Earnings Transcript for LBC - Q2 Fiscal Year 2022

Operator: Good morning, and welcome to the Luther Burbank Corporation Second Quarter 2022 Earnings Conference Call. Before we begin, the company would like to remind you that discussions during this call contain forward-looking statements that do not relate strictly to historical or current facts. Luther Burbank Corporation does not undertake any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. Numerous factors could cause our actual results to differ materially from those described in forward-looking statements. For more information on those factors, please see the company's periodic reports accessible at the Luther Burbank Corporation website and filed with the SEC. The presentation today contains certain non-GAAP financial measures that we believe provide useful information about our operational efficiency and performance relative to earlier periods and relative to other companies. For more details on these non-GAAP financial measures and their limitations, including presentation with and reconciliation to the most directly comparable GAAP financials, please refer to yesterday's earnings release and the related investor presentation, which is available on our website at www.lutherburbanksavings.com. I would now like to turn the conference over to Ms. Simone Lagomarsino, President and CEO. Please go ahead.

Simone Lagomarsino: Thank you very much. Good morning, everyone, and welcome to Luther Burbank Corporation's earnings conference call. This is Simone Lagomarsino, President and CEO; and with me is Laura Tarantino, our CFO. Thank you for joining the call today to review our second quarter results. As is customary, we will focus on our actual financial performance, share our observations regarding recent trends and then open the line for analysts' questions. We reported net income for the second quarter of $22.6 million or $0.44 per diluted share as compared to $22.9 million or $0.45 per diluted share in the linked quarter. The decline in net earnings of $373,000 was primarily attributed to 3 key factors. While our net interest income increased by $2.4 million and our noninterest expense decreased by $2.2 million, these 2 positive trends were more than offset by a $5 million fluctuation in the provision for loan losses between the first and second quarters of the year. This is reflected in our pretax pre-provision net earnings, which improved by $4.9 million in the second quarter compared to the first quarter. Although we had a large swing in our loan loss provisioning, our credit metrics remain strong, and I'll cover asset quality in detail a bit later in my presentation. First, let me address the 2 factors that led to our 16.7% improvement in pretax pre-provision net earnings and our successful second quarter. As I mentioned, when compared to the first quarter, our second quarter net earnings benefited from a $2.4 million improvement in net interest income. Our net interest margin for the second quarter measured 2.62%, which was our best quarterly margin recorded since 2014. Interest income grew $4 million from the prior quarter, primarily as a result of increases in the average balance of the loan portfolio and rising interest rates as well as improved earnings on certain of our interest rate swaps. Interest expense also rose during the second quarter but to a lesser extent of $1.5 million as compared to the linked quarter, also chiefly attributed to rising market interest rates impacting the cost of deposits and borrowings. Our real estate loans grew by $272 million or 4% from the prior quarter; and year-to-date, our annualized loan growth was 10.8%. The increase in our loans was due to both strong loan production as well as slowing in single-family residential loan prepayment speeds. We entered the second quarter with a strong loan pipeline of $815 million as borrowers rushed to submit loan applications and lock-in their low rates during the first quarter of this year before market rates increased. Additionally, the interest -- additionally, the rising interest rate environment benefited our single-family lending business in 2 distinct ways

Laura Tarantino: Thank you, Simone. In a typical fashion, I intend to give you some brief but more granular information that we consider as we're annualizing trends. In the second quarter, our new loan volume was funded at a weighted average coupon of 3.55%. We have mostly worked through our pipeline of loans with lower rates. And in the third quarter, we expect new volume to be added at coupons exceeding 4.25%. The spot rate on our loan portfolio was 3.6% at the end of the second quarter. Therefore, although new loan originations are expected to slow in the second half of this year, new volumes should help pull loan yields in a positive direction, particularly if loan payoffs continue to slow and the recognition of deferred loan costs abate. As Simone indicated, with continued rising interest rates, we have recently seen accelerated increases in deposit repricing. Although the cost of interest-bearing deposits only rose 5 basis points during the second quarter, our deposit portfolio spot rate increased 25 basis points between March 31 and June 30 from a level of 43 basis points to 68 basis points as of the same day. This change reinforces Simone's message that the competitive environment for deposits has only more recently emerged. During the third quarter of this year, we have $824 million of term deposits carrying a weighted average cost of 44 basis points scheduled to mature. Based on our current deposit offer rates, we would expect that these certificates will be priced higher by as much as 1% to 1.5%. With the further Federal Reserve interest rate increase expected today, it would be reasonable to expect further deposit pricing pressure. Our second quarter results benefited from some of the existing interest rate swaps we had on our books. Net swap income totaled $463,000 for the quarter. At June 30, the notional amount of our pay fixed swaps was $950 million with a weighted average net positive carry to us of 64 basis points. As Fed funds continues to rise, these derivative positions will improve. Of course, depending on where rates go and the future shape of the yield curve as well as our level of new loan growth, we may add additional positions to hedge interest rate risk, which would at least initially cost us some yield. Bottom line, we expect the increase in our cost of liabilities to outpace upward movements in the yield on our earning assets and therefore, exert downward pressure on our net interest margin for the balance of this year. Our latest forecast, which included an estimate of Fed funds reaching 3.25% by year-end projects that our net interest margin may initially decline by 20 to 30 basis points per quarter. Lastly, when we think about our noninterest expense run rate, a level of $16 million per quarter is still anticipated. As Simone noted earlier, our second quarter expenses benefited from a $1.4 million retirement liability decrease due to higher long-term interest rates, and our compensation expense was $1.2 million less than the linked quarter related, primarily to record high pace of loan volume for the quarter. Backing out those 2 events, our second quarter noninterest expense approximated $16 million. And with that, we'll conclude our prepared remarks, and we'll ask the operator to open the line for questions.

