Preferred Bank (PFBC) 2021 Q4 法說會逐字稿

Hello, and welcome to the Preferred Bank Fourth Quarter and Full Year 2021 Earnings Conference Call.

(Operator Instructions)

Please note, today's event is being recorded. I would now like to turn the conference over to Jeff Haas of Financial Profiles. Mr. Haas, please go ahead.

Thank you, Keith. Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the fourth quarter ended December 31, 2021. With me today from management are Chairman and CEO, Li Yu; President and Chief Operating Officer, Wellington Chen; Chief Financial Officer, 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 that 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, everyone. I'm very pleased to report Preferred Bank's fourth quarter net income of $26 million or $1.80 a share and a full year earnings of $95 million or $6.41 a share.

The pretax pre-provision revenue, PTPP, together with total assets together with total loans, total deposits, all these are bank records. In the fourth quarter, loan growth was 2.9% sequentially and annual loan growth was 10.5%. We had a very, very active fourth quarter. Total loan production, we generated $587 million of total commitment with $456 million outstanding at year end, which doubles prior quarter's production.

Unfortunately, payoffs also more than doubled prior quarter's at $333 million. For the full year, we originated $1.7 billion of new commitments with $1.26 billion outstanding at year end. But however, again, payoff is $890 million.

Looking ahead, we have a decent pipeline as of now. But -- the payoffs will remain a wildcard, okay? So I personally am very comfortable with our staff's ability to originate new loans. You see Preferred Bank is a custom loan shop. Much of our production depends on our one-on-one contact with the customer face-to-face.

But the pandemic has taken much of that away from us. And I believe going forward, with economy gradually easing -- getting better and pandemic getting easy that we should be reasonably optimistic about our production level although it could be lumpy between quarters.

Deposit side, we have little deposit growth in the fourth quarter, but full year growth is about $17.6 million (sic - see press release, "17.6%") or nearly $800 million. It is very comforting that most of this growth or 90% of it is on the transactional [sign] of lower cost.

Our net interest margin was lower than the previous quarter, but that was mainly because of changes in assets and liability leverage, as our loan yield remained pretty stable between quarters. Looking ahead, as we have 85% of the loans that are all floating should work well in a rate-rising environment.

One good news to us is that in assets quality side, aside from the $9.2 million resolution and the $23 million payout that I mentioned in our press release, we are on our way to advance another loan of over $4 million to the -- from the NPL level to the OREO level that can be sold shortly after. And also, we're looking to resolve another $4 million of loans which will be paid in full as we can see right now. So by the end of first quarter, I hope our loan quality will be even better than the fourth quarter.

For year 2022, obviously, we still have challenges in the [Omicron]. It's hard to predict when the pandemic will be easing up on us. And also with the challenge of a high inflation economy, which I guess, it's taking time to quiet down. But we are confident that our country will eventually dealing with these issues effectively.

But our job is to get ourselves as well prepared as possible and then be alert every step along the way. So I thank you very much. I'm ready for your questions.

(Operator Instructions)

And the first question comes from Matthew Clark with Piper Sandler.

Maybe just starting on expenses, nice decline in comp expense this quarter, but you also had some cautious commentary in the release around inflation, more specifically wage inflation, I would think. What's your thought there on the run rate, Ed, and just overall kind of expense growth for the year?

Ed?

Yes. So yes, so fourth quarter was good in terms of expense control, Matthew. We would expect, going forward, as you know, first quarter is always a little bit of a headwind for us on the noninterest expense side due to the payout of incentive compensation.

But comparing linked quarters from Q3 to Q4, incentive compensation expense was lower in Q4. And then the capitalized loan costs were higher in Q4. And as you know, that's a credit to salary expense because we credit their capitalized to loan cost and amortize them over the life of the loan.

In terms of first quarter run rate, my guess, Matthew, would be anywhere between 15.2% and 15.5%.

Okay. And do you think it trails off like it's done historically through the balance of the year?

That remains to be seen. The big wildcard there, Matthew, is -- you already touched on it, is on the compensation side, specifically for us, recruiting. If we're successful in recruiting in the first couple of quarters of the year, you likely will not see that trail off. However, if not, you probably will see it trail off a little bit. Fortunately, we're not terribly subject to inflationary pressures as it relates to noninterest expense, with the exception of salaries and a few other items.

Got it. Okay. And then just on the loan pipeline, the loan pipeline, I think Mr. Yu, you said it's "decent." When you think about it or when you look at the pipeline, you think about the year ahead, is that still enough to get you to high single digits to low double digits? Or should we think about something...

The first -- add onto it, okay?

Matt, this is Wellington. I think the pipeline is decent to robust. I believe, especially with -- as we continue to have a strategic target to hire new relationship manager and looking at the pattern from last year of our new region and the new hire that we brought in, I think that that has worked out very well.

