Preferred Bank (PFBC) 2020 Q3 法說會逐字稿

Good day, and welcome to Preferred Bank's Third Quarter 2020 Earnings Conference Call. (Operator Instructions)

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

Thank you, Jason. Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the third quarter ended September 30, 2020. With me today from management are Chairman and CEO, Li Yu; President and Chief Operating Officer, Wellington Chen; Chief Financial Officer, Edward Czajka; 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 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. Ladies and gentlemen, thank you for joining our earnings conference phone call. I am very pleased to report Preferred Bank's third quarter net income was $17.1 million or $1.15 per share. These numbers compare favorably with the prior 2 quarters.

In fact, on the pre-provision pre-tax basis, third quarter net income and a 9 months net income was a record high for our bank. The quarter's improvement is largely due to the significant reduction in deposit costs and continued overhead control. Many people have always considered Preferred Bank as an asset-sensitive bank. But if you recall, about 2 quarters ago, I have already reported to you in our press release that we have become a liability-sensitive bank. I'm just very pleased that we have something to show you in this quarter. Deposit costs will continue to decline in the fourth quarter, but not at the same magnitude and the same pace in the third quarter.

For the quarter, our net interest margin was 3.54%, a 3 basis points reduction from previous quarter, mainly due to a larger balance sheet and a much increased excess cash on hand. However, on the ex-PPP basis, our net interest margin actually improved to 3.61% from 3.59%. Quarter-over-quarter deposits continued to grow 1.5% or $64 million. However, our loan has declined $14 million dollars. I guess the prolonged shutdown or lockdown in our main trade area, which is Los Angeles, New York and San Francisco, finally affected the deal flow of our pipeline and new opportunities of loan seems to be -- also seems to be less attractive under the current environment.

Today, much of our attention and focus is on credit matters. As of June 30, we have some nonperforming loans, total a little less than 50 basis points. We have decided to charge-off a portion of them, and we have also decided to reserve whatever exposure, we can see the full amount and on a very conservative basis. Meanwhile, for the quarter because of -- for the quarter, our loan loss provision was a larger number of $9 million.

So as a result, our credit view continues. Total reserve to loans, it now stands at 1.58%. On the deferment side, total loan that received modification under the CARES Act was $610 million. Balance at June 30 was $467 million, and balance at September 30 was $199 million. In the third quarter, we had a 53% reduction. We've also reached out to practically all of our borrowers, inquiring about their plans. And we are very encouraged to learn a great majority of them indicated that they are planning to resume their scheduled payment very soon.

Therefore, deferment balance at December 31, could be a very modest amount. For the third quarter, our return on equity was 13.7%. We at Preferred Bank are elated about this. Not because the number represents after the significant loan loss provision, not because it represents the culmination of all the one year's work to restructure and reposition our loan portfolio in our balance sheet. But rather, we believe bigger earnings will give us bigger muscles to fight the uncertainties ahead. Thank you so much. And I'm ready for your questions.

(Operator Instructions) First question comes from Nick Cucharale from Piper Sandler.

So you mentioned the increase in capitalized origination costs due to higher loan production versus the second quarter. Can you quantify that impact in bigger picture, can you share your outlook for operating expenses?

Nick, this is Ed. I'll take that one on. Loan originations were relatively flat on a quarter-to-quarter basis when we look at Q2 versus Q3, but what we really saw was the PPP loan fees that came in and that's why we had the outsized capitalized credit cost under salary expense. And also that had a benefit, slight benefit under loan fee income as well. In terms of going forward, noninterest expense wise, we really don't make it a rule to give any kind of forward guidance.

But obviously, I think we did an excellent job with respect to expense control in the current quarter. I would look for that to continue. As you know, that's what we're all about. And we actually reached 30% efficiency ratio in this quarter. So I thought that was pretty impressive. But in terms of going forward, I think it's going to be fairly similar, probably up a little bit from Q3.

Sounds great and I agree with your assessment. So this was the second quarter we saw C&I pay downs dampen the growth you achieved in the real estate book. You had the big draw on commercial lines in the first quarter. Now we're back towards the end of the 2019 level with respect to balances. Is your sense the commercial pay downs are in the final innings?

Well, I didn't quite really get the question. I mean you are asking really based on whether the C&I balance is -- continues to -- actually C&I balance in this quarter has reduced about $67 million okay? Mostly in the customers pay down. Okay. So our net production, actually we have a little bit of net production, well our new production versus the payoffs have shown the balance of about $40 million. But because of the C&I, existing customers less usage of our lower mark. So the quarterly total loan balance reduced by $14 million.

