Preferred Bank (PFBC) 2022 Q1 法說會逐字稿

Good afternoon, and welcome to the Preferred Bank 2022 First Quarter Earnings Call. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Larry Clark of Financial Profiles Inc. Please go ahead, Larry.

Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the first quarter of 2022. With me today from management are Chairman and CEO, Li Yu; President and Chief Operating Officer, Wellington Chen; Chief Financial Officer, Ed 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 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 related 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. Good morning, ladies and gentlemen. I'm very pleased to report our first quarter net income of $26 million of $1.74 per fully diluted shares. This is a 23% increase from the same quarter of previous year. Loan growth was a highlight for this particular quarter. It increased 4% on a linked-quarter basis and annualized at 16%. The fourth quarter loan origination momentum has carried over to the first quarter, but with payoff activity, moderating a bit, which resulted this performance in the quarter.

Looking ahead, we are very encouraged by the applications for new loans that is received so far. Although, these applications will be subject to higher standards of underwriting, but we do believe that second quarter results could be quite positive. The positive growth for the quarter was moderate at 1.6% linked quarter or 6.4% annualized. This is well within our expectations in light of Feds activities. The higher loan production versus lower deposit increases has allowed us to deploy some of our excess cash to better usage and which we think is proper financial statement engineering.

Our margin has improved from the previous quarter by 14 basis points. This is partially because of the higher deposits -- a little higher loan increase versus lower deposits increase that changed the leverage. Again, under the current rate rising scenario or environment, looking ahead, we're quite positive about our margin expansion. Preferred Bank has had a very asset-sensitive balance sheet. And I have included some of the components of our assets for your information in the press release.

On the liability side, we had a $1.96 billion of deposit portfolio that is a time certificate of deposits. These deposits carry an average life of 7.3 months, which means they will be repricing at a much slower pace than the interest-bearing transactional account. We have made improvement in our credit posture pay.

Two of the very large -- or the larger Legacy loans on nonaccrual basis has been with the bank for over 2 years. Finally, after months and months of core battles, we finally was awarded the -- to repossess these assets and this so just before the quarter end. Now -- our loan portfolio is pretty pristine with only $2.2 million of nonaccrual loans as of March 31, 2022. There was a charge-off in the quarter -- that the charge-off is related to the charging off of the previously fully established reserve on those legacy loans. There are no income statement effect.

It is almost certain that under current inflationary environment that our operating expense will increase and continue to increase in the months or quarters to come. But Preferred Bank has always been very focused on controlling our expenses. And we have reason to believe that our increases will be not any higher than the industry norm. The first quarter noninterest expense was a little higher than previously guided to you in the first quarter conference call -- in the January conference phone call. And I'd like to apologize for the misguidance. And the actual number for the first quarter being will be the beginning of a new norm. I'd also like to alert you with our share counts on the fully diluted outstanding shares. It has increased this quarter along with the price increase of our stock, and it will continue to change along with the value of our stock change. All in all, we, at Preferred Bank are happy with the first quarter, and we hope we can do even better in the quarters to come.

Thank you, and I'm ready for your questions.

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

Follow-up, Li, your comments on the expense level as the new norm. If you kind of annualize the first quarter, you're around $65 million, that's 7% to 8% growth on top of 2021. Is that the general perspective on the full year increase in expenses that you would expect? Or is there any kind of further upward pressure as we go through the course of the year, do you think?

Well, obviously, it's quite unpredictable with the expense going in the future, there's several forces related to it. The number one, obviously, is inflation. What would it do to all of us, especially in the wage category? And also affecting us with the renewal of our premises on the leases. Some of those come due, and they are subject to increases nowadays. But one other variable is that the success of our recruiting effort, you see, the more successful we are, the higher expense level will be. So we certainly hope that the expense will be higher because with vessel. So generally speaking, first quarter was slightly higher than the second quarter. But in this inflationary environment, it is -- we have to have providers renewal flexibility of thinking.

Okay. And just on the recruiting effort side, I mean I know you guys are always looking to add quality people. Is there a particular geography or market that you're particularly focused today on that (inaudible)...

We are recruiting all from our geographies right now. So we're adding people all over, but also that we are eyeing that a couple of new areas to -- for the new branch in -- if we are -- if we decided and the location and so on, then we'll be hiring a group of people in that particular location. I have better information to report probably next quarter.

