Preferred Bank (PFBC) 2020 Q2 法說會逐字稿

Good day, everyone, and welcome to the Preferred Bank's Second Quarter 2020 Earnings Conference Call. (Operator Instructions) Please note that today's event is being recorded. At this time, I'd like to turn the conference call over to Mr. Jeff Haas of Financial Profiles. Sir, please go ahead.

Thank you, Jamie. Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the second quarter ended June 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; 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 question.

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.

Good morning. Thank you for attending our conference. For the second quarter 2020, Preferred Bank's net income was $15.3 million or $1.03 per share compared to last quarter and the same period of last year. This quarter's earning is little light. That was mainly due to a large $7.5 million loan loss provision that we recorded during the quarter.

On the pre-provision net revenue basis and pre-provision pretax net income basis, we are doing a little better than those comparing periods even with -- even under the current interest rate environment.

For the quarter, return on assets was 1.26% and return on equity was 12.65%. At June 30, total PPP loan made was $74 million. We have earned approximately $1.94 million in fees. And the fees will be amortized over the life of the PPP loans. This loan does carry an interest rate of 1%. Obviously, PPP loans will be negative or have a negative effect to the NIM.

Second quarter deposit growth was $264 million. Loan growth was $70 million. Both number is inclusive of the PPP loans. Actually, we had a net organic origination of loans. We made $211 million of new loans and have $161 million of payoffs, which netted our net organic origination of $50 million. But on the financial statement, that was wiped out by the reduction in revolvers. This large difference between loan and deposit growth has created net deleveraging -- a leveraging of our balance sheet, which also have a negative effect to our net interest margin.

Net interest margin for the second quarter was 3.53% or 17 basis points lower than the first quarter. Other than the PPP factor and the deleveraging factor mentioned above, there was a little bit over $500,000 of interest income reversal that also affect the margin. Compared to the first quarter, our loan yield decreased 47 basis points and our deposits cost decreased 43 basis points. We expect, going forward, deposits to -- deposit cost to continue to decline because of the maturity and the repricing of our time certificate deposit portfolio.

At June 30, total modified loans amounted to $467 million. Towards the latter part of the quarter, activities for new modification has greatly slowed down or moderated. In fact, as of June 30, there's only $4 million more new request in progress -- or in process. And during the quarter, many has returned or are being reinstated to normal status. And between July 1 and July 20, there's another $25 million being reinstated.

Our deferment or our modification is generally for 3 months. 40% of the modification loans -- modified loans are for partial modification, which is for interest only or principal only. 60% is for the full P&I modification. Modification, generally, is for 3 months period.

For the second quarter, as we've reported earlier that we had a $7.5 million of loan loss provision. Quite certainly, going forward, the reserve build will continue. But the new provision to extend the magnitude of the new provision will be dependent on quarter-by-quarter evaluation of the economic condition, the status of the virus and development of our loan portfolio.

The large deposit increase has pushed our total assets to exceed $5 billion. The number is probably very meaningless, except to the morale of the staff of Preferred Bank. The increase of deposit gave us great liquidity but also penalized our ROA and capital ratio. With our current efficiency ratio of less than 33%, the declined -- declining trend of the deposit cost and that all of our floating rate loans with floors are operating at floor. We feel very comfortable with our operating metrics.

Thank you very much. Now I'm ready for your questions.

(Operator Instructions) And our first question comes from Timothy Coffey from Janney.

Great. I think I just want to start first with the nonaccrual loans in the quarter. Can you provide some color on those?

Okay. I would obviously ask Nick Pi to give you more details about that.

Yes, the nonclassified loan are mainly caused by a couple of the loans, which we have recently downgraded to classified nonaccrual. That's why the first loan actually is fully secured by real estate. And during the past couple of months, it's the borrower trying to sell to dispose the properties and pay back the loan. However, the sale was not so successful because of the COVID-19 pandemic. It has been delayed. We're also continuously working with the borrower, try to resolve the problem.

And the second one, we have further downgraded because of the borrower filed Chapter 11 recently, and the cash flow was naturally affected by the COVID-19 pandemic at the very beginning. And also, the third one is related to one of our small loan, around $1.4 million in our New York area, and the loan is also fully secured, and the borrower is working with the bank for refinancing and provide additional collateral to cover the risk.

Okay. What were the book values of the first 2 loans?

It's in L.A.

Book value.

Book value.

