Luther Burbank Corporation (NASDAQ:LBC) Q3 2022 Earnings Conference Call October 26, 2022 11:00 AM ET
Company Participants
Simone Lagomarsino – CEO and President
Laura Tarantino – EVP and CFO
Conference Call Participants
Woody Lay – KBW
Adam Butler – Piper Sandler
Gary Tenner – D.A. Davidson
Operator
Good morning, and welcome to the Luther Burbank Corporation Third Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions].
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 facts. Luther Burbank Corporation does not undertake any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. Numerous factors could cause our actual results to differ materially from those described in forward-looking statements. For more information on those factors, please see the company’s periodic reports accessible at the Luther Burbank Corporation website and filed with the SEC.
The presentation today contains certain non-GAAP financial measures that we believe provide useful information about our operational efficiency and performance relative to earlier periods and relative to other companies. For more details on these non-GAAP financial measures and their limitations, including presentation with and reconciliation to the most directly comparable GAAP financials, please refer to yesterday’s earnings release and the related investor presentation, which is available on our website at www.lutherburbanksavings.com.
I would now like to turn the conference over to Simone Lagomarsino, President and CEO. Please go ahead.
Simone Lagomarsino
Thank you very much. Good morning, everyone, and welcome to the Luther Burbank Corporation’s quarterly earnings conference call. This is Simone Lagomarsino, President and CEO. And with me today is Laura Tarantino, our CFO. Today, we’ll review our third quarter financial performance, share our observations on recent trends, and then open the lines for our analysts’ questions.
Our net income for the third quarter was $21 million or $0.41 per diluted share as compared to $22.6 million or $0.44 per diluted share in the linked quarter. The decline in net earnings of $1.6 million was primarily attributed to the rise in market interest rates.
Three key financial components summarize the changes in net income as compared to the second quarter. Our net interest income decreased by $2 million and our non-interest expense increased by $2.1 million, while our provision for loan losses declined by $2 million.
Let me address each of these in more detail. First, our interest income on earning assets increased as a result of loan growth, slower loan prepayments, greater earnings on interest rate swaps and higher loan coupons on new loan originations. Our yield on interest-earning assets during the third quarter increased by 25 basis points compared to the second quarter.
However, higher interest rates on funding costs resulted in interest expense on deposits and borrowings to increase more rapidly given our liability-sensitive balance sheet, where the cost of our interest-bearing liabilities for the third quarter increased by 49 basis points compared to the linked quarter. Our net interest margin for the third quarter measured 2.42%, a decline of 20 basis points from the linked quarter and in line with the guidance that we provided during our last quarter’s earnings call.
Our real estate loans grew by $217 million or 3% from the prior quarter. And year-to-date, our annualized loan growth was 11.8%. Although loan production fell by $203 million during the quarter, both single-family and income property residential loan prepayment speeds notably declined due to higher market rates, which yielded net loan growth for the quarter that was, on a percentage basis, similar to the linked quarter.
The weighted average coupon on new loan originations for the quarter was 4.65% or an increase of 110 basis points as compared to the prior quarter. And average coupons for the loans that we are originating during the fourth quarter continued to rise. At quarter end, the weighted average coupon on loans within our single-family and income property loan pipelines were 5.59% and 4.91%, respectively.
Growth in our loan portfolio for the quarter was funded primarily by wholesale sources, including FHLB advances and brokered deposits, which grew by $247 million and $217 million, respectively, from the linked quarter. Like several other financial institutions, our retail deposit balances declined.
During the third quarter, our retail deposits decreased by $92 million as some customers opted for other investment choices, including U.S. treasuries. Because wholesale funding can be more expensive than retail deposits, the use of wholesale funding to support our growth had a negative impact on our net interest margin.
As a comparison, during the third quarter, our cost of interest-bearing retail deposits rose 48 basis points from the second quarter as compared to a 112 basis point increase in the cost of wholesale deposits for the same period.
Next, I mentioned earlier that our non-interest expense increased by $2.1 million from the linked quarter. This increase was primarily due to an increase in compensation expense of $1.6 million as compared to the linked quarter, which related to a lower amount of capitalized loan origination costs due to a 28% decline in loan origination volume, which I previously mentioned. Non-interest expense was also impacted by higher advertising costs associated with retail deposit generation.
Finally, net income for the quarter benefited from a $2 million reduction in loan loss provisions as compared to the prior quarter. We recorded a $500,000 loan loss provision primarily for net loan growth. Our classified assets declined by $1.8 million during the quarter and remain at a low level of 30 basis points of the total loan portfolio.
At quarter end, September 30, we had only two delinquent loans of the more than 5,000 loans in our loan portfolio. Our nonperforming asset to total asset ratio remains very strong and measured only 5 basis points at quarter end. 72% of our non-accrual loans by balance are paid current. I continue to be extremely proud of our credit quality and expect our loan portfolio to perform well to any potential economic downturn.
Now turning to our balance sheet. Total assets grew by 5% from the prior quarter and 10% on a year-to-date basis and totaled $7.9 billion at September 30, driven primarily by our net loan growth and funded by wholesale deposits and FHLB advances as we previously discussed.