Okay. Great. And then just last question for me. In terms of kind of operating leverage, I mean, you provided some good detail on the asset sensitivity as it did last quarter in terms of the addressable rate assets. It would seem to me that you're still going to generate some positive operating leverage, but with the increase in expenses, reasonable to expect that efficiency ratio to kind of stay over 30%, it dipped below it for a period of time last year. Is that what you'd expect?

You mean efficiency ratio?

Yes, we likely...

I would like to say there's 2 situations. One is, you have a net increase in net interest income, which as a result of the growth and as a result of the margin expansion, these 2 will create higher net interest income. And then obviously, you have higher expenses. But we hope the combination of the 2 will be right around 30% level, we hope, within a certain range, obviously. We have been bouncing back between 28% to about 35% between the months.

Our next question comes from Matthew Clark with Piper Sandler.

Could we just start with on the loan side of things? Are you able to quantify the new loan commitments in the quarter? How that compared to last and payoffs as well? And then maybe it's a 3-part question. Just any commentary on the pipeline, and how that compares to the prior quarter or a year ago?

Prior quarter, we had $360 million new loan. I mean, new loan outstanding and another commitment outstanding pay for the quarter end. And then we have a $250 million payoff. So this particular quarter, the payoff has reduced from $250 million to $180 million, with approximately the same activity in the origination side. So this is mathematics.

Okay. And then any color on the pipeline this quarter, coming out of the quarter?

Pipeline is good, not any worse than the first or second quarter.

Okay. And then...

As I said earlier, nowadays, the underwriting standard is higher because a very stress test and value situation in light of the inflation and rate increases and also that we have always embedded back-to-back of our mind that after inflation, there will be a recession. So we have always tried to alert ourselves at Preferred Band that good loan -- bad loans are made in the good times. So we'll have to be extremely careful now.

Okay. And then on the margin outlook, kind of thinking through the remix as it relates to deposit growth relative to loan growth. I mean do you feel like loans to earning assets will -- might continue to march higher, assuming deposit growth kind of trails. Or do you feel like deposit growth should come back and start to better fund the loan growth?

Matthew, this is Ed. To Mr. Yu's comment earlier about the loan growth coming in lower previous quarters and within our expectations, I think you touched on something I think we'll see throughout the year. With the M1 supply seemingly going to start shrinking when the Fed ends its QE and also starts to raise rates. We're okay with a lower level of deposit growth and then fully more utilizing the cash and the balance sheet towards the loan portfolio obviously expanding the margin and leveraging the balance sheet.

Got it. Okay. And then just on the provision, there was a comment in the release that part of the basis for reducing reserves was an improving economic outlook and I would have thought that would have been kind of the opposite in terms of commentary and assumption. Should we assume that, that kind of reverses itself here in the upcoming quarter and increase the provision?

I will ask Nick to answer that. I will add on.

Sure. Clark, this is Nick. For the reserve side, even though the current economy seems like at okay stage, but still, we have a lot of other uncertainties that have concerns, such as labor power shortages, high inflation, supply chain interruptions. All those kind of things, quick rate increase environment and the higher energy cost. And also Mr. Yu mentioned, increased the possibility of a future recession. So even though under that kind of a situation, we -- for this quarter, we still add a little bit more reserve on the qualitative side. As Mr. Yu mentioned, we try to take a more cautious posture at this time.

I guess with (inaudible)...

Yes. I think it's probably safe to say the release might have been larger had we had more rosier economic predictions within the CECL model rather than what it came out to.

Understood. Okay. And then last one for me, just on the letter of credit fees. How should we think about that activity in a rising rate environment and a slowdown in the macro environment?

I think it will be probably pretty stable. On the LC...

No, It's also -- you said stable, but I'd like to say sometimes it's very unpredictable because the LC is such that a customer has a need, coming (inaudible) so we're charging the fee. So the activity is deeper. It is really customer specific. I mean it's hard to relate to any economic conditions now. We tried to -- tried doing a pattern on that. We haven't gained success on predicting it yet.

Our next question comes from Steve Moss with B. Riley Securities.

Let me just start off with deposit pricing here. In the release, you guys talked about CDs repricing at a slower pace. Just kind of curious here what are you guys thinking for CD rates with the 50 basis point hike coming up here in May in all likelihood? And just also just how you're thinking about deposit betas more broadly?

