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Luther Burbank Corporation (LBC)
Q4Â 2019 Earnings Call
Jan 29, 2020, 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 Fourth Quarter 2019 Earnings Conference Call. [Operator Instructions] [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 reports 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 from 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 performance are good, it is the Company's policy not to establish 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 & Chief Executive Officer
Thank you very much. Good morning and welcome to the Luther Burbank Corporation 2019 fourth quarter conference call.
This is Simon Lagomarsino, President and Chief Executive Officer. And with me are Laura Tarantino, our Chief Financial Officer; and John Cardamone, our Chief Credit Officer.
I'll begin with our earnings. Net income for the quarter was $12.5 million or $0.22 per diluted common share compared to $12.7 million or $0.23 per diluted common share in the prior quarter. Excluding a $643,000 net after-tax impact of the special FDIC assessment credit recognized during the fourth quarter, adjusted fourth quarter 2019 earnings would have been $11.8 million with an EPS of $0.21 per share as compared to our linked-quarter adjusted earnings of $13.1 million or $0.23 per share. The $1.3 million decrease in adjusted net earnings as compared to the linked-quarter adjusted net earnings was primarily due to a $1.5 million greater provision for loan losses and $836,000 of higher adjusted non-interest expenses, partially offset by a $577,000 improvement in net interest income. I will address each of these items in more detail in a few minutes.
Annual net income for 2019 was $48.9 million or $0.87 per share, representing 8.4% growth in net earnings as compared to fiscal year 2018 net income of $45.1 million or $0.79 per share. The improvement in earnings from the prior fiscal year was primarily attributed to a $3.3 million increase in net interest income, principally from average earning asset growth exceeding net interest margin compression and a $2.4 million decrease in provisions made for loan losses.
The net interest margin compression that began in the second quarter of 2018 continued during the first half of 2019 as our cost of interest-bearing liabilities increased more quickly than our yield on earning assets, primarily as a result of multiple short-term rate increases during 2017 and 2018. The higher level of loan loss provisioning during 2018 was primarily due to 21.6% loan growth in the portfolio during 2018 as compared to 1.6% loan growth in the portfolio during 2019.
I'm pleased to report an improvement in our net interest margin for the second consecutive quarter. Our net interest margin for the fourth quarter of 2019 increased by 5 basis points to 1.89% as compared to a margin of 1.84% during the linked quarter. This increase is primarily the result of lower funding costs and to a lesser extent decreases in the balances of our interest-earning assets and interest-bearing liabilities.
Expanding on the composition of our fourth quarter net interest margin, the $577,000 increase in net interest income as compared to the third quarter was primarily attributed to a decrease in the balance and cost of interest-bearing liabilities of $78.7 million and 9 basis points respectively, which was partially offset by a decline in the average balance and yield of our interest-earning assets of $63.5 million and 4 basis points respectively.
Average interest-earning assets declined during the fourth quarter, mainly as a result of loan paydowns and payoffs exceeding new loan origination volume, causing a $32.7 million decrease in our average loan balances. Although we added over $412 million of new real estate loans to our portfolio during the quarter or a 7.9% increase in new production as compared to our linked quarter, the high prepayment rates we experienced during the third quarter have not abated.
Our loan portfolio CPR was 23% in the fourth quarter as compared to a CPR of 21% for the third quarter of 2019. High prepayment levels are predominantly a function of refinance activity, exacerbated by the steep decline in long-term treasury rates during 2019 which decreased by roughly 80 to 90 basis points at the five-year tenure. During the fourth quarter of 2019 we established an express loan modification program for our existing loan customers to mitigate loan payoffs. And to-date, we've protected approximately $37 million in loans from early prepayment.
During the recent quarter our yield on loans declined by 1 basis point to 4.07%, largely impacted by a 6 basis point reduction in our single-family loan portfolio to 3.51% from the prior quarter level of 3.57%. Our yield on our multifamily loan portfolio remained unchanged during the fourth quarter at a level of 4.31%, despite being impacted by $874,000 less of interest rate swap positive carry as compared to the prior quarter. And Laura will speak more to the fourth quarter impact of swap activity in a few minutes.
At December 31, 2019, single family loans and multifamily loans represented 32% and 64% respectively of our total loan portfolio.
During the fourth quarter we reduced excess liquidity on the balance sheet. The average balance of cash and investments decreased by $30.8 million as compared to the linked quarter, and the yield on cash and investments declined by 24 basis points to a yield of 2.05% for the same period as a direct result of short-term market interest rate decreases. Although average interest-bearing liabilities decreased by $78.7 million during the fourth quarter, the decline was entirely due to less reliance on wholesale funding.
