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RBB Bancorp (NASDAQ:RBB)
Q3 2019 Earnings Call
Oct 22, 2019, 2:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the RBB Bancorp Third Quarter 2019 Earnings Conference Call. My name is Sherry, and I will be your operator today. At this time, all participants are in a listen-only mode. This call is being recorded, and will be available for replay through October 29, 2019 starting this afternoon, approximately one hour after the completion of this call. After the speakers' presentation, there will be a question-and-answer session.

[Operator Instructions]

I would now like to turn the call over to Mr. Larry Clark, Investor Relations for the Company. Please go ahead, Mr. Clark.

Larry Clark -- Investor Relations

Thank you, Sherry. Good morning, everybody, and thank you for joining us to discuss RBB Bancorp's financial results for the third quarter ended September 30, 2019. With me today from management are Chairman and President, CEO, Alan Thian; EVP and Chief Financial Officer, David Morris; EVP and Chief Credit Officer, Jeffrey Yeh; EVP and Chief Branch Administrator, Wilson Mach; EVP and Chief Risk Officer, Vincent Liu; and EVP and Director of Mortgage Lending, Larsen Lee.

Management will provide a brief summary of the results and then we'll open the call up to your questions. During the course of this conference call, statements made by management may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based upon specific assumptions that may or may not prove correct.

Forward-looking statements are also subject to known and unknown risks and uncertainties, and other factors relating to RBB Bancorp's operations and business environment. All of which are difficult to predict and many of which are beyond the control of the Company.

For a detailed discussion of these risks and uncertainties, please refer to the required documents the Company has filed with the SEC. If any of these uncertainties materialize or any of these assumptions prove incorrect, RBB Bancorp's results could differ materially from its expectations as set forth in these statements. The Company assumes no obligation to update such forward-looking statements, unless required by law.

At this time, I'd like to turn the call over to Alan Thian. Alan?

Yee Phong Thian -- Chairman, President and Chief Executive Officer

Thank you, Larry. Good morning, everyone, and thank you for joining us today. I'm going to begin with an overview of our third quarter performance, and then David will provide more details on our financial results.

We are pleased with our performance for the third quarter, which was in line with our expectations. We have completed our balance sheet repositioning and have now -- beginning to resume our loan growth.

During the quarter, we generated strong productions in both residential and commercial real estate lending, which translated into a 7.4% annualized growth rate. The growth would have been even stronger except that we had a high level of loan payoffs than we normally experience.

Our focus on increasing core deposits helped drive deposit growth and reduce our reliance on wholesale funding. While our net interest margin was negatively impacted by temporarily accessed liquidity, our ongoing low credit costs, and well-managed expenses enable us to meet our profitability goal for the quarters.

As we discussed on our last call, mortgage loan sales was significantly cut back in the third quarter. We expect to resume selling mortgage loans in the current quarter and depending on our production levels, we are targeting between $150 million and $225 million for the quarters.

Our integration of First American International Bank is complete, and we are now reaping the benefits on both sides of the balance sheet. The acquisition also presented new efficiencies that are resulting in reduced expenses. We'll continue to optimize First American's operational footprint likely closing another branch or two. We also plan on opening a new branch in Edison, New Jersey, in order to better serve the sizable Asian-American population in that communities.

We are also very pleased to be acquiring Pacific Global Bank, which enable us to expand the RBB franchise to the attractive Chicago market and serve its large communities of Asian-Americans. We intend to open two new branches in metro Chicago next year, adding to Pacific Global's existing three branches. We believe that this transaction will position us well for continued growth and is consistent with our goal to grow both organically and through branch openings and strategic acquisitions.

Finally, we are continuing to invest in our business in order to diversify our revenue mix and create more opportunities to increase earnings, all with the view of creating additional long-term value to our shareholders.

I will now turn it over to David for more details on our third quarter's results. David?