Okay. Your total capital ratio is up nearly 80 basis points from the end of the year. You continue to have strong internal capital generation, as you pointed out, even in spite of big reserve builds. Can you help us think about your capital priorities? And specifically, if and when you may revisit a buyback?

Believe it or not, compared to our peer group, we're at the lower half of our capital ratio. We have designated peer group among our people. So -- and at this point in time, our attention really is focused upon the uncertainties ahead of us.

We just want to be well prepared for any kind of things that can affect us. We will revisit that, providing that our loan growth did not restart. When we start the loan growth, there's no need to buy back stock, we can create more income for our shareholders by growing the bank.

Okay. And then lastly, the tax rate came down quite a bit this quarter, seems to be more a matter of timing rather than a structural change. How are you thinking about the tax rate going forward?

Nick, I'll take that one. This is Ed. Yes, the tax rate came down in Q3, and that was a true-up to the 2019 tax returns. So we would look for a somewhat similar tax rate in Q4, albeit up probably just a little bit. And then for 2021, excluding what happens with respect to the upcoming election, we would expect to head back to the -- right around 29%, 29.5% ETR.

The next question comes from Gary Tenner from D.A. Davidson. (Operator Instructions)

Sorry about that. A couple of questions for me. I just wonder if you could provide any details on the charge-offs in the quarter. I didn't quite catch any detail Li may have provided?

Yes. We have 2 loans, 2 larger loans. There were a bunch of little, insignificant with the larger loans that was -- placed on them, accrued in the second quarter, okay. And these loans are currently in prolonged collection process. Although indication is that the latest appraisal value, which is a while ago, is still well covered alone, but we believe the market value has slide down a bit.

And because of the uncertainty of the collection process (inaudible), we decided to proactively (inaudible) and reserve whatever exposure we can combine. So I hope it's sort of like the proactive move preparing for 2021.

Okay. Great. And Ed, on the previous question in terms of comp, I think you said that you had the benefit this quarter that drove comp lower because the PPP fees came in this quarter. But wouldn't the deferred count had been a benefit in the second quarter from the PPP production?

Well, actually, a majority of it was -- a lot of the fees received and the bookings took place in Q3. So it was after the end of June when a lot of that took place. In addition to that, Gary, with respect to comp expense, bonus expense was also lower this quarter as well. And as you know, bonus expense -- incentive comp expense is a component of the bank's overall profitability.

The next question comes from David Feaster from Raymond James.

Mr. Li Yu, I just wanted to follow-up on your comments at the start, where you had kind of made it sound like your -- that new loan opportunities might be a bit less attractive in the current environment? Is -- did I understand that correctly? And maybe just why is that? Is it structure? Is it just pricing? Is it just uncertainty in the market? Just curious to your thoughts on loan demand and your appetite for new credit?

Actually, you mentioned just about every possibility. But let me be clear, I mean, new opportunity for hotel loan, you don't want to do it, okay? New opportunities for retail loan the chances that you want to do is less than 50%, okay, even in the old days seems to be fine.

And a new opportunity for some specialized product or office and so on, then it becomes -- it's less attractive, especially in some of the areas that we're operating at. And today, with a prolonged interest rate situation people are also looking for loans at the price to the unreasonable level. Would you believe the loan pricing is less than our net interest margin, okay?

So that makes us eliminate a lot of the opportunities that we look at.

David, I'm going to add to that to what Mr. Yu said. A lot of the economic activity going on in the United States is very regionalized right now and very localized. If you look at what's going on in the south and economic activity there, the Midwest, far more than what's taking place in California. I mean, LA County is still in one of the strictest lockdowns in the entire country still.

As well as New York.

As well as New York. And so as we look at lending opportunities, we have to look at our local economy and what's going on there as opposed to what may be more of a macro thing to look at.

That's a good point. So probably -- I mean, you guys are still -- like you said, originations have been flattish. So probably some -- exclusive of PPP, which is obviously going to decline probably some flattish to maybe modest contraction in loan balances in the short run?

Well, actually, because we are a sort of like one-off type of loan company. It depends on the special loans that come to us, okay?

Early indication in the fourth quarter, we maybe have some production. But it is we don't know the payoff situation was coming later in the quarter and so on. So if you look at it, as we try our best. But right now is -- the key situation is for us to manage our credit and to keep our profitability up.

Yes. And kind of along those same lines, you guys have done a tremendous job defending the margin. And a tremendous job reducing deposit costs. And ex PPP was actually up quarter-over-quarter, like you alluded to. But you had mentioned that the incremental reduction in deposit cost is probably going to be less in near term. Do you think that you can continue to support loan yields and outpace the deposit costs or outpace the decline in loan yields and we could see margin flat to up? Or would you maybe expect some further NIM compression just given the pricing challenges that you had mentioned?

