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Hanmi Financial Corporation (NASDAQ:HAFC)
Q3 2021 Earnings Call
Oct 26, 2021, 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 2021 Conference Call. As a reminder, today's call is being recorded for replay purposes. [Operator Instructions] I would now like to introduce Lasse Glassen, Managing Director at ADDO Investor Relations. Please go ahead.

Lasse Glassen -- Managing Director at ADDO Investor Relations

Thank you, operator, and thank you for joining us today. With me to discuss Hanmi Financial's third quarter 2021 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 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, 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 list of factors that may cause our results to differ from our expectations, please refer to our SEC filings, including our most recent Form 10-K and 10-Qs. In particular, we direct you to the discussion of certain risk factors affecting our business contained in our earnings release, our investor presentation and in our Form 10-K. This afternoon, Hanmi issued a news release outlining our financial results for the third quarter of 2021 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 our 2021 third quarter results. It was another excellent quarter for Hanmi. Our results for the third quarter reflect continued strong growth in loan and lease production, a solid uptick in deposits, improving credit quality and record earnings. Our consistently improving performance throughout the year highlights the overall strength of the Hanmi franchise, our robust loan production platform and our ability to develop deep relationships with both new and existing customers.

Momentum continues to build across the enterprise, and Hanmi remains very well positioned to generate profitable growth as we look ahead to the fourth quarter and into 2022. Our strong operational execution helped drive substantial growth in earnings. We reported net income of $26.6 million or $0.86 per diluted share for the third quarter. Net income was a new single quarter record and increased 20% over the prior quarter and nearly 63% from a year ago. Our third quarter earnings were driven by a significant increase in revenues as well as a $7.2 million recovery of a credit loss expense due to strengthening asset quality. Overall, noninterest expense remained well controlled with a modest increase due to higher commissions and the strong loan production and higher advertising and promotional expenses.

Now let's move on to loan production and deposit gathering. During the third quarter, our loan production platform was firing on all cylinders with our loan production growing to $500 million in the quarter, breaking the single quarter record established in the prior quarter when excluding PPP loan originations. We also continued to benefit from an increase in business activity as the economies in our key markets emerge from the pandemic. In total, our loan balance grew at a 14% annualized rate during the quarter ex PPP. In addition, deposits were up solid 7% annualized from the prior quarter and similar to recent prior periods. Growth was led by noninterest-bearing DDAs, which now comprise 44.5% of total deposits, up from nearly 42% last quarter and nearly 38% from a year ago.

Turning next to an update on modified loans and other measures of asset quality. I continue to be encouraged by the performance of our portfolio and the positive trends we are seeing. As of September 30, loans modified under the CARES Act declined 83% from the second quarter to end the third quarter at just $12 million. Overall, I'm extremely pleased with our credit management activities during the challenging times we encountered throughout the pandemic and our team's ability to effectively weather the crisis. Given that the modified loans have become a minor part of our loan portfolio, we will no longer comment on them in future quarters. The positive trends we are seeing in other measures of asset quality further demonstrate Hanmi's comprehensive approach to credit management, our frank and timely assessment of credit risk and our ability to seek positive resolution through payments and payoffs.

Nonperforming loans declined by nearly 60% from the second quarter and 74% since the end of 2020. As of September 30, nonperforming loans were just 44 basis points of total loans. We are also continuing to see loan upgrades as well as payoffs and payments. Balancing these positive and encouraging trends with a caution, our allowance for loan losses remains strong at 1.5% of loans. As we look ahead, I remain very confident in our ability to effectively manage credit quality. 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 I. Kim -- Senior Executive Vice President & Chief Banking Officer

Thank you, Bonnie. Starting off with additional color on loan and lease production. Hanmi's third quarter volumes surged to $500 million, up 7.4% from the prior quarter and almost two times higher than the third quarter last year. During the period, we generated sequential quarter growth across nearly all major loan categories with notable growth coming from commercial real estate and equipment leases, along with record SBA loan production.