David R. Morris -- Executive Vice President and Chief Financial Officer

Thank you, Alan. I'll start with our loan activity. Our total loans were up $44 million at quarter end due to healthy new production in both residential and commercial real estate. But as Alan mentioned, our growth was impacted by higher pay-offs and pay-downs. For the quarter, total loan production was $174.8 million, loan payoffs and paydowns were $98.4 million, and loan sales were $17 million. The latter consisting of SBA loans and Fannie Mae direct mortgages, this compares to a total loan production of $105.9 million loan pay-offs and pay-downs of $92.1 million and loan sales of $187 million in the second quarter.

Total commercial loan production for the third quarter was $82.8 million, up $27.7 million from the second quarter. During the third quarter, we were still ramping up commercial lending across our branch network. So we expect that production will be at a higher pace in Q4.

Residential mortgage loan production was $92 million in the third quarter, up from $50.4 million in the second quarter. We continue to expect origination volumes to increase in the fourth quarter.

Now turning to deposits. While total deposits increased by $16 million during the quarter, our non-maturity deposits increased by $42 million, as our deposit gathering efforts have continued to gain traction. Offsetting this increase was a $26 million decrease in CDs, with brokered CDs declining by $32 million and retail and jumbo CDs growing by $6 million.

Our average cost of interest-bearing deposits was up 3 basis points in the quarter. While we experienced lower cost on our non-maturity deposits given the lower interest rate environment, the cost of our time deposits was up 4 basis points as a result that we paid on new CDs. While down from prior quarters, in many instances was higher than rates that were paid on maturing CDs that were longer term in nature, particularly at First American. Going forward, we expect cost of our deposits to be flat to modestly down, as the gap between the rates that we pay on new CDs and rates we pay on maturing CDs continue to narrow.

Moving onto net interest margin. On a reported basis, NIM decreased by 5 basis points from the previous quarter to 3.59%. Excluding purchase discount accretion, our core NIM declined 4 basis points during the quarter. As Alan mentioned, our NIM was negatively impacted by the temporary excess liquidity. We had derivative loan sales prior to quarter end, as well as a modest decrease in our loan yields and a slight increase in deposit costs that I mentioned. Going forward, we expect that our loan yields will be relatively stable, as commercial originations continue to pick up and they generate higher starting yields than our residential loans.

Given that we are deploying our excess liquidity and we anticipate a further decrease in our cost of funds, we expect that our net interest margin will be relatively stable to increasing slightly in the fourth quarter.

Turning to non-interest income. As expected, we generated lower gain on sale income due to the curtailment of our loan sales during the quarter. For the fourth quarter, we expect non-interest income to increase significantly as we are targeting between $175 million and $225 million of loan sales for the quarter, once again depending upon our production levels. Based on our forecast, we anticipate non-interest income to be in the range of $6.5 million to $7.2 million in the fourth quarter and then return to a more typical level in the first quarter of 2020, when we resume a more normalized schedule of loan sales.

Our total non-interest expense was down $1.1 million from the second quarter. The decrease was due to a number of factors. First incentive compensation was lower in the quarter due to the absence of loan sales. Second, we had lower occupancy and equipment cost, and lower data processing cost due to the integration and consolidation that we had in New York. And third, our legal and professional costs were lower. We had a few other puts and takes, but those were our main three drivers.

We expect that our non-interest expense will increase during the -- due to merger activity, additional commissions from mortgage loan sales, and bonus expense of $400,000. All other expenses will remain stable for the fourth quarter as we continue to focus on controlling our costs.

The efficiency ratio for the third quarter was 52.4%, up from the second quarter due to lower revenues. Longer term, we expect to maintain our efficiency ratio at or below 50%, and it will likely be below 50% in the fourth quarter due to the higher expected amount of loan sales.

Shifting to income taxes. Our effective tax rate for the quarter was 31.5%. This includes the impact of a deduction for stock options exercised in the amount of $38,000. We anticipate an effective tax rate of between 29% and 32% for the fourth quarter.

Now turning to asset quality, we -- which remained solid. Our non-performing loans increased by $3.4 million during the quarter, as we placed six loans on non-accrual status at the end of the quarter, including $2.9 million of related commercial and SBA loans secured by $2.9 million in real estate collateral, of which $1.5 million of the $2.9 million SBA loans is guaranteed.

After taking into account, the expected expense to sell the property, we've set aside a specific reserve of $430,000. The other loans all have more than sufficient collateral values, so we do not believe that any impairment exist.

