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spk03: The conference will begin shortly. To raise your hand during Q&A, you can dial star 1 1.
spk01: Good morning and welcome to the Luther Burbank Corporation second quarter 2022 earnings conference call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity for the analyst covering the Luther Burbank Corporation to ask questions. To ask a question, you will need to press star 1-1 on your telephone. Before we begin, the company would like to remind you that discussions during this call contain forward-looking statements that do not relate strictly to historical or current facts. 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. The presentation today contains certain non-GAAP financial measures that we believe provide useful information about our operational efficiency and performance relative to earlier periods and relative to other companies. For more details on these non-GAAP financial measures and their limitations, including presentation, with and reconciliation to the most directly comparable gap financials, please refer to yesterday's earnings release and the related investor presentation, which is available on our website at www.lutherburbanksavings.com. I would now like to turn the conference over to Ms. Simone Lagarmarsino, President and CEO. Please go ahead.
spk03: Thank you very much. Good morning, everyone, and welcome to Luther Burbank Corporation's Earnings Conference Call. This is Simone Lagomarsino, President and CEO, and with me is Laura Tarantino, our CFO. Thank you for joining the call today to review our second quarter results. As is customary, we will focus on our actual financial performance, share our observations regarding recent trends, and then open the line for analysts' questions. We reported net income for the second quarter of $22.6 million, or $0.44 per diluted share, as compared to $22.9 million, or $0.45 per diluted share in the linked quarter. The decline in net earnings of $373,000 was primarily attributed to three key factors. While our net interest income increased by $2.4 million and our non-interest expense decreased by $2.2 million, These two positive trends were more than offset by a $5 million fluctuation in the provision for loan losses between the first and second quarters of the year. This is reflected in our pre-tax, pre-provision net earnings, which improved by $4.9 million in the second quarter compared to the first quarter. Although we had a large swing in our loan loss provisioning, our credit metrics remain strong, and I'll cover asset quality in detail a bit later in my presentation. First, let me address the two factors that led to our 16.7% improvement in pre-tax, pre-provision net earnings and our successful second quarter. As I mentioned, when compared to the first quarter, our second quarter net earnings benefited from a $2.4 million improvement in net interest income. Our net interest margin for the second quarter measured 2.62%, which was our best quarterly margin recorded since 2014. Interest income grew $4 million from the prior quarter, primarily as a result of increases in the average balance of the loan portfolio and rising interest rates, as well as improved earnings on certain of our interest rate swaps. Interest expense also rose during the second quarter, but to a lesser extent of $1.5 million as compared to the linked quarter, also chiefly attributed to rising market interest rates impacting the cost of deposits and borrowings. Our real estate loans grew by $272 million, or 4%, from the prior quarter, and year-to-date, our annualized loan growth was 10.8%. The increase in our loans was due to both strong loan production as well as slowing in single-family residential loan prepayment speeds. We entered the second quarter with a strong loan pipeline of $815 million as borrowers rushed to submit loan applications and lock in their low rates during the first quarter of this year, before market rates increased. Additionally, the rising interest rate environment benefited our single family lending business in two distinct ways. First, prepayment speed has slowed, which is a welcome change from the prepayment headwinds we experienced last year when our single family loan portfolio would have declined during calendar year 2021 had we not supplemented it with the purchase of a pool of single family loans. Furthermore, our hybrid Our loan product, which is our bread and butter of our single-family business, came back into consumer favor as interest rates on 30-year fixed-rate mortgages increased significantly in comparison to the last couple of years. Returning now to interest expense, I noted that this measure increased $1.5 million from the linked quarter, of which more than half was related to higher deposit costs, also attributed to rising market interest rates. At the beginning of the year, we anticipated that deposit pricing would be slow to adjust to short-term interest rate increases during 2022, given the excess liquidity that existed in the market at the beginning of this year. Although the federal funds rate increased by 150 basis points during the first half of this year, our average cost of interest-bearing deposits originally decreased by four basis points in the first quarter and then increased by five basis points during the second quarter, yielding a year-to-date increase of only two basis points. As I mentioned, the other significant element contributing to the improvement in our second quarter pre-tax, pre-provision net earnings was a $2.2 million reduction in non-interest expense as compared to the prior quarter. The key factors that contributed to this decline were related to strong loan production and rising market interest rates. Strong loan volume increased our level of capitalized salaries by $1.2 million as compared to the late quarter. while higher long-term interest rates reduced our post-retirement benefit liability by $1.4 million