased to $17 million for the third quarter and certain onetime gains in noninterest income from the second quarter did not reoccur. As a result, our net income decreased on a linked-quarter basis.
During the third quarter, we continued to strengthen our balance sheet, which positions us well to take advantage of profitable growth opportunities going forward. Total deposits grew 1% quarter-over-quarter, reflecting stronger customer deposit growth of 3%, partially offset by a planned reduction of brokered time deposits. All regulatory capital ratios expanded. Our liquidity continues to be ample.
Continuing to Slide 4 for a more detailed review of our capital. Our capital ratios are strong and all regulatory capital ratios expanded quarter-over-quarter. As of September 30, our common equity Tier 1 ratio was 11.67%, up 62 basis points from June 30, and our total capital ratio was 13.23%, up 59 basis points quarter-over-quarter. 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 November 16 to stockholders of record as of November 2, 2023.
Moving on to Slide 5. At September 30, our cash and cash equivalents were $2.5 billion, up from $2.3 billion at June 30. At the end of the third quarter, our available borrowing capacity, together with cash and cash equivalents and unpledged investment securities increased to $8.3 billion or 53% of our deposits and well exceeding our uninsured deposit balances.
Continuing to Slide 6. At September 30, our total deposits were $15.7 billion, an increase of 1% quarter-over-quarter, reflecting linked quarter growth of 3% in customer deposits primarily in money market and savings accounts, partially offset by a $368 million reduction of brokered time deposits. Increase in core deposits is a key priority for the company, and we saw excellent results from our frontline efforts during the third quarter. Our gross loan-to-deposit ratio was 91% at September 30, down from 95% at the end of the prior quarter and down from 100% at the end of the year ago quarter.
Moving on to Slide 7. At September 30, our loan portfolio was $14.3 billion, a decrease of 4% quarter-over-quarter, reflecting our prudent approach to loan growth and an intentional decrease in mortgage warehouse lending. Mortgage warehouse lines declined $126 million in the third quarter to $65 million at September 30, 2023. We are in the process of winding down this business. In addition, payoffs and paydowns in a high interest rate environment continued to hamper loan growth.
On Slide 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 for these CRE properties are low across all segments, and the vast majority of these loans have full recourse with personal guarantees. The weighted average LTV of our total CRE portfolio was 45% at September 30, 2023. Office commercial real estate of $455 million represented just 3% of total loans with no central business district exposure.
With that, I will ask Julianna to provide additional details on our financial performance for the third quarter. Julianna?
Julianna Balicka
Thank you, Kevin. Beginning with Slide 10. Our net interest income totaled $135 million for the third quarter of 2023, up 4% from the second quarter driven by a 13 basis point expansion in our net interest margin to 2.83%. The linked quarter increase in our net interest income and expansion of our net interest margin was driven by higher yields on interest-earning assets, a reduction in average borrowings and debt and an increase in the average volume of interest-earning cash and deposits at other banks, partially offset by a higher cost of interest-bearing deposits and a reduction in average loan balances. In the third quarter, we executed on $1 billion of 1-year forward start [receive] fixed pay float swaps that have a 3-year term and will go into effect midyear next year and continuing on after that.
Moving on to Slide 11. Our average loans of $14.6 billion decreased 4% linked quarter. The average yield on our loan portfolio increased to 6.27%, up 28 basis points in Q3. Our average deposits of $15.7 billion were essentially stable, decreasing by only $45 million in the quarter. The average cost of deposits increased to 2.98%, up 19 basis points from the second quarter. The rate of change in the cost of deposits decelerated from the second quarter.
Moving on to Slide 12. Our noninterest income was $8 million for the third quarter compared with $17 million in the second quarter of 2023. Last quarter's noninterest income included a onetime $6 million cash distribution related to an investment in an affordable housing partnership and $2 million of gains on SBA loan sales. In the third quarter, we elected to retain SBA 7(a) production on balance sheet. Excluding these Q2 gains, noninterest income decreased $1 million quarter-over-quarter.
