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Luther Burbank Corporation (LBC)
Q3Â 2020 Earnings Call
Oct 28, 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's Third Quarter 2020 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 2019 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. You may begin.
Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors
Thank you, Tuanda. Good morning, and welcome to the Luther Burbank Corporation Third Quarter 2020 Earnings Conference Call. This is Simone Lagomarsino, President and CEO; and with me today are Laura Tarantino, our Chief Financial Officer; and John Cardamone, our Chief Credit Officer. The past nine months have been challenging for our country, our customers and our employees. As the economy continues its recovery, I'm pleased to see the resiliency of each of these constituencies, particularly during this last quarter. This resiliency had a positive influence on our third quarter 2020 financial results, which I will share with you now. Our net income for the third quarter was $14.3 million or $0.27 per diluted common share, an improvement as compared to the linked quarter net earnings of $9.3 million or $0.18 per diluted common share.
The $5 million increase in net earnings was primarily a result of a reduction in loan loss provisions of $5.3 million recorded in the comparative period to set aside reserves for potential pandemic-related losses in our real estate loan portfolio. Additionally, as compared to the linked quarter, net interest income improved by $3 million due to expansion in our net interest margin. These benefits were partially offset by a $1 million increase in noninterest expense as well as a $2.1 million increase in the provision for income taxes as a result of greater pre-tax income of $7.1 million compared to the prior quarter. So let me now expand on each of these points.
During the third quarter, our net interest margin grew to 2.03% and an increase of 15 basis points from the prior quarter level of 1.88%. The improvement in our net margin and relatedly, net interest income was primarily due to continued reductions in the cost of our interest-bearing deposits, which declined 33 basis points as compared to the linked quarter. Similar to the prior quarter, even with declining deposit offer rates, the bank continued to attract new deposits with the average balance of interest-bearing retail deposits increasing by $256 million during the current quarter. The $4.1 million improvement in net interest expense on deposit during the third quarter was somewhat offset by a $1.4 million decline in interest income on loans as our yield on loans during the third quarter decreased seven basis points as compared to the linked quarter.
Our loan yield has continued to decline for two reasons. The first is that the rates on new loan originations continue to decrease and the second reason is that we continue to experience an elevated level of loan prepayments. Our net interest margin expanded during the third quarter to 2.03%, and this is the first calendar quarter where our net interest margin exceeded a 2% level since March of 2018. In early 2019, based on the shape of the yield curve and the market conditions at the time, the bank made a deliberate pivot and determined that the most prudent strategic objective to benefit our shareholders would be to focus on the quality of earnings rather than continuing to leverage capital and grow assets at very narrow margins. That goal remains unchanged today.
Next, I'll speak to provisioning for loan losses and our asset quality. The COVID-19 pandemic was obviously unexpected. At the outset of the pandemic, we established two goals. The first was to ensure that our bank was well positioned to assist our customers with all of their banking needs, while keeping our customers and employees safe and healthy. This included moving quickly to support a significant increase in telephone calls and transactions and the development of programs for our borrowers who are experiencing temporary hardships. The second goal was to ensure that we maintain the sound quality of our loan portfolio, despite the need to move quickly.
Since the inception of the pandemic, we granted more than 280 loan modifications, allowing short-term payment deferrals with sensible repayment structures that permit borrowers to resume loan repayments without undue hardship. I am encouraged that more than 80% of loans that we modified have returned to payment status, which reflects the strong credit quality of our loan portfolio. At September 30, 47 loans, representing only 1.2% of our loan portfolio have either requested additional assistance or have not yet communicated their intent to resume payments. During the first two quarters of this year, we added $10.2 million to our loan loss allowance pertaining to the credit uncertainty related to the pandemic environment.
We decided to add this amount to the allowance, even though the credit metrics related to the loans that receive payment deferrals exhibited strong pre-pandemic debt coverage ratios, debt-to-income ratios and collateral support, as shown on Pages seven and eight of the investor deck that we filed with our earnings release. Additionally, little time had passed since the declaration of a national emergency to understand how the real estate markets supporting our collateral would be impacted. six months later, we're pleased to see that our lending specialty lines of business, namely the multifamily workforce housing and the jumbo single-family housing real estate sectors on the West Coast remained sound.
