Q3 2023 RBB Bancorp Earnings Call

Participants

Alex Ko; Executive VP & CFO; RBB Bancorp

Catherine Wei

David Richard Morris; CEO & Director; RBB Bancorp

Johnny Lee; President & Chief Banking Officer; RBB Bancorp

Kelly Ann Motta; MD; Keefe, Bruyette, & Woods, Inc., Research Division

Nathan James Race; Director & Senior Research Analyst; Piper Sandler & Co., Research Division

Robert Andrew Terrell; Analyst; Stephens Inc., Research Division

Presentation

Operator

Good day, everyone, and welcome to the RBB Bancorp's Third Quarter 2023 Earnings Call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Catherine Wei. Ma'am, the floor is yours.

Catherine Wei

Thank you. Good day, everyone, and thank you for joining us to discuss RBB Bancorp's results for the third quarter of 2023. With me today is Chief Executive Officer, David Morris; President, Johnny Lee; Chief Financial Officer, Alex Ko; Chief Credit Officer, Jeffrey Yeh; Chief Administrative Officer, Gary Fan; and Chief Risk Officer; Vincent Liu.
David and Alex will briefly summarize the results, which can be found in the earnings press release and investor presentation that are available on our Investor Relations website, and then we'll open up the call to your questions.
During this conference call, statements made by management may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based upon specific assumptions that may or may not prove correct. Forward-looking statements are also subject to known and unknown risks and uncertainties and other factors relating to RBB Bancorp's operations and business environment, all of which are difficult to predict and many of which are beyond the control of the company. For a detailed discussion of these risks and uncertainties, please refer to the documents, the company has filed with the SEC. If any of these uncertainties materialize or any of these assumptions prove incorrect, RBB Bancorp's results could differ materially from its expectations as set forth in these statements. The company assumes no obligation to update such forward-looking statements unless required by the law.
Now I'd like to turn the call over to RBB's Chief Executive Officer, David Morris. David?

David Richard Morris

Thank you, Catherine. Good day, everyone, and thank you for joining us today. We are pleased to be awarded a $5 million CDFI ERP award by the U.S. Treasury in the third quarter. We believe it's a real testament to our ongoing efforts to support the communities in which we operate, and we intend to use the funds to help low- and moderate-income communities recover from the COVID-19 pandemic by investing in their long-term prosperity.
We were also pleased to reach our target 95% loan-to-deposit ratio in the third quarter. As we mentioned, this has been one of our strategic priorities and now that we have achieved it, we expect to resume deposit supported loan growth, which will enhance our profitability and margins. Johnny, who joined us as President in the second quarter has done an excellent job developing a pipeline of high-quality commercial loans that we expect to originate beginning in the fourth quarter.
As part of the deleveraging process, we have also taken steps to de-risk our loan portfolio by reducing our exposure to certain loan categories that we believe could be at risk in a higher for longer interest rate environment. While we believe these proactive approaches to managing our balance sheet will help protect us against potential credit losses, it also impacted our margin and interest income, as the exited loans tended to carry higher interest rates.
The decline in yield on loans held for investment during the quarter was a direct result of the reduction in high-yielding loans as we sought to de-risk our balance sheet. These actions, when combined with the additional pressure of deposit costs, negatively impacted net interest income and net interest margin, which declined to 2.87% in the third quarter.
We expect NIM to decline in the fourth quarter due to continued pressure on deposit cost and loan yields, but we expect the redemption of the $55 million of sub debt will benefit NIM in the future.
Credit remained broadly stable in the third quarter, but we did take a $2.2 million charge against a specific loan that we hope to have off our books in the fourth quarter. We are optimistic that our proactive loan de-risking, combined with the third quarter charge-offs and provisions have positioned us for improving credit over the coming quarters.
With that, I'll hand it over to Alex, who will discuss the financial results. Alex?

