Preferred Bank (PFBC) 2008 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you so much for standing by and welcome to the Preferred Bank third-quarter 2008 conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, this conference will be open for questions. (Operator Instructions) As a reminder, this conference is being recorded today on Thursday, the 23rd of October, 2008.

I will now turn the conference over to Mr. Lasse Glassen, the Financial Relations Board. Please go ahead.

Thank you. Good day, everyone, and thanks for joining us to discuss Preferred Bank's results for the third quarter ended September 30, 2008. As you are probably aware, with us today from management are Mr. Li Yu, Chairman, President, and Chief Executive Officer; Bob Kosof, Chief Credit Officer; and Ed Czajka, Chief Financial Officer. Management will provide a brief summary of the quarter, and then we'll open the call up to your questions.

During the course of this conference call, statements made by management may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based upon specific assumptions that may or may not prove correct. Forward-looking statements are also subject to known and unknown risks, uncertainties, and other factors relating to Preferred Bank's operations and business environment, all of which are difficult to predict and many of which are beyond the control of Preferred Bank. For detailed descriptions of these risks and uncertainties, please refer to the documents the Company files with the Federal Deposit Insurance Corporation, or FDIC.

If any of these uncertainties materializes or any of these assumptions prove incorrect, Preferred Bank's results could differ materially from expectations as set forth in these statements. Preferred Bank assumes no obligation to update such forward-looking statements.

At this time, I would like to now turn the call over to Mr. Li Yu. Mr. Yu?

For third-quarter 2008, our net loss totaled $2.4 million or $0.35 a share of which -- that's after a $6 million charge for OTTI, of which $4.4 million related to Freddie Mac. Now, without these OTTI charges, the net income would be $2 million, or $0.21.

Now, we understand, because of the US government signed the TARP Bill as of October 2, 2008, and for that particular reason we can only record the OTTI charges related to Freddie Mac without any tax benefit.

The tax benefit related to the chargeoff for this quarter and last quarter, which totaled $2.6 million, will be recognized in the fourth quarter. Had this amount been able to recognize in the third quarter, our total loss would be right around $0.08.

I am personally also sad about that we have to record charges related to the trust preferred holdings, some of the trust preferred holdings. We certainly understand the technical aspect may be correct. However, from a common sense point of view, when the government is going to recapitalize most of the bank and all these institutions who issue trust preferred and form the whole trust preferred securities, the value should increase or recover in the fourth quarter. To have it written down in the third quarter, and will not be able to written back up in the fourth quarter, is something that is interesting to me as a layman. But, be it as it may, this is what the current regulation is.

Now, there's two bright spots in our quarter. One is that even during a most difficult situation we have improved our capital ratio. Our leverage capital ratio, Tier 1 leverage capital ratio, now over 10% for the first time, 10.01%. That is an improvement from the quarter end of June 30, 2008.

In the assets quality side, we are feel somewhat slightly relieved that there is no deterioration in our assets quality. We also managed to reduce the exposure in the housing-related construction loan area.

So looking forward, although at the end of August it was pretty optimistic about the real estate situation, but with what is happening in September and October really we think that the general market has taken a backward movement. It looks like that we are still going to be having a challenging environment going into the fourth quarter and the first quarter.

Being well capitalized as we are, and we probably will be seeking new capital from the government, we feel that we are well situated to take care of any problem that we are foreseeing right now. Now, at this time, I would like to answer any questions you may have.

(Operator Instructions) Joe Morford, RBC Capital Markets.

Good afternoon, Li. I guess a couple questions. First, it looked like you moved a fair bit into the OREO category and suggest there may be some continued inflows into the non-accrual loans.

I was just wondering if you could give a little more color about what new deterioration you saw in the quarter in terms of new problem loan inflows.

Well, actually, the net difference between the OREO and the NPL, the combined number between quarters is $1 million or $2 million differences.

Oh, is it? Okay.

Yes, it is only $1 million or $2 million. Actually, for the MPL portion, we saw show a more than $15 million improvement between quarters.

Okay, I'm looking at the wrong number then, sorry.

Probably one of the situations that give us some good feeling further is that in the 30 to 89 days delinquent area, this is one area as management that I look at carefully. As of September 30, we only have $11 million.

