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spk01: Good morning and welcome to the Luther Burbank Corporation Second Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. Should you need assistance, please press star zero on your telephone keypad. After today's presentation, there will be an opportunity for three analysts covering Luther Burbank Corporation to ask questions. To ask a question, please press star then the number one on your touch-tone phone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Before we begin, the company would like to remind you that discussions during this call contain forward-looking statements made under the safe harbor provisions of the U.S. private securities litigation reform of Act 1995. Luther Burbank Corporation does not undertake any obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise. Numerous factors could cause our actual results to differ materially from those described in forward-looking statements. For more information on those factors, please see the company's periodic reports accessible at the Luther Burbank Corporation website and filed with the SEC. I would now like to turn the conference over to Simone. Lago Morcino, President and CEO. Please go ahead.
spk04: Thank you, Tamara. Good morning, and welcome to the Luther Burbank Corporation's second quarter earnings conference call. This is Simone Lago Morcino, President and Chief Executive Officer, and with me today is Laura Tarantino, our Chief Financial Officer. We appreciate that you're joining us today. We're pleased with our positive financial performance trends, and that we're achieving the goals that we established in early 2019. Primarily, these goals included growing that interest margin to a level which generates a return on average assets of at least 1% and simultaneously produces a double-digit return on average equity for our shareholders. During the second quarter, we recorded net income of $21.2 million or 41 cents per diluted share. an improvement of $2.8 million or six cents per diluted share as compared to the prior quarter earnings. Growth in net income compared to the linked quarter was primarily attributed to a $2.2 million increase in our net interest income and a $1.5 million reduction in non-interest expense, which was partially offset by a $1.1 million increase in income taxes. Our returns on average assets and average equity during the second quarter measured 1.2% and 13.3% respectively. The earnings for the second quarter included a $2.5 million recapture of loan loss provisions. And even if we exclude this reversal of loan loss revisions, our adjusted net earnings would have produced a return on average assets of 1.1% and a return on average equity of 12.2%. Our net interest margin expanded to 2.31% during the second quarter, reflecting an eight basis point improvement compared to the prior quarter. While our yield on earning assets declined by five basis points, largely due to prepayment of higher yielding loans as compared to rates on new loan volume, this trend was outpaced by a 15 basis point reduction in our cost of funds. Our lending team generated record loan growth during the second quarter. We originated over $700 million in new real estate loans in the period or an 85% increase as compared to the linked quarter when we exclude the single family loan pool purchase we completed in the first quarter of this year. The improvement in loan origination volume was directly correlated to the record high loan pipeline at the end of the first quarter. We attribute the size of the pipeline and significant loan productions during the quarter to reverting our loan underwriting policies to the pre-pandemic requirements. The interest rate associated with the new volume of 3.34% during the quarter was largely unchanged from the linked quarter coupon on new loan originations, which measured 3.35%, again, excluding the purchase loan pool. Although $729 million in new loans were funded during the second quarter, net loan growth totaled $172 million, or 3%, as the bank continued to experience accelerated levels of loan payoffs and paydowns. The conditional prepayment rate, or CPR, of our loan portfolio averaged approximately 28% this quarter, and the interest rate on loans that paid off during the quarter averaged 4%. Comparatively, we had an average CPR of 20% in the first quarter of 2020 before market interest rates rapidly decreased in response to the COVID-19 outbreak. The yield on our loan portfolio declined by eight basis points during the quarter, primarily due to the interest rate on loans paying off exceeding the rates on new loans, as well as the lower coupon on the single-family loan portfolio purchase that we completed last quarter, which was 2.31%. However, as we previously noted, the significant reduction in our cost of funding of 15 basis points during the second quarter outpaced the declining asset yields and was the primary contributor to our improved net interest margin. Our cost of interest-bearing deposits decreased 15 basis points for the period. Over the past three months, we had $1 billion of retail certificates of deposit that matured at an average rate of 1.24% of which approximately 61% by balance renewed into new term accounts at an average cost of 35 basis points or a rate reduction of almost 90 basis points. Another 18% of maturing funds by balance transferred to liquid deposit accounts. We continue to forge deeper relationships with our deposit and loan customers, which was another goal that we established in early 2019. At quarter end, approximately 65% of borrowers with loans originated in the first half of this year have at least one deposit account with the bank as compared to a level of 53% of customers with new loans funded in the full calendar year of 