Altogether, excluding the impact of PPP loan production in previous periods, loan production in the third quarter was an all-time record for Hanmi, breaking the previous record established last quarter. As Bonnie noted, our loan production platform is performing very well with volume in the quarter diversified across various asset classes and solid contributions from relationship managers that recently joined Hanmi team. With respect to CRE loans in the quarter, the retail category was strong, particularly for neighborhood-based centers with recognizable national chain anchor tenants. We also had solid volume in the quarter in the industrial and multifamily classes. Also of note, C&I production increased approximately 16% compared with the prior quarter.

Commitments under commercial lines of credit decreased by $22.7 million or approximately 3% from the prior quarter to $682.4 million. However, balances on these lines increased by $24.5 million compared to the prior quarter, generating a third quarter utilization rate of 44%. Altogether, newly generated loans and leases for the quarter had a weighted average yield of 3.90%, an increase of 16 basis points from last quarter. Next, I would like to provide an update on the corporate Korea initiative and our new residential mortgage platform, both of which are continuing to contribute meaningfully to our results. As you may recall, the corporate Korea initiative is focused on banking Korean companies, helping to geographically diversify our loan production. This initiative contributed more than 15% of our production for the quarter and has been a solid driver of growth in the C&I loan category.

With a solid Q4 pipeline, the corporate Korea program is well on its way to generate double-digit growth in loan production in 2021 along with a meaningful contribution in deposits. We also continue to be pleased with the results of our new residential mortgage platform. Third quarter lending activity included approximately $41 million of residential mortgages, along with the $28 million of warehouse lending. Looking ahead to the fourth quarter, we continue to anticipate residential mortgage loan will comprise between 10% to 15% of Hanmi's loan origination activity for the full year. Overall, our pipeline of loans and leases remained very strong heading into the fourth quarter, in line with the third quarter pipeline. As such, we expect loan production to remain robust and to finish the year strong. Our underwriting continues to be very disciplined.

The weighted average loan to value and weighted average debt coverage ratio of our CRE loan portfolio as of the end of third quarter were 48.6% and 1.9 times, respectively. Both metrics have been essentially unchanged throughout the 2021. Moreover, we continue to limit origination activities within certain high-risk industries both impacted by pandemic, most notably hospitality. With that, as I said, I would like to provide an update on our hospitality portfolio, which has been the loan category most impacted by pandemic. As of the end of third quarter, hospitality loans declined by more than 8% for the prior quarter and more than 14% since the end of 2020. At present, hospitality represents approximately 16% of our loan portfolio. Importantly, there remains only one nonaccrual hospitality loan totaling just 140,000 collateralized by a property in a metro location in Texas.

De-risking our broader loan portfolio remains a priority, and as such, we are committed to conservative underwriting and reducing loan exposure to riskier asset classes, including hospitality loan going forward. Turning to deposits. Hanmi had another solid quarter. Total deposits were $5.73 billion at the end of third quarter, representing an increase of 1.8% quarter-over-quarter and 10.3% from a year ago. Similar to recent quarters, we continue to benefit from an improving mix shift of deposits with nearly all of the growth driven by noninterest-bearing demand deposits. The key drivers of the increase in DDA during the quarter came from a combination of new deposit relationships, along with growth from existing large accounts that we acquired during the past 12 months, including Corporate Korea accounts. In fact, as Bonnie noted earlier, DDAs now represent nearly 44.5% of total deposits, up from 38% a year ago.

With that, I'd now like to turn the call over to Ron Santarosa, our Chief Financial Officer, for more details on our third quarter financial results. Ron?

