Luther Burbank Corporation
Q1 2020 Earnings Call Transcript

Published: 12 May 2020

[Operator:]

Good morning, and welcome to the Luther Burbank Corporation First Quarter 2020 Earnings Conference Call. [Operator Instructions]Before we begin, I would like to remind everyone that some of the comments made during this call may be considered forward-looking statements. The company’s Form 10-K for the 2019 fiscal year, its quarterly reports on Form 10-Q and reports on Form 8-K identify certain factors that could cause the company’s actual results to differ materially from those projected in any forward-looking statements made this morning. The company does not undertake to update any forward-looking statements as a result of new information or future events or developments. The company’s periodic reports are available for the company or the online company’s website or the SEC’s website. I would like to remind you that while the company’s management thinks the company’s prospects for performance are good, it is the company’s policy not to establish with the markets any earnings, margin or balance sheet guidance.I would now like to turn the conference over to your speaker today, Simone Lagomarsino, President and CEO. Please go ahead.

[Simone Lagomarsino:]

Thank you very much. Good morning, and welcome to the Luther Burbank Corporation 2020 first quarter conference call. This is Simone Lagomarsino, President and CEO and with me today are Laura Tarantino, our Chief Financial Officer and John Cardamone, our Chief Credit Officer.We are in the midst of an unprecedented and challenging economic environment, which is the result of the COVID-19 pandemic. Our primary focus over the past 2 months has been the health and well-being of our employees, our customers and our communities, while also ensuring that we maintain the safety and soundness of our operations. We believe that our strong liquidity and capital levels as well as our historical approach to credit quality leading into this crisis, position the company well to navigate our path forward during these uncertain times.I will focus first today on our risk profile. Over the past 36 years, we have been profitable every quarter, except the very first quarter of operations. This consistent profitability throughout all economic cycles was achieved because we have adhered to maintaining a strong risk profile and credit standards. These standards are reflected in the overall quality of our asset base. At the end of the first quarter, cash, investments and real estate loans represented over 98% of our assets. Our securities portfolio is almost entirely comprised of high-quality liquid investments with little to no risk for impairment. Our loan portfolio is 100% real estate secured with an overall weighted average loan-to-value ratio of 59%. Multifamily and single-family residential real estate loans represent over 96% of our total loan portfolio. Less than 4% of our loan portfolio is secured by nonresidential commercial real estate, and we have minimal exposure to the market segments most acutely impacted by the pandemic, including hospitality and retail, and no exposure to energy or travel. Additionally and most significantly, we have no exposure to C&I loans. A granular breakdown of our non-residential commercial real estate portfolio is available on Page 6 of our presentation deck.We believe that the residential real estate concentration in our loan portfolio and the lack of exposure to C&I lending, credit cards and auto loans, provides a strong risk profile for the current circumstances and set us apart from many of our peers in the industry. The full economic impact of the COVID-19 pandemic is currently unknown. However, we think it is important to recognize that regardless of what lies ahead, people will still need a place to live. Additionally, the supply of housing in our primary markets was not sufficient to support the demand leading into this pandemic. And we do not anticipate that this dynamic will change as a result of the pandemic.In early March, in response to the COVID-19 pandemic, our incidence response plan was implemented. We immediately began taking precautionary steps to protect our workforce and preserve our ability to serve our customers, including prohibiting employee travel, enhancing routine sanitization of our branches and our corporate offices and enforcing social distancing and other safety protocols. We’re pleased to report, as a result of these actions, that none of our employees have tested positive for the virus to date.Our existing technology infrastructure, with a few minor enhancements, effectively accommodated and continues to accommodate approximately two-thirds of our staff who are working remotely. We implemented flexible employee schedules and reduced branch hours to ensure that our employees could be responsive to our customers, work safely and balance their family needs and responsibilities. We elevated and enhanced customer communications being via mailings and website postings to remind our customers about telephonic, online and mobile options for transacting business. We also encouraged our clients to exercise heightened awareness around cyber fraud and particularly in relation to COVID-19 schemes. Throughout this process, we have witnessed a significant change in branch foot traffic. Historically, before the pandemic, customers primarily conducted their transactions in person. Now a significant number of our transactions are handled over the phone.I am proud to report that all of our branches remain open. And as always, when any deposit or loan customer calls our bank during business hours, they do not reach an automated system, but instead, a company representative answers the phone and is ready to serve their needs. To assist our borrowers who have been directly