during the second quarter. Our first quarter net income resulted in a second quarter return on average assets of 1.23% and a return on average equity of 13.41%, both measures which we consider strong. We do believe, however, that rapidly rising short-term interest rates will challenge our results over the next few quarters. So let me share with you more recent trends. We expect loan production to moderate in the third quarter of this year. Current loan offer rates exceed the weighted average coupon on our loan portfolio, as well as typical market offer rates that existed for the past two years, both of which will dampen refinancing activity. In comparison to the linked quarter, Our loan pipeline totaled $455 million at June 30th, a level which is much more typical of our bank. While production volume will flow, the ultimate size of our loan portfolio may benefit from additional flowing in loan prepayment speeds, particularly related to our income property prepayment rates, which remained elevated during the second quarter, in large part due to the volume of our in-house refinancing activity. In addition, increases in deposit costs began to accelerate at the end of the second quarter, And based on deposit rates advertised by several of our competitors, as well as interactions with our customers, we anticipate that the cost of our deposit portfolio will rise much faster in the second half of this year as compared to the first half of 2022. As a result, our projections are that increases in our funding costs will outpace improvements in our yields on our earning assets. And as a result, our net interest margin will decline beginning in the third quarter of this year, particularly in light of the expected pace of further short-term interest rate increases communicated by the Federal Reserve and anticipated by the market. Now turning to credit quality, during the second quarter, we recorded a loan loss provision of $2.5 million to account for both strong growth in our loan portfolio, as previously discussed, as well as a higher level of classified assets. Our classified assets increased by $8.7 million during the quarter, Three multifamily loans comprised the majority, or 73% of this increase. These loans were downgraded due to issues related to the borrower's ability to demonstrate debt service capacity. However, all three loans were paying as agreed at quarter end. The balance of the classified asset downgrade during the second quarter was comprised of three single-family loans, and each of these loans demonstrated some stage of delinquency. We believe that issues exhibited in these six recent classified credits a property or borrower-specific, rather than reflective of a general trend in rents occupancy and in the case of the single-family loans employment. Based on original appraisals and or updated values, these six loans have a weighted average loan-to-value ratio of 68%, and as such, we do not expect to incur any losses on them. Nonetheless, based on our model for our loans for loan loss reserves, methodology, approximately half of the $2.5 million loss provision recorded for the quarter was attributed to these downgrades, while the balance of the provision was primarily recorded for net loan growth. Our classified assets measured 34 basis points of the loan portfolio at June 30th. At the same date, we had seven delinquent loans totaling $7.1 million, or just 11 basis points of total loans, while non-accrual loans measured eight basis points of total loans. We believe that each of these measures compare favorably to the industry and exemplify our continued strong credit culture. At June 30th, our allowance coverage ratio was 54 basis points of the portfolio. And as a reminder, our bank still operates under the incurred loss methodology for the loan loss allowance. We expect to adopt CECL in the first quarter of 2023 And based on our 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. Of course, the ultimate impact of adoption will be dependent on our portfolio composition and the economic forecast at the time of adoption. Now we'll turn to the balance sheet. Our total assets at quarter end grew by $270 million, or 4%, and year-to-date we've grown almost 10% on an annualized basis. As I previously noted, this expansion was attributed to strong real estate loan originations as well as the flowing in our prepayment speeds. Our asset growth was supported by both FHLB advances, some of which also serve as hedging positions for interest rate risk, and deposits. Our loan-to-deposit ratio remains in a typical range for our business model and measured 117% at quarter end. Our total equity increased by $3.6 million since the prior quarter. Our capital position during the second quarter benefited from our net earnings of $22.6 million, but was partially offset by $9.3 million of unrealized losses on our available for sales security portfolio net of tax as a result of the interest rate environment. Our net unrealized loss position on our investment portfolio totaled $21.3 million as of June 30th, and we expect that this full amount will be recovered over time as we both have the intent and the ability to hold these securities until maturity. Importantly, during the quarter, we returned $6.1 million and $4.1 million to shareholders in the form of cash dividends and stock repurchases, respectively, and grew our tangible book value per share by 1.2% to $13.09 per share. Our capital ratios with a Tier 1 leverage ratio of 10.2% and a total risk-based capital ratio of 19.1% demonstrate a strong capital position in our conservative balance sheet. Our capital position will support future growth and provide some protection for our next eventual economic downturn. Finally, yesterday our board of directors declared a 12 cent per share dividend, 12 cent per common share dividend that will be paid on August 15th. And with that, I'll now turn the call over to Laura for some additional comments.
