Ladies and gentlemen, welcome to the Hanmi Financial Corporation's third quarter 2022 conference call. As a reminder, today's call is being recorded for replay purposes. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. I would now like to turn the call over to Larry Clark, Investor Relations for the company. Please go ahead.
Thank you, Shamali, and thank you all for joining us today to discuss Hanmi's third quarter 2022 results. This afternoon, Hanmi issued its earnings release and quarterly supplemental slide presentation to accompany today's call. Both documents are available in the IR section of the company's website at hanmi.com. I'm here today with Bonnie Lee, President and Chief Executive Officer, Anthony Kim, Chief Banking Officer, and Ron Santarosa, Chief Financial Officer. Bonnie will begin today's call with an overview. Anthony will discuss loan and deposit activities, and Ron will provide details on our financial performance. And Bonnie will provide closing comments before we open the call up to your questions. Before we begin, I would like to remind you that today's comments may include forward-looking statements under the federal securities laws.
Forward-looking statements are based on current plans, expectations, events, and financial industry trends that may affect the company's future operating results and financial position. Our actual results may differ materially from those contemplated by our forward-looking statements, which involve risks and uncertainties. Discussion of the factors that could cause our actual results to differ materially from those forward-looking statements can be found in our SEC filings, including our reports on Forms 10-K and 10-Q. In particular, we direct you to the discussion of certain risk factors affecting our business contained in our earnings release, our investor presentation, and in our Form 10-K. With that, I would now like to turn the call over to Bonnie Lee. Bonnie, please go ahead.
Thank you, Larry. Good afternoon, everyone. Thank you for joining us today to discuss our third quarter 2022 results. Once again, our team executed well against each of our strategic growth initiatives, which enabled us to deliver another quarter of exceptional results. By maintaining focus on our customers' evolving needs across our markets, we are providing the right products and services to strengthen our portfolio and asset quality metrics. The investments we have made in our banking talent continue to pay off as we deepen existing banking relationships and importantly, expand into new customer relationships. I am very pleased with our team's performance and the results we have delivered for our shareholders.
For the third quarter, our net loan growth of 2.6% over the prior quarter was strong, reflecting solid production in our Corporate Korea, residential mortgage, and equipment finance groups, combined with lower payoffs and pay downs. Further, net interest income increased 6.8%, driven by higher average loan balances and an 11 basis point improvement in our net interest margin. Net income for the quarter was $27.2 million or $0.89 per diluted share, up 8.5% from the prior quarter, translating into a return on average assets of 1.52% and a return on average equity of 15.58%, both up from the second quarter. Our continuous strong loan production was a significant contributor to our earnings growth.
You'll recall that last quarter, we shared that our loan pipeline had moderated somewhat from the record levels we saw in the first half of the year. Consequently, we expected loan production in the second half of the year to return to more historical levels. In fact, that is what occurred in the third quarter. Loan production was healthy at $492 million, consistent with our historical levels. Let me touch on a few notable highlights. Our residential mortgage business again delivered record production. It represented 29% of our total loan production for the quarter while exceeding our full-year ramp-up target of 10%-15%. Loan production for our Corporate Korea initiative was strong again this quarter as net balances increased 4% from the prior quarter and are up 31% year-over-year.
In addition, we had substantial deposit growth in our Corporate Korea portfolio. Our continued success in this area validates our decision to elevate this work to a corporate-wide initiative. Our deep understanding of how these U.S. corporations of Korea-based companies are structured, coupled with our extensive due diligence and quick turnaround decisions, continue to set us apart from the competition and enabled us to win new business. Another notable result during the quarter was that more than 18% of new loan production came from outside of California, with Texas contributing the highest growth of all the regions. This reflects our continued success in attracting new customers in those growing markets with a top-quality banking talent.
Finally, overall pricing on loans was attractive, with average interest rate at 5.55% on new loan production, up 120 basis points from the last quarter. Our solid loan growth was more than funded by the increase in our deposits during the quarter. Deposits increased 3.7% sequentially, where core deposit relationships drove growth. While we did see healthy new production in demand deposits, some of our existing customers shifted their DDAs into interest-bearing deposits, and we responded to depositor appetite with some CD promotions during the quarter which together affected mix of our deposits. Anthony will provide more details in his comments. We are proud of the robust deposit franchise that we have built over four decades, with a focus on pursuing new customers and expanding our existing relationships.