impacted by this health crisis, we’ve established a prudent customer-friendly loan payment deferral program. Our program allows certain borrowers to defer their monthly P&I obligations for 3 months, or 6 months for borrowers in our first-time homebuyer program, where the scheduled maturity of the loan is equally extended and the deferred interest payments are capitalized to principal and repaid over the revised term of the loan.As of April 30, we have received completed loan payment deferral applications of 166 loans, with principal balances totaling $253 million, representing approximately 4% of of our total loan portfolio balance. Through April 30, we completed modifications for 64 loans, with a total principal balance of $85 million, representing 1.4% of our loan portfolio. Please refer to Page 8 of the presentation deck for more information regarding our COVID-19 payment deferral hardship program. The foregone cash flows associated with the 166 loans that have provided completed applications is approximately $1.4 million per month and can be readily supplemented with our available liquidity resources, totaling more than $1.9 billion at March 31, as shown on Page 5 of our presentation deck.Based on the flexibility afforded by Section 4013 of the recently enacted CARES Act, the vast majority of loan customers who receive a COVID-19 modification will have their payment status reflected as current and will continue to accrue interest monthly in our financial records. As would be expected, each loan that is approved for COVID-19 modification will be added to our internal watchlist and will be subject to increased monitoring. It is not clear whether applications for credit relief will increase or subside over the coming months. The only anecdotal evidence gathered to date is that call volume inquiring about our payment deferral programs has decreased over the past 2 weeks. We believe that our desire and willingness to support our borrowers during this difficult time will reinforce our culture of providing superior customer service, both in good times and in bad, without materially impacting the credit support of these loans considering the generally well-secured nature of the portfolio, as evidenced by our relatively low loan-to-value ratios.We elected not to participate in the Paycheck Protection Program given the nature of our customer base, which includes only a minimal number of small business customers. However, our company remains committed to providing essential residential real estate lending services. Although we have taken steps to temporarily tighten our credit underwriting standards due to the potentially protracted period of the pandemic and the related unknown risks.First, we are no longer entertaining applications for investor-owned single-family homes, single-family second homes, nonresidential commercial real estate loans or construction loans. We’ve reduced loan-to-value ratios for owner-occupied single-family and multifamily loans, the only two loan categories for which we are currently continuing to accept applications. Additionally, debt coverage ratios have been revised and bank control payment reserves of 6 to 12 months are now required on all new multifamily loans, while higher credit scores are mandatory for single-family borrowers. We believe these actions will further support the strong credit quality of our loan portfolio. Nonetheless, we will continue to monitor employment statistics in real estate markets and implement additional protections and changes as necessary.As an emerging growth company, we are not required to adopt CECL until January 2023. And as a result, we did not adopt CECL this quarter. We continue to develop our new model, and had we adopted CECL as of the end of the year prior to the COVID-19 pandemic, indicative loan loss reserve levels were not materially different when compared to our then current allowance which was based on our existing incurred loss model. While it is too early to understand the potential impact of the pandemic on our seasonal modeling, we will continue to analyze this as we learn more about the full economic impact of the virus.Now, turning to our first quarter’s results, our net income for the first quarter of 2020 was $7.6 million or $0.14 per diluted common share compared to $12.5 million or $0.22 per diluted common share in the linked quarter. The notable decrease in earnings was predominantly due to a $5.3 million provision for loan losses, which was recorded entirely to address the uncertain economic consequences of the COVID-19 pandemic. Other contributing factors to the decline in net earnings for the quarter included a $1 million decrease in net interest income and a $1.5 million increase in non-interest expense, with the foregoing expenses somewhat offset by a corresponding $2 million reduction in income taxes.And now I will speak in greater detail to those components. First, our asset quality, as defined by traditional measures, remains very strong and actually improved over the prior quarter. Our criticized loan balances decreased by $10.5 million or 23%, and our nonperforming loans to total loans dropped by 9 basis points from an already low level of 10 basis points as compared to the linked quarter. As a result, absent the onset of the pandemic, the company would have recorded a recapture of loan loss provisions. Instead, we added more than $6.1 million as a qualitative adjustment to our loan loss reserves to specifically account for the uncertain economic impacts of the COVID-19 pandemic. We increased our allowance coverage ratio by 12% from 58 basis points at the end of the prior quarter to a current coverage ratio of 65 basis points.In determining the appropriateness of our total reserve level, consideration was given to 3 key factors

[Laura Tarantino:]