We utilized cash flow resulting from elevated loan prepayments to reduce broker deposits and FHLB advances. The average balance of these declined by $145.4 million and $32.1 million respectively during the fourth quarter as compared to the third quarter of 2019. Conversely, for the same period, our average retail deposits increased by $98.2 million, and we reduced the cost of interest bearing deposits by 10 basis points during the fourth quarter to a level of 1.98%. This reflects a significant improvement as compared to the linked quarter results, wherein our cost of interest bearing deposits increased by 2 basis points.
During the fourth quarter of 2019 we recorded a loan loss provision of $1 million as compared to a $500,000 recapture of loan loss provisions in the third quarter. The $1.5 million increase in loan loss provisions was attributed to a $4.6 million increase in criticized loans during the period as well as a specific provision made for one non-performing single family residential loan. The increase in criticized loans is due to the net movement of $12.9 million in loans to special-mentioned status during the quarter, primarily related to issues with delinquent property taxes or collateral damage. As these loans are not considered impaired, our general valuation allowance methodology calls for a higher loan loss allowance regardless of collateral support and/or insurance coverage.
At the same time, the balance of our classified loans and our nonperforming loans decreased $8.4 million and $6.6 million respectively during the fourth quarter from the prior quarter. These loans were chiefly identified as impaired prior to the fourth quarter without related loan loss allowance levels. The current quarter decrease in classified assets was predominantly attributed to the sale of one nonperforming $6.6 million multifamily loans at a price equal to the full indebtedness due on the loan. The individual single family loan reserve previously mentioned was established as a result of our concerns regarding the potential for collateral devaluation during what is expected to be a protracted workout period due to an impending divorce and possible bankruptcy of the borrower.
We continue to closely monitor the credit quality of our entire loan portfolio and have not noted any significant deterioration in credit trends. Our delinquent loans are a leading indicator routinely evaluated. At December 31, we had five accruing loans with a total principal balance of $5.4 million that were 30 days behind and one accruing loan with a balance of $690,000 that was 60 days delinquent. Of these six loans, four have reinstated; one is in escrow, with an anticipated 45 day close; and one with the remaining balance of $10,000 is expected to pay off shortly.
Our allowance for loan and lease losses increased by $1.1 million over the linked quarter, yielding an allowance for loan and lease losses to total loans coverage ratio of 58 basis points or a 2 basis point increase as compared to the linked quarter.
Finally, our third notable difference in adjusted earnings as compared to the prior quarter was an increase in adjusted non-interest expense. As previously noted and similar to last quarter, our fourth quarter earnings reflected a nonrecurring item related to the FDIC small bank assessment credits made available to us this year.
During the recent quarter we recognized the remaining balance of this credit or a pre-tax benefit of $914,000. After excluding this credit, our adjusted non-interest expense was $836,000 greater in the recent quarter as compared to the linked quarter, primarily due to an increase of $394,000 in marketing expenses related to deposit gathering efforts.
Competition for retail deposits continued to be very active during the fourth quarter and based on recent experience it is our expectation that deposit competition will continue to be intense as we begin 2020.
Other contributing factors to the increase in non-interest expense during the quarter were $235,000 of greater other operating costs, primarily associated with repair and maintenance outlays due to the relocation of our San Rafael branch in our Manhattan Beach administrative office during the quarter as well as higher compensation costs of $180,000, reflecting on average an increase of five full time equivalent employees quarter-over-quarter and the impact of annual merit adjustments on our vacation accrual liability.
Our non-interest expense to average assets ratio and efficiency ratio continued to compare very favorably to the industry and measured 87 basis points and 45.2% respectively for the fourth quarter of 2019 and measured 88 basis points and 46.9% respectively for the calendar year 2019. Looking forward into the current year and based on our strategic initiatives, we would expect our non-interest expense to have a quarterly run rate of between $16 million and $16.5 million.
Now I'll turn to the balance sheet. Our assets at the end of December 31, 2019 totaled $7 billion, an increase of $109 million reflecting 1.6% growth for the year, which was predominantly due to a similar 1.6% increase in our loan portfolio. Although annual loan growth excluding loan sales completed during the year would have been 2.8%, the level of growth is more moderate than expected, primarily due to higher-than-anticipated loan prepayments.