The big wildcard, as Mr. Yu mentioned, is the runoff. So we just have to run faster than the runoff. And that's the wildcard.

Matt, as I said, one thing I'm relying upon is our staff's capability. We did originate $1.7 billion of total new commitment in 2021. So -- which is a very high number considering our total loan size. So none of us have a crystal ball saying how much will be. And I just feel that the economy is getting better, and we should be -- hopefully, we should be doing better.

Great. And then just on the margin outlook, the remix, knowing the loan growth was weighted toward the end of the quarter, would it be fair to assume you see that remix benefiting the margin in the upcoming quarter? And then can you give us some more color behind the loan pricing, that's held up pretty well here and the source of the commercial real estate growth, the types of properties you guys are being able to finance of late?

I will give you the loan pricing information and I would -- that Ed is giving you the movement of the margin situation. So actually -- actually, that -- Hello? Hello? Hello?

We got some background. Go ahead.

The loan for the whole year, the new loans are made at anywhere from 50 basis points to 100 basis points less than the loan that being paid off. And it is higher in the beginning of the year and close by to the year is narrowed down to about roughly 50 basis points. And I have reason to believe the first quarter, if there's a payoff, the differences will be more narrowed, narrowed further, okay?

And this is a national trend, This is a trend interest rate environment. This is a trend of competition, and this trend of all banking. If you have a portfolio loan, you do nothing about it. Yield will continuously go down, okay, because payoffs, what they have to take.

So what we try to do is generate enough new loans, okay, to hopefully, to bring up the total net interest income to the level that we feel is reasonable for our shareholders. So Ed, do you want to add on?

Yes. In terms of the margin, we ended the year and the last quarter at 3.28%. And as we talked about, a lot of that is due to the deleveraging effect during the quarter with the preponderance of the loan growth occurring in the latter part of the quarter and the deposit growth going on throughout the quarter deleveraged the balance sheet. So that led to the -- another decline in the margin.

So that said, going forward, we would expect with a higher earning asset base -- certainly, we expect net interest income to grow, and that's what we really focus on. In terms of the margin or mathematical output, I would say it's going to be probably flat to just slightly expanding a little bit in Q1.

And the next question comes from Andrew Terrell with Stephens.

Ed, I appreciate the guide on expenses. It's really helpful. Maybe just thinking about it kind of more holistically expenses normalized a bit higher to start the year and maybe stay there throughout the year. We also have an improving rate backdrop and you're clearly very asset sensitive. Just taking kind of those 2 pieces together, is there any reason we shouldn't, I guess -- we shouldn't think that you can manage the efficiency ratio kind of at or below that 30% level kind of like we saw this quarter?

Well, yes, 28.8% kind of surpassed even our own expectations, Andrew, but I don't see any reason why we can't keep that below 30s. That shouldn't be a problem at all.

And I just -- I mean, I have to add on this, okay. You see -- I mean, efficiency ratio is a function of net interest income, okay? And when the rates -- if it is a rate rising environment, the net interest income is likely to increase. So with expenses less -- actually that's lesser -- less of a movement than interest income, so likely that we can maintain that efficiency ratio.

Okay. Yes, clearly impressive at 28.8%. Could you guys maybe provide just some -- an update on how progress is going for the Houston, Texas, LPO?

Okay. Do you want to update Houston?

Houston update. We have -- in terms of headcount right now, we have 3 individuals. And we're looking to hire 3 more coming on board towards the end of this month. So I think with that in mind, we always, again, our mentality is always looking for productive relationship manager. What we consider variable cost that can bring in business. So it's going in the right direction, Houston, under the leadership of a veteran. So we feel quite optimistic.

And with that, I also want to add on a little bit from a more strategic point of view, okay? From the view of our Board of Directors, Houston is a diversification. It is a very small percentage of our total production staff and small loan portfolio. And also, we have always been careful when you're going into a new market, you don't want to explosive growth okay, for whatever reason it is, one of the reasons from a chief credit officer that you don't want to have explosive growth in a new market.

So we will be proactively growing the Houston office because that's a good market. And too bad is that pandemic change our capability of visiting or support the office. So this is growing, they're still according to our plan, pretty much along with our plan.

Andrew, just to add on to that, they finished the year ahead of our expectations, and that's a very inexpensive piece of real estate to operate as well. So we feel good about it.

And the next question comes from Gary Tenner with D.A. Davidson.

I had a follow-up on kind of the expense guide, Ed, for the first quarter, 15.2% to 15.5%. If we look at it kind of year-over-year, that's in line, if not below what the first quarter 2021 looked like. I'm just wondering, as you think about kind of commentary on wage inflation and everything we're hearing in the economy in general here, why that would be the case.