According to the National Association of REALTORS October 22 publication, existing home sales in the West rose 9.6% in September from one year ago, while sales of homes in the West of $1 million or more almost doubled over that same period. Additionally, housing inventory is at historic lows, which should provide price support. These trends are attributed to more individuals working remotely and low mortgage interest rates. Also, according to S&P CoreLogic Case-Shiller Indices published on September 29, home prices in the major metropolitan areas located on the West Coast showed price appreciation approximating 5% in the one-year period ending July 2020.
In the multifamily residential arena in its October 21 article, the National Real Estate Investor noted that the pandemic environment has driven urban core renters to the suburbs in search of more space and cheaper rents. The same article adds that Class A vacancies have been higher than Class C vacancies since 2016. Further, the article indicates that while effective runs across the U.S. and Class A apartments have declined 3% on average in August 2020 as compared to the year before. Conversely, average rents grew 3.8% in the lower-cost Class C apartments, which is the type of workforce housing that we finance.
As a result of the significant reduction of loans on payment deferrals and the general strength of the real estate markets in which we operate, our traditional credit quality measures remain strong. We recorded no loan charge-offs during the current quarter, and our nonperforming assets remained at 0.07% of assets at quarter end. Furthermore, although California, Washington and Oregon were all recently afflicted by several serious wildfires. At this time, we are not aware of any property losses suffered by any of our borrowers. Primarily as a result of these factors, we did not record any provision for loan losses for the current quarter as compared to a $5.3 million loan loss provision recognized during the linked quarter.
At September 30, our allowance for loan losses to total loans coverage ratio measured 75 basis points, an increase of two basis points since the end of the second quarter. This increase was chiefly related to a decline in the balance of our total loan portfolio. Although we feel comfortable with the current level of our reserves, additional provisions may be necessary in future quarters as we monitor the ongoing impact of the COVID-19 pandemic and other potential credit changes. Returning to my quarter-over-quarter earnings comparison, the improvements in our pre-tax earnings related to net interest margin expansion and reduced loan loss provisions were partially offset by a $1.1 million increase in compensation expense attributable to a reduction in capitalized salaries directly related to loan origination volume during the quarter.
In the third quarter, we funded $235 million of new loans compared to $488 million in the prior quarter or a 52% decrease. As we discussed last quarter, with the onset of the pandemic, we temporarily tightened certain of our underwriting requirements. These changes, as expected, led to a reduction of loan intake. However, consistent with our conservative credit culture, we felt it was important to pull back and assess the pandemic's impact on the economy and on real estate values. We recently adjusted our credit guidelines, including very selective reentry into nonresidential commercial real estate and construction lending, although some credit parameters remain more limited than they were originally prior to the pandemic.
As a result, we have seen a healthy rebound in our income property loan pipeline, which improved to $191 million at September 30 from $88 million at the end of the prior quarter. The single-family residential pipeline also improved to $65 million at September 30 from $40 million at June 30. However, we believe that single-family loan volume will remain below traditional levels in this historically low interest rate environment, given the ability of jumbo borrowers to obtain 30-year fixed rate financing near a 3% level. We do not offer 30-year fixed rate financing outside of special lending programs designed to assist low- to moderate-income borrowers. Now we'll turn to the balance sheet. Our assets at the end of September totaled $7.1 billion, an increase of $26 million since year-end 2019 or growth of less than 1% year-to-date.
Our cash balances have grown $123 million since year-end, while our loan portfolio has decreased $82 million during the same period. As I mentioned, loan origination volume during the third quarter was about half of that of the previous quarter. At the same time, loan curtailments and payoffs remained at elevated levels. The total loan portfolio CPR for the third quarter, measured 20% as compared to a level of 23% in the second quarter of this year. As a result, our total loan portfolio declined quarter-over-quarter. At the same time, our retail deposit inflows remained strong, with growth of $178 million during the third quarter and $363 million year-to-date.
In keeping with our overall path of improving net interest margin and concentrating on the quality of earnings, we've been decreasing our levels of wholesale deposits and utilizing excess liquidity to reduce low-yielding cash on our balance sheet. Our loan portfolio and deposit trends are not unlike the reports of other banks in the industry. Our ability to grow our loan portfolio this year has been less than originally expected and less than desired, however, our objective is to have smart asset growth and credit quality remains our first priority.
