Luther Burbank Corporation

Good morning and welcome to the Luther Burbank Corporation fourth quarter 2020 earnings conference call. All participants will be in list-only mode. Should you need assistance, please press star zero on your touch-tone telephone. After today's presentation, there will be an opportunity for the three analysts covering Luther Burbank Corporation to ask questions. To ask a question, please press star one. Before we begin, I would like to remind everyone that some of the comments made during this call may be considered forward-looking statements. The company's Form 10-K for the 2019 fiscal year, its quarterly reports in Form 10-Q, and current reports in Form 8-K identify certain factors that could cause the company's actual results to differ materially from those projected in any forward-looking statements made this morning. The company does not undertake to update any forward-looking statements as a result of new information or future events or developments. The company's periodic reports are available from the company or online on the company's website or the SEC's website. I would like to remind you that while the company's management thinks the company's prospects for performance are good, it is the company's policy not to establish with the markets any earnings, margin, or balance sheet guidance. Now I turn the conference over to Simone Lagomarsino, President and CEO. Please go ahead.

Thank you very much. Good morning, and welcome to Luther Burbank Corporation's fourth quarter and full year 2020 earnings conference call. This is Simone Lagomarsino, President and Chief Executive Officer, and with me today is Laura Tarantino, our Chief Financial Officer. The conclusion of the calendar year 2020 marks our 37th consecutive year of recording consistent quarterly profitability. After the unexpected events of last year, I take comfort knowing that our company has remained a reliable financial partner to our loan and deposit customers, and at the same time, a steady performer for our shareholders. Today, I'll begin with our fourth quarter results, summarize our year-end performance, and then conclude with highlights of our 2021 outlook. As a reminder, our fourth quarter investor presentation is available for download on this webcast and will also be available on our website following this presentation. Our net income for the fourth quarter was $8.7 million, or 17 cents, per diluted common share. a decline as compared to the linked quarter net earnings of $14.3 million or 27 cents per diluted common share. Fourth quarter earnings were negatively impacted by our decision to reduce excess cash holdings and incur $10.4 million in pre-tax penalties to prepay $150 million of long-term fixed rate federal home loan bank advances. Had we not made the decision to prepay these borrowings and excluding the impact of the non-recurring prepayment charges, our pro forma fourth quarter net income would have been $16.1 million or 31 cents per diluted common share, an increase of $1.7 million as compared to the linked quarter. This improvement was primarily due to growth in net interest income and stronger loan production. As a result of elevated loan prepayments attributed to the low interest rate environment, as well as solid retail deposit growth, low yielding cash balances continued to grow throughout the year. Rather than deploy this cash into our investment portfolio where yields are equally low, management believed it was in the best interest of the company to deleverage our balance sheet and instead advance the pace of net interest margin improvement and the company's future earnings potential. Our net interest margin for the fourth quarter was 2.13% or a 10 basis point improvement from the linked quarter as the cost of our interest-bearing liabilities declined to a greater extent than the yield reduction on our interest-bearing assets. This resulted in $1.1 million of greater net interest income. Additionally, compensation costs were $1.2 million less than the linked quarter as capitalized loan origination costs reflected the 64% increase in new loan volume quarter over quarter. Similar to the prior quarter, our fourth quarter results did not include any provision for loan losses as trends in the performance of our loan portfolio improved. I will discuss that progress in more detail later in this presentation. Annual net income for 2020 was $39.9 million, or 75 cents per share, as compared to fiscal year 2019 net income of $48.9 million, or 87 cents per share. Again, excluding the impact of the prepayment penalties previously discussed, pro forma net income for 2020 would have been $47.3 million, or 89 cents per diluted common share. As compared to our prior fiscal year, the company's 2020 net interest income improved by $10.2 million, chiefly as a result of the expansion in our net interest margin from 1.84% for the year to 1.97% for the other year, respectively. The increase in net interest income, however, was substantially offset by $9.3 million in higher provisions made for possible loan losses during 2020 as compared to the prior year. The company set aside greater reserves for potential loan losses during the first half of 2020, primarily due to the uncertainty related to the COVID-19 pandemic. Additionally, non-interest income for 2020 declined by $2.2 million due to decreases in loan servicing income and the fair value of mortgage servicing rights related to high loan prepayment speeds, as well as the absence of gains attributed to loan sales executed during 2019 and also a reduction in Federal Home Loan Bank cash dividends as compared to the prior year. Now, as promised, I'll return to credit trends in our loan portfolio. As reported earlier, during 2020, our company was proud to partner with our borrowers by offering temporary loan payment deferral programs for