Preferred Bank (PFBC) Q1 2017 Earnings Report, Transcript and Summary

Good day and welcome to the Preferred Bank’s First Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Ms. Kristen Papke, Financial Profiles, Investor Relations. Please go ahead.

Thank you. Hello everyone and thank you for joining us to discuss Preferred Bank’s financial results for the first quarter ended March 31, 2017. With me today from Management are Chairman and CEO, Li Yu; President and Chief Operating Officer, Wellington Chen; and Chief Financial Officer, Edward Czajka. Management will provide a brief summary of the results, and then we will open up the call to your questions. During the course of this conference call, statements made by management may include forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based upon specific assumptions that may or may not prove correct. Forward-looking statements are also subject to known and unknown risks, uncertainties and other factors relating to Preferred Bank’s operations and business environment, all of which are difficult to predict and many of which are beyond the control of Preferred Bank. For a detailed description of these risks and uncertainties, please refer to the SEC required documents the Bank files with the Federal Deposit Insurance Corporation, or FDIC. If any of these uncertainties materialize or any of these assumptions prove incorrect, Preferred Bank’s results could differ materially from its expectations as set forth in these statements. Preferred Bank assumes no obligation to update such forward-looking statements. At this time, I’d like to turn the call over to Mr. Li Yu. Please go ahead.

Thank you. Good morning. Thank you, ladies and gentlemen, for attending our earnings conference phone call for the first quarter of 2017. This quarter we have a record breaking performance. Our deposits increased $188 million, which is record for our bank, and our loans have increased $143 million, which we think is also a record for our bank. We’re very pleased with the result, although net deposit increases tend to dilute the net interest margin, ROA, capital ratio and even earnings, okay, but they are the franchise maker and we are pleased about that. Our loan increases, probably the only negative part of the loan increase is that most are coming in the month of March and, therefore, the net interest income increases is only a portion of the reserve that was required for these loans. This quarter we earned a net income of $0.71 a share and this quarter’s earnings do have a couple of non-recurring items in it. First of all we have a positive tax adjustment, which is equal to $0.05 per share related to the shareholder and employee stock option cost accounting. Coincidently, we also have $0.05 per share negative adjustment to our earnings nonrecurring. That is because we decided to potentially settle a lawsuit that has been with us for – since 2009 and 2010 and it looks like it’s going to drag on for another two or three years. We decided to settle it for the nuisance, legal nuisance in the approximate amount of what we have reserved for future legal expenses, including the core processing. And we believe that’s probably a positive move to our shareholders. Without this reserve, our efficiency ratio would have been below 40%. Net interest margin for the quarter was flat and there was some reason for that. Certainly that I’m sure that you will ask the question; we will give you some of the reasons. And the bank continued to enhance its platform, its operating capabilities. In the month of March alone we added three people in BSA compliance, three people in the first quarter, three people in digital banking. We rolled out many of the digital banking products and will continue working diligently in further improving our capabilities. Now I was always advised by some of our shareholders that I wasn’t upbeat enough in the earnings phone calls, so I have decided that maybe I should change this time. Obviously we have good reason to do that. First of all is that right after election we have done a whole lot of work and try to find out the mood among our customers. And I like to report to you it is generally optimistic about their future, which is probably reflected in the first-quarter rolling results and deposit results. Next thing is that at this time I think market is still – consensus forecast is of 2 to 3 more times of rate increases. If it happens, we believe we greatly benefit as we are probably one of the most asset-sensitive banks in the nation. Everybody was talking – in the banking industry was talking about regulation, relief, and reform, okay. Our own view is that we cannot dream about the luxury of these reforms and reliefs will have very meaningful results to a community Bank like us, our type of community bank. But we do hope that the pace of compliance cost, other regulation cost increases would slow down in the future. We do think that corporate tax cuts will probably be a reality, although the timing and magnitude of which is hard to predict at this time. But if it happens and when it happens, we would be benefited by that as we are a full-rate taxpayer. And finally, and probably the most importantly, is that our loan pipeline continues to be consistent and vibrant. We hope second-quarter production will also be respectable. Early indication about the deposit production is also active and vibrant. We hope the trend continue into the months of May and June. Thank you. I’m ready for your questions.

Okay, we will now begin the question-and-answer session. [Operator Instructions] Okay, our first question comes from Aaron Deer from Sandler O’Neill & Partners. Please go ahead.

Hey, good morning, guys.

Hi, good morning.