Operator: Our first question will come from Matthew Clark with Piper Sandler.

Matthew Clark: Maybe first just on the deposit beta outlook. I think in your slides, you show 88% last cycle. What are your thoughts this time around, given the improvements you made on the deposit side? I assume it would be less than that. But what are you assuming for kind of a cumulative deposit beta for this cycle?

Laura Tarantino: For our forecast, we tend to just use our historical average. It's pretty difficult to determine. We would have said slower in the first half of this year, and it was slower. But, I don't know, I think there's a lot going on and it's hard to put a specific number to it. But again, we kind of rely for forecasting on our historicals.

Matthew Clark: Okay. And then just on the balance sheet growth outlook. What are you assuming for prepay speeds, in general? And I may not have heard if you updated your balance sheet growth outlook or not, if it's still kind of that 3% to 5% range?

Laura Tarantino: Well, we're ahead of 5% year-to-date. I think we're at 6%, close to 7%. I do think it's going to moderate and a lot of it has to do with where prepayments are going. Our income property prepayments were pretty high during the second quarter, but about 50% of that was in-house refis. So I would expect still prepayment speeds to slow down in the fourth quarter. We're thinking our growth for the year is still at least 5%, 6%, and I'm not sure we're going to -- I don't expect us -- if you were to annualize it and hit double digits, we're not expecting that.

Matthew Clark: Okay. Great. And then just given what rates have done in the multifamily space, I think a lot of what you do on the multifamily side is on existing apartments and structures. But that we have heard from another bank that there's an expectation that multifamily projects might slow pretty dramatically into next year, assuming rates are -- remain at this level, if not increase. How do you -- I guess, can you just kind of walk us through how that might impact your business, if at all?

Simone Lagomarsino: So I just want to clarify, Matthew. Are you saying multifamily projects as in new construction?

Matthew Clark: Yes, construction. I know you guys don't do it -- do construction, but just how that might permeate into what you do?

Simone Lagomarsino: Sure. Well, I'll start with -- we have a shortage of affordable housing in our region. And so we have seen actually double-digit increases in the rental rates of the properties, in general. I mean it's not across the board, but in a number of regions, we're still seeing multi -- double-digit increases in the rental rates. And so how would it impact our business if new construction doesn't happen? We don't do a lot of new construction on the multifamily. So I think on the existing multifamily that we lend on, I think that potentially makes it even stronger because of the fact that we just don't have the affordable housing in our region. And again, you go back to what do we lend on? We primarily lend on multifamily projects that our average loan size is about $1.7 million, 13 to 14 units per apartment building. So these are small suburban apartment buildings, and they really are what we call workforce housing, and there is a high demand and need, quite honestly, and not enough supply. So I think as we've seen in past cycles, our portfolio tends to perform extremely well. And even when you think about, Matthew, in this last pandemic, this last kind of issue that we faced, the moratorium on evictions and some of the other steps that were put in place, we still really didn't have a significant negative impact on our portfolio at all. Our borrowers did extraordinarily well through that.

Matthew Clark: Great. And then just given the slower production going forward, any thoughts on re-upping another buyback in light of the economic uncertainty as well?

Simone Lagomarsino: Well, capital management is always part of our ongoing review. At this time, we don't have a thought of doing a share repurchase. I think we want to look forward a little bit and see what happens with the interest rates and possibility of a recession. But certainly, capital management is always part of our business, and we do it on an ongoing basis. So potentially in the future, but not in the near term.

Operator: One moment for our next question, that will come from the line of Woody Lay from KBW.

Woody Lay: I wanted to touch on expenses. And sorry if I missed it in the prepared remarks, but obviously, second quarter expenses benefited from some increased capitalized origination costs and retirement accruals. So just how should we think about the expense run rate in the back half of the year?

Laura Tarantino: Yes. I'm guessing an average of $16 million. So the volume is going to slow down, which means we won't be capitalizing in as much as the current salaries expenses that we did in the second quarter. And if you look at what the curve has done in the last week or 2, I would expect that retirement liability maybe to go the other direction during the third quarter. Unfortunately, that's the accounting for these liabilities, they move with the changes in interest rates. So I'm expecting -- if anything, we're booking more liability for that retirement accrual in the third quarter. So $16 million is my estimated run rate.

Woody Lay: Got it. And then on the credit front, just with the tick up in the classified loans. Those 3 loans, were they from -- were they made to 1 borrower or were they to multiple borrowers?

Laura Tarantino: Two of the three related entities.

Operator: And speakers, I'm showing no further questions in the queue at this time. I would now like to turn the call back over to you for any closing remarks.

Simone Lagomarsino: Thank you very much for joining us today, and this concludes our call this morning. Thank you very much.

Operator: Thank you. That completes our call today. A recorded copy of the call will be available on the company's website. Thank you for joining, and you may now disconnect.