Total stockholders’ equity grew by $5 million during the prior quarter — since the prior quarter, sorry — grew by $5 million since the prior quarter. Our capital position during the third quarter benefited from our net earnings of $21 million, but was partially offset by $10.5 million of unrealized losses on our available-for-sale securities portfolio net of tax as a result of the rising interest rate environment. Our net unrealized loss position on our available-for-sale investment portfolio totaled $44.8 million as of September 30.
Also during the quarter, we returned $6.1 million to shareholders in the form of cash dividends and grew our tangible book value per share to $13.18 per share. Our tangible capital and Tier 1 capital ratios of 8.5% and 10%, respectively, remained strong.
Finally, yesterday, our Board of Directors declared a $0.12 per common share dividend that will be paid on November 14. Although the recent rate environment this year continues to be volatile and challenging, our net income for the third quarter yielded a return on average assets and return on average equity of 1.1% and 12.3%, respectively. We continue to believe, however, that rapidly rising short-term interest rates will challenge our results looking forward.
Due to higher interest rates impacting refinancing activity and activity in the purchase market, we expect loan production to decline in the fourth quarter — in the third quarter as evidenced by the size of our loan pipeline. At September 30, our pipeline totaled $230 million or about 51% of its level at the end of the second quarter.
While loan production volume was slow, we still may realize net loan growth as loan prepayment speeds in both our income property and single-family portfolio declined by approximately one-third as compared to the linked quarter. We continue to expect deposit cost to increase during the fourth quarter as older term accounts mature and repriced to current offer rates and based on the current posturing of the Federal Reserve Board of Governors.
Additionally, since the U.S. banking and — since the U.S. banking industry generally experienced deposit outflows over the past quarter, we expect strong deposit competition throughout the balance of 2022. Consequently, we anticipate continued deposit cost acceleration during the fourth quarter.
As a result, our projections are that our funding costs will outpace improvements in our yields on our interest-earning assets, and that our net interest margin will compress again in the fourth quarter.
And with that, I’ll now turn the call over to Laura for some additional comments.
Laura Tarantino
Thank you, Simone. As usual, I’ll provide some brief, but more granular information, that we consider as we’re analyzing our trends and our projections.
During the fourth quarter, we expect new volumes to be added at coupons exceeding 5.25%. The spot rate on our loan portfolio was 3.71% at the end of the third quarter. Although loan origination volume is expected to slow, new volume, portfolio repricing and slower prepayments should move our yields — our loan yields in a positive direction.
Additionally, at quarter end, 43% of our invested portfolio securities were currently floating, with a weighted average repricing frequency of 2.9 months. So we should also see investment yields improve as interest rates continue to rise.
Moving to deposits. Although retail deposits declined during the third quarter, we generated approximately $200 million this quarter in new money from our advertising campaigns, of which 36% was from customers new to the bank. Digital advertising yielded 1.1 million impressions, with 23,000 visitors to the bank’s website, of which 70% were first-time visitors. Year-over-year, our total households have grown about 18%.
During the fourth quarter of this year, we have $368 million of term deposits, carrying a weighted average cost of 47 basis points scheduled to mature. During the month of September, the average cost of new and renewed term accounts was 2.59%.
At quarter end, our FHLB advances totaled $1.2 billion and carried a weighted average cost of 2.34% and a weighted average term to maturity of 1.7 years. Our third quarter results benefited from the existing interest rate swaps that we had on our books. Net swap income totaled $2.9 million for the quarter.
At September 30, the notional amount of our pay fixed swaps was $1.3 billion, with a weighted average net positive carry to us of 154 basis points and a weighted average of 23.6 months to maturity. As Fed funds continue to rise, our earnings from these derivative positions will improve, and we would expect to add new positions to our balance sheet as we move forward.
Lastly, as to non-interest expense, a level of approximately $16 million for the fourth quarter is anticipated. We would expect higher compensation costs as a result of reduced loan volumes and the lower resulting amount of capitalized salaries. As we work through our current annual budgeting process, we should have a better projection of non-interest expense for 2023 for you next quarter.
With those last comments, we’ll now ask the operator to open the line for questions.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Woody Lay with KBW. Your line is now open.
Woody Lay
Good morning, guys.
Simone Lagomarsino
Good morning, Woody.
Woody Lay
I wanted to first look at the NIM. I believe last quarter, you guided the NIM being down about 50 basis points a quarter, over the back half of ’22 each quarter. Does that still feel like a good run rate going forward or have expectations changed?
Simone Lagomarsino
So you’re correct. Last quarter, we did guide that we expected a 20 to 30 basis point reduction in our NIM on a quarterly basis. And at this point, Woody, we have not projected our NIM in our conference call because it is just too hard to project at this point.
I would think that that’s probably in large part because of just the volatile market that we’re seeing. And as we’re looking at deposit costs, that’s really the big variable for us. And we are — as Laura went into a great detail on using digital marketing to a greater extent, and that’s helping us to bring in deposits at various different deposit rates.
