Luther Burbank Corporation

Good morning, and welcome to the Luther Burbank Corporation's first quarter 2022 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please press star zero. After the day's presentation, there will be an opportunity for analysts covering Luther Burbank Corporation to ask questions. To ask a question, you'll need to press star one. As a reminder, this call is being recorded. Before we begin, the company would like to remind you The discussions during this call contained 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, future events, or otherwise. Numerous factors could cause our actual results to differ materially from those described in the forward-looking statements. For more information on those factors, please see the company's periodic reports accessible at Luther Burbank Corporation website and filed with the SEC. I would now like to turn the conference over to Simone Lagomarsino, President and Chief Executive Officer. Please go ahead.

Thank you, Norma. Good morning and welcome to the Luther Burbank Corporation's first quarter earnings call. This is Simone Lagomarsino, President and CEO, and with me is Laura Tarantino, our CFO. This morning, we'll focus on the highlights of our financial performance for our first quarter, and then we'll open the line for analysts' questions. Our net income for the first quarter was $22.9 million, or 45 cents per diluted share, as compared to $23.4 million, or 45 cents per diluted share, in the linked quarter. Our results reflected a $443,000 decline in net earnings compared to the prior quarter. This modest decline in net earnings was primarily due to compression of our net interest margin and a mark-to-market adjustment for our equity securities. These negative pressures on our net earnings were somewhat offset by a greater recapture of loan loss provisions as compared to the prior quarter. Let me now take each of these three items individually and provide a little more information. In our last conference call, we explained that we anticipated that our net interest margin would compress each quarter this year. We explained that this compression would occur because our loan portfolio is projected to reprice lower in the near term due to loan origination volume carrying lower rates than both the rates on loan payoffs as well as the weighted average rate on the overall portfolio. We also stated that we felt that the cost of our deposit portfolio had reached its floor. Our net interest margin for the first quarter of this year declined by three basis points to 2.54%. This was primarily due to a 10 basis point decrease in loan yields. Net interest margin compression was partially abated, however, by a three basis point decline in the cost of interest-bearing deposits. The net impact was a $494,000 after-tax reduction in net interest income. We anticipate that the velocity and magnitude of further rate increases, which are generally forecasted this year, will certainly place upward pressure for depositor expectations and therefore on deposit rates. Furthermore, relatively strong loan growth in the industry may deplete excess market liquidity earlier than we originally anticipated, which could also create an upward trending and more competitive deposit rate market. On the other hand, we've recently increased offer rates on all of our loan products, consistent with market competitive pricing. Therefore, new loan volume in future quarters should carry interest rates at origination that are higher than our average loan portfolio rate, thereby helping to partially offset the negative impact to our margin of potentially increasing funding costs. It will, of course, take a couple of months for this higher loan pricing to be reflected in production results as we work through our existing pipeline, much of which was locked in at lower interest rates. All that being said, consistent with our message earlier this year, we continue to expect that our net interest margin will compress during 2022. As I previously alluded, our net income for the quarter was also negatively impacted by the significant increase in interest rates as our sole equity security holding representing an original $12 million investment in a community development fund incurred a $413,000 after-tax mark-to-market loss. We have no current intention of liquidating this investment and it's not uncommon for us to record market adjustments that are typically inverse to the movement of market interest rates, although first quarter's impact was greater than we typically would have experienced. The rising rate environment also affected the market value of our debt securities, the vast majority of which are held as available for sale, which as a result did not impact earnings. And I'll speak to the unrealized losses on that portfolio a bit later. Finally, the third factor that impacted our first quarter net earnings was the reversal of $2.5 million in loan loss provisions. This amount was approximately $500,000 greater on an after-tax basis than the prior quarter's recapture. With this reversal, we have eliminated all qualitative additions to the allowance that we had specifically set aside for the economic uncertainty related to the pandemic. We remain pleased with and appreciative of the resilience of our borrowers and the continued strength of residential real estate in the markets that we serve. Commenting further on asset quality more broadly, we continue to see very strong credit metrics in our loan portfolio. Although we saw an increase in criticized and classified asset levels compared to the linked quarter, our total classified assets to total assets measure of 0.19%, and our total non-performing assets to total assets measure of 0.03% remain at historically low levels, and our credit metrics continue to be among the strongest in the industry. At March 31st, our allowance coverage ratio was 52 basis points of the portfolio. As a reminder, 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 ongoing results of our CECL model test work, we believe that the implementation of CECL will not result in a significant change to the level of our allowance. However, the ultimate impact of adoption will be dependent on the economic forecast at the time of adoption. Now, turning to the balance sheet, our total assets at quarter end grew by $81 million, or 4.5% on an annualized basis. This growth was primarily attributed to over 4% annualized growth in our loan portfolios. Our first quarter loan origination volume of $569 million exceeded the linked quarters volume of $70 million, or 14%, with both our income property and single-family residential units recording strong production. Based on the size of our loan pipeline at March 31st of $815 million, which is more than double the size of our pipeline level at the end of last year, we would expect our second quarter loan volume to reach or surpass our first quarter's production levels. At this point, we appear on track to achieve our calendar 2022 asset growth goal of 3% to 5% that we announced at the beginning of this year. Our asset growth in the first quarter was primarily funded with a combination of retail and wholesale deposits. As I mentioned earlier, the average cost of our interest bearing liabilities declined during the first quarter. We will note, however, that the cost of wholesale funding sources, whether it be broker deposits or federal home loan bank advances, have significantly increased over the last quarter. And at some point, the cost of our retail funding will begin to trend upward as well. However, we continue to strive to minimize the degree of net margin compression by placing greater emphasis on leveraging technology to acquire customers' deposits and furthering our specialty deposit growth for funding. which we generally expect to be less expensive than our typical term deposits. The company's capital position remains strong. However, total shareholders' equity declined $1.1 million at quarter end compared to the prior quarter. The rising interest rate environment caused the fair value of our available-for-sale debt securities to decrease and lower our equity by $12 million after tax. We remain in a strong position to support future growth, and our Tier 1 leverage ratio is at 10.27% at quarter end. Our investment portfolio primarily serves as a contingent source of liquidity, and as such, we generally expect to hold these investments to term. At March 31st, our available for sale securities portfolio of $625 million had an estimated weighted average life of 5.5 years and an average effective duration of three years. As these securities prepay and or mature, the unrealized losses we've recorded will reverse through capital. As based on the current interest rate environment, replacement security purchases are expected to carry higher yields, resulting in better future returns. Although total equity decreased during the first quarter, importantly, our tangible book value per share increased by 5 cents to $12.93 per share as a result of a reduction in outstanding common shares. During the first quarter, we returned $11.9 million to shareholders in the form of common dividends and share repurchases. Additionally, yesterday, our board of directors declared a 12 cent per common share dividend that will be paid on May 16th. And with that, I'll now turn the call over to Laura Tarantino for some additional brief comments.