As a result, non-interest-bearing deposits remain high at 45% of total deposits. Importantly, our overall asset quality metrics remain excellent. Our third quarter results reflect our continued focus on high quality loans, disciplined underwriting, and vigilant credit administration practices. These practices reflect a diligent approach informed by decades of experience and management through multiple economic cycles, including stress testing, sensitivity analysis, and financial projections. As economic indicators continue to suggest a potential downturn, we have taken additional measures to ensure we are prepared, beginning with an increase in communication with our customers. For example, we have enhanced covenant compliance monitoring and business review requirements of our C&I loans to ensure we identified any risks early on. We have also adjusted our CRE annual review process by incorporating borrowers' refinance risk analysis at significantly higher rates.
This helps us to be proactive with the potential problem loans where we may need to implement early active strategies. Finally, we have increased our monitoring of the business conditions in our core geographic markets and submarkets, while at the same time placed some restrictions on loans outside of bank's primary trade area. We believe these strategic actions in combination with those already in place, will help us reduce downside risk in the event of a recession. With that, I'll turn the call to our Chief Banking Officer, Anthony Kim, to discuss third quarter loan production and deposit gathering in more detail.
Thank you, Bonnie. I'll begin with additional details on our loan production, where third quarter volumes were $492 million, more in line with our historical averages. Our third quarter residential mortgage production achieved another record at $140 million despite the run-up in mortgage rates. Our focus on the non-QM market is driving these results. Our correspondent lenders remain active in the market. Additionally, a large portion of our production was for home purchases rather than refinances. The purchase market remained strong in the third quarter as many home buyers were eager to close on their homes and lock in their rates. That being said, we do expect mortgage originations to moderate in the fourth quarter as higher interest rates are now having an impact on both the purchase and refinance markets.
Our commercial real estate loan production was $133 million for the quarter and represented 27% of total production, down from 42% for the second quarter. Originations consisted of a mix of multifamily, industrial and warehouse, hospitality and retail properties. The lower production relative to the second quarter was primarily due to a higher interest rate environment. Higher interest rates have created a market-wide slowdown in commercial real estate transactions, both in purchase and refinance markets. C&I funding was $88 million during the quarter. Our new commitments of $145 million, fairly consistent with the second quarter. Total commitments on commercial lines of credit increased to $976 million at the end of third quarter, up $74 million or 8.2% from the prior quarter and 43% year-over-year.
However, outstanding balances on these lines declined by 6.9% between quarters, resulting in a third quarter utilization rate of 40%, down from the second quarter utilization rate of 47%. This was due to some fluctuation in trade finance balances as well as the scheduled payoff of a large loan. Equipment finance product production was strong again at $86 million for the third quarter but down modestly from the record second quarter. SBA 7(a) loan production was $45 million for the third quarter and continues to trend in line with our expectations. Our investment in banking talent over the last several quarters has enabled us to continue to penetrate this key market. With respect to our Corporate Korea initiative, we had another strong quarter with $71 million in commitments from new customers, of which $48 million was funded during the quarter.
Approximately 60% of fundings were in C&I and the remaining 40% in CRE loans. Our Corporate Korea portfolio has grown by 31% since last year, well above the pace we had expected for this new initiative. These loan balances were $772 million at the end of the quarter, representing 13% of our total loan portfolio. The average rate on all new loan production for the third quarter was 5.55%, up 120 basis points from the second quarter. Payoffs were $140 million for the quarter, down from $230 million for the second quarter. The average rate on loan payoff was 5.26%, excluding PPP loans, up to 83 basis points from our second quarter payoffs.