Yes.

Dollar amount.

The first one is $16.88 million. The second one is $6.32 million. And the third one is $1.13 million.

Okay. And the first one you say was in the Los Angeles area?

Yes.

Okay. And where was the second one?

The second one is also in L.A. area.

Are you expecting additional write-downs on these?

I'm sorry?

Are you expecting to write down the values of these loans still?

We have provided sufficient data. You have provided a sufficient data?

Yes.

It was there, right?

Yes.

For the second loan. The first one doesn't need any --.

The first and third loan, we based on SB 114 analysis. They're fully secured and we don't have -- we don't expect any loss for those 2 loans.

Okay. Okay. I was kind of wondering if that -- the commentary that you had provided earlier on provisions were not related to these loans. Okay. Ed, what was the spot rate on your deposits in the quarter?

When you say spot rates, Tim, do you mean the ending rate as of June 30 or during the quarter?

As of June 30.

As of June 30, the cost of deposits was down to 74 basis points.

And in the comp line item, did you include any deferrals of loan origination expenses?

Yes. Yes. That's always in there, but that was one of the reasons for -- actually for salary expense going up over last year's levels, Tim, is one of the reasons is that salary -- loan origination activity, as Mr. Yu talked about, was there, but it was significantly down from where we were a year ago. So those credits to salary expense that we defer over the life of the loan, those were way down as well.

Okay. Okay. And then just Mr. Yu, the net payoff of $161 million, were those properties -- are -- were those loans refinanced to other institutions? Or why were those elevated?

Some of them is construction loan payoffs, okay? Some of them is being refinanced by other institutions in a rather low way, and some of them is outright sales. Customers just sold the property. Okay? I'm talking real state basis, okay?

Sure. In this current environment, do you expect that number to stay the same or change either way in the next couple of quarters?

I will give you my thoughts after Wellington give you his thoughts about what he's expecting because we each -- we think sometimes slightly differently.

Hi Tim, this is Wellington. For the third quarter, the payoff is unknown, really, because it's so many moving parts, as I mentioned in the past, too. Every quarter, we have projection of the pipeline, what's in the pipeline and also try to project as accurately as possible on the payoff. And really, it's a unknown factor right now.

Well, Tim, my thoughts is that we will be seeing in the third quarter on the origination level on the payoff that both reduced. One other situation is judging from the activity of the payoff in the second quarter. Another situation is that with this virus going on, many of the people are just making no movement.

Our next question comes from Nick Cucharale from Piper Sandler.

So just a follow-up on the NPAs. The first one, you mentioned, the $16.8 million loan. You mentioned the delayed sale process. Is that looking optimistic at that point? It sounds like it could cure in short order just given the fact that a sale -- if a sale were to occur in short order.

Actually, this is a -- this question is kind of hard to answer. From a normal sense point of view, it should happen way back a long time ago, but we have a customer, it's kind of a somewhat hang up to the things they -- hang on to the things they want to have. Every time when a deal is being made, either backed off or somehow it's not return.

You see this property is really qualified as a deferment. But since it was late before the guideline was issued, we really cannot, given the deferment going forward, so this thing is also [hanging] up there. So we obviously is using the utmost of our energy, try to encourage him to get rid of the property.

That's very helpful. I know there were a few moving pieces with respect to the NIM this quarter, but I was hoping you could help us think about the forward trajectory in light of PPP forgiveness on the asset side and a continued repricing on the liability side.

Yes. Ed can do that. Ed is -- he's got it all ready for you.

Well, I don't have a crystal ball. I don't have a crystal ball, Nick, but just a few things. You mentioned moving parts in the NIM this quarter. And as Mr. Yu talked about, there was a pretty significant, what we call a deleveraging of the balance sheet during the quarter where we've taken on a lot of deposits, taken on a lot of cash, it's earning 10 basis points, and loans are not growing. That certainly has a rather negative effect during the quarter.

The reversal of nonaccrual interest had an effect of about 3 basis points. So without that, we would have been about [3.60%] from a NIM of [3.70%], I think the quarter before. So the compression wouldn't have been as severe. Going forward, if we do get PPP forgiveness on the $74 million, obviously, that will be helpful going really into 2021 because I don't know that we expect a lot of movement on that forgiveness piece prior to the end of the year or in the third quarter.