Thank you, Simone. Because we provided a good amount of detail in our earnings release and presentation deck, I’ll spend just a few minutes providing an update on recent trends in our portfolio since the end of the first quarter. As Simone discussed, we have strong loan pipeline. And although we increased loan offer rates at the end of March, the majority of our pipeline loans are at rate loss levels, reflecting interest rate declines experienced during the first quarter of 2020. As a result, second quarter loan originations will likely carry coupons of approximately 25 basis points less than the first quarter level of 3.98%. Also, the interest rate on loan payoffs continues to exceed loan origination rates. These forces as well as the negative carry on our interest rate swaps, currently out of the money by 139 basis points, will continue to pressure our overall loan yield. On a positive note, however, we shall continue to experience additional cost savings in our deposit portfolio. At March 31, the cost of our retail and wholesale deposits measured 1.71% and 1.19%, respectively, as compared to rates of 1.95% and 1.8%, respectively, at the end of the prior quarter. As of the same date, $1.2 billion of retail CDs or 38% of our retail time deposit portfolio, with a weighted average rate of 2.31%, are subject to renewal during the second quarter of 2020. Based on current pricing, we would expect to retain funds or attract new time deposits at a rate approximating 1.25%. Additionally, 91% of our wholesale deposits or $495 million with a weighted average rate of 1.22% at March 31 is also subject to rollover during the second quarter, where market pricing is currently sub-1%.That concludes our prepared remarks. And at this time, we will ask the operator to open the line for questions.

[Operator:]

[Operator Instructions] And our first question is going to come from Gary Tenner from D.A. Davidson. Your line is now open.

[Gary Tenner:]

Thanks. Good morning. I wanted to make sure that I understand kind of how the headwinds from the swap program will kind of show themselves during the second quarter, assuming that there’s no change in rates, which I don’t think anybody expects. You said out of money by 1.39%, I think, Laura. So relative to the first quarter headwind, it seems like the headwind would be less than it was in the first quarter. Is that correct or should it increase because of the full quarter impact of the lower rates on the variable side?

[Simone Lagomarsino:]

Laura, you want to go ahead?

[Laura Tarantino:]

I think it will increase because of the full quarter impact. Nonetheless, we will have offsetting benefits from the deposit portfolio that continues to re-price.

[Gary Tenner:]

Okay. And then just more broadly speaking, what is the impact, do you think, of the eviction moratorium on your multifamily portfolio? How – obviously, you’re extending some, although the request for modifications was more weighted towards your single-family portfolio. What are you seeing from the multifamily borrowers in terms of kind of rents coming in or is it a bit too early to tell?

[Simone Lagomarsino:]

So we have been asking our loan officers to touch base with their clients and in doing that, we have anecdotal information from them. It still appears that a significant number of tenants in many of the properties were paying and I think and John and Laura, correct me if I lose focus. But I think we understood in the 70% to 80%, some as high as 90% of the tenants were continuing to make payments. Now whether that continues into May, how that continues to play out, it’s unknown at this point. But we put the fulfillment program in place to assist those multifamily borrowers who really are impacted negatively because their tenants have been impacted. But because of the way we underwrite our loans, because of the reserves that we look to when we make the loans initially and the strong cash flows that we look to, we expect that many of our borrowers on multifamily, even if they have some tenant impacts, will still be able to make their payments. And John or Laura, if you want to add to that, please do?

[John Cardamone:]

This is John. I thought that was very comprehensive. And yes, the numbers that Simone quoted are what our loan officers are telling us, and we’re pleased with that feedback so far.

[Gary Tenner:]

Okay, thanks. And that 70% to 90%, Simone, that was the April rents that you’re referring to?

[Simone Lagomarsino:]

Correct.

[Gary Tenner:]

Okay. Thank you very much.

[Simone Lagomarsino:]

Again, I want to be careful to say, that’s anecdotal. I mean we haven’t gotten rent rolls to confirm any of that. So it’s really important that I just underscore that.

[Operator:]

Thank you. And our next question comes from Matthew Clark from Piper Sandler. Your line is now open.

[Matthew Clark:]

Hi, good morning. On the non-interest expense run-rate of $16 million to $16.5 million a quarter, can you maybe talk through where you expect to see savings? It sounds like it’s in the comp line and maybe on the marketing side of things or advertising. I just want to double check.

[Simone Lagomarsino:]

Laura, do you want to start on that one, and I’ll follow up, if I may.

[Laura Tarantino:]

Sure. I do think, with the change in interest rates, with the liquidity that’s been brought into the bigger banks, and particularly, we’re seeing a little less competition. Therefore, I think our advertising dollars will be comparatively less than originally planned. Also, we shouldn’t have the payroll taxes headwind that we had in the first quarter or the change in our post-retirement benefits from significant drop in interest rates. Those would be the three largest areas that I would not expect to repeat in the second quarter.

[Matthew Clark:]

Okay. And I think you gave us a couple of deposit rates at the end of March can you give us just the overall spot rate on deposits, whether it’s interest-bearing or total?