For the year ended 2019 we originated $1.6 billion in new loans compared to $2 billion during the prior year or a 23.6% decrease. Comparatively, for the year ended 2019 principal reductions and payoffs totaled $1.4 billion as compared to $959 million during 2018 or a 44% increase. Decline in loan originations year-over-year is primarily due to two factors: first, we implemented more disciplined loan pricing as compared to prior years based on our desire to widen margins on incremental asset growth; additionally, incremental change have been made to our loan products over the year to tighten credit standards given what has now been the longest period of economic expansion.
New loan volume related to single family production has also been hampered by the 2019 market rate environment with a very flat yield curve that has made the 30-year fixed rate loan product an attractive substitute for the five year arm products that we offer. Additionally, we've seen the return of a healthy non-QM securitization market creating greater competition for non-QM jumbo loans.
As previously discussed, the significant drop in interest rates and the flat yield curve has also been the predominant catalyst for the acceleration in loan prepayments in our single family portfolio. Based on changes in the yield curve subsequent to December 31 wherein the curve has flattened further and the five year treasury has declined another 25 basis points, we believe that loan prepayment activity will continue to be a challenge in the near term and we currently expect our asset growth to be in the range of 3% to 5% for 2020.
During 2019 our asset growth was entirely funded by retail deposit growth which increased by $285 million or 6.3% since year-end 2018. Deposit balances primarily increased in our business product lines which are tied to newer initiatives that we started over the past few years.
We continue to emphasize cross-selling deposit products to our loan customers, and to-date, we have accumulated approximately $64 million in deposit balances with a year-end weighted average interest rate of 95 basis points from this channel. Our loan-to-deposit ratio was 119% at December 31, 2019, as compared to 123% at year-end 2018.
Both the Bank's and Company's capital ratios remain strong and are well above the minimum levels required for bank regulatory capital purposes. The Company's ROA and ROE during the current quarter were 70 basis points and 8.14% respectively compared to 71 basis points and 8.45% respectively during the prior quarter. Our ROA and ROE were 69 basis points and 8.1% respectively for 2019 compared to 70 basis points and 7.96% respectively for 2018.
We're pleased to report that on January 28, 2020, the Board of Directors declared a quarterly cash dividend of $0.0575 per common share. The dividend is payable on February 18, 2020 to shareholders of record as of February 7, 2020.
Although our stock repurchase plan remains in place, no shares were repurchased during the fourth quarter. Since inception of the plan which began in August of 2018, we have repurchased 1,044,000 shares at an average price of $9.85 per share. Of the $15 million that was originally set aside for share repurchases, we have approximately $4,700,000 remaining and we will continue to evaluate repurchase opportunities as appropriate.
And now I'll turn this over to Laura who will speak a little bit more specifically to trends in our margin and our loans and deposits.
Laura Tarantino -- Executive Vice President, Chief Financial Officer
Thank you, Simone.
As Simone discussed, the yield on our loan portfolio declined 1 basis point from the linked quarter. There are three main factors contributing to this change. First, as reported in the prior quarter's earnings call and illustrated on page 15 of our slide deck, the coupon on new loan volume has generally declined since the fourth quarter of 2018 as a result of declines in the five-year treasury rate and competitive pricing.
During 2019, the weighted average rate on new loan originations dropped 28 basis points to 4.35% as compared to a weighted average coupon of 4.63% for 2018. At the same time, the interest rate on principal repayments have trended upward and for the past five months the coupon on loan prepayments has exceeded the average rate on new loan production.
During 2019 the weighted average coupon on loan payoffs increased 26 basis points to 4.27% as compared to a weighted average rate of 4.01% for 2018. Highlighting the most recent trends, during the fourth quarter of 2019 the weighted average rate on loan repayments was 4.40% or 25 basis points greater than the weighted average coupon on new loans of 4.15% for the same period.
The third factor contributing to a decrease in loan yields in the fourth quarter as compared to the prior quarter is an $874,000 decline in positive interest carry related to interest rate swaps hedging our multifamily portfolio. The decrease in swap income is due to the reduction in the average federal funds rate during the fourth quarter which decreased to 1.55% at December 31 from a level of 2.04% at September 30. As the weighted average pay fixed rate of our $1 billion in interest rate swaps is 1.44%, these instruments remain in the money and currently have a positive carry of approximately 11 basis points.
Given the impact of lower market rates and the very flat yield curve on the loan portfolio and without any steepening in the curve to a more normalized flow, we would expect the yield on our loan portfolio to remain under pressure and be subject to small decreases over the upcoming fiscal year.