Romolo C. Santarosa -- Senior Executive Vice President and Chief Financial Officer

Thank you, Anthony, and good afternoon all. Let's begin with our net interest margin because it will allow us to highlight changes in our earning asset mix and funding portfolios. Net interest margin was 3.07% for the third quarter, down from 3.19% for the second quarter. Adjusting for the effects of our PPP loans as well as the effect of nonaccrual interest received in the second quarter, we could see a net interest margin of 3% for the third quarter compared with 3.06% for the second quarter, down six basis points. Interest income on PPP loans was $1.6 million for the third quarter, down from $2.7 million for the second quarter.

More importantly, when looking at our loan portfolio since year-end 2020, we have effectively replaced this transient loan portfolio with our own traditional loans. We reported loans ended the quarter at $4.86 billion, little change from amounts we reported at the end of the second quarter and at year-end 2020. Excluding PPP loans, however, which were $295.7 million at year-end 2020 and just $21.9 million at the end of the third quarter, we would see loans increased 5.5% since year-end and 3.4% quarter-over-quarter. In addition, again, excluding the effects of PPP loans, we could see the average loan balance for the quarter was $4.63 billion, trailing the comparable quarter end balance of $4.84 billion. Looking at our funding portfolios. We again saw solid growth in our noninterest-bearing demand accounts, up 8.2% quarter-over-quarter, while average balances grew 10% sequentially to $2.44 billion.

Interest-bearing deposits declined to $94.2 million, principally because of reductions in our wholesale deposit portfolio of $61.6 million; and the cost of interest-bearing deposits fell seven basis points to 30 basis points for the quarter. Last, we also reduced the amount of our wholesale borrowings by $12.5 million on scheduled maturities and repurchased $12.7 million of our 5.45% notes. Finally, as we've noted previously, our demand deposit growth has contributed to the growth in our lower yielding balances at other banks, which was $772.6 million at the end of the third quarter and 11.5% lower than the $872.8 million average for the quarter. As a result, we anticipate that our net interest margin will continue to be at about 3%, albeit with a higher amount of average earning assets. Moving on to noninterest income of $12.5 million.

We continue to see a strong volume of SBA loan sales rising to $47.9 million, up 80% from the previous quarter. And with 11.85% trade premiums, gain on sales increased to $5.5 million from $3.3 million in the second quarter. As you may recall, the bulk of our sales of second draw PPP loans occurred in the first quarter, while the second and third quarter included only $200,000 and $300,000 of gains, respectively. There are no more remaining second draw loans on our balance sheet. We did revise upward our business deposit account fee schedules and improved our business practices, leading to a meaningful change in this particular revenue source. Noninterest expenses increased this quarter on higher advertising and marketing expenses from new marketing campaigns as well as increased compensation on higher loan production volumes.

Our efficiency ratio, however, did improve to 52.01% for the third quarter as revenue growth outpaced the growth in expenses. Pausing here to look at our quarterly results from an adjusted pre-tax pre-provision perspective. We saw adjusted pre-tax pre-provision income of $29.7 million, up 8.4% from the previous quarter. Turning to credit loss expense. We again posted a recovery in the third quarter for $7.2 million. Analyzing components of this expense recovery, we posted a $7.6 million negative provision to the allowance for credit losses, a $1.2 million positive provision to the allowance for losses on off-balance sheet items, a $400,000 negative provision for the allowance for losses on accrued interest receivable on current and previously modified loans, and a $400,000 recovery on a previously established SBA repair loss allowance. As a result and noting that we experienced net loan loss recoveries for the third quarter of $900,000, our allowance for credit losses ended the quarter at 1.58% or $76.6 million.

The allowance for losses on off-balance sheet items was $4.9 million while the allowance for losses on accrued interest receivable for modified loans was $300,000. Overall, we believe our allowance for credit losses adequately reflects various economic forecasts as well as the continued near-term uncertainty of the lingering effects of the pandemic. We continue to closely monitor and evaluate this evolving environment, and we'll update our loss methodology accordingly. Finishing with our capital accounts during the third quarter, we repurchased 249,920 shares of our common stock under our previously authorized stock repurchase program for an aggregate of 4.7 million or approximately $18.70 a share. Our return on average equity for the third quarter was 17.13% and our book value per share was $19.96. Our capital ratios remain strong with a tangible common equity ratio of 8.98% and a common equity Tier one ratio of 11.85%.