This is even a pretty good number at the [glory] days in 2007 or earlier. I mean, a number just amazes me on that. But it is an improvement from last quarter and certainly a big improvement from the first quarter. Which indicating situation as of September 30, seems to be improving, in my point of view.

As I also stated in my press releases, that moving to OREO is really a very welcome situation because we finally can dispose of it, as compared to let it sit there after waiting for the foreclosure process or litigation process.

Okay. Then, I guess a separate question then on the deposit side. Can you just talk a little bit more about what went on this quarter in terms of the restructuring? Getting out of the government agency deposit.

It looks like there were some outflows still in the core accounts. Just a little bit more about what all happened there.

Actually as you can see, we have reduced our total dependence on the institutional government type of deposit -- which is fully collateral supported, security supported deposits -- by selling the security and reduce the government related deposits.

So our other core deposits, our normal core customer deposits, actually show increases from the last quarter. This is partially done is that actually because the state of California remove us from the program, the deposits, that we have to liquidate [the] deposit situation for about $90 million.

The rest we are able to move into a different program and the relief of the collateral situation to improve our liquidity.

The situation related to this is not -- actually the liquidity situation has improved between quarters.

Okay, great. Then I guess lastly, you touched on the TARP program and looking to possibly participate in that. Can you quantify the amount that you could raise? Would your bias be towards the upper or lower end of that range?

We can raise between 14-plus to $42 billion plus. However, the Board of Directors at the meeting two days ago has authorized management to proceed to seek up to $40 million of new preferred stock from the government. We are in the process of preparing application.

Okay, perfect. That's all I need. Thanks so much.

In the meantime, we're also interested in the government guaranteed senior debt program. We are talking -- because a lot of detail is not out; and among constant conversation with FDIC, they don't have all the details yet. So once they have it, we will be submitting for request for their approval.

The trick is that that particular program, for those guys as of September 30 had little or no debt outstanding. It would be an amount up to their approval, so we don't know what they will approve. But we will be talking to them all the time.

Okay, all right. I will follow up on that later. Thanks, Li.

Aaron Deer with Sandler O'Neill.

Hey guys, this is actually Andrew on for Aaron.

Quick question. Can you just tell us why you are comfortable bringing down the reserve level this quarter?

Actually, it is not bringing down the reserve level. Part of it is getting charged off. Okay?

Oh, okay.

Okay, and it is just -- we just feel this. It is not going to be -- the number is not going to be collected. Rather than let it sit on the books to show a fluffy negative amount to loan, it is just to charge off, just to clear the books on that.

Our reserve, if you notice, everything has been marked based on the most recent appraisal.

Right, right. Okay. I guess, we have heard something. Maybe D.R. Horton out near Beaumont just sold a bunch of residential land, I think, for I think it was maybe $0.10 on the dollar.

So would you mind just explaining why you are comfortable holding that freeway, just adjacent residential land in Beaumont, at 42% of appraised value?

We can't -- on this situation, we are in partnership with another bank on this particular deal. They are the one agent bank on the matter.

They are -- that is their appraisal value that they have received. We have it reappraised right now; we should be receiving new appraisal by November to see what the new number is.

As soon as the number is out, if it represents a deterioration we certainly will write it down. Okay?

Okay.

That's actually a different type of property, so we don't know whether it is going down that much or not. Because the last appraisal is 2008, I think the springtime of 2008 appraisal. It is not that different.

The biggest drop of the land value really happened in the fourth quarter and the first quarter of 2008.

So probably that let me just afford to be a little bit more optimistic. We hope the new appraisal coming out will be fairly close to our carrying value, or hopefully better.

Great. Thank you for taking our questions.

Joe Gladue, B. Riley & Company.

Just a couple questions. I guess first off, I guess about a $15.5 million reduction in the exposure to Inland Empire loans noted in the press release. I guess I'm assuming that those things were either charged off or went into OREO. Or just wondered if you could explain what happened to them.

There is about $6 million is either the paydown or paydown of the loan.

Okay.

Paydown, pay off the loan. The rest is a chargeoff to OREO.

All right. I guess I would like to see if you could just talk a little bit about your expectations for the net interest margin, given the Fed rate cuts, and I guess possibility of further ones coming.

