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Operator
Good day and welcome to the BBCN Bancorp Q3 2015 earnings conference call.
(Operator Instructions)
Please note, this event is being recorded. I would now like to turn the conference over to Ms. Angie Yang, Senior Vice President, Investor Relations. Please go ahead.
- SVP of IR
Thank you, Kate. Good morning, everyone, and thank you for joining us for the BBCN 2015 third quarter investor conference call.
Before we begin, I'd like to make a brief statement regarding forward-looking remarks. The call today may contain forward-looking projections regarding future events and the future financial performance of the Company. These statements constitute forward-looking statements within the meaning of the US Private Securities Litigation Reform Act of 1995 and are not statements of historical fact.
We wish to caution you that such forward-looking statements reflect our expectations based on information currently available, are not guarantees of future performance, and involve certain risks, uncertainties and assumptions that are difficult to assess. Actual results may differ materially as a result of risks and uncertainties that pertain to the Company's business. We refer you to the documents the Company files periodically with the SEC, as well as Safe Harbor statements in the press release issued yesterday.
BBCN assumes no obligation to revise any forward-looking projections that may be made on today's call. The Company cautions that complete financial results to be included in the quarterly report on Form 10-Q for the quarter ended September 30, 2015 could differ materially from the financial results being reported today.
As usual, we have allotted one hour for this call. Presenting from the management side today will be Kevin Kim, BBCN Bancorp's Chairman and CEO, Kyu Kim, our Chief Operating Officer, and Doug Goddard, our Chief Financial Officer. Chief Credit Officer Mark Lee and Chief Lending Officer Jason Kim are also here with us today and will participate in the Q&A session.
With that, let me turn the call over to Kevin Kim. Kevin?
- Chairman & CEO
Thank you, Angie. Good morning, everyone, and thank you for joining us today.
As usual, I will begin with some brief comments on the quarter before asking Kyu and Doug to provide more detailed information on the financial results. When they have finished, I'll wrap it up with some closing comments before we open up the call for questions. Let's begin.
We were very pleased to deliver the most profitable quarter in our history, generating $25.1 million in net income, or $0.32 per share. This performance was indicative of our consistent execution in developing new business and adding quality assets to help us offset the continuing headwind of the low interest rate environment. We also continued to have success with credit recoveries, which offset our provision requirements for the strong loan growth during the quarter. And, as noted in our news release, the quarter also benefited from a higher than normal level of OREO-related rental income.
Altogether, we were able to generate strong earnings growth, with net income increasing by 17% over the third quarter of 2014. We also delivered the highest quarter of loan production in our history, with $432 million in loan originations, which was 20% higher than the preceding second quarter and 13% higher than the same quarter of last year. This resulted in total loan growth of 3% in the quarter and 10% over the past year.
On a year-to-date basis, our total loans have increased more than 7%, which keeps us well on track to reach our targeted level of loan growth for the full year. It is important to note that unlike many smaller community banks, we are not reliant on a few key relationship managers to drive our loan production.
We have a well-respected franchise with depth, breadth and strong brand awareness as the premier Korean-American bank in the United States. We have been successful in leveraging our brand and market positioning to great advantage in our business development efforts. And we believe this has allowed us to deliver the consistent application quarter-after-quarter, which ultimately creates long-term value for our shareholders.
I will let Kyu talk in more detail about our loan growth, but I would like to note that we have been able to generate the growth in our loan portfolio while managing our overall expense levels. Notwithstanding the investments we have been making in our organization on a year-over-year basis, our total revenue increased 3.4% while our non-interest expense declined by 2.1%. As a result, our operating efficiency ratio improved to 47.3% in the third quarter of 2015 from 49.7% in the prior year period.
Now let me turn the call over to Kyu to provide additional details on our business development efforts in the third quarter. Kyu?
- COO
Thank you, Kevin, and good morning, everyone. On our last earnings conference call, we noted that the second half of the year is typically a seasonally stronger period of loan production for the bank, and our third quarter certainly held true to this trend.
As Kevin stated earlier, we originated $432 million in new loans for the third quarter of 2015, the highest level ever in any one period. That said, the level of originations in the third quarter is actually not surprising when considering the consistently strong volumes we have posted quarter-after-quarter. And at BBCN, the consistency of our performance is equally as important, if not more, than the performance in any one quarter.
