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spk01: Good morning and welcome to the Luther Burbank Corporation fourth 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. After today's presentation, there will be an opportunity for analysts covering Luther Burbank Corporation to ask a question. To ask a question, please press star then one on your touchstone telephone. 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 Act of 1995. Luther Burbank Corporation does not undertake any obligation to update any forward-looking statements, whether as a result of new information, further 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 Luther Burbank Corporation website and file with the SEC. I will now turn the conference over to Simone Margo Marcino, President and CEO. Please go ahead.
spk03: Thank you, Valerie, and good morning, everyone, and thank you for joining our earnings call today. This is Simone Margo Marcino, President and CEO, and with me is Laura Tarantino, our CFO. This morning, we'll discuss Luther Burbank Corporation's fourth quarter and full year 2021 results, share some of our expectations for 2022, and update you on our strategic priorities before we take our analysts' questions. It's coming up on the two-year marker since the outset of the pandemic, and I want to take a moment and acknowledge the outstanding work of our employees. Our branch employees have continued to serve our customers on the front line each day, while the vast majority of our administrative employees quickly pivoted two years ago to a remote work environment and are currently continuing to work remotely. We're extremely grateful, and we truly appreciate the dedication and commitment of our employees over these past two years. Our team members have been remarkably resilient. Now let's turn to our financial performance. Our net income for the fourth quarter was $23.4 million or 45 cents per diluted share as compared to $24.7 million or 48 cents per diluted share in the linked quarter. The $1.4 million decrease in net income that we experienced during the quarter was primarily due to a reduction in recaptured LOMAS provisions which declined by $1.6 million after tax in the fourth quarter as compared to the third quarter. Although less impactful, fourth quarter net income benefited from a $432,000 after tax improvement in net interest income, which was directly related to a 10 basis point improvement in net interest margin. This, however, was largely offset by higher non-interest expense of $418,000 after tax, which was primarily due to higher compensation expense. For the year ended 2021, our net income was $87.8 million or $1.70 per share. These earnings were $47.8 million greater than our prior fiscal year due to three key factors. The first of which was the significant improvement in our net interest margin. The second was the continued strong performance of our loan portfolio. And the third and to a lesser extent was lower non-interest expenses. I'll now expand on each of these three items. First, net interest margin grew by 43 basis points and net interest income increased by $31.8 million, or $22.5 million after tax for the year ended 2021. These improvements were attributed to our ability to reduce the cost of our deposits. This was facilitated by the drop in market interest rates in early 2020 as a result of the pandemic. However, during the past 18 months, we believe that we have also made improvements to the composition of our deposit portfolio. We focused on growing our specialty and business deposits, which we expect will be generally less rate sensitive and as a result, less costly than our typical consumer deposits. As a result, the ratio of specialty and business deposits to our total retail deposit portfolio has grown to 25% at year end 2021, from 21% at year-end 2020. Next, our credit metrics remained very strong throughout 2021. The provisions that we made in 2020 for the uncertainty of the impact that the pandemic might have had on our borrowers was fortunately conservative. As a result, and similar to many other banks, loan loss reserves set aside for potential problem credits during 2020 were substantially reversed during 2021. Reversals of loan loss provisions in 2021 totaled $10.8 million, whereas in 2020 we recorded loan loss provisions of $10.6 million. This adjustment in reserves resulted in a $21.4 million pre-tax or $15.1 million after-tax improvement in net earnings during 2021. Lastly, net income for 2021 improved due to a $14.8 million or $10.5 million after-tax reduction in non-interest expense. This decrease was primarily due to a $10.4 million non-recurring prepayment penalty incurred in the prior year for the early payoff of FHLB advances. Additionally, compensation costs were $4.5 million lower for fiscal year 2021 due to greater capitalized salary levels attributed to a 46% year-over-year growth in loan origination volume. Our 2021 loan volume of $2.1 billion was the second highest production year in our bank's history, and only $60 million less than the highest volume we recorded, which was in 2017. And this leads me to an interesting segue pertaining to our balance sheet trends for 2021. Our total assets for 2021 grew $274 million, or 4% during the year, and ended at $7.2 billion. This growth was almost entirely attributed to 4% growth in our loan portfolio. Although our lending teams logged a robust increase in production over the prior year, elevated loan prepayments significantly muted those efforts. In contrast to 2021, loan growth for 2017 with similar loan volumes and when excluding loan sale activity that year would have been 28%. In the end, we're pleased with our 2021 asset growth, which was in line with our expectations for the year, although it required considerably more work by our team members than we had planned. While still on the topic of loans, the credit quality