Hanmi Financial Corporation

Ladies and gentlemen, welcome to the Hanmi Financial Corporation's second quarter 2023 conference call. As a reminder, today's call is being recorded for replay purposes. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. I would now like to turn the call over to Larry Clark, investor relations for the company. Please go ahead.

Thank you, Doug. And thank you all for joining us today to discuss Hanmi's second quarter 2023 financial results. This afternoon, Hanmi 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 hanmi.com. I'm here today with Bonnie Lee, President and Chief Executive Officer of Hanmi Financial Corporation. Anthony Kim, Chief Banking Officer, and Ron Santarosa, Chief Financial Officer. Bonnie will begin today's call with an overview, and Anthony will discuss loan and deposit activities, as 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 the 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. Discussions of the factors that could cause our actual results to differ materially from these 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, in 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, and thank you for joining us today to discuss our results for the second quarter of 2023. As you well know, the second quarter was a challenging time for the banking industry with the rising interest rates, ongoing economic uncertainty, and the aftermath of the banking industry events in March. I am pleased to report that even with these challenges, Hanmi delivered solid results for the second quarter of 2023, highlighted by healthy deposit growth, continued expansion of our corporate career initiative, disciplined expense management, and continued improvements in credit quality. We attribute these results to our successful relationship banking model and our team's consistent and steady execution of our strategy. Net income for the second quarter of 2023 was $20.6 million, or $0.67 per diluted share, compared with a $25.1 million, or $0.82 per diluted share, for the year-ago quarter. We have spoken to you about our strategic initiatives to position HANMI to deliver sustained growth and returns over the long term. You may recall these include growing our residential mortgage platform to diversify our loan portfolio by adding lower risk assets that can grow profitably for many years, accelerating our corporate career initiative to grow our loan and deposit portfolios from Korean companies that are investing in the U.S. and expanding our team by attracting top talent with a growth and relationship mindset to win more business and serve more customers. Our success in executing this strategic initiative was evident in our second quarter results, where we most notably benefited from strength in our residential mortgage lending business and our corporate career initiative. Second quarter deposits increased over 7% on an annualized basis to $6.3 billion, and non-interest-bearing deposits remain high at 35% of our total deposits at quarter end. These results reflect our success in maintaining existing customer relationships and building new ones. Our team did an outstanding job staying in close contact with our key customers to maintain both their confidence and deposits during the events in March. We also continued to execute well on our sales and marketing initiatives which result in a substantial amount of new deposit relationships this quarter. Time and again, our team has demonstrated that times of market disruption are some of the best opportunities to partner with the customers to identify evolving needs and to be part of the solution. As we expected, and in line with the banking industry, our 2023 loan production remains under pressure due to higher rates and their impact on borrower demand. Overall, loan production for the second quarter was $259 million, down from $304 million last quarter as we saw lower levels of CRE, CNI, and equipment financing loans, partially offset by strength in residential mortgage lending. As we enter the third quarter, we are encouraged to have a strong loan pipeline. Our customers are resilient and are adjusting to the new reality of higher cost funding. They also have a growth plan and we expect they will continue to view HANMI as their trusted partner for their financing needs. Now turning to credit quality. Our overall asset quality metrics are excellent as non-performing assets, total assets remain low at 30 basis points. Effectively managing risk is always important in banking and even more during a challenging period. We continue to have a highly disciplined and comprehensive approach to underwriting and credit management, and the steps we have taken to strengthen our credit administration practices were evident in our strong credit metrics in the second quarter. Looking ahead, we will continue to take a highly selective and disciplined approach to lending. We will focus on making attractively priced loans to high-quality borrowers who also have a deposit relationship with HOMI. Our Corporate Korea Initiative, which serves Korean companies with U.S. operations, was a strong contributor to our second quarter results from both existing and new customers. We launched this initiative in 2019, and we now have teams throughout the U.S. dedicated to our Corporate Korea business. Korean companies continue to invest in and expanding in the U.S. Hanmi is in a fortunate position to continue tapping into this opportunity, and we believe that our corporate Korea initiative will attract even more new lending relationships and low-cost deposits as Korea-based companies continue to invest in opening U.S. offices. Despite higher mortgage rates, our residential mortgage loan production was strong again this quarter at $100 million. up modestly from the first quarter, reflecting the success of our strategy to diversify our loan portfolio. Since we launched this program in 2020, we have developed close relationships with the correspondent lenders who focus on the non-QM segment of the market and share our high underwriting standards. We continue to look to expand our relationships here as this loan category remains an important part of our diversification strategy. As we execute on our stated strategy, we also continue to be opportunistic in pursuing new growth opportunities, including optimize our footprint to serve growing and expanding markets. Specifically, we are focused on markets where HOMI can serve a market niche or where there is a geographic movement of the business community, and in doing so, expand our loan and deposit base. Last quarter, we mentioned our plans to relocate our branch in San Francisco to the city of Dublin in the East Bay, and we now also have plans to relocate our branch in Edison, New Jersey to Fort Lee, New Jersey. During the second quarter, we continue to manage our expenses well. We are pleased that even with the rising employees' salaries and benefits and continued investment in growth, we were able to keep our expenses relatively contained and well managed with no notable change between quarters. In the second quarter, we generated a return on average assets of 1.12% and a return on average equity of 11.14%. We also improved upon our already strong capital levels with a total risk-based capital at 15.1% and tangible common equity ratio of 8.96%. Looking ahead, we are well positioned to navigate the remainder of the year with a strong base of very loyal customers, a growing pipeline of new opportunities, a healthy balance sheet and liquidity position, solid credit quality, an outstanding team, and a strategy that is working. With that, I will turn it over to our Chief Banking Officer, Anthony Kim, to share more specifics about our loan and deposit activity.