I think going forward, we are going to have, as Mr. Yu mentioned, the CDs maturing. We have $426 million maturing during Q3 at an average rate of about 161. Those will come back on at an average rate of about 70 to 75 basis points. So that will certainly help going forward. And as Mr. Yu talked about the -- on the asset side, we don't see too much more slippage in the way of yields because so many of our adjustable-rate loans are already at their floors. So I think from the -- this was kind of the nadir, if you will, of the margin for the quarter, we'd like to think so.

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

I guess just following up on the margin here in terms of -- there was incremental securities purchases in the quarter. What's your appetite at this point for anything or any structures out there?

In terms of the bond portfolio, not much. I mean what we try to do there is there's no home runs, and there's really not even base hits. I don't know -- there's half hits, if you will, because we are trying to put some money to work, but this is a bad environment to do it.

As you know, there's a lot of yield chasing out there, so we have tried to place a little more money with our correspondent banks. That gets us more return than our 10 basis points at the Fed. And then we've incrementally added here and there to the bond portfolio as we see small glimmers of opportunity.

Okay. And then in terms of the -- going back to the nonaccruals, just kind of curious, on the property types for the $16 million -- $16.8 million nonperformer and the third loan. Are those -- just are they commercial real estate, strip mall? Kind of curious as to any color there.

Nick, why don't you answer that? Okay?

Yes. The loan actually covered by a few properties. This is more high-end residential in a desirable area.

Okay. And then in terms of your hotel exposure, just kind of curious, [can you] give any color around what you're seeing for occupancy at those hotels, where they may be located and what your thoughts are with regard to whether it's -- how you're going to approach restructuring those loans?

I'm going to give you a little bit longer dissertation on that if we have the patience, okay? Then our hotel, this is basically speaking, so some of the hotels closed, okay? They -- somehow, they only decided [custom ball]. They just keep it open.

But the one that's open, the reason the report that we're getting is that anyone ranging from 35% to 50% of occupancy, there are certain hotels because there are special location and because their contract with the customers such as New York contract with the first responders, they are fully -- I mean basically well-occupied, put it that way, that's number one situation.

In our hotel basically are 2 categories. One category is in the metropolitan city, New York proper, San Francisco proper and Los Angeles, basically speaking. They're basically flagged hotel, national flagged hotel and operating that. And then other segment hotel is in the choice of beachside location.

We had a boutique hotel in Newport Beach, boutique hotel in Redondo Beach, right on the water. One of them is on Hermosa Beach, right on the sand. One in Malibu, it's very small, but right on the sand, too. So -- and Venice. All these hotel is property valued. The best we know is holding up very well because of choice location.

And the third thing about the hotel is that -- the leverage rate that I gave you on the report is the leverage at the time of origination. Some of them actually is -- has since appreciated right before the pandemics. But one of the situation I must point out is that substantially all the hotels has recoursed, and we'd like to think this is adequate recourse.

So we are hopeful that when the situation gets better, all these people have the resources to restart the hotel and moving forward with that. I mean I'm not -- obviously, there's 1 or 2, sort of, here or there, but we're not expecting to have a serious problem over there, at least as of today, no.

That's helpful. And I guess if I could ask one more follow-up to that is, what's the mix, if you have it, between the metro hotels versus the boutique hotels on the beach?

Well, in total value is concerned?

Yes, total.

Yes. But for the portfolio? Probably if I had to guess, about 80:20.

Okay. That's helpful. And then in terms of expenses for the quarter, just curious, they came in lower than, I think, expectations. Just any update on the third quarter would be helpful.

Well, yes. We actually -- the second quarter was pretty good in terms of holding expenses down. There's no question about it. I think going forward, Steve, you can -- we can probably expect expenses to be somewhere between where they came in for Q2, which is roughly $14.5 million to $15 million, so we're in that neighborhood.

I'd also like to add on -- add a little bit. First of all is that if you notice that we have substantially exceeded all the forecasts in terms of -- I mean, pretax pre-provision income and pretax provision revenue, all the forecasts -- I mean, that was put out by all of you good people or all of you, okay.

The second situation is my closing remarks that you going forward, okay, we had a low efficiency ratio, but the important thing is the deposit costs on the declining trends. And we expect, other than the repricing of certain loans, we expect the loan yield to be relatively stable. So with these 3 factors, I am comfortable with the operating matrix.

That's fair. Yes. And one more and circling back to kind of, I meant to ask, is -- in terms of just the assumptions for CECL here, kind of curious as to what you guys are using for GDP, unemployment and if there are any overlays this quarter.