In terms of what we are experiencing in the market, it is pretty much business as usual. We are seeing reasonably healthy economic activity and loan demand in our markets and the competition continues to be fierce from both our niche competitors, as well as the larger mainstream banks.
Commercial real estate loans accounted for 80% of the originations in the third quarter, with balanced growth in all of our major property categories. Commercial loans accounted for 18% of new originations in the third quarter. We extended approximately $105 million in commitments to commercial customers and funded $77 million in new C&I loans by the end of the quarter.
Overall, we now have $1.2 billion in total credit commitments outstanding to commercial customers, with a utilization rate of 51% on lines of credit at September 30, 2015. And again, this quarter, the C&I loans booked were broad based, with no particular concentration in any one industry.
Our SBA business continues to be a strong contributor to our overall originations. Of the $432 million in loan production for the third quarter, $55 million were SBA loans and $46 million of this production were 7A loans. As most of you probably know, the small business administration's fiscal year end is September 30 and their national rankings have already been published for the year. BBCN is again the top Korean-American Bank in SBA origination volumes, ranking 13th in the nation among all SBA lenders.
For the SBA's fiscal year ended September 30, 2015, BBCN originated in excess of $240 million in SBA loans, up 11% over the prior year's originations. So congratulations to our SBA team and front line for another strong performance in SBA lending.
Overall, our third quarter originations consisted of 54% fixed rate loans and 46% variable rate. Reflecting the highly competitive market for loan pricing, we saw a drop in the average rate on new loan originations to 4.23% in the third quarter from 4.29% last quarter. Entering the fourth quarter we continue to have a very healthy loan pipeline. In particular, our SBA loan pipeline is exceptionally strong and we expect to have one of the strongest quarters ever in SBA loan originations for the three months ending December 31, 2015.
Overall, we are expecting to close out 2015 with another solid quarter of loan production. With our loan growth year-to-date at 7.3% and given the healthy loan pipeline that we currently have, we are revising our previous guidance of high single digit loan growth and now expect loan growth for the full year to reach the low double digits.
With that, let me now turn the call over to Doug to go over our financial results in more detail. Doug?
- CFO
Thank you, Kyu. As usual, I will limit my discussion to just some of the more significant items in the quarter, since we provide quite a bit of detail in our press release.
Our net interest income increased by $1.4 million from the preceding second quarter. The increase was driven primarily by a 3%, or $176 million, increase in our average loan balances and, to a lesser extent, an increase in our securities portfolio. Compared with the prior quarter, the impact of purchase accounting benefits was unchanged, at $4.3 million. At September 30, we had approximately $15 million in accretable discount remaining on all of the acquired portfolios.
Excluding the impact of purchase accounting, our core net interest margin decreased by three basis points from the preceding quarter. The decline was due to lower FHLB dividend income than the preceding quarter, where we benefited from a special one-time dividend of $923,000. Also impacting the NIM was a modest decrease in average loan yields of 4 basis points and a 2 basis point increase in the cost of deposits.
Moving on to non-interest income, we saw an increase of $2.7 million, or 25%, from the preceding second quarter. The increase was driven by a few particular items. First, our gain on sale of SBA loans was 9% higher than last quarter. We sold $42.4 million in SBA loans during the third quarter, compared with $35.2 million last quarter.
The premium in the secondary market continues to average approximately 10%; however, the actual premium depends on the type and dollar size of the property. Of our SBA loan sales this quarter, we had a couple of larger sales which demanded lower than our usual average premiums. This impacted the overall average for the quarter.
Second, we had $334,000 in gains on sales of OREO, compared with $73,000 in gain last quarter. Third, we recognized a higher than normal level of OREO-related rental income this quarter of $1.7 million, which was recorded in the other income line. Net of related expenses and taxes, this benefited our bottom line by approximately $670,000.
Turning to non-interest expense, there were minor differences between the quarters, but most items were in the normal range of variance and overall expense levels were essentially flat with the preceding quarter. Our salaries and benefits expense was up by approximately $500,000 from the second quarter, which was primarily due to project-related temporary staffing costs.
