Hanmi Financial Corporation

Ladies and gentlemen, welcome to Harmony Financial Corporation's second quarter 2022 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. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference call, please press star and zero on your telephone keypad. I'd now like to turn the call over to Larry Clark, investor relations for the company. Please go ahead, sir.

Thank you, operator, and thank you all for joining us today to discuss HOMI's second quarter 2022 results. This afternoon, HOMI issued its earnings release and quarterly supplemental slide presentation to accompany today's call. Both documents are available in the IR section of the company's website at HOMI.com. I'm here today with Bonnie Lee, President and Chief Executive Officer of HOMNY Financial Corporation, Anthony Kim, Chief Banking Officer, and Ron Santa Rosa, Chief Financial Officer. Bonnie will begin today's call with an overview. Anthony will discuss loan and deposit activities, and Ron will provide details on our financial performance. And then Bonnie will provide closing comments before we open the call up to your questions. Before we begin, I'd like to remind you that today's comments may include forward-looking statements under the federal securities laws. Forward-looking statements are based on current plans, expectations, events, and financial industry trends that may affect a company's future operating results and financial position. Our actual results may differ materially from those contemplated by our forward-looking statements, which involve risks and uncertainties. Discussion of the factors that could cause our actual results to differ materially from those forward-looking statements can be found in our SEC filings, including our reports on Forms 10-K and 10-Q. In particular, we direct you to the discussion of certain risk factors affecting our business contained in our earnings release, our investor presentation, and in our Form 10-K. With that, I would now like to turn the call over to Bonnie Lee. Bonnie, please go ahead.

Thank you, Larry. Good afternoon, everyone. Thank you for joining us today to discuss our second quarter 2022 results. I am very pleased to report that we delivered another quarter of outstanding performance and results for our customers and our shareholders. A performance demonstrating excellent execution in all the facets of our business, from loan production to deposit gathering, from credit management to operations. All of our employees kept their focus on our strategic goals. Net income was $25.1 million, or $0.82 per diluted share, up 21% from our first quarter and 13% from a year ago. As you can see, our net income was solidly higher both sequentially and year over year. Our new loan production for the second quarter was exceptionally strong at $642 million, driving the increase in our loans. Loans grew 6% on a linked quarter basis and 17% from a year ago. And this growth occurred while applying our conservative underwriting standards. Our deposits were up 3% sequentially and 6% year over year, where core demand-deposit relationships drove that growth. The growth in loans favorably shifted our earnings-asset mix, and the growth in our core deposits limited the increase in our overall deposit costs, combining to drive quarter-over-quarter net interest income up by 16% and our net interest margin up by 45 basis points. Notably, we addressed the compensation and incentives for our employees during the second quarter, while maintaining disciplined expense management, leading to a nearly 1% decline in non-interest expense quarter-over-quarter. And importantly, our overall asset quality metrics remain excellent. All in all, these factors enabled us to generate solid earnings for the quarter and to deliver one of Hanmi's strongest of first halves to a year. We continue to make excellent progress on our strategic initiatives to grow and diversify our business. The investments we made over the past several quarters in talent and technology continue to fuel our growth. as was evident in the second quarter. We generated record loan production in our residential mortgage platform and in our equipment finance and our SEA groups. The priority we placed on each of these key business lines is yielding the strong results we were seeking. For example, our residential mortgage business represented 17% of our total loan production, exceeding our ramp-up targets of 10% to 15%. Our SBA group generated record production of $68 million during the quarter, driven by intense focus on our small business relationships. And we continue to gain solid traction with our corporate career initiative, where both loans and deposits grew meaningfully quarter over quarter. The results are clear. Our growth strategies are working. Finally, our overall credit quality continues to be excellent. our delinquencies remain low, our non-accrual loans remain low, and our net charge-offs remain low. Our special mention and classified loans fell 33% from the prior quarter and 42% from a year ago. Our allowance for credit losses, however, remains strong at 1.29% of loans as we stand watchful for the possible effects of the uncertainties that could arise in this environment of a rising interest rate. Altogether, these results reflect our focus on high-quality loans, discipline underwriting across credit cycles, and vigilant credit administration practices. We remain prudent in our approach, and we will not sacrifice credit quality as we grow. With that, I'll turn the call over to Anthony Kemp, our Chief Banking Officer, to discuss the second quarter loan production and deposit gathering in more detail.

