Q2 2022 Luther Burbank Corp Earnings Call
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Good morning, and welcome to the Luther Burbank Corporation second quarter 2022 earnings Conference call, all participants will be in a listen only mode.
After todays presentation, there will be an opportunity for the analyst covering the Luther Burbank Corporation to ask questions.
Ask a question you will need to press star one one on your telephone.
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.
No Sir 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 contain 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 <unk>.
Conciliation 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 Dot Luther Burbank savings Dot Com I would now like to turn the conference over to Mr. Malone Lagomarsino President.
<unk> and CEO . Please go ahead.
Thank you very much good morning, everyone and welcome to Luther Burbank Corporation 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 <unk> 44 cents per diluted share as compared to $22 9 million or 45 cents per diluted share in the linked quarter.
The decline in net earnings of 373000 was primarily attributed to three key factors.
While our net interest income increased by $2 $4 million and our non interest expense decreased by $2 $2 million. These two positive trends were more than offset by a 5 million dollar 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 provision in our credit metrics remained strong and I'll cover asset quality in detail a bit later in my presentation.
First let me address the two factors that led to a 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.
Net interest margin for the quarter measured to six 2%, 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.
We entered the second quarter with a strong loan pipeline of $815 million of 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 is.
Additionally, the rising interest rate environment benefited our single family lending business in two distinct ways first prepayment speed has slowed which is a welcome change from the prepayment headwinds we experienced last year when our single family loan portfolio would've declined during calendar year 2021 had we not supplemented it with the purchase.
Have a pool of single family loans.
Furthermore, our hybrid arm loan product, which is our bread and butter of our single family business came back into consumer favor as interest rates on 30 year fixed rate mortgages increased significantly in comparison to the last couple of years.
Returning now to interest expense I noticed that this measure increased $1 $5 million from the linked quarter of which more than half was related to higher deposit costs also attributed to rising market interest rates.
At the beginning of the year, we anticipated that deposit pricing would be slow to adjust to short term interest rate increases during 2022, given the excess liquidity that existed in the market at the beginning of this year, although the federal funds rate increased by 150 basis points. During the first half of this year, our average cost of interest bearing deposits originally decreased by four.
Basis points in the first quarter, and then increased by five basis points during the second quarter, yielding a year to date increase of only two basis points.
As I mentioned, the other significant elements contributing to the improvement in our second quarter pretax pre provision net earnings was a $2 $2 million reduction in noninterest expense as compared to the prior quarter.
The key factors that contributed to this decline were related to strong loan production and rising market interest rates.
Strong loan volume increased our level of capitalized salaries by $1.2 million as compared to the linked quarter, while higher long term interest rates reduced our postretirement benefit liability by $1 $4 million during the second quarter.
Our first quarter net income resulted in our second quarter return on average assets of one point to 3% and our return on average equity of 13, four 1% both measure measure, which we consider strong.
We do believe however that rapidly rising short term interest rates will challenge our results over the next few quarters. So let me share with you more recent trends.
We expect loan production to moderate in the third quarter of this year current known operates succeed.
The weighted average coupon on our loan portfolio as well as typical market offer rates that existed for the past two years, both of which will dampen refinancing activity.
In comparison to the linked quarter, our loan pipeline totaled $455 million at June 30, a level, which is much more typical of our bank.
While production volume will slow the ultimate size of our loan portfolio may benefit from additional following and loan prepayment speeds, particularly related to our income property prepayment rates, which remained elevated during the second quarter in large part due to the volume of our in house refinancing activity.
In addition increases in deposit costs began to accelerate at the end of the second quarter and based on deposit rates advertised by several of our competitors as well as interactions with our customers. We anticipate that the cost of our deposit portfolio will rise much faster in the second half of this year as compared to the first half of 2022.
As a result, our projections are that increases in our funding costs will outpaced improvements in our yields on our earning assets and as a result, our net interest margin will decline beginning in the third quarter of this year, particularly in light of the expected pace of further short term interest rate increases communicated by the federal.
Is there an anticipated by the market.
Now turning to credit quality during the second quarter, we record recorded a loan loss provision of $2 5 million to account for both strong growth in our loan portfolio as previously discussed as well as a higher level of classified assets.
Our classified assets increased by $8 $7 million during the quarter three multifamily loans comprised the majority or 73% of this increase.
These loans were downgraded due to issues related to the borrower's ability to demonstrate that service capacity. However, all three loans were paying as agreed at quarter end.
The balance of the cloud providers.
Downgrade during the second quarter was comprised of three single family loans in each of these loans demonstrated some stage of delinquency, we believe that issues exhibited in the six recent classified credits are a.
