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Hanmi Financial Corp (HAFC 4.18%)
Q3Â 2020 Earnings Call
Oct 27, 2020, 5:00 p.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Ladies and gentlemen, welcome to Hanmi Financial Corporation's Third Quarter 2020 conference call. [Operator Instructions] Following the presentation the conference will be opened for questions.
I would now like to introduce Mr Lasse Glassen Managing Director at Addo Investor Relations. Please go ahead, sir.
Lasse Glassen -- Addo Investor Relations
Thank you, operator, and thank you all for joining us today. With me to discuss Hanmi Financial's third quarter 2020 earnings are Bonnie Lee, President and Chief Executive Officer; Anthony Kim, Chief Banking Officer; and Ron Santarosa, Chief Financial Officer. Ms. Lee will begin with an overview of the quarter. Mr. Kim will then discuss loan and deposit activities, and Mr. Santarosa will then provide more details on our operating performance. At the conclusion of our prepared remarks, we will open the session for questions. In today's call, we may include comments and forward-looking statements based on current plans and expectations, events, and financial industry trends that may affect the company's future operating results and financial position. Our actual results could be different from those expressed or implied by our forward-looking statements, which involve risks and uncertainties. The speakers on this call claim the protection of the safe harbor provisions contained in the Securities Litigation Reform Act of 1995. For a listing of certain factors that may cause our results to differ from our expectations, please refer to our SEC filings, including our most recent Forms 10-K and 10-Q. In particular, we direct you to the discussion of certain risk factors affecting our business contained in our earnings release, our investor presentation and our Form 10-K. This afternoon, Hanmi Financial issued a news release outlining our financial results for the third quarter of 2020, along with a supplemental slide presentation to accompany today's call. Both documents can be found in the Investor Relations section of our website at hanmi.com.
I will now turn the call over to Bonnie Lee. Bonnie?
Bonita I. Lee -- President and Chief Executive Officer
Thank you, Lasse. Good afternoon, everyone. Thank you for joining us today to discuss Hanmi's 2020 third quarter results. In light of the challenges we have encountered throughout much of 2020, I am extremely pleased with how the bank is currently positioned and the strong performance the Hanmi team delivered in the third quarter. Highlights included strong earnings growth, solid loan production and careful noninterest expense management. In addition, the proactive steps we took earlier in the year to protect our loan portfolio and support our customers that have been impacted by the COVID-19 pandemic has been very successful. While we continue to closely monitor the impact of the pandemic on the banking industry and the fundamentals of our business, we are concurrently taking steps to provide additional products and services and safely drive profitable future growth. Overall, I believe Hanmi is well positioned as we look ahead to the fourth quarter and beyond. With that as a backdrop, the following are some of the key financial and operational takeaways for the third quarter. Net income was solidly higher on both a linked-quarter and year-over-year basis. In particular, we benefited from higher pre-tax pre-provision income and lower credit loss expense in the third quarter. New loan production during the third quarter was a solid and increased 18% compared with the third quarter last year. As a result of a strong production growth over the past year, loans receivable were up 5.8% year-over-year. Net interest margin of 3.13% was down just two basis points from the prior quarter driven by the decline in yield on average earnings assets, partially offset by a reduction in the cost of interest-bearing deposits.
We continue to benefit from a relationship-based strategy that emphasizes both loan and low-cost deposit generation. As a result, our overall deposit mix continues to improve led by the growth in the noninterest-bearing DDA. In fact, noninterest-bearing demand deposits increased to 37.8% of total deposits, up from 35.8% for the prior quarter. During the quarter, we hired seasoned executives to lead our residential mortgage and digital banking initiatives to help drive safe, profitable growth in the quarters and years ahead. And importantly, Hanmi enjoys ample liquidity and remains very well capitalized. Our regulatory capital ratios are strong, and I believe we continue to be well positioned to address these challenging times. Looking in more detail at our third quarter results, we reported net income of $16.3 million or $0.53 per diluted share. This compares favorably to net income of $0.30 per share in the previous quarter and net income of $0.40 per share in the third quarter last year. In fact, this was the best single quarter earnings performance for Hanmi in six years. Compared to the prior quarter, third quarter net income benefited from a significant reduction in the loan loss provision to $696,000 compared with the second quarter provision of $21.1 million. The lower provision expense reflects the improvement during the quarter in some of the assumptions used in determining the allowance for credit losses, which includes level of economic activity and anticipated unemployment level. That said, there are inherent uncertainties with these projections. This remains very fluid situation, and we will continue to closely monitor the impact of the pandemic on our portfolio. Our loan modification program has been very successful, and we are encouraged by the positive trends we are seeing. In the initial phase of the modification program, modifications stood at $1.4 billion or 29% of the total portfolio. In Phase two of the program, modification declined 59% to $571 million or approximately 12% of the portfolio.