With that, I'll turn it back to Bonnie.

Bonita I. Lee -- President and Chief Executive Officer

Thank you, Ron. Overall, it was another excellent quarter for Hanmi, and I am very happy with our expanding loan production, improving asset quality and another record-setting earnings performance. Once again, I thank the entire Hanmi family for its tireless efforts in making our success possible. As we look ahead to the fourth quarter, Hanmi's continued strong operational execution combined with the resurgence in business activity in our key markets and robust pipeline has us poised for a strong finish to the year. I look forward to sharing our continued progress with you when we report our fourth quarter results next January.

Lasse Glassen -- Managing Director at ADDO Investor Relations

Operator, that concludes our prepared remarks. We would now like to open the call for questions.

Questions and Answers:

Operator

Ladies and gentlemen, we will now begin our question-and-answer session. [Operator Instructions] Our first question comes from Jason Stewart with JonesTrading. Please proceed with your question.

Jason Stewart -- JonesTrading -- Analyst

Thank you for taking the questions. I wanted to start with the strength in originations in CRE and C&I. Maybe you could share what you think that tells you about your customers' view on the economy and their confidence in growth at this point?

Bonita I. Lee -- President and Chief Executive Officer

Sure. Yeah. I mean as we communicate with our customers, there are definitely the activities coming from the pent-up demand as well as we see the increase in the purchase transactions, whether it's in CRE as well as the C&I business purchases.

Jason Stewart -- JonesTrading -- Analyst

Okay. And then turning to the resi origination platform, how correlated should we think about that business with purchase volume seasonality? Maybe you could give us a little bit of idea of what drives the origination volume quarter-to-quarter as we look at it just from the outside.

Anthony I. Kim -- Senior Executive Vice President & Chief Banking Officer

Well, actually, there is -- I don't think there's a seasonality factor in there. As the competition's getting fierce, we're more looking to leveraging our -- not only the correspondent channel, but we're trying to leverage our branch network and our existing customer to increase the retail side of the business.

Jason Stewart -- JonesTrading -- Analyst

Okay. Okay. Thank you.

Bonita I. Lee -- President and Chief Executive Officer

Sure.

Operator

Thank you. Our next question is from Kelly Motta with KBW. Please proceed with your question.

Kelly Motta -- KBW -- Analyst

Hi. Thank you so much for the question. Really good quarter. Just wondering, if you could talk a little bit on the deposit side, especially since you're seeing such great growth. You've had a nice influx of non-interest-bearing over the past several quarters now. Just wondering how we should be thinking about the stickiness of those deposits and plans for funding future growth? Thanks.

Anthony I. Kim -- Senior Executive Vice President & Chief Banking Officer

Well, we have been saying the same thing over and over for the last three quarters. At first, we would expect some attrition from the increase. But then we continue to see increase from the -- our largest large accounts that we acquired for the last 12 months. So as far as stickiness goes, I think we would expect 70% to 80% of these deposits will be sticky.

Kelly Motta -- KBW -- Analyst

Great. Thank you so much.

Bonita I. Lee -- President and Chief Executive Officer

Yeah. Just to add additional color. We had a really great success in the corporate Korea initiative and our strategy to really target large business DDA customers and other institution. And we had a really good success even acquiring new DDAs from the PPP loans that we did for the last year and then beginning of this year as well. So we are continuing to see this sizable inflow of funds from our existing accounts and as well as the average accounts for the new accounts that we acquired for the past few quarters has really contributed. So I think the majority of these deposits, we feel, they'll be fairly sticky deposits going forward.

Anthony I. Kim -- Senior Executive Vice President & Chief Banking Officer

Operator, next question.