Ed, do you want to answer that? (inaudible)...

Yes. I'll start off. In terms of deposit growth going forward, I think we're okay with a lower level. But in terms of deposit betas and rate changes going forward, Steve, we're seeing an interesting thing, at least in my opinion, I'm seeing an interesting thing in the market. We're really not seeing much movement at all on the retail side of things. Wholesale funding has moved a lot. It started moving in January. But the retail funding is still -- we get rate surveys every 2 weeks that we go through very extensively. And we are still seeing very few banks move beyond 40 to 50 basis points on a 1-year CD. And so what I think you're going to see this time around and you hear this all the time, this time it will be different, right?

But this time around, with the economy and the consumer and businesses do still have a lot of cash on hand. And so I think it's going to take some time to whittle that out of the system going forward. And as that happens, I think you'll slowly see banks start to raise their offered rates. But at the present time, we're just really not seeing a lot of movement. So it's a little bit like a Goldilocks moment right now for -- at least for the time being.

Do you have anything to add?

Yes, I mean, Ed and I, we review this weekly. And so far, we are holding very well on the consumer side, on the retail side, I should say.

And then on the wholesale side, a lot of those are negotiated rates anyway. So those still are fairly low as well.

Okay. Got it. That's helpful. And then in terms of just on the loan pipeline being strong. Just maybe what types of lending opportunities are you seeing? I mean, obviously, you had good commercial real estate growth here this quarter. Just kind of curious like the underlying types of properties you guys are lending on or you expect to lend on here going forward? And just when we think about loan growth for the year, obviously, a really strong pace here. Are you guys thinking low teens type number ex PPP?

Do you want to answer that?

Sure. We're always looking for new talents as Mr. Yu mentioned earlier. So we there's we're looking for talents. Talents will take the lead of what we're going to expand, whether it's Southern California, Northern California or elsewhere. And in terms of the -- we're looking at the market and pipeline right now, I think it looks -- post pandemic, there are a lot of opportunity. People are looking to acquire property and looking to reposition. And so a lot of opportunity in multifamily and industrial type of facility.

Great. And then just in terms of the tighter underwriting standards here, can you just remind us as to kind of what the debt service coverage or loan to value as you guys are looking at these days.

Nick.

Loan-to-value is -- our current data is around 55% to 56%. And this year, definitely, as Mr. Yu mentioned, that we're very conservatively underwriting the loans with consideration of future rate increase. So currently, it's around [1.2] and above.

And then just one last question and a small 1 in terms of the OREO properties that you guys took over here. You guys made comments about resolving it shortly. Just kind of curious as to how quickly you think you can liquidate them.

We hope it's done yesterday. We had offer (inaudible) but things should be the property is well sought after. So we focus telling us that they feel that the price is very advantaged to us under the current market.

Our next question comes from Andrew Terrell with Stephens.

Maybe, Ed, just to start off. I hear some of your comments on kind of the deposit growth expectations and just the overall kind of leverage of the balance sheet. Just -- I'm looking at there's still quite a bit of excess cash. It seems like on the balance sheet today. I guess just given the move in interest rates we've seen so far, any appetite or willingness to take kind of a bigger swing into the securities book here?

Great question, Andrew. And I'll say at this point, the answer is probably no. We took a little bit of a swing last September and bought almost $200 million of monthly [Ginnie] floaters which have actually performed pretty well. But to the extent we can more utilize the cash into the loan portfolio. And then remember also that cash is also going to move up on rate too, as the IOER rate moves in lockstep with Fed funds, we'll see that cash benefit as well. So that's a nice production of that. So we are not going to forgo deposit growth. Let me be clear on that. We still believe in deposit growth, and that does form the foundation of the bank or the franchise value of the bank. So we will get deposit growth this year, but we will not be as hard pressed for deposit growth this year.

Understood. Okay. That's helpful. I appreciate it. And then maybe looking at just the core loan yields were on kind of the margin down, I think, maybe 10 basis points or so this quarter. Anything unusual in the kind of core loan yields, whether it's interest reversal, lower fees or anything. Just -- do you think maybe noncore in the loan yields this quarter?

No, we don't have it.