Approximately 70% of modified loans will provide interest payments while the remaining 30% are payment deferrals. For the borrowers requesting a second modification, we conducted an in-depth review of their financial conditions. In some cases, we require credit enhancements in the form of additional collateral to reduce risk to Hanmi. As a part of this detailed review of each modified loading Phase two of the program, some loans were downgraded and are now included as a special mention or classified loan. Overall, we remain committed to working with our borrowers with the goal of helping them weather the crisis and avoiding future charge-offs in this challenging time. Let's now turn to asset quality. Special mention loans were $57.1 million at the end of the third quarter compared with the $21.1 million at June 30. The quarter-over-quarter change includes $31.6 million of loans adversely affected by the pandemic. In addition, classified loans were $106.2 million at September 30, 2020, compared with a $93.9 million at the end of the second quarter. Classified loans included $21.7 million of loans adversely affected by the pandemic. Nonperforming loans increased modestly to $64.3 million or 133 basis points of loans at quarter end compared with the second quarter 2020, non-performing loans of $58.3 million or 121 basis points of loans. We were pleased to see that shortly after the closing of the quarter, a $3.6 million classified nonaccrual construction land loan paid off in full.
Before turning the call over to Anthony, I would like to briefly comment on steps we are taking to provide our customers with additional products and services to further diversify our source of revenue and safely and soundly drive growth and profitability at Hanmi. During the quarter, we announced the hiring of Larsen Lee as Executive Vice President and Head of Consumer Lending. Larsen's mandate is to enhance the residential mortgage origination capabilities at Hamni. He has a strong track record of success over the last 25 years in mortgage banking at Royal Business Bank, Washington Mutual and Bank of America. In addition, we also recently announced appointment of Fred Lee as a Senior Vice President and Head of Digital Banking. Fred brings a significant digital banking experience and was previously Managing Director of Digital products for CIT Bank. At Hanmi, Fred will accelerate the digitization of our banking platform to provide a more convenient and seamless customer experience. Given their extensive experience and leadership, we are confident Larson and Fred will enhance our strategic effort to deepen relationships with new and existing customers, allowing us to scale more efficiently and capitalize on exciting growth opportunities for Hanmi.
With that, I would like to turn the call over to Anthony Kim, our Chief Banking Officer, to discuss the third quarter loan production results and deposit gathering activities. Anthony?
Anthony Kim -- Executive Vice President and Chief Banking Officer
Thank you, Bonnie. Hanmi generated solid loan production volume totaling $256.6 million in the quarter, excluding $308.8 million loans originated last quarter under the government's Paycheck Protection Program. Third quarter loan production volume expanded 13.9% quarter-over-quarter. We experienced growth across all major categories, with the exception of CRE loans. More specifically, third quarter production consisted primarily of $99.6 million of CRE loans, $31.3 million of SBA loans and $78.6 million of C&I loans. For Hamni, our third quarter production was $21.3 million of commercial equipment leases. We also jump-started our residential mortgage initiative with $25.8 million portfolio of loans. Newly generated loans and leases for the quarter had a weighted average yield of 4.57% compared to the linked quarter's weighted average yield of 4.20%, which excludes the impact of the lower-yielding PPP loans originated during the second quarter. As expected, the secondary market for SBA loan sales reopened in the third quarter after being temporarily shut down last quarter, due to the disruption from COVID-19. Hanmi resumed SBA loan sales in the third quarter, selling $29.3 million of SBA loans and generating a gain on sale of $2.3 million. Of note, we experienced an elevated level of payoffs in the third quarter as payoff of $139.8 million or more than twice the level we experienced in the prior quarter. The weighted average interest rate on the loans that paid off in the period was 5.13% or 56 basis points higher than the weighted average yield of new production in the quarter. Despite solid loan production in the quarter, the higher levels of loan payoffs resulted in loan receivable at the end of third quarter, remaining relatively unchanged from the prior quarter at $4.83 billion. However, loan receivables did expand 5.8% from a year ago. In terms of underwriting, we remain committed to conservative disciplined credit criteria.