This is the first quarter in the last six quarters where new origination yields have exceeded the yields on loan payoff, excluding PPP, which should benefit our future average loan yields. In summary, our efforts to further diversify our loan portfolio by industry, geography, and loan type is paying off, and that strategy is strengthening our business, which we believe will in turn drive incremental growth and profitability. Now turning to deposits. Deposits grew by $222 million or 3.7% to $6.2 billion and easily supported our loan growth in the quarter. We have had continued success with our deposit gathering efforts, particularly with our new and existing Corporate Korea clients as those deposits balances grew by $129 million in the third quarter, which included an increase of $74 million in DDAs.
Masking that growth as well as growth from other new and existing relationships was the shift by some customers of their funds into interest-bearing deposits. Non-interest-bearing DDAs represented nearly 45% of our total deposits at the end of third quarter, which we believe is a testament to our strong customer service and local market expertise. Our time deposit increased by $277 million in the third quarter as we saw a move by some depositors into this category, as well as renewed interest in time deposits given the recent increases in general level of interest rates. We were successful in growing these deposits as we reached out to new, existing, and former customers of the bank. And now I'll hand the call over to Romolo Santarosa, our Chief Financial Officer, for more details on our third quarter financial results.
Thank you, Anthony. Let's begin with net interest income, which grew 7% sequentially, and our net interest margin that improved by 11 basis points. Net interest income was $63 million for the third quarter, up $4 million from the previous quarter because the ongoing increases in the general level of interest rates propelled our loans and security yields higher and our average interest earning assets, driven by the sequential growth in loans from our continued strong loan production, increased 2.7% or $181 million.
Turning to our net interest margin, which was 3.66% for the third quarter and up 11 basis points from the prior quarter, we saw our yield on loans increase 36 basis points, driving our net interest margin higher by 28 basis points, while at the same time the rate paid on our interest-bearing deposits rose 47 basis points, moderating that margin growth by 23 basis points. We gained a net 6 basis points from the increase in yields on securities and cash, offset by an increase in rates on borrowings and debt. Pausing here to look back at our beta. As we expected, the beta in any particular quarterly period can vary significantly given the amount of the change in the federal funds rate for that period as well as the conditions in the marketplace.
For the third quarter, the federal funds rate increased 150 basis points. As such, our interest earning asset beta for the third quarter was 23%, while our interest-bearing deposit beta was 31%, and the beta on our net interest margin was 7%. We also just noticed the positive differential in our third quarter net interest margin between the higher yields on loans and the higher rates on interest-bearing deposits narrowed to just 5 basis points. We have seen the rate of margin increase slow sequentially, and we know that we have not yet reached the terminal Fed funds rate and that the debate continues as to when it will occur and what it will be. As such, we remain cautious as to the quarterly trajectory of the net interest margin given the uncertainty in interest rates and the economy.
That said, we are very pleased with the performance of our net interest revenues and net interest margin through this stage of the rising rate cycle, especially so given the support from the high level of non-interest-bearing demand deposits and moderated loan growth. We continue to anticipate pre-tax, pre-provision earnings, which did increase 5% for the third quarter, would remain healthy in the coming quarters. Moving on to non-interest income, which was $8.9 million for the third quarter, down from $9.3 million for the prior quarter, due primarily to a $500,000 decline in our SBA gain on sales. The volume of SBA 7(a) loans sold for the third quarter increased modestly to $43.7 million, while trade premiums, as expected, declined 16% to 6.67% for the quarter.
We also saw fees decline by around $300,000 from the second quarter because of lower trade finance activity. With respect to expenses, non-interest expenses for the third quarter were up $1.8 million from the second quarter, with the increases spread across a number of categories. Salaries and employee benefits expense increased by $600,000, reflecting primarily lower deferred costs resulting from decreased loan production. Advertising and promotion expense increased $500,000 because of increased marketing activity, underscoring the drive for new business, as well as a return to more outside meetings and events, somewhat consistent with what we were doing pre-pandemic. However, the efficiency ratio for the third quarter remained relatively unchanged at 46.22% because of our higher revenues for the quarter.
We recorded a provision for credit loss expense of $600,000 for the third quarter, down from $1.6 million for the second quarter. Third quarter expense reflected a negative loan loss provision of $400,000 and a positive off-balance sheet provision of $1 million. The allowance for credit losses was $71.6 million at the end at quarter end representing a coverage ratio of 1.23%. Compared with the second quarter, our specific allowances increased $200,000, while the allowance for quantitative and qualitative considerations decreased by $1.7 million.