Thank you, Bonnie, and thank you for joining us today. I'll begin with the more detail on our loan production. Second quarter loan production was $259 million, down 15% from the first quarter. Given the current interest rate environment, we had expected loan production to moderate this year, and that has been the case in the first half of the year. We attribute the second quarter decline in loan production to a couple of factors. First, we are seeing softer demand for purchases and refinances especially in the CRA sector, where rapidly rising interest rates have had a major impact. In this sector, we're only pursuing high-quality transactions that meet our underwriting standards and provide the appropriate level of yield in this high-rate environment. Additionally, during the second quarter, we approved three large loans totaling about $40 million that did not fund by the end of second quarter. However, these loans will fund in the third quarter. Had these loans been funded in the second quarter, your loan production would have been consistent with the first quarter levels. Our residential mortgage production was a strong performer this quarter at $100 million, which is consistent with the last five quarters. We attribute our success in residential mortgage lending to the close relationships we have built with our correspondent lenders who continue to be active in their own markets by focusing on the non-QM space. Practically all of our current lending is in the purchase market, as refinance activity has dropped off significantly with higher interest rates. These loans now comprise nearly 15% of our total loan portfolio, up from 9% a year ago. As Bonnie said, residential mortgage has been and will continue to be an important part of our loan diversification strategy, and we want to be in the best position to serve this market. Turning to C&I lending, we funded $36 million in loans, an increase of 34% from the first quarter. C&I funding in the first half of 2023 has been lower relative to past years, which we believe reflects the overall cautious environment. That said, we are encouraged that our CNI pipeline is stronger going into the third quarter than it was early in the second quarter. Total commitments on our commercial lines of credit were $1.07 billion in the second quarter, up slightly from the first quarter. Outstanding balances declined 1%, resulting in a utilization rate of 37% in the second quarter, down slightly from 38% in the first quarter. Loan balances for our corporate Korea initiative were 12.3% of total loans. While corporate Korea loan production declined modestly in the second quarter, the pipeline is healthy as we enter the third quarter, particularly for CNI loans. Second quarter SBA loan production was nearly 31 million, down from 35 million in the first quarter. Our team remains active in the marketplace, and we continue to be selective about new loans. Based on our pipeline visibility, we believe we can fund between 35 and 40 million of SBA loans each quarter in the back half of the year. The small business market is a vibrant, long-term opportunity for HOMI, and we remain optimistic about our ability to tap into this market. Our new loan production is driving improvements in the diversification of our loan portfolio and our average yield. CRA loans now represent 62.6% of our portfolio, compared with 67.5% a year ago. Average portfolio yields grew as we continued to fund new loans at higher yields than loans that are being paid off. The average rate on all new loan production increased to 7.39% in the second quarter, up 20 basis points from the last quarter. And the average rate on low payoff was 7.21%, six basis points lower than first quarter payoffs. Now turning to deposits. In the second quarter, we grew deposits by 7.4% on an annualized basis as we strengthened our relationships with existing customers and brought in new customers through focused targeting and relationship building efforts. As you heard from Bonnie, Our corporate credit deposit activity was especially strong in the quarter, up 22% from the last quarter and 64% higher than a year ago. These deposits now comprise nearly 11% of our total deposit base, up from 7% a year ago. As important, this initiative drove a 29% increase in demand audits from a year ago and comprised 15% of our total DDA. We are proud of our team's ongoing success in growing this unique and important business segment for us. We believe we have a very bright future for continued customer acquisition and deposit and loan opportunities with existing Corporate Korea customers. With respect to our total deposits, we continue to see a shift in the competition of the portfolio in the second quarter as some non-interest-bearing demand deposits shift into money markets, savings accounts, and time deposits. However, we have seen the pace of this shift slow from the prior quarters. Non-interest-bearing demand deposits represented nearly 35% of our total deposit at quarter end which is an important validation of the success of our relationship banking model. That closes my remarks. I'll now turn it over to Ryan 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 we posted $55.4 million for the second quarter, down $2.4 million, or 4.2% sequentially, from the first quarter, primarily because of higher interest bearing deposit expense. Here, we saw a $6.6 million increase in interest expense on deposits, largely driven by a 52 basis point increase in average rates paid. Offsetting this effect was a $2.6 million increase in loan interest income, mostly due to a 13 basis point increase in yields. Further offsetting the effect of higher deposit interest expense was a $729,000 increase in interest income from our deposits at the Fed and a $736,000 reduction in interest expense from fewer borrowings. Net interest margin also declined for the second quarter, 17 basis points to 3.11 percent. Here, the cost of interest-bearing deposits contributed 35 basis points to this decline, while the increase in loan yields offset that effect by nine basis points. The contribution of higher yields under deposits at the Fed and the benefit of lower FHLB borrowings further offset the margin decline by another eight basis points. As expected, the pace of decline in our net interest margin moderated from the first quarter, where we saw margin decline 39 basis points from the prior fourth quarter. When we met last quarter, we noted that the rate of change for our interest-bearing deposits was slowing as we entered the second quarter. That did happen, as the second quarter increase in the average rates paid on interest-bearing deposits was about half the increase we experienced in the first quarter. We continue to see deceleration as we enter the third quarter, as the cost of interest-bearing deposits for the month of July to date is about 25 basis points higher than the second quarter average. In addition, The mixed shift in our deposit portfolio also continues to find a composition more reflective of a higher rate environment. The quarterly growth in time deposits, whether from a shift away from existing accounts or from new money, nearly came to a halt in the second quarter as the quarterly decline in savings and money market accounts stopped and flipped to an increase for the second quarter. Noninterest-bearing demand deposits were a healthy 35 percent of our deposit portfolio. The Fed will meet tomorrow, and we will soon learn whether the Fed funds rate increases another 25 basis points. We expect the debate will renew. Will there be further rate increases? Will rates be higher for longer? And when will the first rate cuts occur? So, again, altogether, even though this rising rate cycle may yet have peaked, the answers to the questions noted will linger. But for us, the rate of changes are slowing. Now, turning to non-interest income, which declined $400,000 or 4.8% sequentially from the first quarter, largely because of lower gains from sales of the guaranteed portion of SBA loans. The volume of loan sales declined 33% to $19.9 million for the second quarter, while the trade premium declined 10 basis points to 7.75%. Non-interest income for the second quarter also included a $1.9 million benefit from a legal settlement offset by a $1.9 million of losses realized on the sale of securities. Non-interest expenses were up 4.5% sequentially from the first quarter to $34.3 million. Here, the $1.5 million increase was largely due to a $700,000 increase in our FDIC insurance, while the first quarter included $600,000 of recoveries from an SBA servicing asset valuation allowance and from recoveries of OREO expenses. These items overshadow the stability of our labor costs, which declined $245,000 and represent 59 percent of our operating expense base. Non-interest expenses as a percentage of second quarter average assets were 1.86 percent while the efficiency ratio was 54.11 percent. Credit quality remains excellent. We had a small recovery of credit loss expense for the second quarter, comprised of a positive provision for loan losses of $514,000 and a negative provision for off-balance sheet items of $591,000. The allowance for credit losses stood at $71 million at June 30, or 1.19 percent of loans. Net charge-offs to average loans for the second quarter, annualized, were 12 basis points. Looking to funding, liquidity, and capital, our deposit portfolio remains strong with a solid customer relationships and little reliance on broker deposits or wholesale funds. FHLB borrowings declined $225 million to $125 million, while broker deposits remained unchanged at $83 million. The ratio of loans to deposits declined to 94%, at the end of the second quarter. Our securities portfolio, all of which are available for sale and carried at current market values, when reduced for pledging needs and combined with our cash balances, represent 18 percent of our deposits. The after-tax realized loss on our securities portfolio is included in our capital position, and changes in their market values since the first quarter reduced our capital by $5.6 million. During the second quarter, we also repurchased 100,000 shares of our common stock at an average share price of $14.44, further reducing capital by $1.4 million. Offsetting these reductions to capital was the contribution of second quarter earnings less dividends paid. As a result, tangible book value per share increased 1.2%, to $21.56 at June 30, 2023. Omni and the bank continue to exceed minimum regulatory capital requirements, and the bank continues to exceed minimum ratios for the well-capitalized category. The common equity tier one ratio for the company was 11.91%, and for the bank, it was 13.39%. With that, I'll turn it back to Bonnie.