A property or a borrower specific rather than reflective of a general trend in rents occupancy and in the case of the single family loans employment.
Based on original appraisals and our updated values. These six loans have a weighted average loan to value ratio of 68% and as such we do not expect to incur any losses on them.
Nonetheless based on our model for our allowance for loan loss reserve methodology, approximately half of the $2 $5 million Mark provision recorded for the quarter was attributed to these downgrades while the balance of the provision was primarily recorded for net loan growth.
Our classified assets measured 34 basis points of the loan portfolio at June 30th at the same date, we had seven delinquent loans totaling $7 1 million for just 11 basis points of total loans, while nonaccrual loans measured eight basis points of total loans, we believe that each of these measures compare favorably.
To the industry and exemplify our continued strong credit culture.
At June 30, our allowance coverage ratio was 54 basis points of the portfolio and as a reminder, our bank still operates under the incurred loss methodology for the loan loss allowance, we expect to adopt see below seasonal in the first quarter of 2023 and based on our ongoing results of our CFO model test work, we believe that the implementation of T cells.
Not result in a significant change to the level of our allowance of course, the ultimate impact of adoption will be dependent on our portfolio composition and the economic forecast at the time of adoption.
Now I will turn to the balance sheet, our total assets at quarter end grew by $270 million or 4% and year to date, we've grown almost 10% on an annualized basis as I. Previously noted this expansion was attributed to strong real estate loan originations as well as the flowing in our prepayment speeds our asset growth.
We're supported by both average <unk> advances some of which also service hedging positions for our interest rate risk and deposits.
Our loan to deposit ratio remains in a typical range for our business model and measured 117% at quarter end.
Our total equity increased by $3 6 million since the prior quarter, our capital position during the second quarter benefited from our net earnings of $22 6 million, but was partially offset by $9 $3 million of unrealized losses on our available for sales security portfolio net of tax as a result of the interest rate.
Ironman.
Our net unrealized loss position on our investment portfolio totaled $21 3 million as of June 30, and we expect that the full amount will be recovered over time as we both have the intent and the ability to hold these securities until maturity.
Importantly, during the quarter, we returned $6 1 million and $4 $1 million to shareholders in the form of cash dividends and stock repurchases.
Respectively and grew our tangible book value per share by one 2% to 13 point online person 13, sorry, $13 90 per share.
Our capital ratios with the tier one leverage ratio of 10, 2% and a total risk based capital ratio of 19, 1% demonstrate a strong capital position and our conservative balance sheet.
Our capital position.
Excuse me, our capital position that will support future growth and provide some protection for our next eventual economic downturn.
Finally yesterday, our board of directors declared a <unk> 12 per share.
Dividend 12 cents per common share dividend that will be paid on August 15th and with that I'll now turn the call over to Laura for some additional comments.
Comments. Thank you.
In typical fashion I intend to give you some brief but more granular information that we consider as for annualized in trend.
For the second quarter, our new loan volume was funded at a weighted average coupon of 375% we.
We have mostly worked through our pipeline of loans with lower rates and then the third quarter, we expect new volume can be added at coupons exceeding 4.25%.
Our spot rate on our loan portfolio was three 6% at the end of the second quarter. Therefore, although the new loan originations are expected to slow in the second half for sure new volume should help pool loan yields in a positive direction, particularly if loan payoffs continue to slow in the recognition of deferred loan cost of eight.
<unk> indicated with continued rising interest rates, we have recently seen accelerated increases in deposit re pricing.
Although the cost of interest bearing deposits only rose five basis points during the second quarter, our deposit portfolio as 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 date.
This change reinforces amounts message that the competitive environment for deposits has only recently emerged.
During the third quarter of this year, we had $824 million of term deposits carrying a weighted average cost of 34 basis points scheduled to mature.
Based on our current deposit offer rates, we would expect that these certificates price higher by as much as 1% to 1.5%.
But if there's a 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 that swap income totaled 463000 for the quarter at June 30th the notional amount of our pay fixed swaps plus $950 million with a weighted average that's positive carry to us of 64 basis points.
As fed funds continues to rise as derivative positions will improve of course, depending on where rates go in the future shape of the real curve as well as our levels of 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 earning assets and therefore exert downward pressure on our net interest margin for the balance of this year.
Our latest forecast, which included estimate of fed funds, reaching three in a quarter percent by year end.
Projects that our net interest margin may initially declined by 20 to 30 basis points per quarter.
Lastly, when we think about our noninterest expense run rate level of $16 million a quarter is still anticipated.