In summary, we delivered another commendable quarter with net income of $27.1 million or $0.89 per diluted share, a return on average assets of 1.52%, and a return on average equity of 15.58%. The company and the bank exceeded minimum regulatory capital ratios, and our ratio of tangible common equity to tangible assets was 8.4%, down from the prior quarter. That decline was primarily due to the unrealized after-tax loss on our securities portfolio, resulting from the rapid increase in interest rates during the quarter. However, tangible book value per share was only down 1.6% from the second quarter as our strong earnings helped offset this accounting convention for available-for-sale securities. With that, I will turn it back to Bonnie.
Thank you, Ron. We enter the fourth quarter with a cautious optimism. Our team's focus on our strategic initiatives to diversify our business, along with our continued investments in talent and technology, are fueling growth across our loan portfolio despite an uncertain macroeconomic environment. Our balance sheet is strong, and our margins are healthy. The exceptional performance we delivered both the quarter and year to date has put us on track for another year of a solid financial results for 2022. As we close out the final month of the year, we also look forward to celebrating Hanmi Bank's fortieth anniversary in December. That is four decades of being a trusted community partner to generations of our customers. Today, we are better positioned than ever to meet the evolving needs of our customers.
We look forward to serving them while continuing to drive disciplined growth and deliver attractive returns for our shareholders. With that, we'll open the call for your questions. Operator, please open the line up to questions.
Thank you. At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Our first question comes from the line of Matthew Clark with Piper Sandler. Please proceed with your question.
Hi, good afternoon.
Hello.
Maybe first, for Ron, just on the interest-bearing deposit costs. Can you give us what the spot rate was at the end of September, either interest bearing or total?
Sure. So at the end of September for the month of September, interest-bearing deposit costs were 112 basis points. As I mentioned last quarter, Matthew, the most recent rate increase happened late in the quarter so I do peek into October. For October, I can tell you that we're already about 45 basis points over the third quarter average of 78 basis points.
Okay, great. [Audio Distortion] I'm sorry, just playing around with the model here. What are your latest thoughts on or how are you modeling your through cycle deposit beta at this point, assuming we get, you know, to 4.75% Fed funds?
Yeah. We still anticipate this kind of uneven push-pull between yields on earning assets and the cost of interest-bearing deposits in any particular three-month period. Until we leg into whatever this new interest rate environment may be, I still see that it can start to diminish as we kind of finish out perhaps the year, maybe into the first quarter. You know with only a 5 basis point differential that I saw in the third quarter, I'm just not quite sure when that's going to happen.
Okay. Shifting gears to expenses, 33.3 run rate. I guess, how are you thinking about that run rate in the fourth quarter and then expense growth in general for next year, given inflationary pressures and slower growth?
From a fourth quarter perspective, I would just continue, you know, the same remarks I've made in previous quarters. We'll continue to see, you know, general inflationary pushes in different categories. With respect to 2023, we really haven't pulled together all of our thoughts yet because there will be, you know, certainly inflationary ideas. There will be initiatives, there will be, you know, cost-saving ideas. How those all balance out, I'm just not quite sure at this point.
Okay. Last one for me, just on the SBA outlook, higher rates, you know, obviously slowing that activity. What are your latest thoughts on production and premiums?
Yeah, I think, you know, we've been giving the guidance of about $50 million-$55 million. I think we're gonna stay with that guidance in terms of production numbers. In terms of the premium, the premium has come down to around 6.6%. And then I think it's gonna hover around that area or maybe slightly less.
Perfect. Thank you.
Sure.
Our next question comes from the line of Kelly Motta with KBW. Please proceed with your question.
Hey, good afternoon. Thanks for the question. Maybe starting off with loan growth. It really held in. It's been really strong all year in reflecting the initiatives that you guys have been doing over there. I apologize if this was mentioned during the prepared remarks, but I saw C&I tick down a little bit. Just wondering if you could provide some updates on if there was any large payoffs or trends in utilization and anything like that that could help us understand and kind of help us look forward. Thank you.