In closing, I'd like to thank our analysts and investors for your continued support. I would also like to thank our outstanding team for their dedication to building strong relationships with our customers by delivering superior customer and banking solutions that help them and help HANMI grow. Heading into the second half of 2023, we will remain focused on executing on our strategy, continuing to provide advice, products, and services our customers need, and prudently managing our business to deliver growth and return to our shareholders.

Thank you. Thank you.

Ladies and gentlemen, at this time, we'll be conducting a question and answer session. If you'd like to ask a question, you may press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2. 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 key. Our first question comes from the line of Matthew Erdner with Jones Trading. Please proceed with your question.

Hey, guys. Thanks for taking the question. How are you viewing new loan originations versus share buybacks at the current level?

So to take it, I guess, in two parts, with respect to capital actions, whether they be share repurchase or dividends, as we've said in our previous calls, the board meets quarterly and we review our plans both as they unfolded and what we might see in the future. So share repurchase, in the particular case here for the second quarter, just happened to be very opportunistic given the severe dislocation in the equity markets from the March events. So, the Board will meet again, we will have a conversation, and we will proceed from there. With respect to loans themselves, again, as Bonnie and Anthony have pointed out, you know, that's a pretty slow environment right now given the high rate that borrowers have to pay. and will continue to be selective in what we do in the current rate environment.

That's helpful. And then following up on the loan originations, you guys had a pretty good quarter with resi loans. Could you talk about the average profile of that loan, whether it be size, the rate, and if it was non-QM for this quarter?