For the commercial real estate portfolio, consistent with asset quality data from prior quarters, the weighted average loan-to-value and weighted average debt coverage ratio as of the end of third quarter were 48.1% and 1.9 times, respectively. Looking ahead, we'll continue to prudently originate new loans in light of the economic disruption caused by pandemic, we expect to maintain more stringent underwriting criteria, which includes limiting origination activities within certain high-risk industries. We will likely continue to closely monitor and observe tighter underwriting as we assess the economic impact on our customers over the near term. To this point, I would like to provide an update on the hospitality segment of our portfolio, a segment that has been most impacted by pandemic. As of September 30, hospitality loans totaled $929 million or 19% of Hanmi's total portfolio. Importantly, this segment is conservatively underwritten with a weighted average debt coverage ratio of two times and a weighted average loan-to-value of -- ratio of 50%. At September 30, we had $441 million modifications in our hospitality portfolio, down 26% from $593 million at June 30. Of the $441 million of modified hospitality loans as of September 30, we were able to secure a payment reserve as additional collateral on $111 million or 25% of total amount. Although hospitality industry trends are generally showing improvements over the past several months, key metrics, including occupancy, average daily rate and revenue per available room are well below year ago levels. That said, extended stay, limited service and lower scale hotels are forecasted to fare better than higher end full-service luxury segment hotels. Additionally, low occupancy and closures in the upper price segments are resulting in a disproportionate percentage of total U.S. demand accommodated as lower price segments. Hanmi's hospitality portfolio is comprised mainly of hotels in the economy to upscale range.
Based on hotel metrics provided for the month of April 2020 to September 2020, the bank's overall hotel hos portfolio has experienced a steady increase in occupancy and revenues, similarly in line with the U.S. national average. While risk remains within the hospitality segment, we believe they are manageable. Going forward, we will continue to work very closely with our hospitality customers with a goal of helping them weather the crisis, improve their liquidity position and return to normal loan payment schedules. Moving on to deposit gathering activities. Total deposits were $5.19 billion at the end of third quarter compared with $5.21 billion at the end of preceding quarter, representing a 0.3% quarter-over-quarter decline. However, we did see an improving mix of deposits as higher cost time deposit declined, while noninterest-bearing demand deposit expanded nicely quarter-over-quarter. Overall, we remain very pleased with the strength of Hanmi's deposit franchise. As a result of third quarter loan production and deposit gathering activities, our loan-to-deposit ratio at the end of third quarter was 93.1% compared with 92.6% in the prior.
I'd now like to turn the call over to Ron Santarosa, our Chief Financial Officer. Ron?
Romolo C. Santarosa -- Senior Executive Vice President and Chief Financial Officer
Thank you, Anthony, and good afternoon all. Let's begin with pre-tax pre-provision income for the third quarter with net interest income of $45.6 million, noninterest income of $7.1 million and noninterest expenses of $29.9 million, pre-tax pre-provision income was $22.8 million, up 17.5% quarter-over-quarter when we adjust the second quarter for security gains and the effect of PPP deferred loan origination costs. Third quarter pre-tax pre-provision income benefited from higher net interest income, higher noninterest income and lower noninterest expense. Looking at net interest income. We posted $45.6 million, up 2.6% from the prior quarter. Interest and dividend income declined 1.6% or $0.9 million in part reflecting the full quarter effect of our lower-yielding securities portfolio. More importantly, interest expense fell 18.2% or $2.1 million, driven by lower rates paid on interest-bearing deposits. Turning to net interest margin for the quarter. It decreased only two basis points from the second quarter to 3.13%. The average yield on loans for the third quarter was 4.42%, down seven basis points from the second quarter. However, the average rate paid on interest-bearing deposits dropped 24 basis points to 87 basis points. Our net interest margin also benefited from the continued shift in deposit mix with higher costing average time deposits declining 6.9%, lower costing average savings in money market accounts increasing 5.6% and average noninterest-bearing deposits increasing 17%. As Anthony noted, average rates on new loan production for the third quarter was 4.57%. And just above the average yield posted for the quarter. In addition, we've reduced our deposit rates several times since the onset of the pandemic and have done so again this month.