And although we incurred approximately $500,000 of expense associated with the OREO properties that generated the rental income just discussed, our overall credit-related expense was approximately $600,000 lower than last quarter. So overall it was another good quarter of expense management and, with our revenue growth, our efficiency ratio improved to 47.3% from 49.6% last quarter.
Moving on to the balance sheet. Kevin and Kyu already discussed the loan portfolio, so let me start with some brief comments on our securities portfolio. The portfolio increased by approximately $102 million, or 12%, from the end of the prior quarter. This continues the ongoing buildup we have had in the securities portfolio to get it back within our targeted percentage of earning assets.
The securities we purchased were primarily mortgage-backed securities and municipal bonds and had an average yield in the range of 2.35%. The new securities were consistent with the duration profile that we target and the overall portfolio continues to have an effective duration of approximately 3.4 years.
Turning to deposits. Our total balance has increased by approximately 5% during the quarter. The growth primarily occurred in money market and time deposits.
Our end of period balance of non-interest bearing deposits was down by approximately 3% from the end of the prior quarter, which was attributable to a few transactions associated with larger client relationships. On an average basis, however, our non-interest bearing deposits were up a bit from the preceding quarter.
Moving on to asset quality, we were very pleased with the positive trends we are seeing throughout the portfolio, as well as the low in-flow of new loans into the problem asset categories. On September 30, our non-accrual loans were $32.4 million, down 18% from $39.7 million at the end of the prior quarter. The improvement is largely attributed to the pay-off a few non-accrual loans. As a percentage of total loans, our non-accruals dropped from 54 basis points from 68 basis points.
Total classified loans declined to $179 million at September 30 from $195 million at the end of the prior quarter. This continues a longer trend we have seen in classified loans, which have decreased by 22% over the past four quarters. In general, the decline has been driven by pay-offs, as well as loan upgrades.
We had $1.8 million in gross charge-offs during the third quarter and $2.2 million in recoveries, resulting in net recoveries of $392,000 for the quarter. This continues the extremely low loss experience and strong collections we have had in 2015. Through the first nine months of the year, we have had total net recoveries of $[262,000].
Reflecting the low loss experience and strong recoveries, our provision requirement for the quarter was only $600,000, which covered the growth we saw in the quarter. This resulted in a slight decrease in our allowance to total loans, which was 1.19% at September 30, while our coverage ratio of non-performing loans increased to 82%.
With that, let me turn the call back to Kevin.
- Chairman & CEO
Thank you, Doug. All around, the 2015 third quarter was a strong quarter, reflecting solid execution across all aspects of our business.
We continue to make progress with our new business initiatives, including equipment lease financing, credit card, wealth management and residential mortgage, as we are looking forward to these new business lines ramping up to make more meaningful contributions to our overall business development efforts. With a growing pipeline of loans, we have very strong momentum heading into the fourth and final quarter of 2015.
As we approach the fourth anniversary of the creation of BBCN, I would like to express a few words of thanks to all of our team members and business partners, without whose efforts and contributions we could not have achieved so much.
To date, since the merger of equals, total assets have increased 47%. Our loan portfolio has grown by 60%. Our total deposit base has increased 53%, and quarter-after-quarter, we have been quite consistent in delivering solid financial performance which has led to solid earnings growth year-after-year. Thank you, everyone for your trust and partnership.
Supported by strong and consistent financial performance and steady execution of our strategic initiatives, we believe BBCN is well positioned to enhance the value proposition to our customers, employees and shareholders as the premier Korean-American Bank in the United States.
With that, let's open up the call to answer any questions you may have. Operator, please open up the call.
Operator
(Operator Instructions)
The first question comes from Aaron Deer of Sandler O'Neill and Partners. Please go ahead.
- Analyst
Hello. Good morning, everyone.
- Chairman & CEO
Good morning.
- Analyst
I was hoping to get a little bit more color on the SBA volumes in the quarter and the drop in the gain on sale premium. It sounded like, if I heard you correctly, that the reduction in the aggregate premium stemmed from just maybe a couple of larger loans that were sold, but you generally see the overall premiums holding in at about the same level where they've been running over the past several quarters?