those financially impacted by COVID-19. In this regard, we received 501 applications for payment assistance. We granted modifications for approximately one half of those applications or 254 loans in our portfolio as of year end 2020. This represented 6.3% of the portfolio outstanding balance as of the same date. As the year progressed, our borrowers demonstrated remarkable resiliency and I'm pleased to report that as of year end, over 99% of loans had returned to payment status. More specifically, 250 of the 254 modified loans had returned to making monthly payments, and two loans had indicated they planned to return to making payments at the end of their deferral period, which is the end of this month. The borrower of one loan representing $1.1 million just recently indicated their intent to return to routine debt service payments beginning February 1st. Finally, one single-family residential loan totaling $1.7 million, or less than one-half of 1% of the portfolio, which made its first payment after its deferral period ended, subsequently became delinquent by year end. That loan, which was experiencing payment issues prior to the pandemic, was added to our impaired, non-performing loan balances early in the fourth quarter. We have not received any applications for pandemic payment assistance since last August. During the fourth quarter, our credit team initiated a proactive risk-based approach to evaluate the repayment capacity of income property loans that either applied for or received payment assistance. The approach includes reviewing all non-residential real estate loans in our portfolio with a balance of $1.5 million or greater to ensure that such credits were appropriately graded and adequately reserved for. While the majority of loans reviewed either retained their pass or watch list status or were upgraded, 10 performing loans that are paying as agreed were downgraded to special mention or substandard status given property debt payment capacity and limited evidence of borrower liquidity on hand. Primarily as a result of this evaluation process, during the fourth quarter, our criticized assets increased by $9 million. Although criticized assets increased, we are not anticipating any ultimate losses from these loans as they all appear to be well secured by collateral with a weighted average loan-to-value of 66% and no individual loan exhibiting a loan-to-value ratio of greater than 74% based on original appraisals. As discussed last quarter, collateral metrics in the West Coast market for the type of B- and C-class multifamily residential properties that we typically finance have held stable over the past year. According to data recently published by CoStar, one-bedroom rents in Los Angeles suburban markets increased about 1% during 2020. Additionally, on a national basis, according to graphs published by Yardie Matrix, rent-by-necessity apartment rents have shown less volatility over the last year, and Class B and Class C vacancy rates have remained relatively stable as compared to Class A apartments. While criticized loans grew during the fourth quarter, we recorded no loan loss provision for the period as the impact of higher criticized loan balances was entirely offset by a small reduction in qualitative reserves that were initially established in light of COVID-19, as well as a decline in our total loan portfolio balance as compared to the prior quarter. The company recorded no loan charge-offs in the fourth quarter. For the year end of 2020, we recorded net charge-offs of $337,000 as compared to recording net recoveries of $437,000 during 2019. At year end 2020, both non-performing loans and delinquent performing loans as a percentage of total assets remain at historically low levels of 0.09% and 0.07% respectively. At December 31st, 2020, our allowance for loan loss coverage ratio was 76 basis points as compared to 58 basis points at the end of the prior year. And the company has set aside quantitative and qualitative reserves totaling $12.4 million for the uncertainty of the pandemic's impact on our loan portfolio. Now we'll turn to the balance sheet. Our assets at the end of December totaled $6.9 million, a decrease of $140 million or 2%. since year-end 2019. The decrease was due to a decline in our single-family real estate loan portfolio as a result of loan curtailments and payoffs exceeding loan origination volumes for the year. Our single-family loan portfolio declined by $297 million or 14.7% since the beginning of the year. The decline in the single-family loan portfolio, which experienced a 36.6% CPR during 2020 is attributed to historically low interest rates for 30-year fixed-rate mortgages, a product generally not offered by our company. Conversely, the decline in our single-family loan portfolio was partially offset by growth in our primary lending product of multifamily residential loans, which portfolio represents 68% of our loan balances at December 31, 2020. Our multifamily loan portfolio increased by $115 million, or 2.9%, year-over-year. Although total assets declined during the year, similar to others in the industry, our retail deposit growth was strong. Retail deposits grew $396 million, or 8.2%, from the prior year, while the company utilized excess cash flow to exit wholesale funding positions. Brokered deposits and federal home loan bank advances decreased $366 million and $172 million, or 88% and 17.6%, respectively, since the beginning of the year. The company's capital position remains strong. During 2020, in light of the market price of our stock in a challenging environment for asset growth, we took the opportunity to invest over $36 million in our company through stock repurchase activity. During the year, we repurchased 4 million shares of our common stock in an average price of $9.03 or a 23% discount to our December 31st tangible book value