Also we have $198.7 million of time deposits that will mature in the fourth quarter, which have an average interest rate of 1.69%. Together, this should allow our net interest margin to remain in the low 3s. Next, our noninterest income for the third quarter was $7.1 million, down from $20.9 million for the second quarter primarily due to the absence of security gains. More significantly, however, we returned to the secondary market and sold $29.3 million of the guaranteed portion of SBA loans for gains of $2.3 million. Notably, trade premiums averaged 9.53% for the third quarter. Noninterest expenses were $29.9 million this quarter, higher than last quarter because of the $3.1 million PPP deferred loan origination costs. Notwithstanding that effect, we did see salaries and benefits decline 3.4%. Near the end of the third quarter, we did trim where appropriate, a small number of individuals through attrition and separation. As always, we will continue to scrutinize our resources and activities, striving for a balance among efficiency, effective compliance and risk management and superior customer experience and service. As of September 30, 2020, we had $1 billion of cash and unpledged securities as well as $1.4 billion of remaining unused borrowing availability with the FHLB and $1.9 billion of unused secured and unsecured facilities. We remain confident that we have ample liquidity to operate in the evolving uncertain macroeconomic environment resulting from the pandemic, and we will continue to closely monitor and evaluate our potential liquidity requirements. Our return on average assets and return on average equity both increased in the third quarter to 1.08% and 11.74%, respectively. Last, our tangible book value increased to $17.95 per common share at the end of the third quarter, and our tangible common equity ratio remained strong at 9.05% as do all of our regulatory capital ratios.
With that, I'll turn it back to Bonnie.
Bonita I. Lee -- President and Chief Executive Officer
Thank you, Ron. As we look ahead to the fourth quarter and beyond, we remain committed to supporting our loyal customers, prioritizing the health and safety of our employees and communities, and ultimately, emerging from the pandemic well positioned to drive profitable, sustainable growth and maximize value for our shareholders. I look forward to sharing our continued progress with you when we report our fourth quarter 2020 results in January.
Lasse Glassen -- Addo Investor Relations
Operator, that concludes our prepared remarks. We'd now like to open the call up for questions.
Questions and Answers:
Operator
Thank you. [Operator Instructions] Our first question comes from Matthew Clark with Piper Jaffray. Please proceed with the question.
Matthew Clark -- Piper Jaffray -- Analyst
Good afternoon. The single-family resi portfolio has been running off for quite some time now and turn the corner, though, this quarter. Is the expectation with some new originators that those balances may start to stabilize and maybe grow in this environment?
Bonita I. Lee -- President and Chief Executive Officer
That's correct. That's our plan, yes.
Matthew Clark -- Piper Jaffray -- Analyst
Okay. And then your reserves on commercial real estate declined about 18 basis points to 146. Can you isolate the reserves on your hospitality portfolio and retail CRE portfolio separately?
Romolo C. Santarosa -- Senior Executive Vice President and Chief Financial Officer
The real estate secured element of our portfolio, my recollection, a coverage ratio of about 2.3%, but that excludes the C&I elements, which we do have as part of that. And I don't remember that number as well off the top of my head. It's not a larger piece, but there's another element to it.
Matthew Clark -- Piper Jaffray -- Analyst
Okay. Okay. And then I was going through the release, I thought I might have seen something, but the contribution of PPP to NII this quarter. If you happen to have that?