Oh, boy. Okay. Joe, this probably is one of the most troublesome things as far as I can see in our landscape. Because what we see all over the place is people still offering right around 4% for the time certificate deposits and price their MMAs really high.

In other words, right after the 50 basis points reduction in Fed rate, the deposit rate did not come down. Everybody is still frenzied in getting the deposits. And because interbank lending has been slowed down, everybody is holding these deposits and putting stuff on the -- losing 2% net or 3% net. Okay?

So the situation sitting right now is when this deposit cost will reduce to sort of like along with the lending rate reduce, we do not know. I hope right after the recapitalization of banks by the TARP program, we will see the gradual easement of that.

Especially the two things that affect that in terms of increased insurance on DDA and also the guaranteed [senior debt] interbank lending. These kinds of situations would definitely work to move the deposits cost down and move the liquidity between banks better.

But as it stands right now there is still [seas] ahead. Therefore as it stands right now, it is not only us. I think every bank will see their margin compressed in the fourth quarter.

Okay. Can you give me an idea of, I guess, you know what the net interest margin was for the average for the quarter. Do you have an idea of sort of where that ended up at the end of the quarter?

Ed, can you answer the question?

You're talking about for the last month of the quarter, Joe?

Yes.

Well, I would say excluding the effect of non-accruals, probably somewhere right around 350. It was certainly on a bit of a downward trend.

All right. Lastly, I will ask about expectations for loan growth. Do you still expect to do more -- just letting some things roll off and just to improve liquidity? Or do you think you will have the capacity to grow loans a little bit going forward?

Well, I think, I think that if the proper loan [date] -- please understand, loan demand is not as strong. And the quality that is available to us is not, how should I say, fitting in today's environment. So we are much more prudent in doing the loan.

Having said that, we do have a decent pipeline of loans waiting to be funded. Okay? I think that once we have the situation clear with the FDIC, with the liquidity thing, such as these kinds of situations, all these loans will be booked in no time.

We already see deposits start to flow back into us, especially on the DDA side. We see some drop in the third quarter; and in fourth quarter after the Fed announcement, DDA has been increasing.

So we foresee that the booking more loans in the next -- this quarter. Having said that, we also like to see some of our loans, especially in housing-related construction loan and land loans, being paid down.

But at this point in time, you know as well as I know what the market situation is. The speed of these reductions of these loans will be relatively slow.

All right, that's all I had. Thank you.

Don Worthington, Howe Barnes Hoefer & Arnett.

Good afternoon. A couple things. One is more housekeeping.

In looking at the expense categories, there is just a line that is labeled Other. It was about $2.1 million in the quarter versus -- it was about double from the last quarter. What specifically was in there driving the increase?

Ed, do you want to take that?

Yes, well, primarily -- and I think it is in the text of the press release. I know you guys didn't get all a chance to read that. But OREO expenses are in that Other category, Don, and that was about $770,000 of that increase. So it really accounted for a majority of that.

In addition, FDIC insurance premiums have increased as well. So that is really primarily the major difference between the two quarters.

Okay, great. Then in terms of this other OTTI charge, what types of securities were those, the non-government agency?

About $1.1 million of that $1.6 million was a trust preferred CDO issued by community banks I believe in the early 2000s. The other one was a Ford corporate note, that was about $480,000.

Great, thank you very much.

Julianna Balicka, Keefe, Bruyette & Woods.

I have two questions. On the OTTI charge for the TRPS CDO, of the markdown how much of it is credit related and how much of it is a liquidity discount?

Julianna, if I had that answer, I probably wouldn't be doing this. You know, it is really -- what we really have to do is it is a two-pronged process. Okay?

First off, we get the market valuation from our pricing service on a monthly and a quarterly basis. That is the mark we have to use relative to the balance sheet; and that is what you see on the face of the balance sheet where we show the market value.

The second prong is that with a security such as a CDO, where we own a beneficial interest in a pool of issuers who have issued securities, we have to use EITF 99-20 as our primary accounting guide. Under that EITF we have to go through and simulate what are the estimated future cash flows that a market participant would expect to receive in the current environment as of September 30, given what is going on in the market.