[Laura Tarantino:]

Yes, I had them separately for retail, was a spot rate of 1.71 at March 31, on wholesale, a spot rate of 1.19.

[Matthew Clark:]

Okay. Alright, we can work with that. And then on the prepay activity in the single-family resi book I think in your release, you mentioned that the prepaid speeds were down slightly linked quarter to 36.1% versus 36.7%. But in that chart on Page 22 or the graph, it looks like that single-family resi prepaid speed increased more significantly I just wanted to square the two?

[Laura Tarantino:]

Yes, I’m looking at that graph, January, February March.

[Simone Lagomarsino:]

I think it’s because it’s a 12-month rolling average?

[Matthew Clark:]

Yes, that could be it.

[Laura Tarantino:]

Yes. Simone, thank you.

[Matthew Clark:]

Okay, thank you. And then just on the FHLB advances that you have at 2.25%, can you just remind us of the kind of the schedule and how soon those might re-price going forward, let’s say, over the next three or four quarters?

[Laura Tarantino:]

I would say there is very little to re-price in the next three or four quarters. Most of those were hedged term borrowing, so very little to re-price.

[Matthew Clark:]

Okay, okay, great. Thank you.

[Operator:]

And thank you. And our next question comes from Jackie Bohlen from KBW. Your line is now open.

[Jackie Bohlen:]

Hi, good morning. I just wanted to touch base on the loan purchase and see if that’s something you might look to going forward, or if it was a onetime item?

[Simone Lagomarsino:]

I would say it’s a onetime item at this point. We had started – prior to the pandemic, started the process and entered into the agreements. And I think at this point, with our very strong pipeline and with so much unknown based on the pandemic itself that we probably won’t be doing another purchase in the near term.

[Jackie Bohlen:]

Okay. And then in terms of the 2% to 3% growth rate that you spoke of, understanding the push and pull that’s taking place there. The – what’s offsetting the strong pipeline volume that you have, is that more a function of your assumptions on prepayments? Or is it more a function of what you anticipate the changes in underwriting will have on your ability to generate from the pipeline?

[Simone Lagomarsino:]

So there is a couple of factors, again, very strong pipeline today. Some – there will be some impact from the change in our credit underwriting criteria, the tightening of our credit block, so to speak. But also with long-term rates dropping by 130 basis points, we expect that we will see continued high levels of prepayment. What’s kind of unknown also is the level of real estate transactions that are going to be completed, both on the single-family and multifamily in the current environment that we’re operating in, with people staying at home. So that’s the other piece of it that we’re – still unknown. Fewer transactions are being done, so that will impact the growth as well.

[Jackie Bohlen:]

Okay. So it sounds like it’s more a factor of prepayment expectations, understanding that those could be volatile and there is a lot of factors there, than it is a function of changes that you’ve made to underwriting?

[Simone Lagomarsino:]

Well, in the lack of the reduced levels of just people purchasing real estate right now, both single-family and multifamily. It’s more prepayments, potentially, but also the fact that we don’t expect a lot of new purchases of real estate until or further into and coming out of this economic downturn?

[Jackie Bohlen:]

Yes, yes, definitely understood the environment that we are in. And then I just have one more, related to deposit pricing, and I understand the schedule that you have in terms of CDs and everything. The rates that you are currently offering right now on CDS, assuming a stagnant rate environment, have those all been fully re-priced to where you want them or is there a possibility that you could look to lower those from where they are right now, without any further rate movements? Does that make sense what I am asking?

[Simone Lagomarsino:]

Yes. So Laura, do you want to get that?

[Laura Tarantino:]

Yes, it does make sense. I would say, Jackie, where our CD levels are probably appropriate at this time. We sort of gauge it every week, depending on the inflows and outflows. But there definitely are some competitors out there in the market with rates as high as 150 for 12 months, not a lot and we have definitely seen the pressure come down. So at this point, I don’t see a ton of downward movement, although I think, again, it will depend on how long the pandemic goes if we continue to see people bringing liquidity into banks.

[Jackie Bohlen:]

Okay, okay. Thank you. That’s helpful.

[Operator:]

Thank you. And I am showing no further questions. I would now like to turn the conference over to Simone Lagomarsino, President and CEO, for further remarks.

[Simone Lagomarsino:]

Thank you very much. So this does conclude our first quarter earnings call and we hope that all of you who are joining us today will stay safe and healthy, and we look forward to the eventual recovery of our economy and our country. Thank you very much for joining us today.

[Operator:]

Thank you. This completes our call today. A recorded copy of the call will be available on the company’s website. Thank you for joining us. Everyone, have a great day.