No. But I will say, we did see a small uptick after the rates after the mid-March Fed hike. So -- and we saw that also on the cash side. So that's beneficial.

Yes. Okay. And then one last question for me. Mr. Yu, I know historically, you've not been very active in kind of bank M&A. Just wanted to get kind of updated thoughts from you, whether you were seeing anything kind of interesting on the M&A front, whether there was any appetite if it kind of plays into your thinking about running the bank moving forward. Just any kind of updated thoughts on bank M&A would be helpful.

Number one thing is that maybe it's our DNA. We're a little bit on the conservative side of our -- I mean, acquisition situation. So we look -- and there's continuously obviously intermediaries that we're introducing all the deals to our state. For various reasons is pricing all the talents, all the geographic we have not much success. There's a couple of deals we're getting close to step #2, but it seems to be -- didn't materialize any further. And our calculation about the accretion requirement is probably one of the tougher in our industry.

One of the reason is that when we can internally generate, I mean, more than 15% of growth as the average. And the need for acquisition to increase the balance sheet is not that imminent. And therefore, we choose the most profitable way of organic growth. So needless to say, when the organic growth started to fade in our stock, we have to think about how to make this institution more profitable. And I hope the acquisition we make would be profitable because as I know it, not every acquisition work out well, okay? It just doesn't show up in the financial statement in bold letters.

I hear you. Any kind of color you can provide on just what that -- you mentioned the internal kind of EPS accretion or I don't know if it's IR threshold that you need to meet or tangible book value earn back. Any kind of color or specifics you can give there on the financials you kind of try and target?

Well, obviously, that the things that I'm looking at, I don't look at IR that much. I just look at the accretion of the EPS. And then also the important thing to me is how much is how much is dilution of the book value and the paybacks on the situation. Inflation is you really take a target. You're prepaying for whatever their earnings for many, many years, and hope you can make it back through efficiency and combined operations, and we must be cognizant that not everyone is going to be perfect to be executed. So we're just looking at very careful as the book value dilution side of it.

Our next question comes from Tim Coffey with Janney.

The press release got some really great color on the asset sensitivity of your balance sheet. And you are one of those little more asset-sensitive banks on the West Coast. I'm wondering, can you quantify what the gain to net interest income would be, say, off about a 50 basis point move higher?

Off the top of my head, unfortunately, I can't right now. I can tell you that in a 100 basis point shock, I think we're about 9% to 11% higher on an annualized basis.

Okay. That's helpful. And then can I ask a question about the cadence of loan growth in the quarter. Did the increase in rates pull forward any business towards, say, the March month relative to January, February?

Like you see, the increased rate actually has created more opportunity to us because previously that most -- we lose many, many the payoffs is to the people at often low rate fixed rate loans in 10 years sometimes, okay? Some of them is doing 10 year -- 5 year interest only and 10 years interest only. We're losing through these deals when we're thinking about rate, it's going to change.

And why getting to the fixed rate security, while we are pondering about that, we keep on losing loans or losing competition. I mean, competition for loans on that reason. And thank god, everybody started thinking, I mean, they should not be making low rate fixed rate loan anymore, okay? So we become the equal basis competition, where our -- I think our competitive advantage of high-tech one-on-one service delivery and customer relations start to come back and benefiting us.

Okay. That's good to hear. Then I would -- is your expectation that pipeline fallout will decrease going forward if based on rate?

Yes, I would say that it would decrease. Although the one caveat is that we have to underwrite it more carefully.

Right. Okay. That makes sense. And then speaking of that, the reserve levels of the ratio, do you feel like it's prudent to start increasing that ratio right now? Or do you need to wait for more information before doing so?

We -- are we talking about our credit quality?

Yes. Yes.

So we actually -- and I'm going to answer it in different ways about it. And I just reported to our Board as we will be starting internal loan review again in the late second quarter, early third quarter, in light of 2 situations. I mean one is a continued high inflation. What would that do to many of our customers' industry or customer specific? And we're also to project as to the inflation situation, whether recession situation come, which of our customers likely to be affected. So we can take proactive moves in relating to these things. And the bank-wide review will be starting in late second quarter or early fiscal quarter because we do have examination scheduled in late second quarter, we'd like to take care of the -- our examiners first, okay?