of our loan portfolio places us among the strongest in the industry. We experienced no loan charge-offs during 2021. At the end of the year, we had $2.3 million in non-performing loans, or 0.03% of assets, and over half of that amount is currently paying as agreed. At the same date, we had only one delinquent loan, which was not included within our non-performing totals, and that had a balance of $271,000. Our year-end allowance coverage ratio was 56 basis points and continues to include approximately $2.5 million in qualitative reserves that are pandemic-related and which we felt were prudent to maintain until we have more information on the potential impacts of the Omicron variant. Our 2021 asset growth was fully funded by increases in our retail deposit portfolio of $298 million, or 6%. Although retail branch deposits grew over the prior year, as previously noted, most of the retail deposit growth occurred in our business and specialty deposit products. The categories reflecting the most growth were the 1031 exchange and fiduciary verticals. As a result of strong retail deposit growth, we were able to reduce wholesale funding such as federal home loan bank advances and broker deposits. Before turning to our outlook for this year, I'll mention that in 2021, due to our strong earnings and capital levels, the company returned $27 million to shareholders in the form of common stock dividends totaling $18 million and share repurchases of $9 million. I'm pleased to report that yesterday our board of directors approved a first quarter 2022 cash dividend of 12 cents per common share, and that will be paid on February 14th. Looking forward, I'd like to share our company's outlook for calendar year 2022. Current loan offer rates for commercial real estate and single family mortgages remain below levels that commonly existed between 2015 and 2020. Loans with these origination dates represent 61% of our loan portfolio at year end 2021. Therefore, we expect that payoff rates will remain elevated. With this in mind, our intention is to position ourselves to originate new loan volume for 2022 that is similar to our 2021 production levels. Late last year, we added a loan officer dedicated to lending in our geographical expansion areas of Arizona, Colorado, and Utah, and we continue to source additional experienced lending staff in our existing West Coast markets. As a result of our plans, we anticipate asset growth of 3% to 5% for 2022. We expect to fund asset growth with a combination of retail deposits and wholesale funding sources and have no plans to add to our branch footprint or to close any of our existing branches. Although the Federal Reserve Bank has not yet started its monetary tightening, we believe that our net interest margin will likely have peaked in the fourth quarter of 2021. We noted in prior quarters that loan competitors decreased offer rates during 2021, even when long-term Treasury rates began rising. which we ascribe to the desire by many institutions to deploy the excess liquidity currently held within the financial services industry. As a result, each month new loan volume continues to be added at coupons less than our current portfolio rate, while the rate on loan prepayments remains higher than the average portfolio rate, causing downward pressure on loan yields. For the past several quarters, this decline in the rate of earning assets, excluding the positive impact of interest rate swaps, maturities that occurred during 2021 was mitigated by reductions in the cost of our deposit portfolio. However, fewer reductions in deposit costs are expected going forward. Several increases in short-term interest rates are expected throughout 2022. Given the excess liquidity currently held in financial institutions, we're not expecting that initial Federal Reserve rate hikes will have an immediate impact on deposit rates. as we are anticipating that it will take at least one year for excess liquidity to work itself out of the financial institution industry. As such, while we do not expect that we will see much reduction in the current cost of our retail deposits, we do believe that we will be able to hold deposit rates relatively flat throughout 2022. Current deposit competition is primarily seen from credit unions and one bank competitor that continues to offer above market rates on money market accounts. The resulting impact of our rate views to our projected financial performance is that we believe that our net interest margin will decline by approximately five basis points per quarter during 2022. Of course, this is largely dependent on a number of factors, including the speed and degree of the Federal Reserve rate hikes, and secondly, the impact that those rate increases have on both loan and deposit competitive pricing. We believe that real estate markets and our credit trends will remain strong in the markets in which we operate and that our allowance coverage ratio will remain relatively consistent with the current levels. We expect 2022 loss provisioning to be exclusively related to loan portfolio growth. Our bank still operates under the incurred loss methodology for the loan loss allowance, and we expect to adopt CECL in the first quarter of 2023. Based on current results of our CISO model test work, we believe that our implementation of CISO will not result in any significant change to our allowance. However, the ultimate impact of adoption will be dependent on projected economic trends at the time of adoption. We routinely evaluate new business opportunities that may generate increases in non-interest income, and while fee income from our deposit activities is expected to continue to trend upwards, existing lines of business are not yet a meaningful contributor to net earnings. Total non-interest expense is expected to increase about 8% to 10% compared to 2021 levels. Greater costs are expected