- Chief Lending Officer
Yes. Good morning, Aaron. This is Jason. Yes, during the third quarter sale, we did have two large SBA loans (Inaudible), which we had to provide competency rates. So in terms of premium, it is really indexed by the margin over the (Indiscernible) price. So higher the interest rate, the higher the premium. So in that sense, it kind of brought down the premium overall in the third quarter.
But overall, the secondary market, premium market, is holding very well. And I had a call with one of the secondary market traders and they also expect 2016 will be also a very steady in the secondary market for the SBA lending.
- Analyst
Great. That's very encouraging. And also, it sounds like the pipeline of business that you have coming in, in the SBA, heading into the fourth quarter is also very strong. What do you attribute the strength there to? Have you significantly increased your hiring of SBA lenders, or is it just that they're getting more traction themselves?
- Chief Lending Officer
Well, Aaron, SBA lending is a very competitive lending area, but we mentioned that in the call before. But we opened up an office in the second quarter this year, and we brought in two experienced business development officers whose hitting a really good number and bringing in very solid loans, that we are very comfortable.
And 2016, next year, we anticipate to increase two additional LPOs, as well as continuing to increase the business development officers. So I think we're in the right direction in the SBA lending area.
- Analyst
Okay. Great. Thanks for taking my questions.
- SVP of IR
Thank you.
Operator
The next question is from Julianna Balicka of KBW. Please go ahead.
- Analyst
Good morning.
- Chairman & CEO
Good morning.
- Analyst
Very nice quarter. And I have a few follow-up questions, please, and then I'll step back into the queue. Continuing on onto the SBA conversation, in terms of your comments that the 2016 will also be steady in the secondary market. The last few years, the premiums do seem to be, I think you had said it before, a couple hundred basis points above historical levels. So could you maybe give us some thoughts as to what would make those premiums come back down to historical levels, not in 2016, but in the hypothetical some future year?
- Chief Lending Officer
Well, SBA secondary market really determines by the supply and demand, but most importantly, the demand for this guaranteed product is very high. And even the rate, even the Fed tightens up and increases the rate, given the SBA product is a variable rate, so the premium market will hold up. We noticed the secondary market increase since the third quarter of 2012, so this is actually a third year holding up a very steady premium market. But I think the reason why it is holding well, and continued to well in the foreseeable future, is the fact that I think that there's a lack of investment opportunity out there from the investment perspective. So until that landscape changes completely, I think we will expect a very steady secondary market.
- Analyst
Okay. That makes sense. And then in terms of the originations this quarter, was there any impact from the SBA administration's running out of authorization and being renewed or that was just barely a blip?
- Chief Lending Officer
Just barely a blip, yes.
- Analyst
Barely a blip. Okay. And in terms of your other originations, in your remarks you had said 80% was coming across from commercial real estate and it was very strong business as usual. Two follow-ups to that.
One, in the 18% of C&I, if that includes SBA, could you talk about your outlook and plans from growing just traditional C&I, non-SBA? And two, could you also comment about the seems to be a lower share of reductions or prepayments and repayments this quarter as a relative to your BOP ratio, so is there any trends we should think about there going forward?
- COO
First of all, we do focus on growing C&I loans. So we expect to grow our C&I loans in the coming quarters. What was the second question?
- SVP of IR
The pay-off lower than --
- COO
Pay-off lower than the third quarter of last year. But pay-off was pretty high compared to the second quarter and first quarter. And we try not to compete with the low interest rates, so we did let go of the loans with the lower, getting the lower interest rate offer.
- Analyst
Okay. Thank you.
Operator
The next question comes from Tim Coffey of FIG Partners.
- Analyst
Thank you. Good morning, everybody.
- Chairman & CEO
Good morning.
- Analyst
I had a question about expenses. Do you have any big planned projects, other than the stuff we've talked about in previous quarters, that would have a material impact on expense growth in forward quarters?
- CFO
This is Doug. No. Well, yes and no. We have an ongoing slate of projects we're working on. In fact, this quarter we probably had more net investment in new projects than most. And the thing we try to do is at all times try to have a number of cost containment and cost control strategies going to try to offset that. So in terms, going forward we continue to hope to grow our revenues faster than expenses. We clearly target to have our efficiency ratio less than 50%, and I don't see any big blips upward in expenses coming in the near term.
