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Luther Burbank Corporation (NASDAQ:LBC)
Q2 2019 Earnings Call
Jul 30, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Luther Burbank Corporation Second Quarter 2019 Earnings Conference Call. [Operator Instructions]. 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 2018 fiscal year, its quarterly reports on Form 10-Q and current report on 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 for 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 continued growth and performance are good, it is the company's policy not to establish with the market -- with the markets any earnings, margin or balance sheet guidance.

I would now like to turn the conference over to Simone Lagomarsino, President and CEO. Please go ahead.

Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors

Good morning, and welcome to the Luther Burbank Corporation 2019 Second Quarter Conference Call. This is Simone Lagomarsino, President and CEO. And with me is Laura Tarantino, our Chief Financial Officer; and Brad Satenberg, Senior Vice President, Investor Relations, and CFO of our bank. Let's address our latest quarterly results, and I'll start first with earnings. Net income for the quarter was $11.7 million or $0.21 per diluted common share compared to $12 million or $0.21 per diluted common share in the prior quarter. The second quarter earnings included 2 nonrecurring items comprised of the $384,000 pre-tax recovery on equipment, previously written down, and a $197,000 pre-tax gain on the sale of loans sold net of a lower of cost or market adjustment on loan held for sale of $10.6 million.

Earnings from the prior quarter similarly contained a nonrecurring $333,000 pre-tax gain on the sale of loans sold during the first quarter of 2019. I'll add some additional color about our 2019 loan sale activity in a few minutes. Excluding these onetime items, the adjusted second quarter 2019 earnings would have been $11.2 million and our EPS would have been $0.20 per share as compared to our linked quarter adjusted earnings of $11.8 million or $0.21 per share.

The $525,000 decline in adjusted earnings compared to the prior quarter was primarily due to the following: a $1.5 million reduction in net interest income, resulting from margin compression of 11 basis points during the quarter; a $150,000 increase in our provision for loan losses related to loan growth; and a $326,000 increase in tax provision primarily related to the vesting of stock compensation. The impact of these items was somewhat offset by a $1.5 million reduction in noninterest expense, primarily due to a decrease in compensation expenses as a result of higher capitalized salaries, which were due to stronger loan production in the second quarter compared to the prior quarter.

As a result of further inversion in the yield curve during the second quarter, our net interest margin was 1.75% and decreased 11 basis points as compared to our margin of 1.86% in the linked quarter. Although, the increase in our cost of interest-bearing deposits of 11 basis points was similar to the change experienced between the first quarter of 2019 and the fourth quarter of 2018, the compression in margin was exacerbated by a 3 basis points decline in our yield on earning assets, which decreased to 3.77% in the current quarter from a yield of 3.80% in the prior quarter. And so this quarter, the yield on our earning assets have been increasing since 2017.

Although, the coupon on the loan portfolio continues to increase quarter-over-quarter, the high level of prepayment activity experienced during the current quarter particularly within our single-family residential loan product has accelerated our amortization of deferred costs associated with those loans and that's reduced the yield. Loan cost amortization and net of loan prepayment fees increased by $986,000 in the current quarter as compared to the first quarter of 2019. Additionally, the more pronounced conversion of the yield curve during the second quarter caused accelerated prepayments as well as downward pressure on our loan origination coupon rates.

The 5-year treasury rate, which most closely correlates to our 5-year hybrid loan product, decreased 75 basis points between December 31, 2018, and June 30, 2019. As a result of these factors, the compression in our net interest margin was greater than anticipated. The market appears to fully anticipate that the Federal Reserve will reduce its target rate on July 31. If in fact this occurs, we expect to be able to immediately reduce our deposit offering rates on several of our products. Given this, we would expect to see some small improvement in our cost of deposits immediately, with additional benefits occurring over the next year, considering that the majority of our deposit portfolio is comprised of time certificates of deposit.

That improvement makes somewhat offset -- may be somewhat offset, however, unless we simultaneously see some steepening in the yield curve that would slow prepayments and/or improve loan origination rates. Noninterest income was $1.5 million during the second quarter of 2019 compared to $1.4 million during the linked quarter. As previously discussed, noninterest income included some nonrecurring income as part of both quarter's results. After consideration to these items, adjusted noninterest income was $907,000 in the current quarter as compared to $1 million in the prior quarter. The decrease of $140,000 was primarily due to a reduction in the fair value of mortgage servicing rights related to increased prepayments fees.