of $11.69. While our capital ratios at year-end 2020 remain consistent with or slightly improved from prior year-end levels, our tangible book value per share grew 7.1% over the same period. Additionally, during the year, we paid a cumulative dividend of 23 cents per share to our shareholders, equating to a dividend yield of 2.3% based on the closing price of our shares on December 31, 2020. As previously announced, in early November, we continue to have an active share repurchase plan in place. We're pleased to announce that yesterday the Board of Directors declared a quarterly cash dividend of 5.75 cents per share payable on February 16th to shareholders of record as of February 5th. At this time, we intend to maintain our quarterly dividends at the current level. Before I conclude, I'd like to share our company's initial outlooks for the calendar year 2021. Our primary goal continues to be smart asset growth. Although we have a few remaining credit parameters that have not returned to pre-pandemic terms, we expect that our total origination volume will increase in 2021 as compared to 2020. Our loan pipeline at year-end 2020 was $331 million and approximately 18% higher than the prior year-end level. Additionally, we intend to add income property loan officers to staff this year. However, looking at the spot rate of our loan portfolio at December 31st of 3.99%, we also expect that loan prepayment activity will remain brisk given the current and continued low interest rate environment. As a result, we're looking for asset growth in the 1 to 2% range for this year. Based on the continued repricing in our deposit portfolio, our actions to de-lever the balance sheet Using excess cash and the expiration of some hedge positions, we expect our net interest margin to continue to improve throughout 2021 with greater acceleration in the third and fourth quarters of the year. Our preliminary expectation is that our net interest margin will improve by approximately three basis points per quarter during the first half of 2021, and then once the hedge positions have expired, potentially reach a range of 235 to 240 basis points during the second half of the year. With vaccination programs moving forward and additional stimulus expected, we remain cautiously optimistic that the current pandemic environment will improve during the current year. However, given a number of unknowns, including the potential extension of eviction and or foreclosure moratoriums, we do not anticipate that we will release reserves set aside for COVID-19 in the near term. And as always, should credit conditions deteriorate, additional loan loss provisions beyond the levels needed for loan growth may be required. While we are not expected to adopt CECL until the first quarter of 2023, current modeling under that methodology does not indicate any significant increase in our projected allowance levels. We have no plans to close branches or downsize administrative offices during 2021. Excluding the non-recurring prepayment penalty incurred during the fourth quarter of 2020 that was previously discussed, we expect to hold non-interest expense within a tight range of $16 million to $16.5 million per quarter or less than a 2% growth over 2020. We plan to continue to invest in better technology to improve the digital experience for our deposit customers and improve our efficiency in originating real estate loans. Our capital spend for new projects in 2021 approximates $1 million. I'll now pass the presentation to Laura for some brief details on loan and deposit trends.

Thank you. As Simone mentioned, our loan pipeline reflects healthy activity. Not unexpected, however, given continued low rates, the preponderance of activity or 73% is for refinance transactions and 18% are in-house refinances. The weighted average coupon on loans in our pipeline at year-end was 3.49% or approximately 50 basis points less than the coupon on our full loan portfolio at the end of 2020. Although year-to-date we have seen an increase in five- and ten-year treasury rates, this increase has not translated over into competitive pricing, likely due to the benign loan growth in the industry. During 2020, our loan portfolio coupon decreased by 18 basis points throughout the year. Based on the metrics I provided, we would expect to see continued reduction in our pricing throughout the current year on this loan portfolio, but to a larger degree than in 2020. given the high level of turnover experienced during the past several months. On the other hand, we do expect to see additional cost savings in our deposit portfolio. The ending rate on our retail deposit portfolio measured 94 basis points at December 31st, as compared to 1% at the end of the linked quarter. During the first quarter of 2021, $480 million of retail certificate accounts are scheduled to reprice. The current weighted average rate on these CD renewals measures 1.17%, while in December new and retained money was recorded at an average rate of 44 basis points or approximately 73 basis points less. During 2020, our retail deposit spot rate decreased by 1% from the start of the year to the end of the year, largely as a result of the Fed's 150 basis point drop in the first quarter, serving as a catalyst, as well as greater liquidity in the banking system. Retail deposit repricing improvements are expected to be more gradual this year with the potential to pick up a one to two basis point cost reduction per month. As Simone previously noted, our net interest margin is expected to show the most improvement during the last half of this year. We have $1 billion in interest rate swaps with a current negative carry of 135 basis points, with one half set to expire in both June and August of this year. This concludes our prepared remarks, and at this time, we'll ask the operator to open the line for questions.