Thank you, Bonnie. I'll begin with additional details on our outstanding loan production, where second quarter volumes reached a record $642 million, up 27% from the first quarter and 38% higher than our second quarter production last year. Our commercial real estate loan production was $271 million for the quarter and represented 42% of total production down from 46% for the first quarter. Originations consisted of mix of retail, multifamily, office, and industrial and warehouse properties. As we've mentioned before, we continue to focus on permanent underwriting. Our commitment in this area is evidenced by our weighted average loan-to-value of 61% and weighted average debt service coverage ratio of 1.9 times for our second quarter CRE originations. CNI production was 96 million representing loans and lines to customers operating in a variety of industries. Commitments on commercial lines of credit increased to 902 million at the end of second quarter, an increase of 88 million or 11% from the prior quarter and 28% year over year. Outstanding balances on these lines also grew 32% between quarters, resulting in a second quarter utilization rate of 47% up from first quarter utilization rate of 39%. Equipment finance or lease production was a record $95 million for the second quarter, up 33% from the first quarter. We continue to see business investment in equipment serving the needs of transportation, construction, and manufacturing industries. As Bonnie noted, SBA 7A low production also reached a record level, coming in at $68 million for the quarter. This continued growth can be traced back to our investment in banking talent over the last several quarters, which has enabled us to further penetrate this key market. Our second quarter residential mortgage production reached a record of $112 million for the second quarter, despite the run-up of interest rates. We believe that our focus on the non-qualified mortgage loan segment or non-QM market aided our originations. With respect to our corporate career initiatives, we continue to make great strides on this strategic growth initiative. Second quarter loan production was a very strong at $79 million, up 52% from $52 million for the first quarter. Approximately 60% of lending in this segment was in CRE and the remaining 40% in CNI loans. Our corporate career portfolio has grown by 33% since last year, above the pace we had expected for this new initiative to end the quarter at $742 million, or 13% of our loan portfolio. As Bonnie noted, with our record loan production for the second quarter, our loan portfolio increased 6% from the previous quarter to $5.7 billion, and it grew 17% from the second quarter of 2021. In addition, I would like to point out that our exposure to the hospitality sector declined 28% since the start of the pandemic and now represents 12% of our loan portfolio. The average rate on all new loan production for the second quarter was 4.35%, up 40 basis points from the first quarter. Payoffs were $231 million for the quarter, up from $181 million for the first quarter. However, the average rate on loan payoff was 4.43%, down two basis points from our first quarter payoff. In summary, our efforts to further diversify our loan portfolio by industry, geography, and loan type is paying off, and the strategy is strengthening our business. Our focus on diversification will continue, which we believe will in turn drive incremental growth and profitability. Looking forward to the second half of 2022, against the backdrop of yet higher interest rates, we anticipate that loan production may normalize. Now, a word on deposits. Deposits at the end of second quarter reached $6.0 billion, the highest level in our 40-year history. This result is a testament to the value that our customers place in our relationship banking model. For the second quarter, deposits increased 3.4%, driven primarily by a $104 million increase in noninterest-bearing demand deposits. The overall composition of our deposit base improved again this quarter as our efforts to drive DDA growth continued to work. DDAs represented nearly 47% of our total deposits at the end of second quarter, up from 44% at year end, and 42% at the end of second quarter of 2021. And now I'll turn the call over to Ron Sanarosa, our Chief Financial Officer, for more details on our second quarter financial results.