2020. With continued outbound customer calling campaigns and in-branch conversations, we're also seeing improved trends in our sales of fee income generating and non-interest bearing service and deposit products. Our cost of funding also benefited from a decline in the cost of our borrowings, which measured 2.03% for the period, or a 31 basis point decline from the prior quarter. This improvement was the result of the continued repricing of our federal home loan bank advances, as well as a shorter overall duration. We have historically, and we will continue in the future, using federal home loan bank advances as one of our tools to hedge the interest rate risk associated with our hybrid ARM and fixed-rate loan products as we continue to grow our loan portfolio. Now we'll move to asset quality. As I noted earlier, our net income this quarter benefited from our ability to recapture $2.5 million in loan loss reserves, which was primarily attributed to continued improvements in economic conditions and the sustained strength of our residential real estate markets in the West Coast. I'm pleased to announce that as of June 30th, All of our borrowers who were granted temporary payment deferrals related to the pandemic have either returned to routine monthly payments or they've paid off their loans without concessions. As of the same date, we had five delinquent loans, two of which have subsequently paid off in full. Finally, at quarter end, the bank had three non-performing loans totaling $707,000 with a weighted average loan devaluation ratio of 15%. We did not have any real estate owned and as a result, our non-performing assets to total assets ratio was just one basis point. As you can probably tell, I'm particularly proud of the resiliency of our borrowers and the credit quality and performance of our loan portfolio. During 2020, the bank added over $10 million to our allowance for loan losses for the uncertainty related to the outbreak of COVID-19. Year to date in 2021, we've recaptured $5 million of these loan loss provisions. Our current allowance balance continues to have over $4 million in pandemic related qualitative reserves, which we may be able to recapture in future quarters if credit trends and the economy continue to remain strong. Our allowance to total loans coverage ratio at quarter end was 64 basis points as compared to a ratio of 58 basis points at December 31st, 2019. prior to the declaration of the national emergency. Lastly, in relation to the growth in our net earnings for the quarter, I reported that non-interest expense had declined by $1.5 million from the linked quarter. The improvement was chiefly attributed to a $1.7 million reduction in compensation and related benefit expenses as a higher level of capitalized loan origination costs outpaced increases in employee incentive payments related to this quarter's strong loan volume. Additionally, payroll taxes were reduced in the second quarter compared to the linked quarter as payroll tax expense is typically elevated during the first calendar quarter given the timing of annual bonus payments and the mechanics of tax ceilings. Now we'll turn to the balance sheet. Our assets at the end of June totaled $7.3 billion, an increase of $351 million, or 5% since year end. The increase was primarily due to growth in loans and investments of $394 million and $56 million, respectively, partially offset by a $109 million reduction in cash. When we began this year, we indicated that we expected low single-digit asset growth for 2021. Our year-to-date growth has exceeded that projection primarily due to both the $288 million single-family loan portfolio that we purchased in the first quarter as well as internal loan production spawned by a large pipeline coming into the second quarter. There are no additional loan purchases planned for this year, and our loan pipeline has moderated to more typical levels. As a result, we would expect growth in the second half of the year to slow. During the first half of this year, growth in assets was primarily funded by $198 million in federal home loan bank advances and $138 million in increased deposits. Retail deposits decreased by $14 million during the same period as the bank supplemented retail deposit declines with wholesale deposits. As a result of changes made by the FDIC to its broker deposit rules, which were effective on April 1st, the bank intentionally exited a $120 million deposit relationship, which was previously categorized as retail funding, but after the change on April 1st of the FDIC guidelines, it now became a broker deposit. Additionally, we reclassified $37 million of funds from the retail to wholesale category based on this new definition of matchmaking by the FDIC. We have examined the balance of our retail deposit portfolio and do not believe that there will be any further significant impacts resulting from the FDIC's updated rule. The company's capital position remains strong. Year to date through June 30th, we have purchased 578,000 shares of our common stock at an average price of $11.40 per share or a 7% discount to our June 30th tangible book value of $12.25. We continue to have an active share repurchase plan with $12 million in remaining funds authorized for repurchases at quarter end. And I'm very excited to announce that yesterday the Board of Directors voted to increase our quarterly cash dividend to 12 cents per common share. The dividend will be payable on August 16th to shareholders of record as of August 6th. We believe our strengthened core profitability over the past several quarters supports this increased level of return to our stockholders. And with that, I'll now pass the presentation to Laura for a few added financial details pertaining to the second quarter and our near-term outlook.