So, based on that -- which the numbers actually come out a little different than what our pricing service comes up with. If there is any impairment in the future estimated cash flows compared to the previous estimated cash flows or when the instrument was purchased, then we have to record a charge for other than temporary impairment. That charge has to go back to and has to be based on the original pricing service's market value, not the estimated cash flows we ran under EITF 99-20.

If I were to go back and to look at what our pricing service did in terms of what the default rates they used, the estimated default rates they would use in the future cash flows versus the discount rates used, I would have to go back and find those cash flows. And then determine -- put the discount rate back at the note rate; and then I could determine what the impairment was based on credit and what it was based on discount.

So unfortunately, that's a long answer and it's not even an answer, but it explains a little bit of what we have to do.

I think that is what I was getting at with that. So said that works.

Then in terms of your construction portfolio, with the decrease in balances, which was very welcome to see, what are your outstanding commitments still?

I don't have the number, okay? But I can dig that number out, but it is reducing. Okay? We will try to -- Ed is trying to find the number right now. (inaudible) Seeing the construction commitment, you know, (inaudible).

Okay, and then I have a third question and I will step back.

Okay.

On the $13.2 million NPL in the Inland Empire, recent appraised value. What is the recent appraised value on that?

It's $13.2 million. One of the appraised value is 55% related to that $7.5 million loan. I don't remember exactly what the appraisal is. I think it's about $17 million, $18 million on that $7.5 million piece.

It is two banks together. You know the other bank, right?

That's right.

Okay. So together, the loan was $15 million, and that is equal to 42%. So we have [recognized] about $30-some-million appraised value of that piece of land.

The other piece of land, the appraised value is 55%, and we each have $5.7 million.

Right. All right. Well, I will step back now, and if you are able to get the commitments during your call, that would be great.

Okay.

If not, Julianna, I will get it to you.

Perfect. Thank you very much.

(Operator Instructions) John Deysher, Pinnacle.

Good afternoon. Back to your comment on the TARP program. $14 million to %42 million I think you said.

Yes.

Exactly how will that work? What types of assets, specifically, what types of loans are you putting to the government?

We don't have to put it. It is a government purchase of the preferred stock. They will purchase of us a series of preferred stock. The amount they will purchase is -- minimum is equal to 1% of our risk-based capital. The maximum is 3% of the risk-based capital. Okay? Risk-based assets, I'm sorry.

So, we are just using round numbers, okay? Between $14 million to $42 million. We have decided to go after $40 million.

Okay, $40 million. Okay, so the $40 million is within the range of the $14 million to $42 million?

Yes, sir.

Okay, so you're basically going to sell preferred stock to the government?

Yes.

Okay. What types of terms will that involve?

Well, there's all kinds of publications. I can send it to you, okay?

No, just tell me in a nutshell what you expect to do.

It's 5% of the coupon rate.

5% coupon?

Yes.

It's a perpetual preferred?

It is a 10-year perpetual preferred, a 10-year term. It can be called after three -- I mean, it can be called any time, with [spread] three years with certain conditions.

I'm sorry, called anytime after three years with certain --

No, no. First three year has certain condition. You can call within the first three years; but it has to be through a refinancing on the public market or your capital stock.

Okay. And after three years you can call it without restrictions?

Yes, at par.

Okay.

After five years, John, the dividend rate goes from 5% to 9%. So really what this is intended to do is to be a short-term capital instrument for the institution.

The other component is that we will have to issue warrants to the US government equal to 15% of the capital stock purchased.

Equal to 15% of that $40 million, let's say?

Yes.

Okay.

If you want it, John, would you call us a little later and we will send you a detailed program?

No, that's fine. It just seems to me that your capital ratio went up, but yet you're raising money from the government. That doesn't portend a very favorable outlook in terms of what problem loans or assets you may have going forward.

Well, you probably can draw the conclusions in the first place, but number one is that at 5% coupon rate the thing is not going to be very much of a so-called dilutive. Okay?

The second situation is that during this economic environment, nobody is sure what lies ahead of us, whether it is recession, whether it is depression, or when and if the other shoe will fall on the marketplace. Okay?