- Analyst
Okay. Thanks. And then the REO rental income, is that something that could stick around for a little bit?
- CFO
Not at that level. It was a bit of a protracted settlement process involving a couple of large properties, so we ended up collecting a sizeable amount of rental income and, in fact, paying about $0.5 million of the related expenses on those same properties in the same quarter. It's certainly not unusual to have rental income, but we won't have it at that levels, necessarily, in future quarters.
- Analyst
No, you're absolutely right. It's not unusual. What would be a normal level for any quarter?
- CFO
Fairly minor.
- Analyst
Okay. Well, great. Those are all my questions. Thank you.
- SVP of IR
Thank you.
Operator
(Operator Instructions)
Next is a follow-up from Julianna Balicka of KBW. Please go ahead.
- Analyst
Good morning once again. Thank you for letting me step back in. In terms of expenses and in regards to developing the new business, could you give us maybe some dollars, some quantification around your expense spending that you've been making that's related to business development or maybe infrastructure versus how much -- because you referenced cost containment in your press release -- how much dollars of expense savings you've been able to achieve this quarter and maybe some outlook for efficiency ratios going forward?
- CFO
Boy, that's a lot in one question, Julianna. I will say we probably had $0.5 million of what I would consider project-related expenses in the quarter, which we would consider not run rate, as far as those particular projects recurring. I think we always expect there to be some of that in every quarter, however, so maybe the next quarter or two might be a couple hundred thousand dollars less than that. The key thing for us is -- and having spent that money, our expenses were still flat for the quarter to down slightly, which is basically the magnitude of the other things.
The nature of cost control in a bank when I've been working on, it's not one thing, it's not two things. It's 40 things. I don't have a $0.5 million answer for one thing we've done, but we're trying to work on 40 things which are $20,000 or $40,000 or $50,000 or $100,000, which is why we keep coming back to talking about the efficiency ratio, which is the net impact of all those internal efforts. And we are aiming and expecting to stay under 50% there for the near term.
- Analyst
Okay. Very good. And then in terms of deposits, you had started to talk about them in your prepared remarks, could you give us a little bit of thoughts as to -- your loan to deposit ratio has been consistently around 100%, plus or minus 1%, for quite some time. So is this a level that we should just -- do you feel comfortable with going into a rising rate environment, or do you think that you might need to, at any point, expand deposit growth? And maybe, how come your DDAs didn't grow as strongly this quarter?
- CFO
Well, as we alluded to the comments, our DDA growth has really been fairly steady and nice over the entire history of the merger. We've had pretty steady growth of DDA. And we have quarter to quarter aberrations in that longer term trend, driven by the activity in a handful of very large dollar customers. And that variability in this quarter was downward, as we had some money move out in a couple of our very large customers. I don't see any change in the longer term trend that we're bringing on net DDA of core customers on a quarter by quarter growing basis going forward.
- Analyst
Okay. And final question and I'll step back. Could you give us an update on your opening of the branch in Seoul or around any -- or the branch in general, color on what's going on there?
- Chairman & CEO
This is Kevin. We are currently in the process of discussing with Korean regulators, and we don't believe that we have any obstacles in opening a branch in the first quarter, or first half of next year, as we originally planned.
- Analyst
And do you have any updated expectations for them as contribution to growth fees? I know you've before talked about the fees from that branch will offset what you otherwise now spend on correspondent banking expenses. But do you have any updated color on what the impact will be?
- CFO
I think that guidance is still pretty good. The near-term prognosis is that after opening the branch, the net contributions within really a couple quarters will be positive just from the benefit of foreign exchange fees. Longer term, you're going to see the benefit in related to some of the questions we had earlier in things like C&I growth in the United States, as we help penetrate that market starting overseas.
- Analyst
Okay. Very good. Thank you very much.
Operator
Next is a follow-up from Aaron Deer of Sandler O'Neill and Partners. Please go ahead.
- Analyst
Hello, guys. Kyu, I just had a difficult time hearing you earlier. I think you're away from the microphone. But could you repeat, what was the number that you gave for the line, you said, amongst your commercial customers? And can you tell us where that was a year ago?
- COO
It was 51% (Inaudible) quarter. And if you have another question while you're talking about that, I'll look that up.