Our credit losses remain low during the quarter. We had no charge-offs in a small recovery. Our provision for loan losses was $824,000 for the third quarter, up $467,000 for the second quarter. The increase was due to the SBA loans. This brought our allowance for loan losses to 91 basis points of total loans held for investments, up 2 basis points from the end of the prior quarter.

We are not seeing any asset deterioration. We continue to maintain a strong -- a very strong credit quality culture and will remain vigilant on asset quality. With respect to our capital, our capital levels remained strong. Our tangible common equity to tangible assets increased to 12.12% at the end of September, up from 12.01% at the end of June. We believe that we have sufficient equity capital to support forecasted growth.

With that, we are happy to take your questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from Aaron Deer with Sandler O'Neill.

Aaron Deer -- Sandler O'Neill -- Analyst

Hey, good morning, everyone.

David R. Morris -- Executive Vice President and Chief Financial Officer

Good morning.

Yee Phong Thian -- Chairman, President and Chief Executive Officer

Good morning, Aaron.

Aaron Deer -- Sandler O'Neill -- Analyst

David, you went through the credit quality stuff pretty quickly there. I'm just curious, it sounded like you, if I heard you correctly, there were six credits that drove the uptick in the non-performers. And you gave some details on the one. Is there any overriding similarities between any of these other credits that are having some challenges?

David R. Morris -- Executive Vice President and Chief Financial Officer

No, we don't think so. I stated I think individually to you and to some other -- since it's prior that the loans -- the SBA loans -- there was actually going to be three SBA loans, four total loan -- related loans that are associated with these totals, that will eventually all go on to non-accrual. There is still one that is not there and all. So that's the only thing that's similar is that it's going to be a total of four loans that are to -- that are related to one group of people.

Aaron Deer -- Sandler O'Neill -- Analyst

Okay. And then in terms of the growth, it sounds encouraging in terms of the production that you're getting, notwithstanding the pay-downs that you had here in the third quarter. Given the volume of loan sales that you have planned for this quarter, where would you expect your total loan balances to end the year, including both your held-for-sale and held-for-investment?

David R. Morris -- Executive Vice President and Chief Financial Officer

I would -- OK, I'll separate that out into two categories. Mortgage -- three categories. Mortgage, I would expect our loan balances to be flat. Okay. No growth at all. Okay. So that's our available-for-sale bucket and our held-for-maturity bucket. For SBA loans, we will probably sell $10 million again. I don't know what's in the pipeline right now for payoffs, but payoffs on SBAs have been around $10 million also. So, and we produce about $10 million. So I would expect that to go down by $10 million. Okay. And then on commercial, it all depends on what our pay-offs are, but I would expect commercials to increase for...

Yee Phong Thian -- Chairman, President and Chief Executive Officer

About $10 million over the...

David R. Morris -- Executive Vice President and Chief Financial Officer

$10 million?

Yee Phong Thian -- Chairman, President and Chief Executive Officer

Yeah.

David R. Morris -- Executive Vice President and Chief Financial Officer

That's it?

Yee Phong Thian -- Chairman, President and Chief Executive Officer

I mean, commercial -- only commercial, net. It should be more, yeah.

David R. Morris -- Executive Vice President and Chief Financial Officer

It should be. I was expecting about $40 million. Okay.

Yee Phong Thian -- Chairman, President and Chief Executive Officer

Well, our agreement within this month. I'm sorry. I'm sorry. I was talking about quarters. Okay, sorry.

David R. Morris -- Executive Vice President and Chief Financial Officer

Okay. We're expecting about $40 million, OK? Okay. And that's -- we are seeing higher levels of pay-offs in all areas. SBA still continuing to have high level of pay-offs, mortgage popped up really heavily this last quarter and also we still expect that to happen.

Aaron Deer -- Sandler O'Neill -- Analyst

Okay. And then how much would you calculate the excess liquidity weighed on the margin in the third quarter and do you expect that to be kind of fully deployed then as we go into the fourth quarter?

David R. Morris -- Executive Vice President and Chief Financial Officer

Yeah, we will have that invested in at least other investments, but I would think it would be -- the NIM would be a couple of basis points, not huge.