Moving to deposits. Short-term rate reductions in the second half of 2019 have translated to improvements in the cost of funding. The ending rate on our retail deposit portfolio decreased by 3 basis points to a level of 1.95% at December 31 versus a measure of 1.98% at September 30. The cost of our wholesale deposits declined more rapidly and fell by 30 basis points to a rate of 1.80% at the end of the fourth quarter as compared to a rate of 2.10% at the end of the third quarter.
At December 31, $797 million of our retail CDs or 26% of the retail time deposit portfolio with a weighted average rate of 2.37% were subject to renewal during the first quarter of 2020. Based on current competitive pricing, we would expect to retain funds and/or attract new time deposits at a rate approximating 2%. Additionally, the entire balance of our wholesale deposits are $416 million at year-end with a weighted average rate of 1.80% is subject to renewal during the first quarter, where market pricing is currently 1.70%.
Given the nature of the deposit portfolio of which 67% is comprised of time deposits, we would expect to see some huge improvement in deposit funding costs over the upcoming year. When combining our loan yield and deposit cost forecast and in light of the market rate movement and competitor activity that we have witnessed year-to-date, assuming no changes to today's yield curve, we would expect small improvements of 1 to 2 basis points per quarter in our quarterly net interest margin.
Finally, a summary of our interest rate risk position can be found on slides 22 and 23 of our investor deck. As a result of the flat yield curve, moderate asset growth and hedge positions, our interest rate risk remains at low levels and is comparable to risk measures at the end of the prior quarter.
Net interest income and the economic value of equity declined as a result of a 200 basis point parallel interest rate shock [Indecipherable] 4.3% and 7.9% respectively at December 31, 2019.
That concludes our prepared remarks, and at this time, we'll ask the operator to open the line for questions.
Questions and Answers:
Operator
[Operator Instructions] Our first question comes from the line of Jackie Bohlen from KBW. Your question, please.
Jackie Bohlen -- KBW -- Analyst
Hi, good morning.
Simone Lagomarsino -- President & Chief Executive Officer
Good morning, Jackie.
Laura Tarantino -- Executive Vice President, Chief Financial Officer
Hi, Jackie.
Jackie Bohlen -- KBW -- Analyst
So, I was wondering, just given the higher prepayments -- and I know that you discussed that you expect to see some loan pressure throughout the year, so that's understood. But just given the high prepayments and how quickly the loan portfolio is turning over, does that move you closer to a point of stability than if the prepayments were a little bit slower if we saw an uptick in rates?
Laura Tarantino -- Executive Vice President, Chief Financial Officer
Uptick in rates. If the uptick in rates is in the five to 10-year tenure of the yield curve, that would improve our overall loan yield. If the uptick in rates is short term that really has little effect, given primarily the fact that our loan portfolio is in their hybrid period.
Simone Lagomarsino -- President & Chief Executive Officer
But certainly in the five-year and longer, if as a result mortgage rates go up -- 30 year mortgage rates go up, we would expect a slowdown in the prepayments of our single family portfolio for sure.
Jackie Bohlen -- KBW -- Analyst
Okay. And I should have clarified that. Sorry. I meant longer-term rates, not shorter term. I'm just trying to get the push and pulls on loan yields and when we might see some more stabilization there just given where prepayments are at today. And then in terms of the marketing -- the deposit generation and the higher marketing costs that you have associated with that, was that a one-time effort in the quarter? Or is that going to be just ongoing efforts to continue to improve some of the deposit strategies that you've got ongoing?
Simone Lagomarsino -- President & Chief Executive Officer
It will be ongoing, and our goal is to really continue to focus on our retail deposits. And so at least in the near term, within the next year, we would expect ongoing deposit marketing expenses.
Jackie Bohlen -- KBW -- Analyst
Okay. And are those, are they related to specific campaigns that you have? Or is it just a larger effort just throughout your marketing?
Simone Lagomarsino -- President & Chief Executive Officer
They're really related to several separate campaigns. One, more on the business lines, one more for retail deposits in the branches. So several things going on.
Jackie Bohlen -- KBW -- Analyst
Okay. And are those campaigns rate-driven? Or is there another incentive that you're working with to gather deposits?
Simone Lagomarsino -- President & Chief Executive Officer
We have marketing programs that we'll be doing throughout the year that will be bundling deposit products, focusing on deposit products that are not just rate-driven, but that are transaction products as well.
