KBRA Affirms Ratings for RBB Bancorp

KBRA affirms the senior unsecured debt rating of BBB+, the subordinated debt rating of BBB, and the short-term debt rating of K2 for Los Angeles, California-based RBB Bancorp (NASDAQ: RBB) ("RBB" or “the company”). In addition, KBRA affirms the deposit and senior unsecured debt ratings of A-, the subordinated debt rating BBB+, and the short-term deposit and debt ratings of K2 for its primary subsidiary, Royal Business Bank ("the bank"). The Outlook for all long-term ratings has been revised to Negative from Stable.

Key Credit Considerations

RBB’s ratings are underpinned by the current and historically strong capital measures, notably the CET1 ratio (19.1% as of YE23), which has been maintained well above similarly rated peers, providing the company with some level of flexibility in terms of balance sheet growth, shareholder distributions, and unexpected credit issues. In addition, the management team’s actions in recent periods to manage liquidity more conservatively, including strengthening on-balance sheet liquidity (cash and cash equivalents amounted to 11% of total assets as of 4Q23 compared to 2% as of 4Q22) and reducing the gross loan-to-deposit ratio to 96% at YE23 versus 112% the prior year, have been viewed favorably.

The revision of the Outlook to Negative from Stable is primarily due to the material negative shift in deposit composition, which has resulted in a significant rise in funding costs, and, in turn, weakened profitability in recent periods. While RBB’s funding base has generally reflected higher costs due to its concentration in time deposits, which is a function of its business model, the higher interest rate environment has facilitated a meaningful shift in the deposit mix, with time deposits growing to 63% of total deposits as of YE23 compared to 35% at YE21. As such, this has resulted in a considerable rise in the cost of interest-bearing deposits (4.12% for 4Q23). As a result, despite reflecting a more asset sensitive balance sheet, which was a benefit at the commencement of the Fed’s rate hiking regime (NIM improved 54 bps in 2022), the company has reflected considerable NIM compression in recent periods, falling by 154 bps compared to the prior year (2.73% for 4Q23 vs. 4.27% for 4Q22). Moreover, given the less conducive mortgage banking environment and increased competition in the non-QM lending space, noninterest income has decreased to around 7% of total revenues during the last two years, compared to averaging 13% from 2018-2021. Altogether, this has led to core ROAA (excluding the one-time $5 million award recognized in 4Q23) falling to 0.94% for 2023, versus averaging above 1.50% from 2018-2022.

KBRA also recognizes the significant turnover in the Board of Directors and Executive Management team over the last few years. The turbulence among leadership appears to have led to shortcomings with the company’s corporate governance and internal compliance programs. In 4Q23, RBB entered into a consent order with the FDIC and its state regulator, which was primarily due to alleged violations of the BSA program and required enhancement of its AML/CFT policies and procedures. While we acknowledge that the majority of these aforementioned concerns have been addressed, and the new additions to the management team are considered favorable hires that reflect larger bank experience, there are still uncertainties of further action from regulators.

As of 4Q23, cash and short-term investments plus total AFS securities comprised 19% of total assets. The bank has remaining borrowing capacity from FHLB and FRB amounted to $1.1 billion. While acknowledging that contingent borrowing sources may not always be available depending upon various factors, these sources combined cover 135% of total uninsured deposits, which we view as adequate.

With regard to credit quality, RBB reflects a lower risk profile, in our view, albeit a more concentrated loan portfolio that is largely comprised of non-QM residential mortgage loans (53% of total as of YE23). The portfolio reflects an average LTV of 61% as of 4Q23, with most the properties being owned in favorable markets in footprint (Southern California and New York). KBRA also positively views the company's below average exposure to investor CRE (183% of total risk-based capital at YE23), notably a nominal amount of office loans (~1% of total loans). Despite the recent uptick in the NPA ratio (0.99% as of 4Q23), RBB has maintained a minimal NCO ratio (0.10% for 2023), and management does not foresee any material loss content on the horizon given the aforementioned conservative underwriting and de-risking of the loan portfolio over the past year.

Rating Sensitivities

Given the Negative Outlook, a rating upgrade is unlikely over the medium term. However, a revision of the Outlook to Stable could be considered in the event of the resolution of regulatory issues without material impact on financial results, as well as meaningful improvement in the funding base, notably, a decreased reliance on time deposits. This should result in a reversion in earnings trends, which KBRA expects to track closer to historical levels over time. Conversely, there is the potential for the ratings to be downgraded over the intermediate term. This would occur if the negative trends in the funding mix persist, or if credit quality measures deteriorate meaningfully, or if there is a significant reduction in regulatory capital ratios.

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