Noninterest expense was $14.7 million during the second quarter beyond $1.5 million from the prior quarter. Compensation and related benefits expense declined $1.4 million as a result of greater capitalized cost attributed to a 47% increase in loan origination volume quarter-over-quarter. As a result, noninterest expense to average assets for the second quarter of 2019 was 84 basis points, comparing favorably to the prior quarter level of 93 basis points, and our efficiency ratio improved to 45.9% from 48.6% in the linked quarter.

Now I'll turn to the balance sheet. As we made adjustments to our loan offering rates to respond to the reduction in treasuries as well as competitive pricing, we were pleased to see that our loan pipeline returned to more normal typical levels, and our loan origination volume increased. During the quarter, we had originated $457 million of loans as compared to buying $312 million in the prior quarter. Since year-end, our loan portfolio grew by $136.1 million or 4.4% on an annualized basis. Similar to the trend evidenced in the prior quarter, our multifamily loan composition continue to increase, representing 63% of total loans, while our single-family loan portfolio declined to 34% of total loans due to our high prepayment rates in that portfolio.

Given that the multifamily loan product has been a best performing asset class for our bank as well as for the industry, we are comfortable with a higher concentration of these loans. During the first 6 months of 2019, we sold or transferred the held for sale $61.7 million of loans that were primarily comprised of 30-year fixed-rate, single-family mortgages at a pre-tax gain of $530,000. With the current year reduction in long-term rate and given that these single-family loans with CRA product and had elevated loan-to-value ratios, we took the opportunity to reduce our interest rate risk and credit risk associated with these loans. Our additional loan sales outside of the $10.6 million reflected on our balance sheet as loan held for sale are not currently planned, we would entertain future sales of these types of loans going forward.

At quarter end, our loans held for investment included an additional $25.9 million of long-term fixed-rate single-family loans. Our credit quality remains very strong with nonperforming assets to total assets of 16 basis points. Nonperforming loans increased by $9.7 million in the second quarter compared to the linked quarter. The increase in nonaccrual loans is represented by 3 loans: one, $6.6 million multifamily loan; and two single-family loans, totaling $3.8 million. By June 2019 quarter end, one of the single-family loans had already reinstated and was current as the principal on interest. With the combined weighted average loan-to-value ratio of 70% and no individual loan exceeding a 73% loan-to-value ratio based on original appraisals, no losses are currently anticipated on these 3 loans.

Of our 7 loans on nonaccrual status as of June 30, 2 were current and performing at the end of the quarter. At the same date, we had 12 accruing loans, that were 30 days behind, and no accruing loans that were 60 days delinquent. Of the 12 loans, 11 have already made their payment and are now current. Our assets at the end of June 30, 2019, totaled $7.1 billion, an increase of $177 million or 2.6% year-to-date. The growth in assets was primarily attributed to our net loan growth. We continue to project asset growth of between 5% and 7% for the calendar year 2019. Excluding the loan sales discussed above, our asset growth would've been 3.3% year-to-date and 6.6% annualized. During the second quarter, our retail consumer deposits declined by $3.8 million, while retail business deposits grew by $101.3 million.

The reduction in consumer deposits was centered in our Santa Rosa market, where most outflows appear to be directed toward real estate investments. The increase in business deposits was related to a pickup in fiduciary business, which continues to offset a slow down in 1031 Exchange depository activity. Both the banks and the company's capital ratios remained strong and are well above the minimum levels acquired for bank regulatory capital purposes. With asset growth at the projected level noted above, we believe we will have adequate organic capital to support operations over the next few years.

The company's ROA and ROE during the quarter was 0.66% and 7.83%, respectively, compared to 0.66% and 8.19% during the prior quarter. Excluding the impact of onetime items discussed above, our current period ROA and ROE would have been 0.64% and 7.55%, respectively, compared to prior quarter adjusted amounts of 0.68% and 8.03%. We are pleased to report that on July 29, 2019, the Board of Directors declared a quarterly cash dividend of $0.0575 per common share. The dividend is payable on August 19, 2019, to shareholders of record as of August 8, 2019. During the second quarter, we repurchased an additional 367,000 shares as part of our share repurchase plan at an average price of $10.22 per share.