Moving on to Slide 13. We continue to maintain expense discipline. Our noninterest expense of $87 million decreased 1% quarter-over-quarter, salaries and benefits expense of $51 million decreased 2%. Our efficiency ratio was 60.5% as of September 30, up slightly from 59.1% as of June 30. The change in the efficiency ratio was primarily due to the decrease in noninterest income.
Now moving on to Slide 14. I will review our asset quality. Our nonperforming assets at September 30, 2023, decreased 20% quarter-over-quarter to $62 million or 31 basis points of total assets. The linked quarter decrease reflects charge-offs of nonaccrual loans, payoffs and workouts, partially offset by new inflows. Net charge-offs for the 2023 third quarter totaled $31 million, which included an idiosyncratic full charge-off of $23.4 million related to a borrower that entered Chapter 7 liquidation in August 2023. As of June 30, 2023, we have recorded $9.6 million in impairment reserves related to this credit. For the third quarter, our provision for credit losses was $17 million, reflecting the increase in charge-offs.
At September 30, 2023, our allowance for credit losses was $159 million, representing 111 basis points of loans receivable. The allowance coverage as of June 30 was 116 basis points. However, excluding the $9.6 million of impairment reserves related to the idiosyncratic charge-off, the allowance coverage as of June 30 was 110 basis points. Year-over-year, allowance coverage is up from 104 basis points at September 30, 2022. Special mention loans at September 30, 2023, decreased quarter-over-quarter to $187 million. Substandard loans increased to $174 million during the same period. $21 million of the linked quarter increase in our substandard loans were completed multifamily residential projects. These projects are well secured and are awaiting the issuance of temporary certificates of occupancy by their local jurisdictions. Overall, we are not seeing any broader systemic issues within the loan portfolio.
With that, let me turn the call back to Kevin.
Kevin Sung Kim
Thank you. Thank you, Julianna. Moving on to Slide 5 (sic) [15]. Today, we announced a strategic reorganization that is designed to enhance shareholder value over the long term. Accordingly, the company realigned its structure around lines of business and product delivery channels, optimized its production capacity and reduced headcount. Since its inception, Bank of Hope has made great progress in growing from a traditional community bank into a diversified regional bank. However, our industry continues to undergo secular changes and adapting our business model to meet these challenges is essential to long-term success.
With this reorganization, we will have 4 distinct business groups instead of our prior region-based structure, namely Retail Banking, Commercial Banking, Corporate and Institutional Banking and a Fee-based Business Group. This will enable us to expand our client relationships, empower deposit growth, enhanced revenue generation and run our bank more efficiently. As part of this transformation, we are planning to rationalize our branch network over the next 6 months, subject to customary notices and approvals and are winding down certain noncore businesses. We understand this action has a human component and thus, we have not made this decision lightly. We are making every effort to support those employees affected by the reorganization. These decisions are never easy and we deeply value their contributions to our franchise.
We believe these changes will benefit customers, employees and shareholders in many ways over the long term and allow us to sustainably expand our profitability. Upfront, we expect to realize more than $40 million in estimated annualized cost savings, largely related to the staffing reduction, the branch rationalization and operational process improvements. Related to the reorganization, we expect to recognize onetime charges of approximately $12 million in the fourth quarter of 2023.
In light of the organizational restructuring, we will dispense -- providing you with an outlook for the remaining 2 months of the year, and we will provide a full year outlook for 2024 when we report earnings in January.
With that, we would be happy to take your questions and add any additional color as requested. Operator, please open up the call.
Question and Answer Session
Operator
(Operator Instructions) Our first question comes from Chris McGratty from KBW.
Christopher Edward McGratty
Kevin, I wanted to start with the strategic reorganization. In the past, you've talked about managing the company to an expense to asset ratio I'm interested kind of what the bogey will be for judging success? Will it be that (inaudible) metric? Will it be the ROE, the efficiency ratio, which has its limitations because of rates. I'm just trying to understand how we should be thinking about capturing this $40 million into the numbers?