And I'm just wondering, is it related to the capitalized cost of benefit of having increased production potentially this quarter versus where it was first quarter of '21 or something else?

Yes. That's part of it, Gary. The other thing we did is we accrued some of the payroll taxes that are going to be coming due in February when we pay out the annual incentive compensation. Our payroll tax expense does go up. So we did accrue some of that in the year 2021. So that's why you won't see that quite as high.

In addition to that, FDIC premiums have actually come down for the bank as our risk profile has improved relative to a nonperforming asset.

Also first quarter only, the bank-wide raises to our staff, will be beginning on March 1. So it's not immediately that creating a big impact.

Okay. Okay. That's helpful. And then the second question I had, just on the fee side. Third quarter, you had a really significantly stronger quarter on letter credit fees. I think you talked about fourth quarter being lower, but it was kind of below where it was in the first half of the year. So in terms of -- as we're looking out to 2022, knowing that there's going to be some volatility probably in that line item, how are you thinking about that line of business today versus maybe how were you thinking about it when we talked in October?

Anybody wants to answer that? Wellington, you want to answer that?

Gary, on the letter credit fee side, I think we should do similar or probably will be greater than what we did in 2021. In fact, we -- I think we have to observe who already connected with their source. So that's something that we would do. And on the other type of service, deposit service and that's something that we believe in our forecast, you'll see will surpass the 2021.

In addition, Gary -- thanks, Wellington. In addition, service charges on deposits continually increases, and that doesn't get a lot of notice because it's not a big line item, but year-over-year, service charges increased 30%, and that's due to a number of programs that we began internally in order to take advantage of the larger DDA base that we have.

And the next question comes from Steve Moss with B. Riley Securities.

Maybe just starting with -- turning back to loan yields here, there's relatively stable quarter-over-quarter. Mr. Yu, I heard you talk about pricing coming down. Just kind of curious where there just any unusual fees or extra fees in the loan yields this quarter?

No.

No. As a matter of fact, I think we actually had a small reversal of interest income of about $60,000 on a couple of loans. So there's been nothing unusual in the interest income on loans. And as a matter of fact, to take that a step further, Steve, looking at loan yields over the past 5 quarters -- over the past 4 quarters, our average loan yield is only down 12 basis points against this backdrop.

Okay. This is obvious, strong deposit growth, okay? I mean, twice amount of the loan growth and also the pattern of deposit growth and loan growth changes our I mean net interest margin quarter-by-quarter. But again, that, as I said, that we will spend much more time and effort in net income, okay?

Right. Okay. And maybe just sticking with the inputs to the margin. Just kind of curious, we've had a move up in rates here. What is your appetite for any additional securities purchases if at all, given your $1 billion plus in cash?

Let me -- Ed started to mention to me that we should buy a couple of more -- security.

I did not. Actually, Gary, we did add -- as you can see in Q4, we did add to the bond portfolio, about $190 million, and that's Ginnie Mae monthly floater stuff. So it's very short in terms of duration. But from here on, I was looking at the average balance sheet. Since March, we've added $500 million in cash on the balance sheet just in the last 9 months.

And so I think at this point, we'd probably be pretty reluctant to put any decent part of that to work. We really look for the IOER rate to be increased as Fed fund rates go up, and then that's going to certainly help.

Right. Maybe just on that...

Okay. Go ahead.

Okay. And then, Ed, maybe just on that point on rates here, I think if I recall correctly, it's 50 basis points -- the floors are about 50 basis points in the money. I'm just kind of curious, what percent -- remind me just what percentage of loans have in the money floors.

So let me go through this for you, Gary. So as of right now, the floating rate represents about 86% of the book. Of the floating rate, about 84% have a floor. So when we're looking at the first rate increase, we're going to look at -- we're looking at about $800 million -- a little over $800 million of the loan portfolio moving up in the first rate increase. And then as we go to 50% -- 75%, it gets greater.

Well, loan portfolio is one thing. And I want to add on the 1 building and [$50 million] of cash on hand, and that will move [about] altogether. And as part of the securities about $250 million is also will move along with the rate changes.

So I calculate it, we have about $2.45 billion in assets together with the [first 25] sensitive loans where $2.45 billion assets -- it will be going up if rate changes. And also, our immediate sensitive liability is $2.06 million of money market and interest-bearing DDA. And the remaining segment is TCD, the $1.9 billion which were raised 1/12 every month.

Actually, we have a 18-month maturity schedule. So we were basically gradually increasing on the whole situation. So I am personally hoping, with some luck and some management, actually, when the rates first move, we should be doing a little bit better. And along the way with further increases. And then...

Okay. (Multiple speakers) I'm sorry?

Does that answer your question?

Yes. No, that's very helpful. And then maybe just 1 last question for me. Going back to the loan pipeline. Just kind of curious what is the mix of business you guys are seeing in the pipeline coming up?