Thank you, Anthony. Let's begin with net interest income, where Bonnie noted that we grew an impressive 16% sequentially, and our net interest margin had jumped 45 basis points. Net interest income was $59 million for the second quarter, driven up from the previous quarter from a combination of factors. Average loans increased 6.5% sequentially to $5.57 billion from our stellar loan production. The recent increase in the general level of interest rates pushed our loan and security yields higher. We no longer have the interest expense on our 5.45% subordinated notes, which we redeemed in the first quarter, nor did we have the $1.1 million charge related to that redemption, and we funded our loan growth primarily with lower yielding cash balances. Turning to our net interest margin, which was 3.55% for the second quarter, these same factors led to the 45 basis point increase from the previous quarter. We did see the 14 basis points save arising from the subordinate note redemption, which if you recall last quarter, we indicated this would occur. Our yield on loans increased 13 basis points from the increase in the general level of interest rates, as well as from a mixed shift to CNI loans. Our yield on earning assets also increased 34 basis points to 3.8%, partly from the increase in interest rates, but also from the mixed shift in earning assets where we used lower yielding cash to fund higher yielding loans. And importantly, our cost of interest-bearing deposits remained low at 31 basis points, increasing only five basis points from the previous quarter, while the cost of all deposits only increased three basis points, in part because of the growth in our non-interest-bearing demand deposits. Moving on, non-interest income was $9.3 million for the second quarter, up 9% from the prior quarter as we posted a 10% increase in our SBA gain on sales. The volume of SBA 7A loans sold for the second quarter increased 41% to $42 million, while trade premiums, as expected, declined 19% to 7.97% for the quarter. We also benefited from higher trade finance activity for the second quarter, pushing these revenues up 24% sequentially. Non-interest expenses for the second quarter were favorable at $31.5 million, down just under 1% from the prior quarter. Our annual merit increases began at the start of the second quarter, and with the continued strong loan production, we adjusted our estimates for incentive compensation which, taken together, led to the 6% increase in salaries and benefits quarter over quarter. Offsetting this increase were beneficial declines in all of our other expense categories. So, with increased revenues and slightly lower non-interest expenses, our efficiency ratio for the second quarter improved to 46.05%. We recorded a modest provision for credit loss expense of $1.6 million for the second quarter, primarily reflecting the growth in our loan portfolio. The allowance for credit losses was $73.1 million at quarter end, up slightly from the prior quarter, but lower relative to total loans at 1.29%. Specific allowances for loans declined $200,000, while our allowances, based on quantitative and qualitative loss factors, increased $1.8 million. Quantitative loss factors declined slightly, while qualitative loss factors remained essentially unchanged. However, these loss factors now begin to reflect the uncertainties of future economic conditions in a rising rate environment. In sum, a great quarter with net income of $25.1 million, or 82 cents per diluted share, a return on average assets of 1.45%, and a return on average equity of 14.92%. The company and the bank exceeded minimum regulatory capital ratios, and our ratio of tangible common equity to tangible assets was 8.74%, down from the prior quarter. That declined primarily due to the unrealized after-tax loss on our securities portfolio, stemming from the increase in interest rates during the quarter. Looking forward, We know that the cost of our non-maturity deposits rose at the end of June in response to depositor reaction to the Fed's 75 basis point mid-June rate increase. The rates on our maturing time deposits have also inched upward over the second quarter, increasing the cost of these deposits, too. For July to date, our cost of interest-bearing deposits was about 30 basis points higher than the average rate paid for the second quarter, or a beta of approximately 40% when measured against the June 75 basis point increase in the Fed funds rate. As you also heard, we anticipate that loan growth may moderate in the second half of the year, and we will learn tomorrow what the Fed's next rate increase will be, as well as their outlook for future rate increases. As such, if we were to anticipate about 150 basis points of rate increases over the second half of the year, we would expect that our net interest revenues and net interest margin would begin to diminish from that for the second quarter before finding their new level in that higher rate environment. In addition, we also expect that SBA trade premiums would decline, and that too could diminish our SBA gains on sales. However, with careful expense management, we anticipate that pre-tax, pre-provision earnings would remain very healthy. With that, I'll turn it back to Bonnie.

Thank you, Ron. Before moving to our outlook, I want to take a moment to thank the entire HANMI team for their hard work and dedication to exceptional customer service and for consistently delivering solid financial performance. Our employees are the heart of our company. and I am very proud of all they have accomplished over the years, including serving our communities. Looking ahead, as you heard from Anthony and Ron, we are carefully watching the potential macroeconomic impacts of a rising interest rate environment. Our loan pipelines have moderated somewhat from the record levels we saw in the first half, and as a result, We expect our loan production in the second half of the year to turn to more historical levels. That said, we now anticipate that full-year loan growth will likely be in the low to mid-teens. During these times, we are confident that our business model and dedication to customer service will position us well as we move forward. Our loan pipeline remains solid, our credit quality is excellent, and our earnings and capital are strong. Our talented team brings a wealth of banking experience to our customers who know that they can rely on us in uncertain times as they have done over the last 40 years. With a well-defined strategic plan in place and our ongoing focus on execution, we're well-positioned to continue to deliver disciplined growth and attractive returns for our shareholders. With that, we'll open the call for your questions. Operator, please open the line up to the questions.