Kevin Sung Kim
Well, the main purpose of this restructuring is obviously to obtain sustainable profitability on a longer-term basis. And we have been really trying to operate and run this company with the existing structures that we inherited from the predecessor organizations, and which turned out to be vulnerable in an economic situation where interest rate were fluctuating very rapidly at an unexpected pace. And we really took time to reassess the whole structure, how we can be a more profitable, more sustainable organization. And obviously, ROE and ROA and profitability efficiency ratio. All those metrics are very relevant, but the baseline is how we can provide better services to customers, how we can motivate our employees for a better opportunity in their career and how we will have a better return to our shareholders. It's all stakeholder consideration.
And this is a very painful process in that, we have to let go a certain level of people, much higher than the level that we had in the past. But I think this is a fundamental change of this organization, which will ultimately bring to a better profitability over a long term in a very sustainable manner.
Christopher Edward McGratty
If I could ask a follow-up on the metric. Is this -- given the environmental pressures that you spoke about, is this to capture certain metrics, whether it's expense to asset or efficiency for moving further, maybe higher, or is it an outright reduction? I guess is your goal to outright reduce these metrics...
Kevin Sung Kim
Yes. The reduction reflects the realignment around our business -- lines of business, which minimize redundancies in both frontline and back-office support staff. In our prior region-based structure, A lot of resources have been fragmented and we have redundancies because the regions were kind of independent in their operations. And so as a result of this alignment, I think we will be a lot more effective bankers providing our customers with a more consistent level of excellence in service. So this is not just a cost savings measure. This is a more fundamental change in how we do our business and how we drive our profits from our businesses.
Christopher Edward McGratty
Maybe if I could get one more on capital, Kevin, we ask you every quarter about how you're thinking about capital return, certainly shrinking some of these businesses that are not core will free up some capital. How are you thinking about buybacks given the value of the stock and the outlook for '24?
Kevin Sung Kim
Yes. We believe capital preservation and capital expansion, they are very important in this current environment. In terms of shareholder return, I think we are maintaining a strong dividend payout ratio. And eventually, our robust capital base will give us opportunities to more effectively take advantage of growth opportunities going forward. So if you are asking more specifically where -- whether we will be beginning to share our -- beginning to repurchase our shares, I think that is not likely.
Operator
And our next question comes from Matthew Clark from Piper Sandler.
Matthew Timothy Clark
First one for me around the reorg and that $40 million of savings you expect to extract. Can you give us a sense for the realization or timing of those savings and whether or not there might be some reinvestment necessary to realign these businesses? Trying to get a sense for whether or not that $40 million will fall to the bottom line or not?
Julianna Balicka
Matt, this is Juliana. Thank you for that question. A substantial amount of the cost savings that we are expecting of that $40 million, namely $34 million of that is going to come from the staff reduction that we executed last week. So that is already in place and will start to manifest itself in our operating results beginning now. Then in the next 6 months, we have plans to consolidate some branches and the cost savings from that will roll in over the first half of the year. And then lastly, some cost savings from process improvements will continue and be phased in throughout the whole of the next 12 months. So then the $40 million that we are providing to you on Slide 15, that's the fully loaded number.
That being said, Near-term actions around operational process improvements will continue to generate benefits that are not yet necessarily identified and quantified. And that's an important consideration to think about when you are reorganizing an organization and removing redundancies and streamlining operations for more efficient, simpler banking.
And in terms of how much of this is going to drop to the bottom line, the second part of your question -- needs to be considered is that this organizational restructuring was designed to position our bank for high-quality, well-balanced growth regardless of cycle and to promote total relationship banking through collaboration between our business groups and the expansion of our fee-based business products. And to succeed, we need to continue to invest in our franchise, and we've talked to you in the past. So this isn't anything new about investments that we've been making in treasury management solutions. And for example, we recently opened a new branch in Bellevue, Washington. So investing in people, processes and technology to strengthen our bank is going to be ongoing.