Jackie Bohlen -- KBW -- Analyst
Okay. Okay. Thank you. That's helpful. And then just one last one for me. In terms of the $16 million to $16.5 million guide, assuming that the FDIC expense normalizes and the marketing expense remains near its current level, what kind of an uptick are you expecting in compensation in 1Q just related to payroll taxes and any other factors in there?
Laura Tarantino -- Executive Vice President, Chief Financial Officer
There's always a bump. I can't give you a specific number, but I would expect my Q1 non-interest expense to be higher than Q2 for that purpose...
Jackie Bohlen -- KBW -- Analyst
Okay. Fair enough. Thanks.
Laura Tarantino -- Executive Vice President, Chief Financial Officer
In the range that will take you [Speech Overlap] closer to the $16.5 million than the $16 million.
Jackie Bohlen -- KBW -- Analyst
Okay. Great. Thank you. I'll step back.
Laura Tarantino -- Executive Vice President, Chief Financial Officer
Thank you, Jackie.
Operator
Thank you. Our next question comes from the line of Gary Tenner from D.A. Davidson. Your question, please.
James Kerr -- D.A. Davidson -- Analyst
Hi. Good morning. This is actually James Kerr on for Gary. How is it going?
Laura Tarantino -- Executive Vice President, Chief Financial Officer
Hey, James.
Simone Lagomarsino -- President & Chief Executive Officer
Good morning, James.
James Kerr -- D.A. Davidson -- Analyst
Good morning. So my first question, I guess, regarding CDs. Is it possible you could walk me through CD maturity and renewal rates by quarter through 2020?
Simone Lagomarsino -- President & Chief Executive Officer
It's a little bit hard to hear you. But [Speech Overlap] renewal rates...
Laura Tarantino -- Executive Vice President, Chief Financial Officer
Yeah. By quarter.
Simone Lagomarsino -- President & Chief Executive Officer
So, I think you'll see first quarter it was about 2.37%. And our second quarter of 2020 will be somewhat higher, but I don't have a specific number for you.
James Kerr -- D.A. Davidson -- Analyst
Okay. Okay.
Simone Lagomarsino -- President & Chief Executive Officer
So we do have higher-priced CDs maturing in the first half of the year that we would anticipate that will be pricing down to more current level.
James Kerr -- D.A. Davidson -- Analyst
Okay. Okay. Fantastic. Thank you. And my next question. So, as far as the planned El Segundo branch, what is the quarterly expense run rate that you're planning on that?
Simone Lagomarsino -- President & Chief Executive Officer
And I apologize, we're having a little bit difficult time in hearing you, James. But I think you asked for the El Segundo branch, what's the quarterly cost for that. And I'll start by saying, it's one of our newer branch models. And it's a very small footprint, like half of what our other branches [Indecipherable] and we did that really more to kind of work down the track of a different model.
I will say, and I'm going to let Laura respond more specifically, we've included the cost of that in that $16 million to $16.5 million that we've set out there as the range of our non-interest expenses for the year quarter by quarter -- $16 million [Indecipherable] quarter by quarter in that range for the year. And I don't know if you...
Laura Tarantino -- Executive Vice President, Chief Financial Officer
Yes. I was thinking about rental personnel. We'll still stock it with three to four people at that branch, so overall personnel. And as Simone said, square footage is not very large. Rental expense is not terribly significant.
James Kerr -- D.A. Davidson -- Analyst
Okay. Perfect. And then just one more last question before I hop off here. So, as far as your Day 1 CECL impact, is there any color you could provide on that by chance?
Simone Lagomarsino -- President & Chief Executive Officer
I can tell you that each quarter we are running what we expect to be our CECL model. And for us, of course, it's not implemented until 2023. But as we look at the results, it is within our current level of reserves or total allowances that we have. So, I would say, as expected for a real estate lender, we're not seeing any significant increases in that CECL estimate.
James Kerr -- D.A. Davidson -- Analyst
Okay. Thank you for taking my questions.
Simone Lagomarsino -- President & Chief Executive Officer
Thank you, James.
Operator
Thank you. And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to management for any further remarks.
Simone Lagomarsino -- President & Chief Executive Officer
Well, this concludes our fourth quarter earnings call. So thank you very much for joining us and good morning, everybody. Thank you.
Operator
That completes our call today. A recorded copy of our call will be available on the Company's website. Thank you for joining us.
Duration: 29 minutes
Call participants:
Simone Lagomarsino -- President & Chief Executive Officer
Laura Tarantino -- Executive Vice President, Chief Financial Officer
Jackie Bohlen -- KBW -- Analyst
James Kerr -- D.A. Davidson -- Analyst