spk02: Thank you, Simone. In typical fashion, I intend to give you some brief but more granular information that we consider as we're annualizing trends. The second quarter, our new loan volume was funded at a weighted average coupon of 3.55%. We have mostly worked through our pipeline of loans with lower rates, and in the third quarter, we expect new volume to be added at coupons exceeding 4.25%. The spot rate on our loan portfolio was 3.6% at the end of the second quarter. Therefore, although new loan originations are expected to slow in the second half of this year, new volume should help pull loan yields in a positive direction, particularly if loan payoffs continue to slow and the recognition of deferred loan costs debate. As Simone indicated, with continued rising interest rates, we have recently seen accelerated increases in deposit repricing. Although the cost of interest-bearing deposits only rose five basis points during the second quarter, our deposit portfolio spot rate increased 25 basis points between March 31st and June 30th, from a level of 43 basis points to 68 basis points as of the same day. This change reinforces Simone's message that the competitive environment for deposits has only more recently emerged. During the third quarter of this year, we have $824 million of term deposits carrying a weighted average cost of 34 basis points scheduled to mature. Based on our current deposit offer rates, we would expect that these certificates will be priced higher by as much as 1 to 1.5%. With the further Federal Reserve interest rate increase expected today, it would be reasonable to expect further deposit pricing pressure. Our second quarter results benefited from some of the existing interest rate swaps we have on our books. Net swap income totaled $463,000 for the quarter. At June 30th, the notional amount of our pay fix swaps was $950 million, with a weighted average net positive carry to us of 64 basis points. As Fed funds continues to rise, these derivative positions will improve. Of course, depending on where rates go and the future shape of the yield curve, as well as our level of new loan growth, we may add additional positions to hedge interest rate risk, which would, at least initially, cost us some yield. Bottom line, we expect the increase in our cost of liabilities to outpace upward movements in the yield on our entering assets and, therefore, exert downward pressure on our net interest margin for the balance of the share. Our latest forecast, which included an estimate of Fed funds reaching 3.25% by year-end, projects that our net interest margin may initially decline by 20 to 30 basis points per quarter. Lastly, when we think about our non-interest expense run rate, a level of $16 million per quarter is still anticipated. As Simone noted earlier, our second quarter expenses benefited from a $1.4 million retirement liability decrease due to higher long-term interest rates. And our compensation expense was $1.2 million less than the linked quarter related primarily to record high pace of loan volume. Backing out those two events, our second quarter non-interest expense approximated $16 million. And with that, we'll conclude our prepared remarks and we'll ask the operator to open the line for questions.
spk01: Thank you. As a reminder, to ask a question, you will need to press star 1 1 on your telephone. To withdraw your question, please stand by while we compile the Q&A roster. One moment for our first question. Our first question will come from Matthew Clark with Pap or Sandler. Please go ahead.
spk04: Hi, good morning. Good morning, Matthew. Maybe first just on the deposit beta outlook. I think in your slide you show 88% last cycle. What are your thoughts this time around, given the improvements you've made on the deposit side? I assume it would be less than that, but what are you assuming for kind of a cumulative deposit data for this cycle?
spk02: For our forecast, we tend to just use our historical average. You know, it's pretty difficult to determine. We would have said slower in the first half this year, and it was slower, but I don't know. I think there's a lot going on, and it's hard to put a specific number to it. But again, we kind of rely for forecasting on our historicals.