Laura Tarantino Thank you, Simone. As Simone indicated, with rising interest rates, we expect our net interest margin to decline further this year. Given interest rate volatility over the past quarter, let alone the past year, and changing expectations about the frequency and magnitude of short-term rate increases, we are not providing any specific margin guidance. However, I will give some greater granular detail for our loan and deposit portfolios. As previously mentioned, we have increased our offer rates recently. Our current best pricing for any hybrid arm, single family, or income property loan product is 4%. This is an improvement over our first quarter loan origination rate, which averaged 3.14%, and it is also a level greater than our weighted average loan portfolio coupon of 3.6% at March 31st. Assuming competition and the interest rate environment remain unchanged, loan growth later this year is expected to improve the trajectory of our loan yield. However, as Simone previously stated, it will be a few months before current offer rates are reflected in our production numbers. At quarter end, 695 million, or 85% of our pipeline, carried rate locks with a weighted average coupon of 3.39%. Moving to deposits, at March 31st, the spot rate on our retail deposit portfolio was 43 basis points. During the month of March, our interest rate on new and renewed term accounts averaged 41 basis points, while our new non-maturity accounts had an average interest rate of 37 basis points. During the second quarter of this year, 505 million of our term deposits with a current weighted average rate of 37 basis points will mature. At renewal, we would expect the cost of these deposits to increase. In late March, we executed one new derivative instrument, a two-year interest rate swap with a notional amount of $100 million to assist in hedging our interest rate risk position. Fixed pay swap carries a fixed pay leg of 2.24%. Finally, last quarter, I stated that I expected our non-interest expense to run at a rate of approximately $16.5 million per quarter. Our lower-than-anticipated G&A expenses for the first quarter of this year were primarily attributed to higher-than-planned capitalized loan costs related to strong loan volume during the quarter and a delay in staffing opened positions. Given the level of our loan pipeline, it is reasonable to expect non-interest expense to be closer to $16 million for the second quarter of this year since we will expect to have higher capitalized loan costs in the second quarter based on the size of our loan pipeline at the end of March 31st. This concludes our prepared remarks, and at this time we'll ask the operator to open the line for questions.