Since the inception of the plan repurchase -- the share repurchase plan, in August of 2018, we have repurchased 933,000 shares at an average price of $9.78 or an 8% discount to our book value. We have approximately $5.9 million remaining of the $15 million that was originally set aside for share repurchases, and we will continue to evaluate for future repurchases as appropriate.

And I will now turn the call over to Laura, who will speak a little bit more specifically as to our trends and our margin and our loan and deposit portfolio.

Laura Tarantino -- Executive Vice President, Chief Financial Officer

Thank you, Simone. As discussed, our margin in the second quarter compressed at a greater pace than previously anticipated, primarily as a result of market rate changes and the greater inversion in the yield curve. In response to those changes, the coupon on our loan originations decreased to 4.44% in the current quarter from 4.62% in the linked quarter. While at the same time, the rate on loan payoffs and curtailments increased to 4.33% in the current quarter from 4.19% in the prior quarter. As a result of the spread between loan originations and payoffs decreased to 11 basis points in the current quarter as compared to 43 basis points in the linked quarter. The compression in these rates has translated to a smaller monthly increase in the overall portfolio rate.

In coupon, our loan portfolio was 4.18% at the end of June '19 as compared to 4.15% at the end of March 2019, an increase of 2.4 basis points or less than 1 basis point per loan. Additionally, given the decline in long-term rate, loan prepayments continue to accelerate, particularly in the single-family portfolio, which had exhibited a 32% CPR in the current quarter as compared to a 26% CPR in the linked quarter, causing further compression in loan yields. As a result, although, our average earning assets increased by 1.1%, interest income only grew by $277,000 or 0.4% improvement. And our total yield on earning assets declined by a 3 basis points compared to the linked quarter.

On the deposit side, although the change in retail deposits reverse course and grew by $103 million in the current quarter as compared to declining by $63 million during the linked quarter, the overall cost of deposits continue to advance increasing 11 basis points quarter-over-quarter and ended the quarter with a 2.10% deposit portfolio rate. This increase was in part offset by a decrease in wholesale FHLB funding rates, average cost improved by 9 basis points quarter-over-quarter as we took advantage of the inverted yield curve and extended the duration of some of our FHLB advances.

As a result, our cost of interest-bearing liabilities increased by 6 basis points compared to the linked quarter, which is an improvement from the 11 basis points increased experienced between the first quarter of 2019 and the fourth quarter of 2018. Our time deposits continue to represent 69% of our deposits composition. Looking forward, approximately $1 billion or 3% of the time deposit portfolio is subject to renewal during the next 3 months. $611 million of this balance is represented by wholesale deposits with the weighted average interest rate of 2.43% and recurring pricing is in the 2.20% range. Remaining $455 million of this balance comprised a retail term deposit with a weighted average interest rate of 2.14%. Interest in average rate on new and renewed retail CDs of 2.38% during June of 2019.

As Simone noted, we would expect to begin fee reduction in the cost of our retail deposits as the Federal Reserve advised to cut rates tomorrow. I've already begun to see a decrease in wholesale funding cost, and both of these should allow our net interest margin to begin to stable -- stabilize, particularly if the longer end of the yield curve steepens and/or loan prepayment rates begin to decline. Although, significant decreases in long-term interest rates have tempered loan yield, those rate decreases along with the sale of 30-year fixed-rate loan additional expenses in our FHLB advances and other hedging activity to have greatly improved our level of interest rate risk.

Declines in net interest income and the economic value of equity as a result of a 200 basis point parallel rate increase has improved to decrease of the 7.4% and 13.5%, respectively, at the end of the current quarter from decreases of 11.4% and 21.3%, respectively, at the end of the linked quarter. I'll conclude with a few other brief points. We expect that future loan loss provisions will be made to tempering that loan growth and that our ALLL coverage ratio will remain at or near its current level.