Alex Ko

Thank you, David. Slide 3 has a summary of third quarter results. The decrease in loan yield that David discussed resulted in a decline in interest income, while continued pressure on deposit costs led on increase in interest expense. The decline in net interest income was offset by sharply higher non-interest income, which benefited from the $5 million CDFI award.
Noninterest expenses decreased by 8.9%, primarily due to a reduction in legal and professional fees, as the insurance we have referenced in the past began to cover a significant portion of investigation-related legal expenses. We continue to closely manage expenses and anticipate total noninterest expenses to be approximately $70 million in the fourth quarter, before a temporarily seasonal increase in the first quarter of next year.
As David mentioned, third quarter net interest margin decreased 50 basis points to 2.87% due to the impact of decreasing loan yield, lower loan balances and increase in deposit cost.
Slide 4 includes summary balance sheet information, and you can see that the decline in net loans held for investment. The net loan-to-deposit ratio at the bank level at the end of the third quarter was 95.4%.
Slide 5 provides additional detail about our loan portfolio, which totaled $3.1 billion at the end of the third quarter with the annualized yield of 5.99%. Commercial real estate loans, which include construction and land development loans comprised 46% of our total loans.
And Slide 6 and 7 have some details about our exposure. Our CRE office loan exposure stands at $45 million and represents 1.4% of total loans and has an average weighted LTV of 62%.
Slide 8 has details about our $1.5 billion residential mortgage portfolio, which mostly consists of non-QM mortgages in New York and California with an average LTV of 61%.
Slide 10 has some details about our deposit franchise. Total deposits decreased by $21 million from the prior quarter. The decrease was mainly from a decrease in time deposits under $250,000.
Non-interest bearing deposits decreased slightly from the prior quarter. However, the pace of reduction of non-interest bearing deposits significantly slowed in Q3 compared to Q2. Our average cost of interest-bearing deposits for the quarter was 3.83%, up 36 basis points from the last quarter.
It's worth noting that the pace of increase has slowed significantly from 72 basis points in the second quarter and 82 basis points in the first quarter. We continue to expect the pace of increases in deposit costs to slow in future quarters.
Slide 12 provides some details on credit. Non-performing loans decreased to $40.1 million from $41.6 million from the last quarter due to $2.2 million partial charge-off of 1 large loan. We are cautiously optimistic that the remaining balance of this loan will be resolved in the fourth quarter with no additional losses.
Delinquent loan increased by $12 million from the prior quarter, mainly due to one large delinquent loan. However, after the end of the quarter, the delinquent loan balance decreased by $16 million after a non-credit related -- temporary delay in payment of the large loan was corrected.
Apart from the $2.2 million charge-off, credit quality remained stable. Our allowance for credit losses remained stable at 1.36% of total loans. Our capital levels remain strong with all capital ratios well above regulatory well capitalized ratios.
With that, we are happy to take your questions. Operator, please open up the call.

Question and Answer Session

Operator

Certainly. (Operator Instructions) Your first question is coming from Nathan Race from Piper Sandler.

Nathan James Race

Appreciate the commentary around the pressure to the margin in the quarter. And it sounds like you guys are expecting additional compression at least in the fourth quarter as well. I was kind of wondering if you can kind of just frame up the magnitude of pressure that you're expecting into the fourth quarter and early next year, assuming -- the rate hikes stop from here?

Alex Ko

Sure. I'll be happy to do that, Nathan. As you mentioned, our net interest margin actually compressed this quarter, actually more than what we expected in the second quarter. And the reason for the larger compression was due to our de-risking strategy, as David mentioned. There is a large amount of payoffs and paydowns, especially payoff for the second quarter, but the level of the payoff came down in the third quarter. As an example, $165 million paid off in Q2, so $36 million payoff in the third quarter. And I would expect there is 1 large loan that will be paid off in the fourth quarter. That will have a higher interest rate. It will maybe impact maybe negatively to further compress loan yield and net interest margin. But that's the only one that I think will have a negative impact on the loan yields and the margin.
Related to deposit costs, as I mentioned, non-interest bearing deposits didn't decrease that much and also time deposits on the 250,000 increase. But I think the level of the increase on the deposit cost will slow down in Q4 and more slowdown or even stabilize next year. So that's a true net interest income and margin impact. Also, as David mentioned, we are expecting to redeem our sub debt, total $55 million on December 1. So Q4 impact, it will be minimum, but it will -- more positively impact in Q4 as well as next year, because the rate was 6.18% and quarterly -- or annually actually about $850,000 we could have saved going forward. But any also, with all those in the combination of the loan deposits and redemption of the sub debt, we would expect to compress in Q4, a little bit more, but not to the extent that we have seen a 50-basis point reduction in Q3.