So with that, the Board decided to have that. Please remember that if the market quickly returns to good situation we can always pay it off early.

Well, you can pay if off early subject to certain restrictions for the first five years.

For three years with restrictions. You know, let's say if the market turns out to be really well and we, as a bank, also turn out very well, it is conceivable we can raise some kind of capital through the open market within the next three years to pay for the government's -- pay for the $40 million. That is, if they allow us to have $40 million.

If not, you know, if we don't have any use for it, at the end of three years we certainly can pay it off.

Okay, and this is nonvoting stock?

Correct.

Nonvoting.

Okay.

John, just so you know, I've actually listened to a couple of conference calls since this capital purchase program was announced, and a number of institutional shareholders have been on these calls.

There has been, really just unanimous, widespread favorable response to this, especially in light of what is going on. Of course, as Mr. Yu said, there is a lot of uncertainty going forward relative to the overall economy.

Given the fact that right now our dividend yield is in excess of 5%, a 5% on preferred shares looks pretty cheap at this point.

Well, yes, I guess are scratching our heads and trying to figure out. Are you doing this strictly as a safety measure or as a backstop in case things really get bad? Or do you see holes in some of the loans that you know you're going to need the capital for?

Well, let me put it this way, okay? Since you asked the question, we have just been examined by the state of California. We don't have exit interview yet. But we have loan exit already, and we are gone through all the loans.

Our loan loss reserve is being done based on whatever their classification that they review it at. Their review covered almost 40% of our total loan portfolio.

I might say, your government has been working very hard this time in looking at the loans. They are taking a very, very, how should I say, careful view about all the credits.

Okay. Well, the 40%, would that be the diciest portion of the portfolio, would you say?

Obviously, it will be the diciest situation. They will decide on the situation, but it usually covers -- the sample is big enough. We have some of the smaller things, when you have a small apartment, $3 million cash flow sitting there, they don't what to look at those things.

Okay. Well, I guess we take some comfort in that. That you have been held to pretty high standards in terms of the examiner requirements.

Yes. I have to say that all over what I hear in the industry is that both the state and the FDIC now, and for that matter OCC too, has been more than proactive in doing the loan reviews.

Right. Was that a routine exam?

It is a scheduled exam, but it is early a little bit. But it takes a lot longer time, a lot bigger sample.

Okay, all right, great. I guess final question unrelated to that preferred offering. Are you seeing any --? What does the commercial real estate loan portfolio look like at this point?

Generally speaking, I have also not only in ourself, I am also talking to many of my peer group people, that it seems to me the commercial real estate portfolio at this point in time [stayed] largely pretty reasonable.

Okay, you are not seeing any rise in vacancy rates or anything like that?

You know, there is some vacancy rising from what I hear in the [shop]. I mean in the selective, some type of office building and some type of strip centers and so on. Largely, you know, we like to think we don't have much situation in that.

Many of the loans we did is underwritten four or five years ago, where the rent rate four or five years ago has been elevated to today's rent. Even with some vacancy they still have enough cash flow.

Okay, so you've got a buffer there if vacancy rates go up?

Yes, in general, yes.

In general, okay. Very good. Thank you.

(Operator Instructions) Gentlemen, I'm not registering any further questions. Please continue with any closing comments.

Well, anyway, we thank you very much for your interest in that. You know, obviously, this credit market really really is amazing what is happening in late September to early October situation.

As a matter of fact, we have a couple deals, a couple loans, a couple of our nonperforming loans is ready to be sold, and one OREO ready to be sold. And as of September 30, the market changes, the funding stopped, and the deal gets terminated.

We were hoping to report better assets quality at September 30. It just didn't happen, which is very disappointment of ours, because of environment.

Having said that, again, you know that I like to think that the third-quarter credit quality actually improved a bit rather than deteriorated a bit now.

With that, thank you very much, and any questions you may have, please call either Ed or myself.

All right. Thank you. Ladies and gentlemen, this concludes the Preferred Bank third-quarter 2008 conference call. If you would like to listen to today's conference in its entirety, you may dial 800-405-2236 or 303-590-3000 and put the access code 11121375. (Operator Instructions)

ACT would like to thank you very much for your participation and you may now disconnect. Have a very pleasant rest of your day.