For some reason the system wasn’t taking the call log request. Mr. Yu, you gave some color on some of the back-office hires that you’ve done to kind of strengthen the platform. Can you also talk about what has been done in recent months in terms of hiring new front-line personnel to keep this impressive growth rate going?

Well, we have several personnel of so-called senior relationship managers’ level of people joining us in the fourth quarter of 2016 whose productive effect has gradually been shown in the first quarter of 2017. In the 2017 we’ve had one senior member join us from Northern California. Do we have anybody else?

We have two one senior, and one more mid level.

Okay, alright. So we’ve continued to look for these people on the opportunistic basis. We hope with the recent mergers there will be some more talents will be available to us.

Sure. Are these recent hires more focused on the commercial real estate side or commercial lending side or…

It's actually on the deposit side I’m looking at senior-level person.

Okay. Related to that, perhaps you can give some color. With the balance sheet changing as much as it is, can you give us an update on the sensitivity on the loan book in terms of what percentage of loans are currently variable and above floors? And then also on the deposit side, given this growth and efforts to fund it, what we might expect in terms of deposit costs going forward?

Okay Aaron, on the first question there's the loan book is clearly getting more sensitive in terms of rate adjustments with this now being the second hike in the middle of March. We did see an expansion in loan yields from the months of January, February, and then March kind of spiked up. So what we had, what we experienced is a little bit of a decline in loan totals in the month of January and on into February as Mr. Yu said, with the production in March brought it back up, but in terms of earnings it didn't have full earnings impact in the margins, so that's why margin is flat essentially. In addition to that we have two fewer days in the first quarter than in the fourth quarter, so that's a bit of a headwind as well; not so much as a percentage, but on the absolute dollar amount itself. In terms of deposit costs, we were very pleased, I will say, to see that on a linked quarter basis deposit costs only increased one basis point. So that was certainly very positive. Although that being said, looking at the trend during the first quarter, we did see about a 3 basis point increase from the month of February to March in terms of deposit cost.

Okay. Are you guys fully up on the California CD opportunity? Is that used up?

Well we tried that as well. The question of whether it gets used up or not is kind of an ambiguous one, but we did increase our state of California money during the quarter by about $15 million.

Okay. I guess are you maxed out on that program I guess was to phrase it.

We’re definitely not.

Our level of a California CD is below our 2007 level.

Right.

The bank is about twice the size, or really more than twice the size.

Okay. And then just last question on the new mortgage business. I was hoping you could give us some color on how that is – what kind of traction you are starting to get there. I know it's very new. But then also on the – maybe give us a sense of the type of rates that you are getting on that product and the type, in terms of three-year ARMs, five-year ARMs, longer term what that is…

Hi, Aaron; it's Wellington. We started our mortgage program on March 31 and we have a very, I would say. So far the pipeline is on schedule. We have one mortgage due to fund early next week. And the average rate is around 1.5%. Most of the loans will be about three to five ARMs.

Okay, that's great thanks for taking my questions guys.

Thanks Aaron.

Pipeline seems to be much more than one [indiscernible]. We have above 15 point mortgages in our pipeline right now.

Okay. Our next question comes from temp Tim Coffey of FIG Partners. Please go ahead.

Thank you. Good morning gentleman.

Hi Tim.

Hi. In terms of the loan growth, was there any geographic – is part of your footprint that really did better than the others, or a little more color on where that growth came from this quarter?

Well generally speaking no loan growth by geographical area is pretty homogeneous, okay. Right now still much of the loan growth is still coming in the Southern California area. And the percentage loan growth in New York and San Francisco may be slightly higher as a percentage but the dollar amount is limited.

Okay. And any kind of color on what opportunities you are seeing in the commercial real estate space given the strength you had this quarter?

Well we have seen a whole lot of commercial real estate applications. The biggest application is in the construction loan and we end up have to become very, very choosy in booking these loans. Loan inflows have been – pipelines has been even than last year in comparison speaking, but our standard seems to be at least maintain the same.

Okay. And then kind of looking at the net charge-offs in the quarter, would you describe that as a typical quarter for you or is it on the low side?

This thing is still linger on related to the so-called [indiscernible] that C&I loan that we reported earlier. What we like to do is that whenever we have some new events happening and we just decided to just reduce the amount of carrying actually the economics has not been changing much.

Okay. Alright, well thank you those are my questions.

Thank you.

Our next question is from Bob Ramsey of FBR. Please go ahead.