Thank you very much. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star and one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star and two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions.

The first question comes from Kelly Marta from KBW.

Please proceed with your question, Kelly.

Hi, good afternoon, great quarter, and thanks for the question. I appreciate all the color on On the deposit side and where we're running in July, just wondering if you could give a bit more detail on where new CDs are coming in and just the competition you're seeing with other players in the space.

So, Kelly, we are seeing that, you know, within our market, we see the 12-month CD money anywhere from 1% to 2%. and we'll see how that will change after tomorrow.

Got it. That's really helpful. And then I apologize if I missed it in the prepared remarks, but I saw your criticized loans came down quite a bit. Can you provide any color as to the migration out of the special mention category, what was driving that? that would be really helpful. And also, you know, if there's any areas within your book that you're watching a bit more carefully given where we are in the cycle. Thank you.

Sure. I'll ask the first part first. So the improvement in the special mention category, it's mainly due to three relationships that had moved up from the special mention categories. And some of them actually include, one of the relationships actually include the partial pay down on the loans and also elimination of any of the concerns that we had to put them in a special mention category.

Got it. That's helpful. And any categories you're watching more carefully or seeing early signs of the past? Yes.

Yeah, I would expect additional rate increases. You know, one of the areas I think that we are looking very closely is the unguaranteed portion of the SBA portfolio. So I think all the SBA lenders are very keenly focused on that. Having said that, you know, we have only about $150 million on the SBA unguaranteed portion. out of that $150 million, a little over $100 million is tied to the SBA CRE loans. So all in all, although we are mindful and watching it closely, at the end of the day, the ultimate loss is probably pretty minimal.

Got it. That's really helpful. Maybe the last one for me is just carrying on on the SBA side. gain on sale premiums have come in for you as well as at other banks. Is this a good level of gain on sale premium that you had this quarter of where the margins are? Is that a good level to assume on a go forward basis or anything we should keep in mind that may make the margin come up or down relative to where it's come in now?

Right, so in the second Q, we saw the premium level around 7% to 8%. But I think it's a trending down. It was a trending down earlier part of this month. However, what I've been told is it's been stabilized. But still, I think the expectation is to be around the 6% to 7% premium. versus, you know, what we saw in the second quarter, which is a 7% to 8%. However, you know, for us, you know, with the talented bankers that we were able to acquire for the last couple of quarters, our productions have really picked up from our run rate of 35 to 40 million. Every quarter, we actually produce our 7 to 8 million. So I think in terms of production, we're going to have a higher production rate of hopefully $55 million and above. So although overall the premium market is trending down, hopefully we will be able to deliver the level of gain that we had, but probably slightly lower for the immediate future.

Got it. Thanks again for all the color, Bonnie, and congrats on a great quarter. Thank you.

Thank you. The next question comes from Matthew Clark from Piper Sandler. Please proceed, Matthew.

Hey, good afternoon. Hello. Maybe first on the margin outlook, Ron, I just want to make sure I heard you correctly. I think you mentioned that you think the the benefit of rising rates will diminish just given the higher cost of deposits going forward. But are you suggesting that 2Q is kind of the peak NIM and we should see some decline from here? I know you have a decent slug of loans still repricing in the next quarter.

Yes, Matthew. I think, you know, second quarter, you know, to put it in a short phrase, revenues were pushed by higher interest rates. I think as we go into the third quarter, we're going to see more of the pull of interest deposit costs. I think as we've noted before, you know, betas aren't linear. And so I just have a sense as we step into a higher rate environment, you're going to see a little bit more of a shock on the non-maturity deposits kind of stepping up before you start to see the benefit of those higher rates on the loan portfolio.

So that gives me some pause that I do think that debt interest margin may diminish a bit.

Okay. Okay, great. And then just shifting to the loan to deposit ratio up a little bit. but it sounds like loan growth is fully expected to slow here in the second half and you have some city specials. Can you just remind us what your internal threshold is on the loan-to-deposit ratio and what you're expecting for deposit growth for the balance of this year and maybe even into next year?