This is all to say that while I'm encouraged by the rebound in our loan pipeline and the continued health of the West Coast real estate markets, there are other factors that are creating headwinds in terms of asset growth, namely the ongoing pandemic, the social and political uncertainty surrounding the upcoming U.S. presidential election and the very low and relatively flat yield curve, all of which will likely result in very limited growth, and we anticipate that we will have balance sheet trends consistent with what we've experienced in the recent quarter. The company's cash -- capital ratios remain strong. And as shown on Page 10 of the investor deck, we continue to maintain significant capital cushions above regulatory required minimums.
Although we do not have any active share repurchase plans currently in place, we are routinely monitoring the market for our stock, and we believe we are well positioned to lend support in the future under the right circumstances. We are pleased to announce that yesterday, the Board of Directors declared a quarterly cash dividend of $0.0575 per common share payable on November 16 to shareholders of record as of November 6. At this time, we intend to maintain our quarterly dividends at the current level. In conclusion, I'm very proud of the strong earnings we recorded this quarter and the continued growth in our net interest margin. I also take great comfort in the resiliency that our communities, deposit customers, borrowers and employees have demonstrated during the pandemic and fire season environment.
And with that, I'll now pass the presentation to Laura for some brief comments.
Laura Tarantino -- Executive Vice President, Chief Financial Officer
Thank you, Simone. I'll spend just a few minutes providing an update on recent trends in our loan and deposit portfolio since the end of the third quarter. Based on current pipeline indications, we would expect fourth quarter loan volume to improve, but carry an average rate of approximately 20 basis points, less than the 3.66% achieved during the third quarter of this year. Generally speaking, competition pricing has trended down over the past several months. And although we've seen some small recent steepening in the five- and 10-year treasuries over the past week or so attributed to the expectation of additional fiscal stimulus, I would expect competitors to wait to see if this change is transitory and the impact, if any, on the market as a result of election outcome, which may be protracted.
Consistent with the prior quarter, we have not yet seen a deceleration in loan prepayments and therefore, we would expect to see some continued downward pressure on loan yields. Conversely, we do expect to see additional cost savings in our deposit portfolio. A spot rate on our retail and wholesale deposit portfolio measured 1% at the end of the third quarter as compared to 1.3% at the end of the linked quarter. Retail deposit repricing improvements are expected to be more gradual during the fourth quarter, as only $370 million of retail certificate accounts are scheduled to reprice compared to a level of $1.1 billion that were subject to repricing in the last quarter. The current weighted average rate on this quarter's CD renewal measures 1.46%.
While in September, we opened new certificates, enrolled existing certificates at an average rate of 43 basis points or approximately 100 basis points less. Given the excess liquidity position that Simone referenced in her presentation, we would expect to continue to roll off wholesale deposits. In summary, as a result of our forecasted loan and deposit activity, we would expect to see continued improvement in our net interest margin, albeit at a lower price than in the third quarter of this year.
And with that, I'll now turn it back over to Simone.
Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors
Thank you, Laura. Before we conclude our prepared comments, I'd like to acknowledge John Cardamone, who's been our Chief Credit Officer for seven years. Earlier this year, John announced his plans to retire at the end of the year, so this will be the last earnings call in which John will participate. John has done an excellent job during his tenure, and he has helped us maintain a very high-quality loan portfolio. In June of this year, we hired a Deputy Chief Credit Officer, Mike Stedman, who joins us with more than 25 years of experience in real estate lending, credit and risk management. Mike will transition into our Chief Credit Officer role in January. This concludes our prepared remarks.
At this time, we'd like to ask the operator to open the lines for questions from our analysts.
Questions and Answers:
Operator
Thank you. [Operator Instructions] Our first question comes from the line of Matthew Clark with Piper Sandler. Your line is open.
Matthew Clark -- Piper Sandler -- Analyst
Hey. Good morning. Wanted to start on the balance sheet shrinkage within SFR. I understand prepayments are elevated and the product is not in favor in terms of 30-year fixed relative to what you're willing to book. But is there anything else you can do to kind of stem the runoff there, whether it's -- maybe it's getting more competitive on hybrids? Just wondering if we can -- if there's a way you can help kind of stabilize those loan balances?
Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors
So Matthew, thank you for the question. I will say that we have actually done a couple of things even before the pandemic. We put in place a loan modification program we've modified. And this is not the modification to defer payments, but this was working with borrowers who were interested in staying with us, but looking to maybe lower their rates. And so who maybe were looking to refinance elsewhere, and we work with them to say, let's work with you to modify your rates, and we've maintained that program throughout this. Again, not people who wanted to defer payments but who wanted to just work with us, and we modified over $100 million in loans through that program, and we're continuing to do that.