David Richard Morris

I also think it depends on what the Fed does. If the Fed increases rates now or in November, which most of us do not believe anymore? We would have probably less -- compression on the loan side, then we'll see if they do not increase rates. Okay.

Nathan James Race

Got it. Understood. And Alex, I couldn't quite catch in terms of the amount of kind of non-core runoff that you had in 3Q and subsequent. I think you guys had about $320 million in kind of non-core loans that you guys are looking to runoff going forward. So I guess I'm just curious where those balances stand going forward?

Alex Ko

Are you referring to the Q4 loan expected payoff? I just want to make sure I hear it correctly.

Nathan James Race

Yes, I'm just trying to understand how much more in kind of non-core loans you guys have remaining as of today?

Alex Ko

Yes, I believe we are talking about a $57 million if you're asking me the dollar amount. And I think that's the only loan that we are aware that we strategically decided to let go or refinance by other -- our competitors.

Nathan James Race

Okay. Got it. And then just curious around any additional color you can provide on the charge-off in the quarter. It sounds like it came from 1 loan in particular. So any other color on that would be helpful?

David Richard Morris

Okay. Yes. I'll talk about it first and other people can chime in. It's a -- it was -- it still it's a $12 million loan on the books that we've charged off $2.2 million. The reason for the collateral value decreases -- at least according to the appraisal is due to this millionaire's tax where it is in the city of L.A. and it's a block away from Beverly Hills, which does not have a millionaire's tax. So with the new appraisal, we charged-off, they do have an offer on the place that would get us out a whole right at the moment. And we'll see if that can be closed by the end of the year.

Nathan James Race

Got it. If I could just ask one more on kind of the expectation for share repurchases continuing. Any thoughts on perhaps when that could occur? And any governors that we should be monitoring in terms of perhaps resuming share repurchases going forward?

David Richard Morris

We're very optimistic that we'll be able to resume our repurchase in the November time frame, we're hoping, mid-November. Okay.

Nathan James Race

Great.

David Richard Morris

433,000 shares left.

Operator

Your next question is coming from Andrew Terrell from Stephens.

Robert Andrew Terrell

I wanted to follow-up on some of the questions around the margin, just to make sure I understand maybe the magnitude of how we should think about the move in the fourth quarter. Do you have the spot cost of deposits at the end of the quarter, either total or interest-bearing?

Alex Ko

Yes, Andrew. Let me give you a breakdown of the spot rate for the deposits now and MMA accounts, we have about 2.5% combined. And the savings account, we have about $134 million. The spot rate for that is 1.15%. And CD, let me break it down between those 2, under $250,000 and over $250,000. On the $250,000 CD, the spot rate is 4.43% and CD over $250,000 the spot rate is 4.5%.

Robert Andrew Terrell

Okay. That's incredibly helpful. I really appreciate it. And then similar question just on loans as well. I'm trying to understand the timing throughout the quarter of -- when the paydown occurred, the weighed on the loan yields. It might be easy if you have just like the exit spot loan yield on the loan portfolio or how it's trending so far in the fourth quarter?

David Richard Morris

Well, right now, for the fourth quarter, we haven't had significant runoff at all in the fourth quarter. We expect, we have a $20 million mortgage loan sale that's closing today. And they're about 6.75% coupon. And then we have this one $57 million, which is at a 9.5%.

Alex Ko

9.5%.

David Richard Morris

9.5%. And we don't know exactly when that's going to roll off. It's currently on our books today. We expect that it would be rolling off by November 15. It's supposed to go by the end of this month, but it's only a week away, so.

Alex Ko

Yes, Andrew, let me give you a little bit more color if that will be helpful on your model of the margin. Like we had about $45 million of loan originated for the Q3. We've been talking about the payoff and pay down, but the rate was not bad and the average rate of 9.75% and we will continue to originate our loans. And obviously, we're deleveraging the high-risk loans. That's one point. Second point, the margin compression for the quarter was due to the payoff paydown. And I did mention $165 million in Q2 and $36 million in Q3. And other than that $57 million that we talked about, that should be it. So, I think that will give you an idea of the loan yields and the margin side of the equation.

Johnny Lee

Yes. In addition to that -- $57 million, and at the most we are expecting it less than $10 million.

Alex Ko

Yes, normal.

Johnny Lee

Right, normal interest paydown, payoff, paydown.