Sure, Kelly. In terms of a C&I, particularly in the line facility, actually, you know, we grew our commitment compared to the second quarter. Our commitment was around $902 million. We grew that to around $977 million in the third quarter. In terms of fluctuation in the actual balances, last quarter line utilization was around 46%, and this quarter it's actually around 40%. Looking at just a couple of quarters, it ranges from, you know, 40%- 45%, 46%. That's the impact that you see in the change in the C&I.
Got it. That's helpful. Looking at yields, it looks like loan yields expanded really nicely, up 36 basis points quarter-over-quarter. Can you remind us, just like the percentage of the book that floats, as well as how we should be thinking about, we've spoken a lot about deposit betas, but how we should be thinking about the repricing of loans going forward in this higher rate environment?
Sure. About 25% of the loan book reprices within a three-month interval, a quarter interval. About another 5% kind of is subject to potential renewal, if you will. You know, the HELOCs that are rolling down or the maturing loans that are rolling down. You can look at anywhere between 25%-30% of the book could reprice in any quarterly period.
Got it. That's helpful. Maybe last question from me and then I'll step back is just looking at funding and how you're funding your loan growth going forward. You clearly ran some deposit specials in there. Your loan to deposit ratio, it's I mean, you're still in the mid-90s, so still some room. Just wondering how you weigh you know, CD and CD promotions versus maybe extending out with some term funding in there and if that's a consideration or if you're gonna continue funding with CDs and ongoing deposit generation.
Maybe I'll start with in terms of a CD promotion. It's actually a it's more of a campaign that we had. We're trying to bring back our former customers, you know, who we have a current relationship. That was a part of the promotion, not necessarily entertaining the higher rates. For the rest of the funding I'll have Ron Santarosa cover.
Sure. As you noted, Kelly, we're at about a 95% loan deposit ratio, and we're comfortable at that level. We anticipate that the moderated loan growth that we're probably gonna continue to see as we go through this rising rate cycle, you know, should be met with continued, what I will characterize, core deposit, I mean, our own franchise. We have very nominal amounts of wholesale funding. You know, you see the $100 million of FHLB funds. You know, those were secured back in the low rate environment. You know, they're at 87 basis points, and they'll run, you know, from now till about February of 2025. We have some brokered money, just under about a $100 million. That's in about 43 basis points, again, garnered during the zero rate timeframe.
That runs out till 2024. Then I've got some, the kind of a barbell approach with some California tax-exempt on the shorter end between, you know, 90-day, 180-day. We're comfortable with what we have, you know, I continue to see the wholesale funds as being marginal to the proposition. But we'll continue to grow, and we'll continue to, I think, have healthy, you know, pre-tax earnings, pre-tax pre-provision.
Great. I appreciate all the color. I'll step back. Great quarter. Thank you.
Thank you.
Our next question comes from the line of Jason Stewart with Jones Trading. Please proceed with your question. Hello, Jason, are you on mute? It seems as if we are having technical difficulties with Jason, unfortunately. Our next question comes from the line of Gary Tenner with D.A. Davidson. Please proceed with your question.
Thanks. Good afternoon. Bonnie, I think I heard you comment on the commitment growth in the quarter. Can you give us a sense of where the pipeline stands at the end of the quarter compared to June 30? I don't think I heard that during the prepared remarks.
Can you repeat the question again, Gary?
Yeah.
You are asking for.
You had given us the growth in commitments quarter to quarter, but was wondering if you could update us on where the loan pipeline stood at the end of the quarter compared to June 30.
Sure. Yeah, you know, going into the 4Q, our loan pipeline is actually pretty strong. I would say it mirrors pretty much the beginning of the third quarter.
Okay. Thank you. Secondly, just as you talked about kind of the increased oversight and, you know, restricting some growth outside your primary trade area, could you know, maybe just give us a sense as to what segments that's gonna impact mostly and, you know, what degree you think that kind of is a restraint on growth?
Yeah, I mean, we try to stay focused within our business network. Also, depending on certain markets, you know, certain industries that we focus on. You know, it varies from region to region.
Thank you.
Sure.