spk03: Thank you, Simone. The more recent flattening of the yield curve along with the reduction in the 10-year Treasury by approximately 40 basis points since last quarter is not a change that we would have predicted and certainly not a banker's preferred shape of the yield curve. Nonetheless, as we look at our contractual positions, we would expect some additional growth in our net interest margin over the balance of this year. At June 30th, the rate on our loan portfolio was 3.78%, or an eight basis points less than last quarter end. While our loan rate will likely continue to decline about three basis points per month, merely from turnover within the portfolio, the impact from the maturity of two $500 million interest rate swaps one this past June, and one upcoming in August, will offset most of the negative effect of loan turnover. Based on current competition, our new loan origination rates should remain near our second quarter levels. However, given recent yield curve changes as well as excess liquidity in the market, continued elevated prepayment patterns and the resultant acceleration of deferred loan costs are expected to continue to challenge loan yields. And there remains downside risk of market participants decreasing new lending rates to stimulate growth. On the other hand, we do expect additional pricing improvements in our deposit portfolio, albeit at a slightly slower rate than experienced in the prior quarter. The spot rate on our retail deposit portfolio measured 64 basis points at June 30th, or a 19 basis point reduction compared to the end of the linked quarter. During the third quarter this year, we have $1 billion of retail certificate accounts that are scheduled to reprice, which level is similar to the second quarter's maturing balances. However, the current weighted average rate on these CD maturities measures 1.08%, which is about 13% lower than our CDs which repriced during the second quarter. Additionally, our current month's CDs are opening and or renewing at a weighted average rate of 46 basis points. or approximately 13 basis points greater than the cost of those that were new or renewed during the month of April. As shown on pages 24 and 25 of our investor presentation, our interest rate risk, as measured by the economic value of equity model, increased during the second quarter. The percentage decrease in our estimated equity at a 200 basis point parallel upward shock and rate increased to 23% from a level of 18% as of the end of the prior quarter. The increase in risk measure quarter over quarter was primarily due to a change in a modeling assumption and secondarily due to strong loan growth during the second quarter. In June, we added two new hedge positions, including a $100 million three-year FHLB advance at a cost of 38 basis points and a $300 million Fed funds interest rate swap with a fixed pay leg of 21.5 basis points or current negative carry of approximately 12 basis points. The cost of hedging our liability-sensitive balance sheet increased during this quarter due to changes in the shape of the yield curve. Based on continued anticipated loan growth, additional hedge positions in the form of derivatives and or long-term FHLB advances are expected during the third quarter. Given current rate conditions, the counter but net beneficial dynamics of our loan and deposit portfolios, somewhat offset by the cost of active interest rate risk management, we would expect our net interest margin to improve to a range of 2.40% to 2.45% by year end. Lastly, because compensation expense is highly correlated to loan volume and our quarter our quarter end loan pipeline is 31% less than levels at the end of the first quarter, we would expect our non-interest expense to increase and approximate $15 million in the third quarter. This concludes our prepared remarks, and at this time, we'll ask the operator to open the line for questions.
spk01: Okay, to ask a question, please press star 1 on your telephone keypad. Again, that's star 1 to ask your question. To withdraw your question, press the pound key. Your first response is from Eleanor Hagan of KBW. Please go ahead.
spk02: Hi, good morning. Thank you for taking my question.
spk01: Good morning.
spk02: Just starting out on expenses, I think you kind of already touched on this in the prepared remarks, but how much of an impact did deferred compensation have on salary expense in 2Q21? Understanding that origination volume can be challenging to predict. Do you have a sense for what is an appropriate run rate going forward? Are we back to more of a pre-2020 level?
spk04: So I'll start and then turn it over to Laura to give more specifics, but I just want to clarify that when you talk about, you use the term deferred compensation, the accounting would be considered the FASB 91, where we take the... costs of generating a loan at the time of origination and we book that and amortize that cost over the expected life of the loan. So we don't consider that a deferred compensation. We consider that just the FASB 91 loan origination costs that are booked over the life of the loan. We do have deferred compensation which is separate and I just wanted to clarify that for the conference call. And Laura, do you want to talk specifics? I think you mentioned that in your comments about where we would expect that to be at the end of the third quarter, but do you want to clarify further?
spk03: Sure, Eleanor. As I think I mentioned, I would expect our non-interest expense next quarter or for the third quarter to approximate $15 million, which is about almost $1 million greater than the second quarter, primarily because of lower origination.
