RBB Bancorp quarterly report, Q2 FY2023

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RBB Bancorp — Q2 2023 Form 10-Q

Business context and reporting period

RBB Bancorp is a bank holding company whose Royal Business Bank serves businesses and individuals across California, Nevada, New York, New Jersey, Illinois and Hawaii. Its principal revenue source is lending. This unaudited filing covers the three and six months ended June 30, 2023; balance-sheet comparisons are with December 31, 2022. Amounts below are in U.S. dollars.

Financial results and condition

  • Second-quarter results: Interest income was $57.0 million, up from $42.3 million a year earlier, but interest expense rose to $25.1 million from $5.2 million. Net interest income fell 13.9% to $31.9 million. Net income declined 29.3% to $10.9 million; diluted EPS was $0.58 versus $0.80.
  • Six-month results: Net interest income was $66.0 million versus $71.6 million; net income was $21.9 million versus $30.1 million. Diluted EPS was $1.15 versus $1.54.
  • Margins and efficiency: Tax-equivalent net interest margin was 3.37% in Q2, down from 4.08%; for the first half it was 3.53% versus 3.77%. The Q2 efficiency ratio increased to 53.80% from 43.47%.
  • Credit costs and asset quality: Q2 provision for credit losses was $0.4 million versus $0.9 million, while net charge-offs increased to $0.6 million from $0.1 million. First-half provision was $2.4 million versus $1.3 million, and net charge-offs were $0.7 million versus $0.04 million. The allowance for credit losses was $43.1 million, or 1.35% of loans, versus $41.1 million, or 1.23%, at year-end.
  • Nonperforming assets: Nonperforming loans rose to $41.9 million (1.31% of loans) from $23.5 million (0.71%) at year-end. Nonaccrual loans were $41.6 million; the increase was driven principally by residential mortgage and commercial real estate loans. There were no loans 90 or more days past due and still accruing.
  • Balance sheet: Total assets were $4.08 billion, up 4.0% from year-end. Gross loans declined 4.2% to $3.20 billion; deposits rose 6.6% to $3.18 billion. Shareholders’ equity increased to $500.3 million. AFS securities totaled $391.1 million and carried $32.3 million of pretax unrealized losses, primarily attributed to interest-rate changes.
  • Liquidity and funding: Cash and due from banks was $246.3 million, up from $83.5 million at year-end. The six-month cash flow statement reported $34.8 million from operations, $6.2 million from investing and $121.7 million from financing, producing a $162.8 million increase in cash and cash equivalents. Uninsured deposits were estimated at $1.29 billion; brokered time deposits were $370 million. Management stated it did not anticipate a need for additional liquidity and reported $1.1 billion of additional FHLB borrowing capacity, $92 million of unsecured federal funds lines and $40.8 million of Federal Reserve borrowing capacity, with none drawn from the latter two sources.
  • Debt and capital: FHLB advances were $150.0 million; long-term debt was $173.9 million and subordinated debentures were $14.8 million. Total borrowings were approximately $338.7 million, down from $408.3 million at year-end. The Bank remained well-capitalized; consolidated CET1, Tier 1 risk-based and total risk-based capital ratios were 16.91%, 17.46% and 25.27%, respectively.

Material changes versus comparable periods

  • Higher market rates lifted loan and securities yields, but sharply increased deposit costs. Q2 interest expense on deposits was $21.9 million versus $2.4 million a year earlier; the average rate on interest-bearing deposits rose to 3.47% from 0.49%.
  • Customers shifted funds from noninterest-bearing accounts into higher-yielding accounts and time deposits. Noninterest-bearing deposits fell 26.7% from year-end to $585.7 million, or 18.4% of deposits, versus 26.8% at year-end.
  • Loans contracted from year-end, particularly commercial real estate and commercial and industrial balances; single-family residential loans increased. Management attributed part of the decrease in cash generation needs and loan balances to slower lending and deposit promotions.
  • Noninterest income declined 27.1% in Q2 and 23.7% for the first half, including lower loan-sale gains and no repeat of the prior-year fixed-asset sale gain. Noninterest expense rose 5.1% in Q2 and 11.2% for the first half, including higher legal and professional fees and FDIC assessments.

Outlook, commentary, risks and unusual items

  • Management said it expects to reduce loan portfolio size in coming quarters by slowing originations and focusing on core relationships. It is offering ICS and CDARS deposit products to customers with balances above $250,000 to reduce uninsured deposits. The filing gives no numerical earnings or margin guidance; management said the continuing effect of banking-sector disruption on 2023 results is uncertain.
  • RBB’s real estate concentration is a significant credit exposure: commercial real estate represented 37.0% of loans and single-family residential mortgages 48.7% at June 30. Management noted an increase in classified loans and temporarily lowered its CRE maximum LTV policy from 75% to 70%.
  • Interest-rate exposure is material. Management’s model projected higher net interest income under parallel rate increases, but lower economic value of equity under rate increases; a +300-basis-point shock corresponded to a 15.91% decrease in modeled EVE. AFS securities also remained exposed to further fair-value declines.
  • The filing identifies banking-sector confidence and liquidity, uninsured deposits, credit deterioration, interest-rate changes, real estate values, regulatory and FDIC assessment changes, and cyber and operational risks. LIBOR-based loans represented approximately 4.7% of gross loans; the company selected CME term SOFR with a spread adjustment for relevant contracts beginning July 3, 2023.
  • The proposed Gateway Bank acquisition, announced in 2021 for approximately $22.9 million in cash, remained subject to regulatory approvals and other conditions; its agreement expiration was extended to September 30, 2023.
  • Legal and professional expense included costs related to an internal investigation and increased external auditor fees: $2.9 million in Q2 and $5.9 million for the first half. Management stated ordinary-course litigation was not expected to materially affect the company.
  • Control weakness: Management concluded disclosure controls and internal control over financial reporting were ineffective at June 30 because of four material weaknesses involving related-party transaction controls, segregation of duties and IT access, CECL assumptions and review controls, and staffing and competence in financial reporting controls. Management reported no material misstatement in the periods noted and described remediation efforts, but said the controls had not operated long enough to conclude the weaknesses were remediated.
  • After quarter-end, RBB announced a $0.16-per-share dividend, payable August 11, 2023 to shareholders of record July 31.

Important facts for investors to verify

  • Whether nonperforming loans and classified CRE and residential mortgage exposures continue to rise, and whether collateral values and the allowance remain adequate.
  • Deposit stability and cost: uninsured deposits were $1.29 billion, time deposits were 62.7% of deposits, and brokered time deposits were $370 million.
  • Whether loan and deposit repricing continues to compress net interest margin and earnings.
  • Progress in remediating all four material weaknesses and the timing of management’s conclusion that controls are effective.
  • Status and conditions of the Gateway acquisition, and the effect of any proposed regulatory capital or FDIC assessment changes.
  • Exposure to unrealized securities losses, interest-rate changes and the LIBOR-to-SOFR transition.