So on the CRE side, obviously, we went through many, many drills report, we plan to do the same drill in the third quarter and looking at as what product line is for out of the market situation, what product line is continued to be the favorite investment. But it's safe to say, and just speaking from common sales in my past experience, when they're in early stage of inflation, there's many, many of our customers, astute customer is really -- and try to acquire real estate because they think over the long term and they had holding power, they think over the long term, assets is the best protection for the inflationary situation. So while we are also cognizant about that, but we still have to do our assets review on the thing.

To answer your question, would result -- it depends on the results of the review that Mr. Yu spoke of, Tim, whether how we look going forward relative to the ACL.

(Operator Instructions) Our next question comes from David Feaster with Raymond James.

Mr. Yu, I just kind of wanted to follow back up on your commentary kind of talking about the competitive landscape. It sounds like it's a bit more rational than it has been. But as you think about your adjustable rate loans, how effective -- have you been able to fully push through that 25 basis point increase on the $1.4 billion of loans that reprice immediately? And I guess just with the competitive landscape, how do you think about your ability to push through the next couple of rate hikes? Like if we do give a 50 basis point rate hike in the next 2 meetings, would you expect to see more payoffs and paydowns as competitors price lower? Or I guess, just how do you think about your ability to push through higher rates on the .....

Each cycle is different, okay? But however, in this cycle, what I can see is that our margin, meaning that the index number is competitive with other. I mean, competitive to what they offer. In other words, if the loan is worst people assess, everybody is offering people (inaudible). And so right now, for other people to offer much lower index number to do the loan, I don't see many of our competitors is doing that. There's always been a few over there, but I don't see a majority of the people will be doing that, okay? And they say that just they are equally as sensible as we are, okay? So I actually do not think that we'll lose a lot of business because many of the things will push to higher rate due to the loan. More so if anybody wants to do that is because of the economics of their own thing, it's owner driven.

Okay. So are you starting to see new loan yields improve? Have you seen like an inflection in new loan yields across the portfolio?

In the last few quarters, I have told you that all the loans paid off as rate is generally anywhere from 75 basis points to 50 basis points higher than the loans being made. This quarter, the number is narrowed down to $0.26 to $0.27, okay? So -- and I have a feeling on a situation in the second quarter, the new loans will carry a better rate.

Okay. Okay. That's helpful. And then just on the C&I growth in the quarter, that was great to see. Just curious whether you think that, that was a function of drawings on existing lines as borrowers are starting to build inventories? Or are you seeing increased demand for new lines? And then just what are you hearing from C&I clients? And how is the C&I proportion of your pipeline? Has it increased at all? Or is it still kind of that 70-30? I think we talked about that last quarter.

(inaudible) Wellington comment.

David, it's Wellington. It's not necessary, not much on the existing line drawdown. We had a couple of good wins on the new C&I relationship and really that's where really mainly coming from the growth.

Our next question comes from Jordan Hymowitz with Philadelphia Financial.

Before I ask my question, Lee and team, I just want to say I covered you guys for 20-something years since the IPO. You've done not only a great job of the integrity and thoughtfulness and your willingness to say when things are better or worse, is really refreshed. And you guys deserve a great kudos. So good job. And the after the commercial for you guys.

Thank you, Jordan.

I have a question for you on the follow-up to the other gentleman's M&A question. And I'm not saying you should or shouldn't do M&A. It's a different thing. But with RBB's Chairman now resigning because of your proprieties, there's rumors that, that may or may not go on the market, who knows. But would that be a property at a certain price that you might be interested in if.....

Well, number one, we're well aware of the situation, and I had a lease among the group of firms that was represented here today. At least 2 or 3 has contact me on this particular thing, except none of them knows them as well as I do, okay? Many of the Board members, my friend, okay? And obviously, the former Chairman, former President and CEO was a longtime friend of mine too.

So I know the situation. And it's a matter of their expectation. And it's a matter after they have stabilized the situation with their business level, how much still represents a vibrant ongoing businesses are sort of like a slow growth business. So it depend on the price. Unless I can deliver you guys, you're the shareholder, you deliver to you a better future year by year, why should I do that?

Congratulations, and I appreciate it.

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

Thank you so very much for joining our conference. You have any questions, please call Ed and I or I, more so added meet anyway, okay? But we'd love to answer that. Thank you so much.

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