Aaron Deer -- Sandler O'Neill -- Analyst

Okay. And then, are there any additional cost saves to be recognized here from the First American deal or is that pretty much entirely in the run rate at this point?

David R. Morris -- Executive Vice President and Chief Financial Officer

Well, we are going to close one more branch sometime in the next six months, it will be in the six months, it will be next year. So you don't -- that won't -- that will be added to the cost saves. But as I stated in my talk, because of the lower mortgage and lower income, the commissions and so forth expenses were not -- were also lower. And I don't think we talked about that at the last conference call. Okay. So that will be added back. So I would not add $1.1 million deduction ongoing, I would -- in your math.

Aaron Deer -- Sandler O'Neill -- Analyst

Understood. Okay. Great. Thanks for taking my questions.

David R. Morris -- Executive Vice President and Chief Financial Officer

Okay.

Operator

Thank you. Our next question comes from Tyler Stafford with Stephens.

David R. Morris -- Executive Vice President and Chief Financial Officer

Hey, Tyler?

Andrew Terrell -- Stephens -- Analyst

Hey, this is actually Andrew Terrell on for Tyler. Good morning, guys.

David R. Morris -- Executive Vice President and Chief Financial Officer

Hi, Andrew.

Andrew Terrell -- Stephens -- Analyst

Hi. I just wanted to start on the margin. Going back to the big commentary you guys gave around the flat to increasing margin head into the fourth quarter, does that include an October rate cut?

David R. Morris -- Executive Vice President and Chief Financial Officer

No, it does not.

Andrew Terrell -- Stephens -- Analyst

Okay. If we did get an October rate cut, could you quantify just what the basis point impact that would be on the margin?

David R. Morris -- Executive Vice President and Chief Financial Officer

I ran the model of quarter point cut, and it increases -- I'd like to just say it's flat because it increases our margin by $45,000 on a quarter. So I would prefer to just say it's flat.

Andrew Terrell -- Stephens -- Analyst

Understood. Thanks. On the CD discussion, can you give us the rates that these are currently, I guess rolling off versus what the new CD price is currently?

David R. Morris -- Executive Vice President and Chief Financial Officer

Yes, hold on. Let me get hold that. I have that information here. Okay. Based upon -- based upon -- so I have to do it in two different sides. Okay. For the Western region, have about $164 million of CDs in the next quarter maturing, in the fourth quarter, that's excluding brokered CDs with a weighted average rate of 2.25, and a weighted average term of 10.5 month, and the projected weighted average rate is 1.79 and the weighted average term is 9.7 months.

Now for the East Coast, we're doing separately. We have $339 million will mature with a weighted average 2.37, weighted average turn of 18 months. Projected weighted average rate is 1.87. The weighted average term is expected to be 11 months. Okay. And this also assumes no rate decrease.

Andrew Terrell -- Stephens -- Analyst

Got it. Okay. That's very helpful. I guess, so the new CD rate could potentially go down from the rates you just gave, if we do an October cut?

David R. Morris -- Executive Vice President and Chief Financial Officer

They could go further down, if we have a rate cut, yes.

Andrew Terrell -- Stephens -- Analyst

Okay. Thanks. And then just on the commercial loan yields. I saw those moved up about call it 15 basis points, that's a 6.62% in the quarter. Can you talk about the dynamics on what you're getting for new pricing in this portfolio?

David R. Morris -- Executive Vice President and Chief Financial Officer

Well, I don't foresee our yields still creeping up on our commercial portfolio, because of the pressure on rates, and especially if there is another rate decrease, because most of our commercial portfolio is prime based, OK. So it all depends upon our mix, so if we do more construction loans, that's going to be prime plus one, prime plus 1.5, if we do C&I, that's going to be prime [Indecipherable] quarter. They are very small and even our traditional CREs will be prime -- prime, just basically prime. That's where we are now having -- we're seeing the rates in today's market. So SBA, we could still get prime plus 1.5, [Indecipherable]. So that's where we are today with our rates.

Andrew Terrell -- Stephens -- Analyst

Okay. That's helpful. That's it for me. Thanks for taking the questions.