Operator

Thank you. Our next question comes from Timothy Coffey with Janney. Please proceed with your question.

Timothy Coffey -- Janney -- Analyst

Great. Thanks. Good afternoon everybody. Given the success that you're having on the origination side and loans and the comments you've made so far in this conference call, is the right way to think about kind of a forward loan growth rate in that low double-digit range?

Bonita I. Lee -- President and Chief Executive Officer

It may happen in 2022, probably later part of 2022. But for time being, because I think there's still -- the environment is such that I think that we are targeting to keep our single -- low to mid single-digit growth for the -- at least next one or two quarters.

Timothy Coffey -- Janney -- Analyst

Okay. And then the gain on sale trends, how should we think about that considering that your period end loans held for sale were much lower than they were last quarter?

Romolo C. Santarosa -- Senior Executive Vice President and Chief Financial Officer

So the volume, when you compare quarter-to-quarter, had a little bit of second draw PPP in it, so that -- we try to isolate that for you, Tim. But going forward, again, our SBA production volume, we anticipate to be strong, let's say, not too dissimilar from third quarter. What remains to be seen, though, as we move into the first quarter of the new fiscal year for the federal government, the guarantee rates will change, moving down to 80% from 90%. Still not quite sure where trade premiums will settle out. They've been very healthy for the good three quarters here of 2021. So I would say there's a chance of continuing, maybe fading a bit. I'm -- absent volume, I'm not sure they would necessarily increase relative to the trade premium.

Timothy Coffey -- Janney -- Analyst

Okay. Great, Ron. Thanks. That's very helpful. And since I've got you on the line, the marketing spend in the quarter was about equivalent to what you were doing in 2019. Is that kind of a good run rate for the advertising and promotion expense?

Romolo C. Santarosa -- Senior Executive Vice President and Chief Financial Officer

So if you look at our quarterly spend going back pre-pandemic, you'll kind of see a seasonality to it, where it's low for a few periods and picks up toward the end of the year. It's -- I'd like to say that the seasonality is returning, although maybe off a quarter or two. But it should stay at a level perhaps not too dissimilar to what we're seeing here in the third quarter and then kind of drift down again. So I believe that pattern will return. I'm just not quite sure how it's going to manifest as we go through quarter-to-quarter.

Timothy Coffey -- Janney -- Analyst

Okay. That's helpful. Thank you. And then, Anthony, just a question on the SFR, the mortgage business. Is there a targeted mix between originations and warehouse lines that you're looking at?

Anthony I. Kim -- Senior Executive Vice President & Chief Banking Officer

There's no actual targeted mix. Our target on the warehouse line commitment is $100 million, and average outstanding balance is about $50 million to $60 million.

Timothy Coffey -- Janney -- Analyst

Okay. Great.

Bonita I. Lee -- President and Chief Executive Officer

So I'd just add. Yes. As we were saying that we expect our mortgage side of the business contribution in terms of production will be 10% to 15%. So it's a combination of retail mortgage as well as the warehouse buying as well as some of the portfolio, if there's an opportunity to acquire, so that will be a combination. So we're just overall targeting that business about 10% to 15% of our overall production.

Timothy Coffey -- Janney -- Analyst

Okay. Okay. I got it. I got it. Thanks Bonita. I'll step back. Thank you very much.

Anthony I. Kim -- Senior Executive Vice President & Chief Banking Officer

Sure.

Operator

Thank you. Our next question comes from Gary Tenner with D.A. Davidson. Please proceed with your question.

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

Hi. Good afternoon. A lot of my questions were answered. But I wonder if you could share with us the loans and deposits that you're currently holding related to the corporate Korea initiative. Just give us a sense of kind of the current scale of that initiative.

Anthony I. Kim -- Senior Executive Vice President & Chief Banking Officer

Currently on the loans, we have 12% of the loans are in corporate Korea space, and approximately 6.5% of deposits are in corporate Korea.

