Preferred Bank (PFBC) 2022 Q3 法說會逐字稿

Good afternoon, and welcome to the Preferred Bank Third Quarter 2022 Earnings Conference Call. (Operator Instructions) Please also note, today's event is being recorded. At this time, I'd like to turn the floor over to Jeffrey Haas of Financial Profiles. Please go ahead.

Thank you, Jamie. Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the third quarter ended September 30, 2022. With me today from management are Chairman and CEO, Li Yu; President and Chief Operating Officer, Wellington Chen; Chief Financial Officer, Edward Edward Czajka; Chief Credit Officer, Nick Pi; and Deputy Chief Operating Officer, Johnny Hsu.

Management will provide a brief summary of the results, and then we will open up the call 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 a detailed description of these risks and uncertainties, please refer to the SEC required documents the bank files with the Federal Deposit Insurance Corporation, or FDIC. If any of these uncertainties materialize or any of these assumptions prove incorrect, Preferred Bank's results could differ materially from its expectations as set forth in these statements. Preferred Bank assumes no obligation to update such forward-looking statements. At this time, I'd like to turn the call over to Mr. Li Yu. Please go ahead.

Thank you very much. Good morning, ladies and gentlemen. I'm very pleased to report that we have another record quarter. Third quarter net income was $35.2 million or $2.40 per fully diluted share. This quarter's earnings was contributed to -- aided by the federal reserves, the rate increases in a very sensitive -- asset-sensitive balance sheet. Also, the large loan increases on June 30 has also fully reflected in the quarter of September's end.

This quarter, our return on equity is over 23%. Loan growth has moderated down to 8.5% for the quarter. It is not unexpected under the current economic condition. Year-to-date loan growth was 14.1% ex-PPP. Deposit growth was 3.5%, okay? Deposit cost has increased, but the deposit cost increase will continue to accelerate starting from September and seems will be considered continue to accelerate in the fourth quarter, okay. Because deposit cost increase is much less than our loan year increase, we had a 60 basis point expansion in our net interest margin.

Our net -- our credit quality remained stable. Our classified assets is moderately reduced. This quarter, we had no charge-offs, but we have a $2.4 million recovery. Together with a $2.7 million a year provisioned, our loan loss reserve has increased to 1.33% of total loans. The bank's operating cost has increased because of the inflationary conditions and also the bank's growth in asset size.

However, since we have a large increase in revenue, the efficiency ratio has actually decreased to a little bit over 25%. We, at Preferred Bank, recognize the macro economy is heading into a recession. At present time, our top priority is our credit quality and the management of deposits and deposit costs. We have done well so far, and we will certainly be -- continue to be alert in the future quarters. Thank you very much. I'm ready for your questions.

(Operator Instructions) Our first question today comes from Gary Tenner from D.A. Davidson.

So last quarter, Ed and Li, I think you said that you thought third quarter NIM expansion will be less than it was in the second quarter. Obviously, we had some more tightening than, I think, expected or rate hikes than expected at that point in mid-July. But as you think about the fourth quarter now, potentially 275 basis point hikes, the full quarter of the September hike. Can you kind of position the NIM outlook given the commentary of the press release regarding deposit cost acceleration since September?

Okay. The final answer is we have no idea, but I have to tell you the things that we know about, right? First of all, like you said, the September quarter is at 75 basis but will be fully priced in the fourth quarter. And in November, if it is 75 basis points will be 2 [surge] priced in the fourth quarter in December is anybody's guess at this point in time. That will be the revenue expansion.

The cost increase has accelerated quite a bit, okay? And if you know that over the marketplace, there's -- I mean, people is paying all over the place rate for the deposit, especially in the interest-bearing demand deposit like money market and so on. And the TCD rates, paid by the major banks is now over 3.5% now. I guess they really set the bar for all of the small guys.