Currently, we -- our forecast is that unemployment rate is around 11% to 12%. Definitely, this number can go very, very large if some of the major employment center after reopening definite based on the pandemic situation. If they re-shut down, so we definitely -- we'll look for a much, much higher numbers. And also GDP contraction, we forecast is around 5% to 6% at this point. So we closely watch these 2 numbers down the road, and we'll make adequate reserve in the Q3 or Q4.

Our next question comes from David Feaster from Raymond James.

I just wanted to start on deposits. I mean $264 million of core growth, even like -- I mean, with just a modest benefit of the PPP side. I mean that's real strong organic growth. Just curious how much of that you think is sticky that's going to remain on the balance sheet, maybe how deposits have trended in the third quarter and just any thoughts on the deposit front.

Well, at this point in time, I can only -- deposit is probably the hardest thing to forecast on our side of it because really there's no pipeline on such state, and it largely depends on the customer usage. But for the third quarter, we're seeing continuing slightly increase as of July 21, today as compared to the quarter end. Okay?

And obviously, that -- we have to moderate the increase. If it is going anymore the same magnitude, we have to moderate that and balancing between paying less interest and slowdown the deposit growth. Well you see, for every dollar we deposit, we're taking in, we're actually losing money, if it's other than DDA, which we do have growth on that plan.

So the question is that, unlike the old days, you like to grab deposits every way, which way you can, we like to grab it, obviously, with some caution. So I don't know how best to answer that. It's kind of really a moving thing.

Yes. Yes. That's great. That's incredible. And then I guess just taking the deposit growth, decreasing deposit costs and then the floors that you've got in place on the loans, offset by lower-yielding new originations.

I mean, how effective do you think those floors are going to be to where, I guess, deposits reprice faster than loans and we could actually see core NIM expansion from here? Or I mean, should we expect additional modest contraction?

Well, the leverage factor aside, okay? Actually, without the leverage factor, you can actually really figure out that the certain of the onetime item, which is the interest reversal, unless within the near future that the loan falls apart, and we have more things like that, which we have not seen as of today.

So unless that, we should see NIM to be relatively stable. As I said -- previously, we said, I think deposit cost will be improving. Loan yield will be generally stable. Loan yield is always depending on -- the payoff at the rate is always higher than the new loan being made. That's number one. But right now the interest rate is lower.

The second situation, there's always a group of customers coming in and say, well, we're being offered by so and so bank, okay, to do a lower rate. Do you want to match it? And selectively, we'll match. Okay? So these 2 factors are always there bringing the yield down a bit. But with the pandemics going on, we think it's going to be mild. Okay?

Yes. Okay. And then just following up on the conversations on the deferrals. I mean it's great to hear that you've already had about $25 million come off, but with the 2- to 4-month term, where basically a lot of those should be coming at the expiration of the initial deferral really in the third quarter, I guess, what are your expectations for redeferral rates as we go through the third quarter?

We -- as you said, we have the 3 months deferral, okay? We -- deferrals, what we're seeing basically are the one that's seriously affected. Some of the -- with very small amount in the restaurant, $4 million. Those things, if they are coming in with a request, we know that you have to grant it to them. I mean, under the safety and some skyline, of course.

The next thing is that, hotel, there's number of hotels that's not opening, so we grant them the deferral. For the hotel that's opening -- I mean operating, and we're seeing some kind of activity cash flow, we ask them to defer only partially, maybe either interest only or principal only.

So for the ones that currently with partial deferment, either interest only or principal only, especially those interest-only part, we expect them to return to be reinstated in the third quarter. But thank heaven, we have not seen too many new requests. It's basically staying -- the referral basis is staying in those obvious industries.

Okay. Okay. And then I guess the last one for me is more of a -- maybe more of a strategic question. I mean we've -- we're in the midst of a pandemic, which is changing not only customer behaviors, but you've got more employees working remotely. I guess how does your strategy change, if at all?

I mean is there additional opportunity for either expense rationalization? Or is there anything that you've seen maybe that you need to invest in further in order to keep up with the evolving client behaviors? Just curious on any changes in strategy or thoughts going forward.