David R. Morris -- Executive Vice President and Chief Financial Officer

Okay.

Operator

Thank you. Our next question comes from Kelly Motta with KBW.

David R. Morris -- Executive Vice President and Chief Financial Officer

Hey, Kelly.

Kelly Motta -- KBW -- Analyst

Hi. Thanks for taking my questions. Good morning. So I was wondering if we could talk a bit more about your plans in Chicago, and your announcement that you're also opening two branches there. Just wondering in terms of timing, how we should be thinking about that next year?

David R. Morris -- Executive Vice President and Chief Financial Officer

Okay. The branches I mean we haven't even found the location yet. So maybe, we're a little bit premature in announcing that, but we would like to have open up two branches, one in the Westmont area and the other is yet to be decided, OK. So that will be at least probably at the earliest at the end of the second quarter, third quarter at the earliest, I would think, OK.

Kelly Motta -- KBW -- Analyst

Okay. Great. And then going back, maybe to one of Aaron's questions, you've mentioned a couple of times that commissions will be higher next quarter, given there weren't any mortgage sales this quarter. Just kind of wondering how we should be thinking about the incremental step-up in expenses and kind of sizing how that -- how big that usually is a quarter to get a better idea?

David R. Morris -- Executive Vice President and Chief Financial Officer

Okay. I think your -- the expenses are low. by -- well approximately $400,000.

Kelly Motta -- KBW -- Analyst

Okay. I'll sit back. Actually one last one -- two. I was wondering where the gain on sale premiums? You anticipate those kind of coming out for your regular mortgage product, if those picked up at all?

David R. Morris -- Executive Vice President and Chief Financial Officer

We're seeing, well we have -- we've seen about 2.5% -- 102.5, OK?

Kelly Motta -- KBW -- Analyst

Great. Thank you.

David R. Morris -- Executive Vice President and Chief Financial Officer

But they have picked up.

Operator

Thank you. And today's final question will come from Bill Dezellem with Tieton Capital.

Bill Dezellem -- Tieton Capital -- Analyst

Thank you. I wanted to touch on CECL now that we are almost on top of implementation, what are your thoughts relative to the original allowance or initial allowance that you will need to make -- the adjustment you'll need to make? And secondarily, what are your thoughts on the ongoing provision starting next year?

David R. Morris -- Executive Vice President and Chief Financial Officer

Okay. On CECL, OK, we have to -- we're a merchant growth company. So we have an extra year. But we have run parallel -- we are running parallel now and we've tested three different models out. And the biggest issue we have with impact is on the acquired book of business. So they acquired book of business because they -- most of them are not PCIs or in the new world PCDs. We're going to have to put a CECL reserve on them.

And so we're projecting anywhere from $6 million to $8 million will be that -- at this time. $6 million to $8 million will be that initial hit to capital.

Now concerning A LLL, even though we run lower than this on average, our view is that A LLL needs to be between 1 and 1.25 OK. And that's what we in fact we budget at 1.25. So what we budget our A LLL at. Okay. And then all depends on the product mix, of course because construction is more, more risky than, let's say, a single family home. So depending on what our mix is, but we said on average, it will be 1.25.

Bill Dezellem -- Tieton Capital -- Analyst

Thank you.

David R. Morris -- Executive Vice President and Chief Financial Officer

Okay.

Operator

Ladies and gentlemen, thank you for participating in today's question-and-answer session. I would now like to turn the call back over to management for any closing remarks.

Yee Phong Thian -- Chairman, President and Chief Executive Officer

Once again, thank you all for joining us today. We look forward to speaking with you next quarter. Thank you, again.

Operator

[Operator Closing Remarks]

Duration: 28 minutes

Call participants:

Larry Clark -- Investor Relations

Yee Phong Thian -- Chairman, President and Chief Executive Officer

David R. Morris -- Executive Vice President and Chief Financial Officer

Aaron Deer -- Sandler O'Neill -- Analyst

Andrew Terrell -- Stephens -- Analyst

Kelly Motta -- KBW -- Analyst

Bill Dezellem -- Tieton Capital -- Analyst

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