Romolo C. Santarosa -- Senior Executive Vice President and Chief Financial Officer
Just give me a minute, Matt.
Matthew Clark -- Piper Jaffray -- Analyst
Yes.
Romolo C. Santarosa -- Senior Executive Vice President and Chief Financial Officer
So for the third quarter, interest includes fee and cost amortization, $1.7 million.
Matthew Clark -- Piper Jaffray -- Analyst
Okay. And then just on the SBA gain on sale, it looked like good volume sold and premiums are a little bit higher than expected. What's your expectation in terms of production going forward in premiums? Can we sustain this level? Or do you think we'll have some seasonal slowdown here in 4Q?
Bonita I. Lee -- President and Chief Executive Officer
Based on the pipelines that we have for the FDA, in terms of production, I think that, that will probably sustain the production level in the fourth Q and hopefully, in the first Q. As far as the premium levels are concerned, at least it's holding up, and it's 9.5% -- in between 9.5% to 10%. And hopefully, it will stay at that level as well.
Matthew Clark -- Piper Jaffray -- Analyst
Okay. Thank you.
Operator
Thank you. Our next question comes from Kelly Motta with KBW. Please proceed with the question.
Kelly Motta -- KBW -- Analyst
Hi. Thank you for the question. I guess my first question has to do with the migration of special mention and classifieds. I was just wondering, was that mostly within what's in second round deferrals? And about how much of that second round deferral amount has migrated into these categories at this time?
Bonita I. Lee -- President and Chief Executive Officer
So our release covers in terms of a special mention category, about $31.6 million is COVID-impacted loans, and that's composed about six loans. For the substandard category, it's about $21.7 million impacted by COVID and that includes about five loans.
Kelly Motta -- KBW -- Analyst
Okay. So since the ones highlighted as COVID impacted, are those currently in those second round deferral buckets? Or are they currently paying right now?
Bonita I. Lee -- President and Chief Executive Officer
The ones in the special management category, some of -- most of them are in the interest paying bucket. And there is a -- in terms of a substandard category, there are -- some are in the interest-only -- interest payment and then some are in deferral category.
Kelly Motta -- KBW -- Analyst
Great. Thank you. And then on the securities book, you added a fair amount, it looks like -- of securities this quarter. So just wondering if this is kind of a good level to hold that at? Or if you're going to continue to kind of put some of your liquidity into securities going forward still?
Romolo C. Santarosa -- Senior Executive Vice President and Chief Financial Officer
So securities are roughly 12% of our balance sheet. I think up from about, if I remember correctly, 10% at year-end before the pandemic struck. So I suspect, Kelly, that, again, most of our book is actually pretty much, substantially, all of the book is a high cash flow book. So we do put back to work the remittances that we receive each month. So I can see the book growing slightly, but if I had to put a boundary around it, I don't think at this point, it would grow bigger than 15%, and it won't be less than 10%. And so 12%, 12.5% is the midpoint. So we'll kind of bounce in and around that level, depending on where the market is each month, what our outlooks are for funding and so on. So I would say that about 12.5%, maybe a little bit higher, maybe a little bit lower, but I think that's about where we would be.
Kelly Motta -- KBW -- Analyst
Great. And if I can sneak a final one in. Given where your valuation is, and you continue to build capital. At what point do you start to revisit the buyback? And is that entering the discussions at all in terms of how you're viewing capital return?
Romolo C. Santarosa -- Senior Executive Vice President and Chief Financial Officer
Well, as I think I've mentioned in the past, the Board, particularly given the onset of the pandemic, discusses quarterly our capital actions and whether that's dividend or whether that's year repurchase. So I think we're all encouraged of what we saw in the third quarter, but we're still in the pandemic. So we'll deliberate longer, further on what fourth quarter or what first quarter might do. And make a decision informed by that outlook.
Kelly Motta -- KBW -- Analyst
Thank you so much.
Operator
[Operator Instructions] Our next question comes from Tim Coffey with Janney. Please proceed with the question.
Tim Coffey -- Janney -- Analyst
Great. Thank you very much. I had a couple of questions on the hotel modifications for the quarter. When do these -- the hotels that are in modification, where those modifications set to expire?