Well, we just had a Board meeting yesterday. We started to -- start to think about that. I think as previous to that, our -- in 1 quarter, you just remember, at this end of second quarter -- first quarter, just when the lockdown has been started, and we just had 1 quarter events. And I think within this 1 quarter, whether it comes through PPPs, the deferment, new loans and gone through closing up in certain branches to short-term because testing positive or these kind of things. So we're pretty busy just to keep our head above the water.

So obviously, going forward, if everybody has to work home, you know that the staff realignment will be some of the issues that we'll be looking into it because, obviously, that in -- the origination activity has to continue and also the maintenance activity maybe because the fact that everybody is working from home changes somewhat in the situation. This is something, for a small institution like us, we have not gone around and really have the luxury of digging into that yet. But sooner or later, it's going to happen to every one of us. Okay?

And our next question comes from [Brandon Zhang from M3 Funds].

Yes. So we saw that your current report shows a $23 million addition to the total debt restructurings in the multifamily category. Could you share with us some details on this situation and what type of modifications were made and in what geography?

That's the one of the loans that -- in L.A., pretty prestige, kind of a real estate collateral. And our loan-to-value is less than 50% and because of -- they had some sort of cash flow issues at the very beginning, then they work with the bank, then we are under a forbearance agreement, the bringing [auto] payments, bringing additional interest payments. However, because this happened before the agency's guidelines, so we couldn't provide them for payment deferrals. So we have to put it under TDR at this time.

That's very helpful. And could you remind us how much of your loan portfolio is in California versus the New York area?

The New York is only $350 million around. The rest are in either North California or Southern California.

It's not much. (multiple speakers).

Though [it still matters].

And our next question is a follow-up from Timothy Coffey from Janney.

(inaudible) to follow up. I just had a question about the PPP loans. Can you quantify what amount or percentage are less than $150,000?

I'll have Johnny answer that, okay? Ed, you have readily available?

Under $150,000? I would say probably a good 60% to 70%.

Did you hear that, Tim?

And -- I did. 60% to 70%?

Yes.

Okay. And what -- just kind of -- I mean, I don't know if you're able to share this, but what are your internal expectations for when those might be forgiven? Is this -- is it good by year-end or into early next year? Just kind of your thoughts there.

Well, I think our expectations would be that certainly, a majority of them are forgiven. We obviously hear things coming out of the Fed and other places talking about forgive -- automatic forgiveness for those loans under a certain dollar threshold. We're fortunate in that we do have a majority under that threshold. But I think probably by year-end or by the time we have more succinct and final guidance.

These are all -- mostly, they are all our customers. Okay? So on a KYC basis, that -- we have high confidence that the numbers they gave us will lead to forgiveness.

And our next question comes from Gary Tenner from D.A. Davidson.

I appreciate all the color you gave on the NPAs and otherwise. I just wonder if you could give us some thoughts on what you're seeing in terms of just general credit risk rating migration in the portfolio separate from the downgrades of those loans that previously were being classified into nonaccrual status.

Hi, [Tim]. Other than those couple of loans, we don't see any deteriorating in our overall credit quality at this time. Definitely later on after deferment payment ends, and that's for the Q3 or Q4 things, we have to watch that closely. But up to now, we haven't seen any other issues on our credit at this -- our portfolio.

Okay. Putting a loan on deferral or modification certainly doesn't stop the process of kind of reviewing and thinking about internal risk ratings, though. So you're just saying that you're kind of deferring, no pun intended, until after that period is over?

Actually, [our] deferment, every one of them has gone through our internal procedure looking at if they qualify for deferment or not. And also in the loan [per se], we're about at the -- we already started, but we will continue our full bank review on all the loans like -- yes, each of the deferment and any additional loans that any one of us feel that we need to have a further dive into that. Okay? That's our process. Even -- we also look at even loans, okay, in this review. So we also look at the loans that will be affected by the China trade.

And ladies and gentlemen, at this time, I'm showing no additional questions. I'd like to turn the conference call back over to Mr. Yu for any closing remarks.

Well, thank you very much for your interest, and I know that in this quarter that there's a -- for us, there's a slight of bit of noise compared to the previous quarters. But, again, all of us are staying here to hope that the virus will be soon over, the vaccine can be found soon, we can get back to our normal lives because most of us is facing situation.

We all have our good customers or people like that, they will be generally a -- all the credit will be good in a normal circumstance. We just don't hope that there's an increased number of credit is being become a problem because of the virus or people lost their livelihood or wealth because of the -- because of virus and cross our fingers and pray. Thank you.

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