Okay. Loan-yield reduction in the third quarter, okay, is in the neighborhood -- actually yield is in the single-digit situation there. So I'd like to think in the fourth quarter that -- probably that the reduction in interest costs okay, will be offsetting the loan yield reduction, at least.

Okay. Okay. That's helpful. And then last one for me. You guys have done a terrific job on the deferral front. Deferrals have -- they're down significantly but I guess how have deferrals trended since that [9 30] level? Like where are they today? How much of the balances are second deferrals versus those that are still on first deferrals and kind of does that $27 million deferral target that you guys put out in your presentation. Is that still holding true?

Well, why don't -- Johnny, you want to take on that question and then I'll add on to it?

I think -- David, this is Wellington. I think that the deferrals you saw on the second -- already on the second, that's included. So this is it.

Okay. Okay. Like after your conversations, there's -- nothing has really changed in that $27 million kind of target that you laid out after all the conversations with your borrowers. You're still thinking minimal at the end of December.

Actually, David, if you read the text of our press release, they indicated there are still $4 million new request for deferrals, okay? As of September 30, okay? So the question of deferral sometimes are coming, but the number is very mild. You see many of our customers has been paying out of their pocket for a period of time. But since the lockdown is less than -- more than you and I were originally anticipated, okay?

So the question, some of them is finding -- I mean, starting to have difficulty. In many cases, the new deferral with lending is only principle only or partial interest, okay? So if you look at our -- the deferral composites, 40% of our deferral is partial deferrals, okay? So we look at everything, study everyone and try to see the underwriting principles in granting out deferrals.

The next question comes from Tim Coffey from Janney.

And thanks for hosting the call today. I guess, I want to follow-up a little bit on the loan demand from your clients. So if the restrictions were lifted tomorrow. I mean, would you expect to see a resurgence in demand for credit from your borrowers? Or is it more that your borrowers are just kind of hesitant right now to make new investments and things of that nature?

Well, my impression is that -- my impression is that there's a lot of money on the sidelines, okay? And the people are just waiting to jump into it, okay? I mean, Wellington don't you want to add on that?

I mean, I agree. I think that there are a lot of money on the sideline. They are waiting for opportunities. And is it going to spike up overnight? Probably not, because we're going to also be cautious too and ramp it up gradually. But I think that there's definitely -- if pandemic is done tomorrow then we have to look at our competitors as well, too, how the market reacts, and we have to look at what's the -- again, as Mr. Yu mentioned earlier, the pricing of the loan.

Sure. Okay. All right. That's helpful. And just circling back on the deferrals, with the positive trajectory of the deferrals, are you done reserving? Or is it a little too early to make that call?

Well, we have no -- I mean, talk on the reserve, it's overall, okay, is for the future, okay. Let me answer you by saying this, okay? I have reached out to several of our shareholders, I said, " Well, given our situation, our deferral doesn't look that bad, okay? In fact, you can say it looks reasonably good. But what do you want me to do under the uncertainty because there may be a second wave on the vaccine?

And today, I mean the government official come out saying that all maybe 6 months before everything is happening and so on. What about if New York is locked down for another 6 months and we'll not let anything happen. So the majority of my shareholders tell me, says "Li, you're in the long game, you should manage the bank in the safest and most conservative basis under the current environment." So I guess, I mean, we will make some additional further, further reserve of credit view, okay? But again, we will open our eye to COD market condition. I know we are anticlimax. Most of the bank is reporting reduced provision and so on and so forth.

But seems to be -- the mandate of my shareholder is that they want us to play it safe, especially playing safe we still have a 13% return on our investment and seems to be they're happy with that, yes.

Yes. Okay. No, that's helpful. And then, Ed, just if I could, on CDs that might be repricing this quarter. If you know what the yield on those are -- or the cost of those are and where the market rate is right now?

I know the number...

That is $434 million would be renewed in the fourth quarter, okay, okay? The rate on that is 116, okay? And currently, our CD rate is in a 60 to 70 basis points range. So there will be some savings. But mind you, the $434 million is not really evenly renewed during the [fourth] quarter. Some of I guess, a bigger portion would be in December.

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The next question comes from Steve Moss from B. Riley FBR.

I guess just starting with -- going back to credit here for a moment. With regard to the provision this quarter, just kind of curious how much was the specific reserve for the 2 larger credits here?

I think we'll reserve additional $6 million or also, approximately $6 million. Okay. Other than when we write the charge-off.