No significant changes are anticipated to noninterest income as adjusted for nonrecurring items. And our quarterly run rate for noninterest expense is expected to range between $15 million and $16 million. And although, our effective tax rate in the current quarter approximated 31%, our current quarterly provision includes the tax impacts related to stock vesting and our effective tax rate should range between 29% and 30% moving forward.

With that, we will ask the operator to open the line for questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question is going to be from Gary Tenner with D.A. Davidson. Your line is open.

Gary Tenner -- D.A. Davidson -- Analyst

Thanks. Good morning. Just wanted to confirm that I heard you clearly on the margin. So if the Fed cuts tomorrow, you are able to immediately change from your deposit pricing. If the curve stays inverted as it is, so the file doesn't really move. Can you hold the line on margin at that point? Or is there further compression? And you need the steepening to really stabilize?

Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors

Laura, do you want to go ahead and answer that?

Laura Tarantino -- Executive Vice President, Chief Financial Officer

Sure. Gary, I do think that with short-term rates dropping a bit, we will begin to stabilize our margin. I'm hopeful that it will continue to decrease and, again, the loan side is if we were throwing a ball -- arranging to think that -- I think it will begin to stabilize and potentially, could be better, if the curve steepened and prepayments slowdown.

Gary Tenner -- D.A. Davidson -- Analyst

Okay. All right. It helps. And then on the loan searching portfolio, what was the fair value adjustment in the quarter on that in actual dollars? I think you had the top sequential delta on servicing fees in your pressure list?

Laura Tarantino -- Executive Vice President, Chief Financial Officer

Don't remember the dollar level, I just remember there being a small adjustment -- it wasn't terribly material, I believe it was like less than $300,000 in total.

Gary Tenner -- D.A. Davidson -- Analyst

Okay. Thank you. And just one last really quick one. On the income producing loan, was that a multifamily or a commercial real estate loan that weren't inaugural?

Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors

Go ahead, Laura.

Laura Tarantino -- Executive Vice President, Chief Financial Officer

I wasn't following, I wasn't sure I followed Gary's question.

Gary Tenner -- D.A. Davidson -- Analyst

Of the loans that were not on the accrual but one would think I'm producing loan, was that multifamily or some other sort of commercial?

Laura Tarantino -- Executive Vice President, Chief Financial Officer

Yes. As Simone said, it was a multifamily loan.

Gary Tenner -- D.A. Davidson -- Analyst

I understand. All right thank you very much.

Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors

Thank you.

Operator

Thank you. And our next question is from the line of Matthew Clark with Piper Jaffray. Your line is open.

Matthew Clark -- Piper Jaffray -- Analyst

On the compensation expenses, the compensation expense this quarter, how much of it is related to FAS 91, just the deferral looks origination costs relative to some other action you might have taken from a personal standpoint, if at all?

Laura Tarantino -- Executive Vice President, Chief Financial Officer

It was primarily related to the greater loan origination volume during the second quarter and capitalize salaries, those really wasn't any material changes in compensation.

Matthew Clark -- Piper Jaffray -- Analyst

Okay. Great. And then catch it, but the retail CD is the amount that's maturing here in the third quarter, the rate in kind of where they are expected to renew, can you just repeat that for me?

Laura Tarantino -- Executive Vice President, Chief Financial Officer

Retail CDs were $465 million over the next 3 months. They are maturing at interest rate of 2.14% and are rates for new and renewed CDs during the month of June was 2.38%

Matthew Clark -- Piper Jaffray -- Analyst

Okay great. Thank you Laura.

Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors

And just, Laura, to go back to the comments about there was an increase in the fair value on the equity securities of $311,000 in the current year and then $185,000 decrease in servicing fee income. I think that was -- I guess that was the question Gary was asking.

Operator

[Operator Instructions] I'm not showing any further questions.

Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors

Okay. Well, this then concludes our Second Quarter 2019 Luther Burbank Corporation Conference Call. Thank you all for joining us.

Operator

[Operator Closing Remarks]

Duration: 23 minutes

Call participants:

Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors

Laura Tarantino -- Executive Vice President, Chief Financial Officer

Gary Tenner -- D.A. Davidson -- Analyst

Matthew Clark -- Piper Jaffray -- Analyst

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