for employee compensation as we backfill higher than normal levels of turnover and add some specialists in the areas of fraud and data governance. Other notable increases are expected in advertising and data processing as we look to improve our digital presence and customer experiences. Lastly, higher than typical third party audit fees will likely be incurred for the first year implementation of SOX 404B and related to the 2023 planned implementation of CECL. Our expected non-interest expense run rate is projected at approximately $16.5 million per quarter and our effective tax rate should approximate 29.3%. Lastly, before turning our presentation over to Laura for a more granular focus on our numbers, I'd like to give you a brief update on our strategic priorities. First, our commitment to credit quality remains steadfast. Although we returned our underwriting requirements to pre-pandemic terms, we intend to maintain strong credit quality, and that is included in our loan origination projections that I noted earlier. We believe that we've made progress on improving the composition of our deposit portfolio, but we have more work to do and expect that it will take several years to meaningfully grow lower cost transaction and business accounts. Each year, we prioritize the quality of earnings with a goal to maintain a return on average assets of greater than 1% and to provide a double digit return on equity for our shareholders. We believe we will achieve these measures for 2022. While we remain heavily reliant on net interest income, we will continue to strive to keep our efficiency ratio at levels that outperform industry averages. As previously noted, we continue to evaluate niche market opportunities to increase the income and or create greater franchise value. However, it is important for us that any strategic opportunity be a good culture fit and provide long-term benefits for our shareholders. Finally, we've adopted an ESG framework, which includes our commitment to further diversity, equity, and inclusion within our employee base and vendor spend. With our small number of branches that support our $7 billion balance sheet, along with our emphasis on residential real estate lending, we believe we have a small carbon footprint. We've also formalized our ESG accountability structure with a formation of a management level ESG council that reports to our governance and nominating committee. Our attention to ESG considerations will be ongoing for years to come. And with that, I'll now pass our presentation to Laura for some additional brief comments.
spk02: Thank you, Simone, and good morning, everyone. As Simone indicated, we expect our net interest margin to come under pressure this year, so I'd like to provide some additional information to explain this expected trend. Loan offer rates as a spread to Treasuries have significantly compressed over the past year. essentially driven by fierce competition for loan volume to deploy excess liquidity in the industry. In December 2021, we funded over $200 million in new loan volume, primarily comprised of five-year hybrid arms, which carried an average interest rate of 3.15% or an approximate 2% spread to the five-year treasury at the end of the year. Conversely, one year ago in December of 2020, our average loan offer rate of 3.35% also comprised primarily of the five-year fixed hybrid loans, was priced at an approximate 3% spread to the five-year Treasury at that time. This represents a 1% spread compression over the one-year period. The weighted average interest rate of our loan portfolio at December 31st was 3.67%, and therefore we're currently funding at rates approximately 50 basis points less than our average portfolio rate. while last month our loan portfolio payoffs and paydowns of $192 million carried in an existing interest rate of 3.89% or approximately 20 basis points higher than our average loan portfolio rate. As we look at funding costs, at year-end 2021, the spot rate on our retail deposit portfolio was 46 basis points. During December, our interest rate on new and renewed term accounts averaged 45 basis points, while new non-maturity accounts had an average interest rate of 32 basis points. During the first quarter of 2022, 656 million of our term deposits with the current weighted average rate of 69 basis points will mature. Thereafter, monthly CD maturities during 2022 bear weighted average interest rates of 52 basis points or less, and as a result, the ability to improve our retail deposit costs upon repricing is far more limited than existed in the previous fiscal year. Given our liability-sensitive balance sheet and the likelihood of several rate increases this year, we expect to execute approximately $1 billion in new hedge instruments throughout 2022. While actual results could be different, at December 31, 2021, our interest rate risk as modeled by the net interest income sensitivity model forecasted that a 100 basis point parallel yield curve increase would reduce our net interest income by approximately $2 million. We typically use a combination of on-balance sheet FHLB long-term advances and off-balance sheet interest rate swaps or caps to hedge our interest rate risk. This concludes our prepared remarks, and at this time, we'll ask the operator to open the lines for questions.
spk01: Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star then one on your touchtone telephone. One moment for our first question. Our first question comes from Woody Lay of KBW. Your line is open.
spk05: Hey, good morning.
spk01: Good morning, Woody.
spk05: So, elevated payoffs continue to offset, you know, really strong loan production. It looks like prepayments, at least on the CRE side, peaked in November and took a a small step down in December. Is there any optimism that we could see prepayment levels normalize in 2022? Laura, do you want to comment first?