However, what is important to point out is that the investments that we have been making have not caused large fluctuations in our expenses because we do practice disciplined expense management, and we do not expect that approach to change. So to state firmly, the restructuring was not designed to extract cost savings just so we could redeploy into some new large scale, not yet unveiled projects. That's not the case. However, one thing that I would say for your modeling purposes is that the cost savings are improvement to your existing 2024 baseline, and we will share our outlook in January. And your 2024 baselines will naturally have assumptions around typical business-as-usual expense growth in an organization. And so that's where the cost savings would be applied to.
Matthew Timothy Clark
Got it. Great. And then on the mortgage warehouse business, just remind us of the balance there at the end of the quarter. And then I think I can answer the question myself, but just the rationale to exit that business.
Peter J. Koh
This is Peter, Matt. The balance is actually $65 million, and we've been continuing to wind that down. I think as you know, the mortgage business has had a big slowdown. And overall, I think pricing and risk profile of that line of business, we thought that winding down that business made more sense for us at this point.
Matthew Timothy Clark
Okay. And your SNC exposure. Can you just update us there on the size of that portfolio and whether or not you went through a recent exam, and whether or not there are any upgrades or any downgrades there?
Julianna Balicka
There were downgrades related to the Shared National Credit exam and the syndicated lending portfolio that we have, the Term Loan B type portfolio, it's approximately $300 million, and that's down from approximately $600 million at the beginning of the year.
Matthew Timothy Clark
Okay. And then just last one for me on the deposit costs, if you spot rate at the end of September.
Julianna Balicka
One second. Let me get you the spot rates. 3.70% -- no, excuse me, 3.10% was the spot rate. That's for total deposits just to be clear.
Operator
(Operator Instructions) And for our next question, we have Gary Tenner from D.A. Davidson.
Gary Peter Tenner
A couple of questions. First, in terms of the loan yields in the quarter, was there anything unusual that kind of drove some of that loan yield expansion this quarter? Or was it more of a mix change quarter-to-quarter?
Julianna Balicka
It's a combination of 3 things. The mix change quarter over quarter. The accumulation of interest rate increases and interest rates moving higher on our variable loan portfolio and interest rate -- interest income recoveries. And one thing I'd like to add to Matt's prior question that was into my answer. Our spot rate on deposits was 3.10% at the end of the quarter, up from 2.97% at the end of the prior quarter. So the spot moved 13 basis points quarter-over-quarter.
Gary Peter Tenner
Julianna, on the interest income recoveries that you just mentioned. Could you quantify that, I guess, maybe relative to the prior quarter, how much of an impact that was?
Julianna Balicka
This quarter, the interest income recoveries were $3 million.
Gary Peter Tenner
Versus any meaningful amount in the second quarter?
Julianna Balicka
There wasn't a meaningful amount in the second quarter.
Gary Peter Tenner
Then in terms of the...
Julianna Balicka
To your question in terms of kind of our net interest margin expansion, even with the net interest income recovery when we back that out, our net interest margin still expanded from the improvement on the liability side.
Gary Peter Tenner
Okay. I appreciate that. And then on the swaps you mentioned, what is the received fixed rate on those?
Julianna Balicka
[3.67%] over on SOFR.
Operator
And we do have one more question from Chris McGratty from KBW.
Christopher Edward McGratty
Just maybe Julianna, coming back to the margin, net interest income comments. Normalizing for the recoveries, I guess, maybe a little help on the trajectory of net interest income. It feels like a smaller balance sheet but more profitable, but interested in your comments about whether the trough might be in NII.