- Analyst
Maybe just give us the total balances, as well, relative to in terms of dollar amount.
- Chairman & CEO
Total dollar amount outstanding on commitments?
- Analyst
Yes, on the line of commercial line commitments.
- CFO
It's about $570 million.
- Analyst
Okay.
- Chief Lending Officer
And you also wanted the utilization rate for the --
- Analyst
I was curious what the utilization rate was a year ago relative to this 51% number here in the third quarter of 2015.
- Chief Lending Officer
Unfortunately, I don't have that data on hand. I only have the data from the quarters.
- COO
I'll have it in just a second. It was 53% a year ago.
- Analyst
Perfect. Great. Thanks so much.
Operator
The next question comes from Don Worthington of Raymond James. Please go ahead.
- Analyst
Good morning, everyone.
- COO
Good morning.
- Analyst
Just wondering if you could provide a little color in terms of the strength of lending in the markets outside California during the quarter?
- COO
As we have mentioned in the past, we are very pleased to see that we are making progress in Pacific Northwest market. For the Midwest market, it's a little slower than we expected. But our Midwest market continues to be a very good source of deposit gathering for us to fund our loan growth.
- Analyst
Okay. Great. Thanks, Kyu. And then any comments on the outlook for M&A, any opportunities that may be there?
- Chairman & CEO
Well, Don, as we have stated many times, we are in a growth mode, both organic and strategic. So we remain very interested in M&A opportunities that would enhance our presence in both existing and new markets. Obviously, any deal which is large or small would have to make financial sense and fit in, fit within our acquisitioned models. So the short answer is, we are very interested in pursuing deals which would make sense for us.
- Analyst
Okay. Great. Thanks, Kevin.
Operator
And the next question comes from Gary Tenner of D.A. Davidson. Please go ahead.
- Analyst
Thank you. Good morning. Just had a quick question about future expansion on a de novo basis. If you look at the markets where you've got LPOs but don't have branches today, which of the markets do you think would be the most likely avenue for you guys to put a full service office in?
- Chairman & CEO
Well, obviously, Texas is a good candidate area. So is Alabama and Georgia area. Southeastern states are the area that we do not have full service, physical full service branches, but where we have some good size potential customers. So logically, those areas have priorities over the other possible areas.
- Analyst
Okay. And as you look at that Georgia, Alabama market and you've had the LPO there, how has the -- as you've tried to cross sell into the Korean auto makers and suppliers, excuse me -- how has the success been there from a production standpoint?
- COO
Well, we've been very active in making loans in the area for the Korean subsidies. And we also have a good CMS, cash management service product, that we offer to those companies and we attract sizeable deposits also from that area.
- Analyst
Okay. Thank you.
Operator
And next is another follow-up from Julianna Balicka of KBW. Please go ahead.
- Analyst
In terms of the -- hello. Thank you. In terms of the Washington, DC branch, that area branch that you are planning on opening, do you have any outlook for how quickly that can ramp up in terms of deposits or loan size contributions?
- COO
Well, we expect to open the branch at the end of this year, and we think that the area is pretty good for deposit gatherings for us. So probably the first or second quarter that we will see meaningful contributions from that market.
- Analyst
Okay. And then going back to the capital growth and M&A question that was posed. For the, I guess, nine quarters now you've been at an 11% TCE and you've been in growth mode all of those nine quarters, so should we think about the 11% TCE as your steady state and that is kind of where you're not going to vary from there, or at what point do you think about a more active capital management from the perspective of dividend increases? You increased $0.01 today, yesterday. Or maybe buybacks or anything like that in regards to how much capital do you need for the growth that you've been achieving?
- CFO
I still think we're looking at a year to 18-month period where we're thinking of a lot of potential ways to deploy that capital internally through growth or special projects or through deals, and probably want to keep that powder dry for the next few quarters to not miss those opportunities.
- Analyst
And the Korean branch does not require any particular capital levels or anything like that?
- CFO
That's correct.
- Analyst
Okay. All right. Thank you.
Operator
There are no other questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.
- Chairman & CEO
Thank you. Thank you again for joining us today and we look forward to speaking with you next quarter. Thank you, everyone.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.