So, with respect to deposit growth, we had anticipated for 2022 you know, low to middle single digits, and it seems to be bearing out in that fashion. And we're particularly pleased that within that growth, it's really skewed to the DDA side of life rather than to the interest-bearing deposit side of life. So that helps moderate, you know, the aggregate cost of deposits. So we anticipate that that growth will happen. With respect to loan and deposit, you know, we're comfortable at that 90%, 95% level. You know, we think, you know, we can still achieve that, although in this kind of, let's say, flex moment, we'd probably be at the higher end of that range than at the lower end of the range. Again, until we know where this interest rate environment will be, I think we're going to be in very choppy waters quarter to quarter.

Okay, great. And then last one for me, just on expenses, you guys have done a good job of holding the line there for the last few quarters. Any updated thoughts on the run rate and anything unusual in the latest quarter?

No, I think, you know, again, you know, we saw the, you know, what we were expecting with respect to salaries and benefits being kind of at, let's say, inflationary rates. We don't expect that to repeat itself, of course, but we do anticipate that the remainder of our components of non-interest expenses will probably be buffeted by, I'll call it, you know, normal market inflation ideas.

Okay. Thank you.

Thank you. The next question comes from Gary Tinner from D.A. Davidson. Please proceed, Gary.

Thanks. Good afternoon. I want to ask about the kind of loan growth outlook and call for moderation back half the year. Obviously not, you know, dramatically different than what we've heard from most banks. But in terms of the segments, as you think about, you know, the most likely areas of slowdown, can you kind of walk through where you think, you know, the production or net growth comes from over the back half of the year?

Sure. I think overall, you know, from our commercial lending group to our SBA leasing mortgage, just looking at the pipeline in queue, you know, it has moderated. But I think that, you know, where some of the, I guess, additional decline slowness is probably on the perhaps on the CRE sector.

Okay, thank you.

And then in terms of the equipment finance portfolio, it's around 10% of your book and about half of that is trucking. Do you have any kind of upward limit on concentration in that portfolio segment?

No, so we are monitoring, you know, the, I guess the specific, the sector within the within the equipment finance. But, you know, within that sector, there really isn't, I guess, a name concentration. So these are, you know, UPS trucks in terms of average size. So it doesn't really warrant. So, you know, from our overall loan portfolio, the entire leasing book is only about 10%. So I think we're comfortable, you know, down the road.

we'll make the decision accordingly. Thank you.

Thank you.

The next question comes from Jason Stewart from Jones Trading. Please proceed, Jason.

Hey, this is Matthew filling in for Jason. Congrats on the good quarter. So when it comes to non-QM mortgages, do you guys look to keep up the same volume there? And what is kind of the available credit that you guys are willing to take on there?

Well, although the refinance market is really dampened, we still see purchase loan application coming in very actively. So we'll continue to pursue the non-QM and our portfolio non-QM product.

Gotcha.

So I guess what are you looking there in terms of the credit box as a consumer or a borrower there?

Credit box, are you referring to our perimeter of the credit? Yeah. We usually require 30% to 40% down payment, and then we verify 12 months of payment reserve, not as a form of collateral, but as a liquidity verification.

Gotcha. Thank you.

Thank you. The next question is a follow-up question from Kaylee Malter from KBW. Please proceed, Kaylee.

Hi. Thanks for the follow-up. I just wanted to ask one on the deposit side. We're seeing non-interest bearing roll off at a lot of other banks, but you notably had an increase I'm just wondering if you're starting to see a migration out of non-interest bearing into higher rate deposits, and how much of that increase was related to the deposit initiative you are currently working on from corporate Korea to other things that you're doing? Thanks.

Yeah, particularly in the second quarter, the increase in the DDA. It's a combination acquisition of a new customer base in the corporate career initiative. And then also some of the fluctuations within the larger customer, larger average balance customers as well. But the key is that, you know, it's a consistently growing index sector. And we do have targeted market, target marketing initiatives for the corporate career sector. customer base as well as our general customer base in the businesses that we operate under.

Got it. Thank you so much for the call, Bonnie. Sure.

Thank you. Ladies and gentlemen, we have reached the end of the question and answer session. Now I'd like to turn the call back to Ms. Bonnie Lee for closing remarks. Thank you.

Thank you for participating in our call today. We appreciate your interest in HAMI and look forward to sharing our continued progress with you throughout the remainder of the year.

Thank you very much. This concludes today's conference.

You may disconnect your lines at this time, and thank you very much for your participation.