But sooner or later, the deposits will increase. In the fourth quarter, we will have about $400 million deposit, which is -- our PCB will be maturing, will be repricing. And there will be many deposits PCB will be early withdrawal and pay a penalty or we open for a higher rate, okay? The magnitude, the pace of increase, we are really at the mercy of our competitors. So the best we can do is keeping alert and managing, okay?

But I'd like to say that I will see that NIM probably will be continuing to expand but not to the same level of the third quarter. On the other negative side in the fourth quarter, we also will see that we probably will be -- we have to reprice one of the IOs we have, okay? And then because the market condition has changed. Appraisal value has changed, we will conduct appraisal to reflect better value on the situation.

In terms of that specific -- were you saying we're talking to one specific REO? Or are we talking about that portfolio broadly?

Yes, it seems to be in contract waiting to close.

Okay. And what's the size of the one that you're suggesting you may have to reprice for (inaudible)

(inaudible) $21 million.

$2$22 million .

$22 million, yes.

$32 million, I appreciate the color there. And then historically, Preferred has been a very much a low and spread-driven revenue story. And even the growth in the third quarter, which is low by Preferred standards is quite a bit stronger than most that we've seen. So given broad expectations of selling economy, particularly as it relates to real estate activity, where do you think loan growth looks like in the fourth quarter and frankly, as we go out to at least the early part of 2023?

Well, it's October, the pipeline is kind of -- it does not tell us enough of a crystal ball. But again, it has to do with what the economy is developing. And what we know is in the marketplace, at least on the real estate side, the transaction or a new transaction is much reduced -- and many of the loan portfolio came to us is subject to a much higher standard understandably, the cash flow tax will be completely different then.

So we are not going to hoping a high hope for huge loan growth. If we will reach the third quarter, I consider we're very, very lucky, okay? But then the actual amount will also depend on the fourth quarter's, I mean, commercial and industrial or C&I loans they'll draw down their usage in the fourth quarter will sort of pick up and down a little bit, which we have no control over at this point in time. Sorry, we wish you (inaudible) that's the only way I can answer now.

Our next question comes from Andrew Terrell from Stephens. .

So I wanted to start on some of the deposit growth. It was good to see this quarter. Can you just talk about how you think just overall deposit growth trends over the next few quarters? And then it looks like we saw some migration from noninterest-bearing to interest-bearing accounts. Do you think we should see a similar level of kind of deposit mix shifts moving forward? Or do you think, I guess, commensurate with deposit cost acceleration, do you expect the mix change in the deposit composition to accelerate from here?

Well, I would do some explanation. Then I'll ask Wellington to answer some of the questions you have, okay? Well, first of all, at this juncture that we manage deposit, we try to stay above our current level. We don't want to lose any deposits. That's our most primary goal, okay? So and if we have to grow a little bit, then we will do so. So the matter is wherever deposit is coming from, from my point of view, I want to keep it because under the current situation, we don't know it affects tightening what event -- what situation it can happen. And the second is consumer (inaudible) customer's behavior has changed. Preferred Bank's customer basically are wealthy individuals and business owner -- businesses. They are very savvy with their money.

And they had many choices with their money. So the question is that what do they want to put into a different type of accounts we do not know any they're managing. But we're facing much more competition from the market side. So our job is to stay on top on the daily basis, which we will led stay on a daily basis with our deposit base. Wellington, you want to add to that?

I couldn't add anymore, Mr. Yu. That's straight to the point.

No, that's great. And maybe for Ed, do you have the spot cost of deposits, either interest-bearing or total at the end of the quarter?

Yes. Total cost of deposits, including DDA, would be 96 basis points at the end of the quarter. That was the run rate in September.

Okay. And then where are you -- I know you mentioned the kind of market rates from some of the larger banks for term deposits, where are you pricing new kind of 1-year CD rates at?

Right around 3 -- 3% to 3.5%. Depending on the client relationship, size, et cetera.

We just raised it. We have to continue to raise. We almost -- we almost change our rates on a weekly basis. That's how fast market is changing now.