Yeah, we produce mostly non-QM loans. About 90-something percent, over 90% of the production is in California. Average rate we produce was 6.43, I believe. And then average loan-to-value is about 60%. Thank you.

Our next question comes from the line of Matt Federaca with KBW. Please proceed with your question.

Hi, guys. Thanks for taking my question. Obviously, you guys have a high base of non-interest-bearing deposits, and I know they're running off a little bit, and you guys mentioned that pace is slowing. I don't know if you guys could give any more specific color around recent trends that you may have seen at the end of the quarter in June and possibly even into July on the non-interest-bearing deposit movement.

You know, looking at the recent trends, obviously there has been some shift from DDA to a CD and interest-bearing account for the, you know, past two quarters. But the pace has actually been slowed. And we expect the non-interest-bearing deposit to either hold or maybe slow. go down slightly from the current 35%. So maybe when this is all done, it'll stay at about 30% to 33% of non-interest bearing deposits, the total deposits.

Got it. Got it. That's super helpful. And maybe just kind of similar following up on that with the margin. Looking forward to you guys expecting a similar maybe another quarter or two of dip in margin in the back half of the year. Or what are you guys kind of expecting with the margin moving forward here?

So as we've tried to point out, we continue to see the deceleration and the decline. Difficult to call when the inflection point will occur. I doubt it's going to be the third quarter. Fed, you know, will likely do something tomorrow. So, you know, when Fed stops, then we have a better sense of when we might get to the inflection point.

All right. Very cool. One last question here on expenses. Obviously, you guys talked about the increase that you saw here. Is this $34 million a good run rate moving forward, or is this a little bit higher than what you guys might expect for future quarters coming up here?

I think it's a pretty good run rate. But what we try to do in our earnings release is to isolate especially the the OREO and repossessed personal property expenses, they can alternate from a net benefit to a net expense. So, you know, when you kind of look outside of that, and I can't tell you what those numbers might be in any one quarter, you can kind of start to see some stability around that $34 million, you know, dot X type of idea.

Got it. Thank you guys for the questions. Appreciate it.

Sure. As a reminder, it's star one to ask a question. Our next question comes from the line of Adam Butler with Piper Sandler. Please proceed with your question.

Hey, everybody. Good afternoon. This is Adam on for Matthew Clark. Hello. I saw that borrowings came down a significant amount during the quarter, and I imagine that's mostly due to the increase in deposits. Do you envision the balance of borrowings remaining in this range going forward, or

So, the 125 million bars that we have at June 30 represent term financings. And they were, they are three-year term financing. So, they've been on for a while, maybe the most recent tranche about a year ago. So, the differential pretty much represents just overnight ideas depending on what might be needed. When you go back to March where there was still uncertainty with respect to just the banking industry, I would say they were just, you know, bulked up just to ensure that should anything adverse occur, we were well positioned to address it. Of course, that did not materialize, so those borrowings went away pretty quickly in the top of the second quarter.

Okay, great. Thanks. I think I appreciate the color on deposit cost pressures decreasing thus far. And I think I heard you say that deposit costs were up 25 basis points quarter to date. Is that interest-bearing or total deposit costs?

It's just I only focus on interest-bearing. So, interest-bearing deposits.

So, it's down to 3.5 as of today?

Correct.

Okay, great. And then one more question with regard to credit. I saw the specific reserve increase on the D&I healthcare loan. Is there, could you just provide an update on the status of that credit?

Sure. So, in line with what we actually shared last quarter, the borrower is in the student reorganization. and also including possible sale of the business as well. So it's still going through the reorganization process.

Okay, great. That's all from me. Thank you. Thank you.

There are no further questions in the queue. I'd like to hand the call back to Ms. Bonnie Lee for closing remarks.

Thank you for participating in our call today. We appreciate your interest in honey and look forward to sharing our continued progress as we move through the remainder of 2023.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.