Hey good afternoon guys.

Hi good afternoon.

I guess first question for you; I know you highlighted that the deposit costs were relatively stable in the quarter. What was the change in loan yields this quarter versus last?

Okay, you have anything that's readily available, Ed?

Yes the change in loan yields was about two basis points over the prior quarter.

Okay, got it. I'm just curious maybe why that wasn't a little more – I think you all saw more improvement last quarter over quarter. I'm just curious this quarter why it was a little bit slower.

Well as I indicated a lot of it Bob really depends on the timing of our new loan production during the quarter. And so what typically happens especially more so in the first quarter of each year is we do have some pay down in the portfolio and then the production really gets ramping up in February and March. And so what you see is basically a back loading if you will on the new loans. And so that's why you do not see a meaningful increase over the prior quarter. In addition to that as we mentioned in the press release we also have loan fees went down to the tune of about four basis points all in quarter basis.

Got it, okay. That helps. And then I know you all said in press release that the net interest margin in the month of March was stronger than it was for the quarter as a whole. Can you give us a sense of kind of where you ended the quarter on margin?

Well the month of March came in at 3.70.

3.70 got it. Okay, shifting gears to expenses I think you also said in the press release that the litigation charges quarter could have some favorable impact on expenses no a go-forward basis. Just wondering if you can quantify that at all?

Well we have previously incurred legal fee as it to come in a neighborhood between $100,000 to $200,000 a month and continuously for the past two years, okay. And we expect the number will be related to its case only. We expect the number will be reduced.

Okay, so you said $100,000 to $200,000 per month was the amount?

It's varied, but not every month is the same thing.

Okay, got it. And then just kind of any educational thoughts on sort of the backend loading of long growth which you guys saw this quarter is that mostly seasonal or are you seeing customers sort of getting more willing to pull the trigger I’m just kind of curious your thoughts on what drove the pick up late in the quarter?

Actually it is kind of the pattern is kind of very strange. This quarter is do called the back loaded. And I think last year third quarter, second quarter is front loading. So sometimes it's just it have to explain it has something property was a real-estate market. The sentiment on the real-estate market and how people want to do things, I think a lot of decisions being not been changed the quarter is people always try to figure out what the tax angle is going to be to the real estate industries in terms of the detail investing patterns. And some are just waiting to see to clear picture on the registration side. But overall the real-estate damages keep on increase in the mix investing attractive.

Okay, got it. And then on the deposit growth you guys obviously have a very strong quarter for deposit growth. I'm just kind of curious maybe where you attribute that to?

Well first of all the strong growth in the quarter you also have to look at is a mostly in M&A side, okay. Actually we have a reduction in an non-interest bearing account which also accounted for the net interest margin changes more than the 1% a mixture of changed quite a bit there. Normally this particular pattern is very familiar for us in the first quarter and most businesses are paying taxes in the first quarter. So it tends to reduce the first quarter DDA amount. But the growth of it is really our entire effort the bank is coming out with the so-called full force ahead for everybody to get deposits and Wellington has been putting all the pressure on the production people that whether they are loan originated or they are branch people, deposit gathering is one of the most important thing to do. So I think our people just responded. We have so many customers banking with us but didn't give them – give us an amount of deposits we amount of deposits we previously

Okay, got it, perfect. And then I'll a last question I’ll hop out here. But the deferred comp movement here this quarter will that have an impact on the salary employee benefit line going forward?

Eddy you want to answer that?

Yes I’ll answer that in a word no. That was a very long standing plan that has been in place for a number of years and that was contributed to almost slowly by the officers themselves. And that plan has been terminated in 2015 and the payout happened on January one.

Okay, got it, perfect. I said last question but I’m going to ask one more. I know you all said tax would return to a more normalized level. Is it fair to use 39% for the next three quarters or should we be closer to that for the full-year, I'm just kind of curious how you think about tax?

I would say at this point, although very subject to change, of course, but I think 40% would be a more fair rate to use.

Okay, alright. Thanks for taking the questions guys.

Okay, our next question comes from Gary Tanner of D.A. Davidson please go ahead.

Thanks. Just had a follow-up, Ed, regarding the loan yield question. It seems like loan yields, if you adjust for the lower loan fees, would've been up 6 basis points effectively from the fourth quarter, but still less than I think what many of us would've expected. And I'm not quite clear on why the timing of loan growth would impact the loan yield. It seems like simply, when they are on balance sheet, they are going to be in the average. So why would that timing have an impact on the movement in loan yields that you would've gotten a benefit from the rate hike in December?