Right. Okay. So then absent that specific reserve, your provision for the quarter would have been closer to $3 million, just as we kind of think about economic impacts, kind of a fair way to think about it?

I think the charge-off really has no economic impact. Reserve is the amount that has really a good impact. In other words, in obtaining every (inaudible) basis, if we make reserve $5 million provision will be $5 million, okay? And the next quarter charge-off is just a reduction of the reserve that was previously made on them.

Right. Just trying to think about the -- just the driver of the provision going forward, if economic forecasts remain relatively stable, the biggest driver going forward will be whatever you may have in terms of specific reserves?

Could you be a little bit more specific about that, okay? So I mean -- okay....

So I mean...

Yes, hang on, I'm sorry. Let me -- Steve, I'm sorry, I want to correct what Mr. Yu said earlier. Apologies. But the specific reserve assigned to those 2 specific credits was $3.3 million when we're looking at the overall provision of $9 million. So the specific was $3.3 million, and then the charge-off on the 2 was $3.5 million.

Charge-off is already done. Okay. So it's already taken care of, so additional $3 million, right...

I just want to clarify that. Yes. So back to your question.

We (inaudible) and charge off the $3 million.

Yes. (inaudible)

Okay. So then just as I think about the drivers of your provision forecast -- of the provision going forward, if economic forecasts continue to generally improve barring some exceptional specific reserves, probably should see a meaningful reduction in the loan loss provision going forward?

Well, yes, sir. If economic forecast is showing the improvement. We would definitely reduce the provision, okay? If the deferment works out to be like we projected to be and there are no new surprises in the home situation. Maybe somewhere in 2021, we shall release the reserve, okay? Given the situation as of today, I don't think any economist has given a definite answer that how economy is doing that well. And as I stated earlier is that the majority of the constituents of us is expecting us to play it safe.

So the short-term (inaudible) will still continue for (inaudible) provision will still be large. But we were definitely making the adjustment. I mean, whenever timing is indicating so.

Okay. That's helpful. That was -- I just wanted to try to dig down a little further into that. The rest of my questions have been asked, so I appreciate that.

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The next question comes from Andrew Terrell from Stephens.

So most of my questions have been asked and answered already. Maybe do you guys have the balance of classified and credit sized loans this quarter?

We do...

I do. Just hang on. Got a lot of paper here, hang on. Here it is. Classified is [59.] And then overall, criticized would be the special mention plus the criticized and about a added together.

That's helpful. So I'm looking at the table you guys provided in the release that breaks down the loan portfolio by bucket and gives the loan-to-value and the debt service coverage. This is extremely helpful breakdown, by the way. If I compare this quarter versus kind of last quarter, most of the real estate buckets saw an uptick in loan-to-value by about 3% on average. I'm curious, is this more just an ebb and flow of the portfolios? Or are you getting updated appraisals on properties right now? And if so, how are those valuations comparing to the previous ones in place?

You want to answer that first, Ed?

Yes. I would say at this point, Andrew, it's really a combination of both. There is certainly churn through there, even though the portfolio only moved $14 million, there's a fairly decent amount of activity that goes in there with respect to payoffs, new originations as well as renewals. So on the renewals, depending on the length and size appraisals are updated. Other than that, it's as you said, it's the ebb and flow.

All right. And just last one for me. Have you guys started submitting applications for the PPP forgiveness? And do you have any kind of just ballpark estimate on when you anticipate recognizing the fees?

Johnny, do you want to answer that?

Yes. We did submit forgiveness applications already. And few have come in, in early October. So we expect that to be continuing throughout the fourth quarter.

The fees are currently being amortized over the lives of these loans right now. So the fee recognition at the end of this won't be that significant because we'll also have deferred cost to recognize.

And also our total PPP is only $74 million out of $4 billion of loan portfolio. So in relative sense, it's -- it would not affect things that much.

Next question is a follow-up from Nick Cucharale from Piper Sandler.

Just a quick follow-up on the NIM. So point-to-point, you had a big increase in cash balances at September 30 relative to June 30. We're only a few weeks into the third -- the fourth quarter here, but has that excess liquidity started to come down materially at this point?

No.

No. Not even slightly. Hopefully -- not much. Nowadays, and our -- when the cash inflows (inaudible) DDA we're kind of sitting there happy but not happy about that.

Upside down.

This concludes our question-and-answer session. I would like to turn the conference back over to Li Yu for any closing remarks.

Well, thank you so very much for your attending the conference. And we hope -- we hope we can continue our operation under the current metrics, which -- that give us kind of a profitability and situation we'd like to have. Okay. Thank you so much.

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