spk02: Sure. I think as Simone tried to indicate during her presentation, when we look back at where origination rates were, particularly in 2018 when they were over 4.5%, we still have quite a few loans in our portfolio that have a huge benefit of repricing and are coming up, you know, towards the end of their prepayment penalty term. So as much as we would like to be optimistic that things will slow down, we're preparing for similar payoff levels for 2022.
spk05: Got it. And then I think in your prepared remarks, you said asset growth could be between 3% and 5% in 2022. Would you look to – grow your securities portfolio if, you know, loans continue to shrink, or will you just keep that in cash and sort of wait for the payoff environment to kind of normalize?
spk02: Typically, we would not deploy much more into securities. We tend to keep our securities very vanilla and conservative, therefore low yielding. If we got to a point where I could not reduce wholesale funding by the excess cash flow on the balance sheet, we might. But we tend to prefer to use our capital for loan growth.
spk05: Okay. And then last for me, you disclosed you have about $2.5 million in qualitative reserves attributed to the pandemic remaining. Any timeline on when these reserves could be released or will you kind of hold on to them through the CECL adoption?
spk02: It's difficult to say. I mean, we really just take each quarter at a time, and it's not the 2.5 million has nothing to do with CECL. It's all about how we feel about the pandemic environment.
spk05: Right. Okay. Thanks, guys.
spk01: Thank you. Thanks, Woody. Thank you. Thank you. Our next question comes from Matthew Quark of Piper Sandler. Your line is open.
spk00: Hey, good morning. Good morning. Good morning, Matthew. Maybe just revisiting the loan yield outlook, weighted average rate in the portfolio is about 351. And I thought I heard you say that new business was in and around there. Can you just revisit a couple of those numbers? And I know you have stuff that's maturing that's coming off at a higher rate, but I'm trying to get a sense for the incremental pressure on loan yields.
spk02: Yeah. coupon on the portfolio is 3.67 percent at year end and we're currently funding at about 315. So about 50 basis points less than the portfolio rate and then on the opposite side prepayments 20 basis points higher.
spk00: Yep, okay. And then on the the margin pressure of five basis points a quarter. What's your underlying assumption on rate hikes and what's the deposit beta you're assuming maybe over, you know, the first hundred basis points?
spk02: Our projections of rate hikes are potentially at least three hikes during the year. Our general rate view is that we think we can hold deposit costs relatively flat, meaning that we don't expect to see a lot of pressure. And as Simone also mentioned earlier, it could change based on competitive pressures. But at this point, given the liquidity in the market, we think that we can hold those costs relatively flat.
spk00: Yeah, I did hear you say that. I heard you say that. I'm sorry. Okay. And then on the asset growth outlook, should we assume that's consistent with your loan growth expectations or would you expect loan growth to lag that?
spk02: No, it's typically related right to loan growth.
spk00: Yeah. Okay. Okay. And then on the expense run rate, 16 and a half, a quarter, a decent step up here. do you feel like you get to that run rate right right away or do we kind of grind that um you know by mid-year and start to exceed it in the back half i think in general it's um pretty level over the year you know i
spk02: Our projections are always that we're starting hiring right away in the beginning of the year and that we're rolling out our technology products. Sometimes those get delayed, so it could start a little slower, but in general we're thinking about $16.50 a quarter.
spk03: And generally for employer taxes in the first quarter, we tend to have a higher expense there. So even if we don't hire everybody right away, we still will have a little bit higher expense, I think, generally in the first quarter because of that.
spk02: Good point. And then, of course, we do incentives or merit increases in the first quarter as well.
spk00: Okay. And then on the buyback, which kind of dried up a little bit this quarter, what are your thoughts on buying back stock this year?
spk03: Our buyback continues to be open, and we continue to be monitoring and monitoring When we are able to, we do repurchase shares. We repurchased $9 million worth of shares last year, and so the buyback is still open, and we're continuing to monitor the market.
spk00: Okay. Thank you.
spk03: Thank you, Matthew.
spk01: Thank you. Our next question comes from Gary Tenner of D.A. Davidson. Your line is open.
spk04: Thanks. Good morning. Matt just answered or asked my remaining questions. Thanks.
spk01: Okay. Thanks, Gary. Thank you. I'm still on no further questions. I'd like to turn the call back over to Ms. Largo-Marcino for any closing remarks.
spk03: Terrific. Thank you, Valerie, and thank you all very much for joining us today. This concludes our call, and we appreciate your joining our call today. Thank you.
spk01: Thank you. That completes our call today. A recorded copy of the call will be available on the company's website. Thank you for joining.
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