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

Okay. And then, Ron, do you have plans to redeem any more of the 5.5% sub-debt, or at this point, do you expect to hold the remainder there along with the new sub-debt?

Romolo C. Santarosa -- Senior Executive Vice President and Chief Financial Officer

So we have a redemption option at the end of March of 2022, which we are going to take a very hard look at given the attractiveness of exiting the 5.5% notes. Redemptions or repurchases between that date would be more what the market might present. So that was one opportunity we had in the third quarter, so we took advantage of that. I don't know how to predict if any of those opportunities will present themselves in the fourth quarter, but we're clearly looking at the redemption that can occur at the end of March.

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

Okay, great. And then finally, on the revision to the business account fee schedules, did that impact the full quarter, so it's fully loaded into that third quarter run rate?

Romolo C. Santarosa -- Senior Executive Vice President and Chief Financial Officer

Yeah. You could look at that as affecting the third quarter completely, so it's a fairly representative run rate. I think the variations to that idea will be a little bit more of depositor activity, which would be a little bit hard to predict what might occur in the fourth quarter. But the first digit to the left of the decimal point is pretty good. After that, it'll be depending on depositor activity.

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

Okay, great. Thank you.

Operator

Thank you. Our next question is from Kelly Motta with KBW. Please proceed with your question.

Kelly Motta -- KBW -- Analyst

Hi. Thanks for the follow-up. My question was actually about the sub-debt redemption, so that was just covered. Did want to ask, though, about buybacks as well, how you're thinking about deploying that as a use of capital?

Romolo C. Santarosa -- Senior Executive Vice President and Chief Financial Officer

So as we've pointed out in all of our previous calls, we do look at our capital practices each quarter, whether they be repurchases or dividends or both. Clearly, during the third quarter, there were some very good market opportunities to effect repurchases, so we took advantage of that. We'll see what, kind of, market opportunities present themselves in the fourth quarter and again, in any period thereafter.

Kelly Motta -- KBW -- Analyst

Thanks so much Ron. Maybe a last one on credit. Obviously, you had a nice reserve release this quarter, but it's still high relative to peers, especially given how credit quality has been trending. Just wondering, I know we -- none of us have a crystal ball. But assuming things stay as they are, is there still room on the qualitative side to bring that down further or -- and we should be -- or did you kind of just take it as a -- this quarter with a big negative provision you attacked [Phonetic]?

Romolo C. Santarosa -- Senior Executive Vice President and Chief Financial Officer

So just focusing on the principal idea, which is the traditional allowance for credit losses and set aside the mechanics of off-balance sheet and the other allowances that we have, as we pointed out, we ended the third quarter very strong at 1.58%, and it's roughly about $77 million of loss allowance. When you look inside of that, you'll notice that we have about $45 million associated with commercial real estate. And of that, about $30 million of it is associated with hospitality. So it should follow then that as hospitality continues to demonstrate improvements, there will be opportunities and needs to continue to watch the reserves -- watch the allowance drip lower.

Kelly Motta -- KBW -- Analyst

Got it. Thanks for all the color on that. That's really helpful. Appreciate it.

Operator

Thank you. We have no further questions in the queue at this time. Please continue.

Lasse Glassen -- Managing Director at ADDO Investor Relations

Thank you for listening to Hanmi Financial's third quarter 2021 results conference call. We look forward to speaking with you again next quarter.

Operator

[Operator Closing Remarks].

Duration: 35 minutes

Call participants:

Lasse Glassen -- Managing Director at ADDO Investor Relations

Bonita I. Lee -- President and Chief Executive Officer

Anthony I. Kim -- Senior Executive Vice President & Chief Banking Officer

Romolo C. Santarosa -- Senior Executive Vice President and Chief Financial Officer

Jason Stewart -- JonesTrading -- Analyst

Kelly Motta -- KBW -- Analyst

Timothy Coffey -- Janney -- Analyst

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

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