Okay. Either one of you want to answer that?

Well, I think the business right now, I would say about 70-30. 70% CRE-related, and 30% on the C&I side. Johnny -- that's about right.

Yes.

Actually, C&I includes mortgage because the mortgage was a small percentage increase. Yes. So that has always been along our business line. We always keep somewhere around between 28% to 31% in the last few years in C&I loans.

And the next question comes from David Feaster with Raymond James.

This is Eric Spector on behalf of David Feaster. Congrats on a great quarter. It's really great to see the quality improvement and the further improvement early in 2022. Just curious how you think about reserves and the provision going forward and what you would expect it to decrease back to that 1.24% level, and -- which is the post day 1 CECL level. So if you can just kind of give a quick update on that, that would be great.

First of all, we're going to give you an official answer of the reserve, which is from Nick that he has to be answering to the CPAs and so on the result of that situation now.

Sure. David, as Mr. Yu mentioned earlier that our asset quality is heading to really positive side starting out from 2022. Yes, and by the end of this quarter, I believe our -- both our classified and also special mention loans will be dropped substantially.

However, there's still a lot of things that we're watching at this time. Probably the most is supply chain disruptions and also high inflation, as Mr. Yu mentioned, that the Fed will try to increase rate several times this year and also probably there's some it's a bubble during the past years because of the lower cap rate and everybody chasing the property.

However, yes -- even though our key underwriting on those things actually is based on the DCR instead of the value. This as a bubble -- maybe it gives a good cushion for our existing loans. For new loans, we are closely watching that [cube]. And apparently, Omicron, pandemic issues, labor shortage, all these kind of things will give us some pressure to economy growth.

So, no matter what, our portfolio is getting better and better. And I believe once these issues go away then our normal range is around 1.2%, plus or minus.

I guess, you're asking is that right now, we're at 1.37% and [day] after CECL at 1.15%, what do we think about the differences? Obviously, from an operator's point of view, I hope we can get back to the 1.15% level. But right now, still a whole lot of qualitative factors that we are not releasing. And we think the economy is not necessarily out of the woods yet, okay?

So we will evaluate every quarter along the way. And I hope that someday, if we can maintain a very, very clean credit quality, we might even go below 1.15%, but we just have to go every step that way. Am I right in this?

Yes, Mr. Yu.

Would I be getting in trouble with the [CPA]?

You're good.

All right. Okay. Great. I just wanted to do a quick follow-up on loan demand across your footprint and where you're seeing opportunities and the potential for de novo expansion opportunity as well and just kind of hear where you're most interested.

Okay. Either one of you want to discuss the opportunities?

Well, I think the opportunity is we always go -- I mean, in terms of de novo, we never expand into a territory for the sake of a geographic location. We look at the talents that we have. For example, Houston, we went into that market because we were able to recruit a group of experienced banker and go into that area. So that's where the opportunity is.

And Johnny, feel free to chime in, in terms of our recruiting, new hire strategy and all that.

Yes. In terms of your question on -- Eric, on the demand, I think demand is pretty consistent across all of our geographic footprints with Houston, New York, Northern and Southern California. But like Wellington said, we always look for opportunities for expansion, but we have to find the right team and the right people. That's always been our philosophy.

Great. One more, if you don't mind. I'm just curious about your thoughts on capital deployment opportunities. Obviously, organic growth remains paramount, but I'm just curious your appetite for buybacks or dividend growth.

Well, I can talk about buyback, okay? I have to something where I have to ask all you analysts, okay? And we will always [look] buyback is something rewarding our shareholders. Well, then, after we buy it back, our net worth become less. And the shareholder -- I mean many of you [valuing] us, valuing our stock based on the book values.

So -- and buying back is that really rewarding our remaining shareholders? So I keep on asking the question, we did the buyback, okay? So I guess you buy it back when [you see] the market [settlement] fully change to PE-based, okay, -- PE-based.

So yes, we will continue to do that once we have -- when we have excess capital, okay? And when we anticipate -- when we see the growth is not requiring use capital, we will use it for with shareholder return to shareholders. As you can see, we're increasing our dividends continuously now.

Congrats, again, on a great quarter.

And this concludes the question-and-answer session. And now I would like to turn the call over to Li Yu, Chairman and CEO, for closing comments.

Well, thank you very much. And consider that we're still in the middle of pandemic and consider that what the country has gone through all these -- for the last 2 years, we are fortunate to be able to have the operating results as we have just discussed, okay?

And now if you base on whatever the Fed is saying or Mr. Jamie Dimon is saying that we're in the rate rising environment that -- which is more of a beneficial to a rate sensitive bank like we are, okay? But we will be careful every step of the way in the near future. Thank you so much.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.