Robert Andrew Terrell

Okay. Understood. Okay. I appreciate it. And then maybe just 1 more question around the expenses. It sounds like about $17 million or so in 4Q. And then if I heard you right, a little bit of a seasonal lift into the first quarter of next year. Just wanted to get maybe updated expectations on -- in this kind of operating environment, how you're thinking about managing expense growth. Is that $17 million number, something you think you can kind of manage around throughout the balance of 2024? Or should we expect some expense growth off that base, as you -- kind of continue to reinvest in other franchise?

Alex Ko

Yes. Maybe I can attempt to answer for that. Yes, the basis for the $17 million in Q4 was based on the fact that our legal and professional fee expense will be much smaller than the previous quarters and even smaller than the Q4, given about 85% or even higher of those SEC investigation -- investigation-related expenses -- it used to be $1 million will be covered by the insurance. So that is the biggest contributor for the reduction of legal expenses. But also, as you know, we did have some mature weaknesses and a lot of outside terms of advisory, consulting services, not to mention the credit related. We want to make sure the reviews by third-party CECL-related some validation, all those professional fees, I would expect that will go down.
So $17 million is the one that we expect in Q4. But if you're asking me the run rate for '24 and going forward, I think it can be even lower than $17 million. But the -- like salary and benefit expenses, obviously, we are very careful in managing the salary and benefit expenses. But if we really grow, we need to hire the qualified employees. But I think overall, the run rate for Q4, I would feel comfortable about $17 million in 2024. It can be even lower or higher, but in the neighborhood of $17 million caveat is a Q1 on seasonal kind of high expenses.

Operator

(Operator Instructions) Your next question is coming from Kelly Motta from KBW.

Kelly Ann Motta

I was hoping maybe you could provide us with an update on the SEC investigation. It was nice to see the insurance kick in, so it's not dropping down to expenses, but I was wondering if you had any idea in terms of potential time line towards resolution?

David Richard Morris

Well, if you know how the SEC works, they don't tell us anything. So, we really cannot really comment on, where they are. We just know where they are based upon if they're asking us for a bunch of information. And that has significantly that's pretty much has slowed down and stopped.

Kelly Ann Motta

Got it. And I know gateway was terminated. Just wondering as we look ahead, is that San Francisco market still one that you're interested in getting in? And does this shift at all your appetite for M&A versus potentially de novo branches or things like that in order to drive expansion into new markets as you've done in the past?

David Richard Morris

Okay. It depends on the type of acquisition. But yes, we are -- after a while, we would be -- we would entertain an acquisition in San Francisco. And we would also look at local market here or local markets where we already have branches where we can get significant cost savings much more than your typical 30% to 40%, something closer to a 70% or 80% cost save. And that would like -- that would make a lot of sense, because there's a lot of duplication, especially here in L.A., there's 17 or more Chinese American banks, and we all have branches on Valley Boulevard, maybe multiple branches on Valley Boulevard, and it doesn't make sense that we have 17 banks serving the same market. So, but right now, it is not on the radar screen. Okay?

Kelly Ann Motta

Got it. And then in terms of -- now that you're down to your targeted loan-to-deposit ratio, just wondering where you're seeing the best opportunities for growth by category, if there's any particular industry or segment where you're seeing more attractive risk-adjusted returns.

David Richard Morris

Yes. Go ahead, Johnny.

Johnny Lee

It's Johnny. Well, we -- there's no -- obviously, there's still a lot of demand for construction, CRE-related type of loans and -- all because there's not too many lenders right now that are very keen on want to do more construction loans. But for us, obviously, that's an area that we still continue to look at case-by-case on opportunistic basis.
If there's good quality experience, development, good track record, certainly we still look at that. On the non-construction CRE side, on the C&I types of businesses, certainly, for example, SBA where you have SBA lenders only there -- we see demand there. But obviously, we're very selective even though these are government guarantee types of credits. But for C&I, there's certain demand here, but this we just reached a 95% loan-to-deposit ratio -- and now obviously, we are better positioned now to sort of to launch our lending. So on the C&I side, certainly, we will be pursuing a little bit more on an elevated basis, but still very selective at this point.

Operator

There are no further questions in the queue.

David Richard Morris

Okay. I would like to thank everybody for joining us today. You all have a good day. Thank you. Bye-bye.

Operator

Thank you, everyone. This concludes today's event. You may disconnect at this time, and have a wonderful day. Thank you for your participation.