Woody Lay
Got it. And then just to the extent we do see some growth — some loan growth in the coming quarters, how do you expect to fund that growth? I mean do you think increases in retail deposits can fund it? Or will you look to the wholesale market?
Simone Lagomarsino
Probably all of the above. So we have been, as Laura said, successful and actually more recently in this — for this quarter, in growing retail deposits through some of the digital marketing efforts that we have rolled out. So we would expect some growth in retail, and then also possibly some wholesale funding as well.
Woody Lay
Okay. That’s good color. And then last for me, credit, just looking at the metrics, remain very clean. Just as you talk to your borrowers, I mean, as — is there anything that gives you pause on the credit front, just given the macro uncertainty? Or is — or are you cautiously optimistic at this point?
Simone Lagomarsino
We continue to be optimistic — cautiously optimistic. But if you look at the average loan-to-value on our portfolio, both single-family and multifamily. And you look at the debt coverage, in particular, on the multifamily and the FICO scores on our single family, I think we’ve got just a really solid loan portfolio.
And as we said, we had 2 loans that were delinquent at the end of the quarter at over 5,000 loans. So it is I think — I say it, it may sound like a cliche, but people need a place to live. Affordable housing is hard to find, and primarily what we provide in the multifamily is workforce affordable housing for people.
And as we continue to see vacancy rates are quite low in those markets, and rents have been strong. Although we think they might have plateaued, but we still have a very strong debt cover and loan-to-value ratio in our portfolio. So we feel fairly confident, and we look back to the Great Recession, and the portfolio performed extremely well at that point as well.
Woody Lay
That’s all great, that’s all for me. Thank you.
Operator
Our next question comes from Adam Butler with Piper Sandler. Your line is now open.
Adam Butler
Hi, everybody, good morning. This is Adam calling in for Matthew Clark. Deposit growth during the quarter was pretty successful from the advertising campaign that you recently mentioned. I was curious if you expect to see a similar level of deposit growth in 4Q? Or what are your outlooks on that front?
Simone Lagomarsino
So it’s hard to say if it will be a similar level, but we are quite successful in our digital marketing and in terms of new visitors to our website as a result of our digital marketing. And we are actually doing some regional pricing as well and different pricing on different products and kind of fine-tuning the digital campaign as we see what’s successful in different markets.
So we do expect to see some growth through that campaign in our retail deposits. And as we mentioned a minute ago — a couple of minutes ago, we expect probably to also augment that with some wholesale funding, whether both wholesale deposits and federal home loan banks or one or the other, but possibly all of those.
Adam Butler
Okay. Great. Thanks for the color there. And I was wondering if you guys have the spot rate on deposits as of the end of September?
Simone Lagomarsino
Laura is looking for that. I apologize. I don’t have that write-off.
Adam Butler
Let’s do another question. Just going ahead and turning over to expenses. We saw a slight increase this quarter. And then going forward into 4Q, should we expect to see that run rate go a little bit lower based on lower levels of capitalized loan origination costs? Or do you kind of expect that to be offset by increased advertising efforts? Or — any color there would be great.
Simone Lagomarsino
Yes. So we do expect, and Laura, I think, we both commented on that our run rate will be about $16 million for the fourth quarter in terms of noninterest expense, and that’s partly because we’ll have lower levels of capitalized salaries because of our lower loan production levels. That does include some additional marketing costs for the marketing that we’ve been doing.
Laura Tarantino
Sorry, Adam, I also have your spot rate at 9.30% for a retail deposit portfolio of 1.38%.
Adam Butler
Okay, awesome. Those are all my question. Thank you.
Operator
[Operator Instructions] Our next question comes from the line of Gary Tenner with D.A. Davidson. Your line is now open.
Gary Tenner
Thanks. Good morning. My questions were largely asked, but just thought I’d ask about expectations around capital and share buyback. I know you previously completed the — in the second quarter, the repurchase authorization. I don’t believe you’ve announced another one at this point, but given where the stock is below tangible book value, I would love to get your thoughts around that topic.
Simone Lagomarsino
Thanks, Gary. Sure. Capital management is an ongoing role that we take very seriously and we monitor and consider whether or not it makes sense. And at the present time, we are not considering a share repurchase, and that has something — some in part to do with the margin compression that we talked about earlier and more, I think, to do with just the rising interest rates.
And as we’ve seen our mark-to-market on our securities portfolio has — well, it doesn’t impact us on a capital ratio perspective. For regulatory capital, we are seeing the impact in our book value per share as well.
So we just think, at this point, capital — we want to preserve capital and — we do that on an — we look at it on an ongoing basis, and that posture may change, but that’s where we’re at right now, particularly in the possibility of heading into a recession.
Gary Tenner
Thanks, Simone.
Operator
That concludes today’s question-and-answer session. I’d like to turn the call back to Simone Lagomarsino for closing remarks.
Simone Lagomarsino
Thank you very much. And this concludes our call this morning. We appreciate all of you sharing and joining with us. Thank you.
Operator
That completes our call today. A recorded copy of the call will be available on the company’s website. Thank you for joining us.
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