Yes, certainly, a quick rate environment. Maybe just one more for me. I wanted to ask just kind of looking at the step-up in loan yields quarter-on-quarter, obviously, nice to see, but just thinking about a lot of the prime based commercial real estate loans, on your balance sheet. I'm curious, have you looked at kind of updated debt service ratios for your clients? And are there any areas specifically whether it's segments of the portfolio, geography where you're becoming a little more concerned just given the kind of magnitude of shift upward in prime rate?

Well, Nick, do you want to answer the first, then I will answer.

Yes. Definitely, there will be some pressure on the DDR side. However, during the last quarter, all the management team on the loan side has gone through all C&I loans, CRE loans with our officers one by one with a certain dollar amount over $1 million. And we did not recognize any issue at this time. Definitely, there are some of the loans that we need to watch a little bit closely, but we don't notice any severe trouble at this time.

Well, another situation, Andrew. The great majority of our loans or at least over 90% of the loan is protection guaranteed, okay? So whereas when we do our underwriting, we have severally considered personal cash flow and their capability and their networks in stay behind the loan. So that's 1 added protection for our bank.

Okay. Perfect. Congrats for a good quarter.

Thank you.

Our next question comes from Adam Butler from Piper Sandler.

This is Adam covering for Matthew Clark? Getting started with noninterest expenses. I saw that it increased this quarter mainly due to kind of inflationary pressures. Is that a good run rate to assume going forward?

Yes. Going forward, we had 17.4% this quarter. That's with a real estate-owned charge of $300,000. So on a regular run rate, you could make the case that was closer to 17.1%. But looking forward, we'll have some more on that. And on a regular run rate, I would say high 17s -- mid- to high 17s going forward because we'll continue to have expense increases. We're going to have lease cost increases, still additions to personnel, et cetera.

Okay. Great. And do you guys have the weighted average rate on new loans in September?

Weighted average rate on new loans in September. So we -- we got it for the quarter. We got into the quarter this quarter.

For the quarter, new loan is the new loans that we're getting it. Let me see I had right here in my hand.

5.99%.

5.99%.

And our next question comes from Tim Coffey from Janney.

Most of my questions have been answered, but I did have one for you, given kind of your geographic, reaching your specialties. Is that we're hearing from different parts of the country that certain banks are starting to pull back from what we consider kind of core loan products like commercial real estate and certain construction loans right now. Are you seeing that from your competitors right now?

Well, what do you see long-term, are you seeing it? I see that basically that generally everybody seems to be more cautious, okay? And this certain (inaudible) segment is universally, including us, is being more careful as it's like office products, certain loan area that would be very careful, okay. So -- but then, loan is one-off. You have to see the LTV of the loan and also the sponsorship and their cash flow, okay. So but generally speaking, I see a lot more reluctance for our competitors, and including ourselves in doing a new loan.

Yes, that's very true. I mean the market is pretty much everyone is very cautious.

So pullback is probably a strong, strong word than I think cautious is.

Okay. Okay.

Yes, the geographies I'm talking about aren't necessarily ones that you're in right now. So it could be different markets that they're seeing.

(Operator Instructions) Our next question comes from Eric Spector from Raymond James.

I just wanted to follow up on the NIM. How do you guys think about managing rate sensitivity here in light of accelerated betas? And how would you prefer doing that? Is that putting in more floors on your loans, adding swaps, doing more fixed rate lending? I'm just curious just kind of your thoughts on managing rate sensitivity going forward?

We have many of our loans, which we have previously disclosed that. You can please refer to the last quarter's press release. It's outlined there that I mean, how much loan we have a full on the whole situation. So the majority of our floating rate loan can be floored, okay, I guess this practice will continue. And in fixing the product -- fixing the product will definitely come sometime in the future. But the timing of it is cannot be predicted right now. It has a lot to do with the Fed acting. It has a lot to do with the economy situation. So we were -- it's definitely in our plan, but the timing of it is not sure.