spk04: Okay. And then just on the balance sheet growth outlook, what are you assuming for prepay speeds in general? And I may not have heard if you updated your balance sheet growth outlook or not, if it's still kind of that 3% to 5% range.
spk02: Well, we're ahead of 5% year-to-date. I think we're at 6%, close to 7%. I do think it's going to moderate. A lot of it has to do with where prepayments are going. Our income property prepayments were pretty high during the second quarter, but about 50% of that was in-house resize. So I would expect still prepayment speeds to slow down in the fourth quarter. We're thinking our growth for the year is still at least 5%. I don't expect us, if you were to annualize it and hit double digits, we're not expecting that.
spk04: Okay, great. And then just given what rates have done in the multifamily space, I think a lot of what you do on the multifamily side is on existing apartments and structures. We have heard from another bank that there's an expectation that multifamily projects might slow pretty dramatically into next year, assuming, you know, rates remain at this level, if not, you know, increase. How do you, I guess, can you just kind of walk us through how that might impact your business, if at all?
spk03: So I just want to clarify, Matthew, are you saying multifamily projects as in new construction?
spk04: Yeah, I know you're doing that. Yes. Yes, construction. I know you guys don't do construction, but just how that might permeate into what you do.
spk03: Sure. Well, I'll start with, you know, we have a shortage of affordable housing in our region. And so we have seen actually double-digit increases in the rental rates of the properties in general. I mean, it's not across the whole board, but in a number of regions, we're still seeing double-digit increases. increases in the rental rates. And so how would it impact our business if new construction doesn't happen? We don't do a lot of new construction on the multifamily. So I think on the existing multifamily that we lend on, I think that potentially makes it even stronger because of the fact that we just don't have the affordable housing in our region. And again, you go back to know what do we lend on we primarily lend on multi-family projects that you know our average loan size is about a million seven you know 13 to 14 units per apartment building so these are small suburban apartment buildings and they really are what we call workforce housing and and you know there is a high high demand uh in need quite honestly and not enough supply so you know i think um as we've seen in past cycles, our portfolio tends to perform extremely well. And even when you think about it, Matthew, in this last pandemic, this last kind of issue that we faced, the moratoriums on evictions and some of the other steps that were put in place, we still really didn't have a significant negative impact in our portfolio at all. Our borrowers did extraordinarily well through that.
spk04: Great, thank you. And then just given the slower production going forward, any thoughts on re-upping another buyback in light of the economic uncertainty as well?
spk03: Well, capital management is always part of our ongoing review. At this time, we don't have a thought of doing a share repurchase I think we want to look forward a little bit and see what happens with the interest rates and you know possibility of a recession but certainly capital management is always part of our business and we do it on an ongoing basis so you know potentially in the future but not in the near term okay thank you thank you one moment for our next question
spk01: That will come from the line of Woody Lay from KBW. Please go ahead.
spk00: Hey, good morning, guys.
spk03: Good morning, Woody.
spk00: I wanted to touch on expenses, and sorry if I missed it in the prepared remarks, but obviously second quarter expenses benefited from some increased capitalized origination costs and retirement accruals. So just how should we think about the expense run rate in the back half of the year?
spk02: Yeah, I'm guessing an average of $16 million. So the volume's going to slow down, which means we won't be capitalizing as much as the current salary expenses that we did in the second quarter. And if you look at what the curve's done in the last week or two, I would expect that retirement liability maybe to go the other direction during the third quarter. Unfortunately, that's the accounting for these liabilities. They move with the changes in interest rates, so I'm expecting... If anything, we're booking more liability for that retirement accrual in the third quarter. So 16 is my estimated run rate.
spk00: Got it. And then on the credit front, just with, you know, the tick up in the classified loans, those three loans, were they made to one borrower or were they to multiple borrowers?
spk02: Two of the three related entities.
spk00: Got it. All right, that's all for me. Thanks, guys.
spk03: Thank you, Woody.
spk01: Thank you. And speakers, I'm showing no further questions in the queue at this time. I would now like to turn the call back over to you for any closing remarks.
spk03: Thank you very much for joining us today, and this concludes our call this morning. Thank you very much.
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, and you may now disconnect.
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