Julianna Balicka
I think in terms of our net interest income expectations and net interest margin expectations, obviously, we will talk about 2024 in January. But -- and we are pleased with the improvement that we saw this quarter even with the -- outside of the interest income recovery. One thing I will remind you all about is that we do have some $1.8 billion of CDs maturing in the fourth quarter from a promotion that we ran last year. So that will put some downward pressure or upward pressure rather on the cost of deposits in the fourth quarter. So in terms of the trough in the NII and NIM we'll talk about that in January. It's kind of curve dependent, right, higher for longer versus when the interest rate -- will be coming in. But we're pleased with what happened this quarter and our frontline continues to execute excellently on growing customer deposits, which gives us the flexibility to run off higher cost funding. And net-net positions us to have a more profitable balance sheet.
And then on my prior answer just now, the fixed rate is [3.67%]. I said over SOFR, but I just left it at 3.67% . So that was for your clarification.
Christopher Edward McGratty
The $1.8 billion, Juliana that's coming up for renewal, what was the rate that was put on, I guess, probably last year sometime?
Julianna Balicka
It was put on last year in the fourth quarter because these were 12-month CDs when it was put on. So the average rate that, that was put on was [4.43%].
Christopher Edward McGratty
Okay. And then maybe last one, the SBA loan sale comments. Do you have any thoughts on retaining versus selling near term?
Julianna Balicka
At the moment, it is more profitable, more economically profitable to FDA loans.
Christopher Edward McGratty
To be sure, maintain them, is that what you said?
Julianna Balicka
Yes. Yes, to maintain balance sheet. So we evaluate that from a perspective of profitability.
Operator
Our next question comes from David Chiaverini from Wedbush Securities.
David John Chiaverini
I wanted to follow up, I guess, indirectly on the NII question. In terms of balance sheet growth and loan growth, any kind of figures or informal guidance in that regard?
Julianna Balicka
No informal guidance at this time, we will provide guidance and outlook for 2024 in January, as you can imagine, we're going through our budgeting process, and we are going through a reorganization.
David John Chiaverini
Yes. Understood. And then shifting gears over to credit quality. Any other kind of areas. You mentioned that you're not seeing any systemic risk, which is great. But can you comment on any areas that you're paying any more particular attention to? I like the slide you laid out with the commercial real estate exposure and the low LTVs, but any other areas that you're focusing in on?
Peter J. Koh
No. Actually, as you may know, we went through a pretty substantial derisking process over the last couple of years. particularly related to some of our CRE concentrations in hotel areas. So at this time, outside of sort of the one-off case that we had seen this quarter really, we're not seeing anything systemic.
David John Chiaverini
Got it. And that one-off case. I'm assuming that it was the shared national credit related to an oil company, but can you confirm what that was related to?
Peter J. Koh
It was that participation. I think it was generally covered with the lead bank. We do have a participation in that credit, and it was related to mountain -- gas industry. Yes.
Operator
(Operator Instructions) Right now, we have a follow-up question by Matthew Clark from Piper Sandler.
Matthew Timothy Clark
I just want to follow up on the office CRE portfolio and get an update on the reserve that you have against that portfolio and what amount is criticized?
Peter J. Koh
We'll look at the reserve level right now. But as you know, we have a very small office CRE portfolio. So I think over 99% of our portfolio -- or around 99% of it is past rated. We do not have any central business district exposure, and most of ours is really Class B in office properties in metropolitan areas. So we do understand the concern from an industry perspective, but really within our portfolio, we're not seeing any signs of concern at the moment. And do we have any reserves?
Julianna Balicka
Well, the reserves in our total book are 111 basis points, and that covers all of our portfolios, office is very small. So the reserves that we have specifically on office is not a meaningful number, 111 basis point coverage. Is what I would go with for the -- thank you.
Operator
And at this time, we have no further questions. And this will conclude this session. I would like to turn the conference back over to management for some closing remarks. Thank you.
Kevin Sung Kim
Thank you. I am confident that our strategic reorganization announced today will enable us to better serve our customers, expand customer relationships and operate our bank more efficiently, benefiting all our stakeholders through sustainably improved profitability. Once again, thank you all for joining us today, and we look forward to speaking with you next quarter.
Operator
And the conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Have a good day.