Well, I was just going to add on the deposit cost side, which you already talked about it, it's really just a balancing act. It's more art and science really is managing the deposit cost in an upward environment like this. versus your deposit growth and managing the costs at the same time. It's just a very tricky thing to try to do. But fortunately, with the asset sensitive balance sheet, we have a little cushion.

And in terms of the rate floors at last count of the prime-based loans, roughly 3/4 of them have floors on them. And then in terms of swaps, we have not entered into any swap type agreements at this point.

Okay. Thank you for the color. And then you deployed a portion of our cash this quarter, but you still have a large portion of your assets in cash. How do you think about deploying liquidity going forward? Is this earmarked to potential deposit flows? And then just kind of curious if you have a targeted cash ratio? Yes.

I just read from your investment side, which I'm your customer and telling me cash is king, okay? This unsettled environment you all need to be careful. So I guess I follow your from the [vice].

I think at some point, there will be opportunity for increasing the investment portfolio. I don't think we're there yet though.

You should be sorry about that okay.

And then just kind of curious your thoughts on capital. You completed your share repurchase during the quarter. How do you think about that going forward? And -- are you taking a more cautious outlook or porting capital ahead of like a recessionary period? Or how are you thinking about that?

Well, first of all, in a recessionary period, especially when people like Jamie Dimon says it's a serious recession, you want to keep your capital, okay? And not only us, I think majority of our shareholders. And I think our regulators, everybody, including our Board of Directors, wants us to be hold on to our capital. When the situation eases, then obviously, we have to deploy that.

Okay. Got it. And then one last question. Just curious about your Houston LPO and how the pipeline is kind of developing there and your appetite for additional de novo opportunities near term, given the backdrop?

Wellington, do you want to talk about it?

Sure. Eric, Houston, they continue to contribute, I think, we have a full team over there. So our plan, of course, is graduating from LPO to a full service branch. So that plan is still ongoing. So it's been good for us.

And what was the other question? De novo, again, as Mr. Yu mentioned before as we look at the opportunity, de novo strictly based on the human talent. We're not going to go anywhere because we feel like it's a good geographic location, whatever, unless we have a local team available. It's an opportunistic situation.

Okay. Got it. Congrats again on a great quarter, and I'll step back.

Thank you so much.

Our next question is a follow-up from Andrew Terrell from Stephens.

Kind of in the same vein, maybe is capital, but you're earning a lot more money now with higher interest rates and obviously, incredibly profitable, the efficiency ratio is 25%. I'm just curious how you're thinking about kind of maybe using some of this kind of the higher profitability or higher level of income in terms of reinvestment in the franchise. Are there any targeted areas that have been earmarked that you may be able to accelerate in terms of a franchise investment standpoint, I love to hear any thoughts there.

Do you want to answer the first?

Well, I think as Mr. Yu talked about going into this environment, capital is king, and we are obviously putting a lot more into the coffers. I think one of the first things would probably revisit the dividend level. That would be at the Board. They would want to do that, I'm sure, fairly soon. The other thing is to keep capital to the extent we can and then perhaps once we have some clarity in terms of where the economy is going, it might be time to reinstitute what we did this year in terms of perhaps buying some stock back.

Okay. And is there a targeted capital ratio or level you're looking to?

Well, not the short-term situation, we just -- within the next 6 to 9 months, we just want to hold on to what we have. And we'd like to use some capital if we can. I mean if it is -- If the methodology allows us to -- is to reserve a bit more, okay.

So as we go along that when the economy is clear, the lending is not a hard day then, we obviously we'll be doing things that's probably more progressive. At this point in time, we want to be treating safety as our #1 issue.

And ladies and gentlemen, at this time, we've reached the end of today's question-and-answer session. I'd like to turn the floor back over to the management team for any closing remarks.

Well, thank you so much. We're very lucky to the questions asked to us about capital planning, so I mean we can afford to be more conservative as we're very lucky to be able to have the profit we had in this quarter. And certainly, we will be putting our full -- full attention in managing our sales going forward. Thank you.

And ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for joining today's presentation. You may now disconnect your lines.