They do need to qualify, and we make sure that they're able to make the payments once we do modify them. So that's one program. And we're continuing -- I will say, part of the reduced level of new loan originations in SFR came because we did tighten our credit underwriting criteria and reduced, for instance, loan to values from 80% downward so that we were able to have confidence that if there is a drop at some point in values that still had a very strong credit quality. And in light of that, we have seen -- we've now made a few adjustments, but we have seen an increase in our pipeline as a result of some of the changes that we've made. And with that, I'll maybe suggest that Laura add to that. And if John wants to add to that as well, we can have both of them make additional comments.
So Laura, you want to go first?
Laura Tarantino -- Executive Vice President, Chief Financial Officer
Yes. I think, I agree with what you said, and just to Matthew's point, we do monitor our offer rates quickly, and it really has been less about pricing and more about where the 30-year mortgages for jumbos. It's just ridiculous to compete at that price.
Matthew Clark -- Piper Sandler -- Analyst
Great.
Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors
And John, do you want to add anything to that? Or...
John A. Cardamone -- Executive Vice President, Chief Credit Officer
I would just say, yes, we did tighten our credit policy, which I think was a very prudent decision to take place in the March, April time frame. We have opened up a little bit. We're not back to where we were pre-pandemic and monitor that on an ongoing basis, and we'll make adjustments accordingly as we see fit. But I'm comfortable with the parameters that we have now. And as we said many times throughout this presentation, credit quality is obviously an important driver at this bank.
Matthew Clark -- Piper Sandler -- Analyst
Great. Maybe shifting gears to deposits. You still have, I think, a fair amount of CD repricing to go, less so this coming quarter than 3Q. But I guess what's your sense of which deposit costs can kind of trough or bottom? I mean, is there only -- we only go so low on CDs or could you go lower? Obviously, mix change would help too, but.
Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors
Yes. And I would say that, again, with such a significant amount of our deposits -- in certificates of deposit, we have 60% approximately. It takes time for those to mature for us to then reprice based on current market rates. And we've benefited from the last two quarters of having relatively high amounts of maturity -- CD maturities. And so we've been able to reprice. We expect the same that we will have the ability to reprice the $300-plus million that mature in the fourth quarter. So it's not the same as the $1 billion-plus that we've had in the last two quarters.
However, we do expect, as we continue going forward, that the CDs will reprice at lower levels, probably over the next six months because the current rates on those are still higher than where we're currently pricing them. And Laura, if you want to provide actually more details to that, I encourage you to do that.
Laura Tarantino -- Executive Vice President, Chief Financial Officer
Well, as I said, the spot rate is at 1% and our special rate today for 12 months CD is 50 basis points. So there's definitely room to move, just to be a little slower based on the levels of repricing coming up.
Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors
And to follow-up on your point, Matthew, I mean the abundance of liquidity in the banking industry right now is really allowing all banks to really work to reprice down especially based on the 150 basis point drop in rates that the Fed moved in March. And so we're continuing to reprice and feel like there's still more opportunity, just not to the same extent we've had in the last two quarters. At least not in this quarter.
Matthew Clark -- Piper Sandler -- Analyst
Okay. And then just on share repurchase. What do you need to see to get active on that front, given where your stock is trading and knowing deferrals are very low?
Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors
We're monitoring it daily, and we're very focused on exactly what you just said. So yes, what do we need to see? I think we are continuing to monitor and agree with everything you said.
Matthew Clark -- Piper Sandler -- Analyst
Okay. Thank you.
Operator
Thank you. Our next question comes from the line of Jackie Bohlen with KBW. Your line is open.
Jackie Bohlen -- KBW -- Analyst
Hi. Good morning. Just following up on Matthew's question real quick. If you were to restart a buyback, is that something where you would need to make a formal announcement about that or is it something where, as part of the normal course of operations, you would just begin repurchasing? I'm sorry, I'm mid thought here. You don't have an outstanding authorization, correct? So last one was completed, and a new one was not issued, right?
Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors
Correct. And so yes, we completed $45 million in share repurchases during the second quarter. We did not renew the share repurchase plan and again, we are monitoring on an ongoing basis and recognize, certainly, with a significant reduction in deferrals, loans on deferrals and in the current share price levels, we monitor daily and agree with the comments made by Matthew.