spk02: Okay, great. Thank you. And then kind of sticking with Salary expense, how does your employee base compare to what you would consider full employment? And are you seeing or experiencing any inflationary pressures on salaries, given kind of the pressures that have been on hiring recently?
spk04: We had about 285 employees at the end of the second quarter, and we've been pretty consistent. We have been fortunate to be able to fill open positions as they come up, and we have not seen significant pressure on salary costs at this point. However, we are obviously hearing about it in the market and expect that that may happen over time, but at the present time, We have, again, been able to fill open positions, and generally speaking, I mean, there may be a few here or there that are more difficult to fill, but generally we've been able to fill our open positions. Laura, anything more to add? No, that's accurate.
spk03: Okay, great. Thank you.
spk01: Thank you. Your final response is from Gary Tanner of D.A. Davidson. Please go ahead.
spk00: Hi there. This is Clark Wright speaking on behalf of Gary Tanner. My question refers to the single-family real estate originations year-to-date. Excluding the Q1 purchases, you are nearly at pre-pandemic 2019 full-year levels, let alone 2020. Can you provide any thoughts on where you think these origination levels are going to be heading in the second half of the year? And if you could, just provide any more commentary on the CRE origination level projections as well.
spk04: So, again, I'll start. This is Simone, and then I'll let Laura pick up. I would say that we have had a very strong single-family loan origination, both from the loans that we purchased, but also loans that we've originated. A significant portion of the loans that we're originating are for purchase transactions, which I think is very important, and it really is the key aspect of our loan originations that separate us a little bit. So rather than refis, which we're seeing an uptick in re-buys generally across the board from what the Mortgage Bankers Association has reported. We are still seeing a very strong loan purchase volume. And if you look at our loan pipeline at the end of June, for single family alone, it is very similar to where we were at the end of March. So we expect, at least in the near term, to have strong loan originations in single family. With the recent downturn in 10-year treasuries, we may see an uptick in loan prepayments, though, as more people who have adjustable rate mortgages with us decide to refi into fixed rate longer-term 30-year mortgages. But that, you know, it's unknown. We've seen a little bit of a slowdown recently, but we may see an uptick just based on what's happened with recent rates. And then in terms of CRE, we've seen a significant reduction in our pipeline as we would have expected as we noted in our prepared comments. We had a big uptick in the pipeline at the end of the first quarter and we have moved that volume through our origination process and booked those loans. But we're now down to more of what we would have said typically would have been the normalized level and so we would expect normalized levels of CRE loans for the last half of this year. And Laura, if you want to get more specific on any of that, I'd welcome you to do that.
spk03: Thank you. Actually, I don't think I have anything else to add.
spk00: Awesome. Thanks for those. And then just my other question, you guys have already really pretty much talked about the repricing activity that's going to be happening. Were you expecting to see your cost of funds moving from here, it looks like the cost of interest-bearing deposits, down to 74 basis points? down 15 basis went from Q1 levels. Do you see it moving any further below that, or do you think it's going to be stable at level 2 at ROI currently?
spk04: Laura, you want to take that?
spk03: Sure. I do think it'll move down from the spot rate at June 30th, but just maybe half of what we achieved last quarter. Again, there was a pretty large differential in the cost of CDs that were maturing in the prior quarter, and We're definitely, I think, sensing a little bit of price sensitivity on where people are willing to roll over their CDs at what rates, right? And we've even seen some movement just into money market accounts given the continued low interest rate environment.
spk04: Laura, do you maybe want to mention also the that expired at the end of June, so close to the end of this last quarter, and then now coming up so that people can understand the impact that might have as well to the margin?
spk03: Sure. As I noticed when I was speaking, we had one $500 million swap mature in June, another $500 million matures in August, and that should pretty well offset the monthly decline we see in our loan yield just from the turnover of the portfolio. So that's going to be the largest impact, I think, for our net interest margin over Q3 and Q4 because they had pretty significant negative carries.
spk01: Okay, there are no further questions in the queue at this time. I will turn the call back over to Simone Lacomarsino.
spk04: Thank you very much. We want to thank all of you for joining us today for our second quarter conference call, and this concludes our second quarter earnings call. Thank you very much.
spk01: That concludes our call today. A recorded copy of the call will be available on the company's website. Thank you for joining us. You may now disconnect.
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