As noted earlier, our second quarter expenses benefited from a $1 $4 million retirement liability decreased due to higher long term interest rates.
Compensation expense was $1 2 million less than the linked quarter related primarily to record high pace of loan volume.
Backing out those two events, our second quarter noninterest expense approximated $16 million.
And with that we'll conclude our prepared remarks, I will ask the operator to open the line for questions.
Thank you as a reminder to ask a question you will need to press star one one on your telephone.
Please standby, while we compile the Q&A roster.
One moment for our first question.
Our first question will come from Matthew Clark with Piper Sandler. Please go ahead.
Hi, good morning.
Good morning, Matthew.
Maybe first just on the.
Deposit beta outlook I think in your slide you show, 88% last cycle.
What are your thoughts this time around given the improvements you've 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.
For our forecast we tend to just use our historical average.
You know, it's pretty difficult to determine we would've said slower in the first half of this year and it was slower but I.
I don't know I think there's a lot going on in it.
Hard to put a specific number to it but again, we kind of rely for forecasting on our historical.
Okay, and then just on the.
Balance sheet growth outlook.
What do you 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.
3% to 5% range.
Well, we're ahead of 5% year to date I think we're at six six close to 7%.
And do you think it's going to moderate a lot of it has to do with where prepayments are growing 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.
Thinking our growth for the year still at least 5%, 6% I'm not sure we're going to I don't expect us if you were to annualize it and hit double digits.
No.
Okay, Great and then 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 all existing.
Hum.
Apartments.
In structures, but.
We have heard from another bank that theres, an expectation that multifamily projects might slow pretty dramatically.
Into next year, assuming you know rates are.
Remain at this level if not incur.
Increase.
How do you I guess can you just kind of walk us through how that might impact your business if at all.
So I just want to clarify Matthew are you, saying multifamily projects is in new construction.
Yes, yes.
Yes, yes, construction I know you guys don't do it do construction, but just how that might permeate into Europe .
And to what you do.
Sure well I'll start with we have a shortage of affordable housing in our region and so we.
We have seen actually double digit increases in rental rates of the properties.
In general I mean, it's not across the board, but in a number of regions.
<unk> seen a double digit.
Increases in rental rates.
And if so how would it impact our business.
New construction doesn't happen.
Don't do a lot of new construction on the multifamily and so I think on the existing multifamily that we landed 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 you know our average loan.
Size is about $1 713 to 14 units per.
Apartment building.
Small suburban apartment buildings and they really are what we call workforce housing and and you know there is a high high demand.
And you need quite honestly and not enough supply so.
Thank you.
We've seen them in past.
Cycles, our portfolio tends to perform extremely well and even when you think about it Matthew and this left pandemic. This last kind of the issue that we faced.
The.
Moratorium on evictions and some of the other stuff.
Steps that were put in place we still.
It really didn't have a significant negative impact on our portfolio at all.
<unk> did extraordinarily well through that.
Okay.
Great. Thank you and then just given the slower production going forward.
Thoughts on.
We up in another buyback.
And in light of the economic uncertainty as well.
Low capital management is always part of our ongoing review at this time, we don't have.
Thought of doing a share repurchase I think we want to look forward, a little bit and see what happens with interest rates some possibility of a recession, but.
Certainly capital management is always part of our business.
And we do it on an ongoing basis so.
You know potentially in the future, but not in the near term.
Yeah.
Okay. Thank you.
Okay.
One moment for our next question.
That will come from the line of Woody lay from K B W. Please go ahead.
Hey, good morning, guys.
Good morning Woody.
I wanted to touch on expenses sorry.
Sorry, if I missed it in the prepared remarks, but obviously second quarter expenses benefited from some increased capital capitalized origination costs and retirement accruals.
Just how should we think about the expense run rate in the back half of the year.
Yeah.
Im guessing that an average of $60 million. So the volume is going to slow down which means we wont be capitalizing them 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 two I would expect that retirement liabilities maybe to go the other direction during the third quarter.
Yeah.
Unfortunately, the accounting for these liabilities they live with the changes in interest rates.
If anything we're booked.
More liability for that retirement accrual in the third quarter 16, as my estimated upfront right.
Got it.
And then on the credit front just with.
The tick up in the classified loans.
Three loans were they from where they made to one borrower borrower or were they to multiple borrowers.
Two of the three related entities.
Got it alright, that's all from me thanks, guys.
Thank you Bonnie.
Thank you 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.
Thank you very much for joining us today and this concludes our call. This morning. Thank you very much.
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.
Yeah.
The conference will begin shortly to raise your hand during Q&A you can dial star one one.
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