Anthony Kim -- Executive Vice President and Chief Banking Officer
Those majority of modifications -- second round modification expires toward the end of October, November and December. We have given three months -- limited to three months in the first month and second month, three months as well. So it's maturing starting end of October.
Tim Coffey -- Janney -- Analyst
Okay. The cash collateral that you've collected, do you plan to apply that to the back end of the modification? Or has that already been used up to for interest-only payments?
Anthony Kim -- Executive Vice President and Chief Banking Officer
No, we're holding it as a reserve. Customers will pay as agreed, whether it's interest payment or...
Tim Coffey -- Janney -- Analyst
Okay.
Bonita I. Lee -- President and Chief Executive Officer
So Tim, just to add on the payment reserves, some of our customers, although they are in modification, some of the customers are sitting on ample liquidity, so we wanted to have customers commit to their payment going forward. So there was a spirit behind getting the -- some of the interest payment reserve.
Tim Coffey -- Janney -- Analyst
Okay. Yes. And that kind of follows on my next question, Bonnie. As you look at the loans that are on the second deferral, just generally speaking, are these properties where the owner just needs a little bit of time to -- just needs a little bit of time, or is it a situation where they're actively seeing occupancy rates that are well below your portfolio average?
Bonita I. Lee -- President and Chief Executive Officer
It's a combination. Some -- as we look at the individual financial conditions of the hospitality borrowers. Some of them do show debt service ability. However, given that we're still in the pandemic, some of the customers are taking more conservative approach of still asking for the modification. That's where we require the payment reserve to show their commitment. And some of it, depending on where the properties are, some of them recover much better than the others. But if you are obviously in the convention closer to convention type of properties or the airports or airline industries are the main customers, then the recovery is a little bit slower than the average industry.
Tim Coffey -- Janney -- Analyst
Okay. Okay, that's super helpful. Thank you. And then just my last question was, just looking at the PPP loans. Has any of your borrowers started the forgiveness process?
Bonita I. Lee -- President and Chief Executive Officer
Yes. We actually just began the process. SBA came out with the -- at least for the loans up to 50,000, they came out with the guideline. So we have started the process.
Tim Coffey -- Janney -- Analyst
Okay. I have no more questions. Thank you.
Bonita I. Lee -- President and Chief Executive Officer
Sure.
Operator
We have a follow-up question from Kelly Motta with KBW. Please proceed with the question.
Kelly Motta -- KBW -- Analyst
Hi, thanks for the follow-up. Just a quick question about the loan portfolio. This is the second quarter that leases fell kind of substantially. I was just wondering if there's any pivot there or if it's just a change in demand and how we should be thinking about growth in leases in this environment?
Bonita I. Lee -- President and Chief Executive Officer
So it's not so much of the -- that the market has changed or there's a lesser demand. I think that there's a consistent demand in the leasing industry. Having said that though, we are being very cautious in terms of providing new leases to the service industry accommodations or retail. So that's why I think that if you compared our production and the historical production, it's lower. But I think going forward, as the economy activities improve, we'll see some of the improvements in the production. But it may not be the same level as last year, but certainly, it may cover the runoff, if not slightly lower. So that's what the expectation is.
Kelly Motta -- KBW -- Analyst
Thank you so much, Bonnie.
Bonita I. Lee -- President and Chief Executive Officer
Sure.
Operator
And at this time, there are no further questions in queue. I would like to turn the call back over to management for closing comments.
Lasse Glassen -- Addo Investor Relations
Thank you for listening to Hanmi Financial's Third Quarter 2020 Results Conference Call. We look forward to speaking with you again next quarter.
Operator
[Operator Closing Remarks]
Duration: 34 minutes
Call participants:
Lasse Glassen -- Addo Investor Relations
Bonita I. Lee -- President and Chief Executive Officer
Anthony Kim -- Executive Vice President and Chief Banking Officer
Romolo C. Santarosa -- Senior Executive Vice President and Chief Financial Officer
Matthew Clark -- Piper Jaffray -- Analyst
Kelly Motta -- KBW -- Analyst
Tim Coffey -- Janney -- Analyst