Our next question comes from the line of Timothy Coffey with Janney. Please proceed with your question.
Great. Thanks. Afternoon, everybody.
Good afternoon.
Obviously, paydowns came down big this quarter-over-quarter, year-over-year, really good way. In what product categories are you seeing slowdowns or seeing paydowns slow down the most?
Obviously with a rising interest rate environment, we see substantial reduction in paydown in mortgages. We usually
Okay.
Yeah, averages about $25-$30 million a quarter. This quarter, we just had very minimal at $3 million.
Okay.
And, and-
Yeah. Sorry, Bonnie.
Yeah. Just to add, in addition to the mortgages, obviously, in the CRE, the payoffs were much reduced from the second quarter.
Okay. Specifically the CRE, do you think that's the beginning of a trend?
I would say somewhat, yes. Because I do think both in the payoffs and the new origination, it's affecting upside. You know, we'll see, but I think it may be.
Okay. That'd be a positive. Can you provide some color on the relationship and the special mention this quarter?
Sure. Yeah, you know, it's the customer is a manufacturer of auto parts industry. Mainly, the fundamental operation is sound. As we noted on the earnings release, there's a change in the executive management. It had happened. They have the new management in place. We thought it was prudent to put in the special mention and then watch the relationship.
Okay. Of the asset-based lending line business that you have, do you have relationships that are bigger than that $18 million outstanding for this relationship?
We may have. I don't have that information.
Oh.
I can get back.
Okay. Yeah. I'm just curious if that's one of the larger relationships in that portfolio. I guess my last question is for Ron. If I remember correctly, there's a regular maturity schedule to your time deposits, where about a quarter of them reprice or mature and reprice every quarter. Have you given any thought to changing that maturity schedule given the violent uptick in rates that we've seen and are gonna see this quarter?
That so-called maturity schedule is a function of depositor appetite for 12-month CDs. It just happens that they kind of come in about every quarter. That 25% relationship became a little bit distorted as we went through kind of that low spot of last year where you saw the entire, you know, CD book, you know, fall to about 16% of total deposits. There's some lumpiness that's gonna happen, I think, in the third quarter of next year just because there's just been a, let's say, a dearth of individuals that wanted, you know, CDs as we went through 2021, 2022. That's picking up now because, you know, CD rates are attractive. I have a sense we'll continue to probably see that idea as we kinda settle into this newer rate environment.
Okay, great. Well, those are my questions. Thank you very much for your time.
Thank you.
Again, as a reminder, if anyone has any questions, you may press star one on your telephone keypad to join the question-and-answer queue. Our next question comes from the line of Kelly Motta with KBW. Please proceed with your question.
Hey, thank you so much for the follow-up. I'm just going over the commentary from the last call and I feel like your commentary around margin then was more cautious and we again got expansion even with the deposit betas you've seen. You know, I know you've given different pieces of the NIM, but you know, given the expectations for you know, probably another 75 basis points again and continued rate hikes, do you think we've reached a peak NIM here at 3Q 2022, or do you think we can still get a quarter or two more of expansion with the way loans are repricing relative to deposit betas?
Well, it's certainly possible, but I just, you know, I just don't see that as very probable. The only reason for that is I've tried to mention in any particular quarter there is a strong push/pull between what's occurring in the loan book and what's happening on the funding book. As I mentioned this quarter, you know, we only ended up with a five basis point differential. That's a very narrow differential, which can easily shift in any one quarter. We'll see what happens next week with what the Fed does and whether we're at a peak with respect to what they believe the terminal rate should be.
Once I get into whatever that terminal rate is, and again, I still of the mind that people are still debating what that rate is, should be, will be. It's very difficult for me to tell you when we're gonna get to the peak and when we're gonna get into that, you know, different rate environment.
Got it. Thanks. Thank you so much for entertaining the question, Ron. I really appreciate it.
Sure. Not a problem.
Thank you. We have no further questions in the queue at this time. I'll now turn the call back to Ms. Bonnie Lee for concluding remarks.
Thank you for participating in our call today. We appreciate your interest in Hanmi and look forward to sharing our continued progress with you throughout the remainder of the year.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.