Jackie Bohlen -- KBW -- Analyst
Okay. I apologize. I knew that you did not have anything outstanding. That was a silly question. Switching topics. So it sounds like then the balance sheet, if I'm interpreting your comments correctly, could be fairly flat just based on -- fairly flat to maybe even declining based on remixing of deposits and then the prepayments offsetting any loan generation. Am I thinking about that properly?
Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors
I would say -- let me actually go back to one comment that you made, your prior question. We would have to do a new announcement. And just to be clear, that would have to be when we're out of a blackout period as well. So we would have to do a reannouncement to do a share repurchase plan and put it in place because we do not have one existing today. So I just want to clarify that.
And then secondly, to your point, we do feel that we will see some strength in originations this quarter, particularly in income property in the multifamily side because of the strength of that pipeline at September 30, it was over $190 million versus a very low $88 million in the prior quarter end. So we see that we'll have some strength in originations and we do expect to continue to see higher levels of prepayments, but we're hoping that we'll see, at a minimum, a flat balance sheet, hopefully not a reducing balance sheet and maybe slightly increasing in the loan side.
But we are continuing on the funding side to look at how can we continue to lower cost of funds. And so we are working to replace wholesale funding with lower costing retail deposits where we can. And Laura, I encourage you to fill in where I've left off.
Laura Tarantino -- Executive Vice President, Chief Financial Officer
I agree with all your comments, and I would say that flat is a fair expectation, particularly where we have excess liquidity that we probably will continue to run off in Q4. So while assets were hopefully will grow a little -- or excuse me, we hope that loans will grow a bit. We would expect cash balances to come down.
Jackie Bohlen -- KBW -- Analyst
Okay. And at this point, with some wholesale balances remaining, is the -- is your preferred use of any excess cash reducing those wholesale balances rather than keeping it in cash or deploying into securities?
Laura Tarantino -- Executive Vice President, Chief Financial Officer
Correct.
Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors
Yes. I'm sorry. When you look at the returns on securities, really the best use of our money is -- and improving margin is to not hold on or invest in securities, in our opinion, either loans or reduced cash.
Jackie Bohlen -- KBW -- Analyst
Okay. Great. Thank you both, very much.
Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors
Thank you, Jackie.
Operator
Thank you. Our next question comes from the line of Gary Tenner with D.A. Davidson. Your line is open.
Gary Tenner -- D.A. Davidson -- Analyst
Thanks. Good morning. Quick question on the outlook for loan growth. I think as you talked about the third quarter and kind of the forward book, it was a little more focused on single family. It seems like multi-family and overall commercial real estate, while the yields came down very similarly this quarter on originations, the volumes held in a bit better. So just wondering, is multi-family where there's a little more opportunity right now potentially to kind of stabilize and grow the loan portfolio?
Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors
Absolutely, yes. Laura do you -- my very brief comment on that.
Laura Tarantino -- Executive Vice President, Chief Financial Officer
No, I agree.
Gary Tenner -- D.A. Davidson -- Analyst
So as you think of your underwriting now, having tightened up your overall underwriting, what are the kind of thresholds for LTVs and debt service coverage you're looking at for now in that portfolio?
Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors
John, you want to take that?
John A. Cardamone -- Executive Vice President, Chief Credit Officer
Sure. We're at the 71 20 underwriting in that portfolio, and all of our CRE originations are in the multi-family. We're really not doing anything in other commercial real estate at this point.
Gary Tenner -- D.A. Davidson -- Analyst
Okay. Thank you.
Operator
Thank you. I'm showing no further questions in the queue. I would now like to turn the call back over to Simone for closing remarks.
Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors
Thank you, Tuanda, and thank you to all of our shareholders and investors who have joined us here today. This concludes our call today. Thank you very much for joining us.
Operator
[Operator Closing Remarks]
Duration: 31 minutes
Call participants:
Simone Lagomarsino -- President and Chief Executive Officer, Board of Directors
Laura Tarantino -- Executive Vice President, Chief Financial Officer
John A. Cardamone -- Executive Vice President, Chief Credit Officer
Matthew Clark -- Piper Sandler -- Analyst
Jackie Bohlen -- KBW -- Analyst
Gary Tenner -- D.A. Davidson -- Analyst