Let's go over it. First off, Gary, loan yields from the month of February to March climbed by 18 basis points and that was the effect of the production plus the rate hike, obviously which took place right during the month. In terms of the yield from the prior quarter to this quarter, as I indicated, loan fees were down and that is a component of the loan yield and so on new production. If we are typically collecting a point on loans and we're only collecting a point on loans and we’re only collecting only three quarter of the point or half a point, part of that gets booked upfront and we will see a decline in overall loan fee income. So that explained about four basis of it.

Gary, I'd like to add on a couple things or so. We have about a couple of hundred million dollars of our SNC loans. During the fourth quarter and some part of the first quarter roughly $15 million, or maybe slightly more, of those loans was repriced and generally repriced between 50 to 100 basis points lower. I don't want to go down the names of these customers, because we should not, but this repricing has created a reduction of the income. Maybe it's only a couple basis points, 3 basis points. May be every little thing adds up. And so this is part of the reason. Another small reason is that as we continue to have heavy paydowns, although our production is more, but generally the loans that paid offs is usually at a higher rate than the loans being newly booked. So that can account for a couple, 3 basis points also. It's all a multitude of things. We're in the process of trying to understand more about every move and even ourselves. Some of them is behavior even. For instance, most of these customers used to be, let's say – let's use a hypothetical number. If people say 5% is supposed to be the floor or whatever it is, what used to be is people say it's a prime rate plus 1.5% that was [indiscernible] being floor. Those were the days when the rate was low. But nowadays, when the rates were up, our customers demand maybe P plus one with a floor equal to five. [Indiscernible] comes the same situation, but when it's moved it moves a little bit differently. So with all these little things everything is 1 basis point, 2 basis point, 3 basis point of things, so we have not come to the conclusion about, well, we should have about 17 basis point, 18 basis point in number. We think we comment for 12 basis point to 15 basis points of differences that will show up later, but the rest of them we will see; are in the process of researching it.

Okay, that's all. Appreciate it. One other question. Just can you remind me what the margin benefit of the fourth-quarter adjusted dividend was?

Hello 2 basis points.

That was a 2 basis point benefit, okay. All right, great. Thanks for all the additional color.

Sure.

Okay. Our next question comes from Don Worthington of Raymond James. Please go ahead.

Good morning everyone.

Hi Don.

On the noninterest income category, it looks like you had a pretty good bump in letter of credit fees. I guess what would you attribute that to and where do you see that going forward?

Well, those things happen whenever we focus, especially on a letter of credit, so there's really no patterns as far as how much average could be. It's just there's a couple letter of credits being issued in the month of January of sufficient size.

Okay, okay. And then any thoughts on acquisitions or additional branch openings?

We are in the process of trying for looking at some branch openings and, hopefully, we can report to you soon. But acquisition is concerned with that; that was previously, how should we say, excited in our heads when we have a $57 valuation. Now with the valuation come down [indiscernible] dollar amount makes many of the economics that does not work. So that's one of them. And so another situation is our Board and several of our large shareholders, when we are conferencing with them, always fear that we can't deliver the kind of growth that was delivering currently. To do an acquisition would definitely dilute a small bank's managing effort into the new acquired targets. Are we actually being that accretive? Probably take away our own accretion that we were doing it internally and devoted into the acquired subject area. So we are still looking at that. I think is that it will continue a subject; we're looking at it, but with our current pricing and with currently what market is demanding, the possibility of something being done soon is very, very remote.

Okay, all right, thank you.

[Operator Instructions] Our next question comes from Tyler Stafford of Stephens. Please go ahead.

Good afternoon, guys.

Hi, Tyler.

Hi, Tyler.

Hi. Nice quarter. One more for me on the margin and your liquidity position. Any interest in repositioning the cash into the securities book at this point?

Well, the question is the split situation is that what’s our loan growth will be, what the following deposit growth will be. I think our idea is to keep this cash available readily for the loan growth that we have, okay. And we have to meet our customers' demands. And as far as security is concerned, the yield on security, the difference between what it can yield versus our costs and our opportunity costs seems to be that this is not the most attractive time. But we certainly are on the market every day and trying to look at anything that made sense to us.

Okay, great. Maybe one just kind of clarification question on the deferred comp plan that you guys terminated this quarter. How much of the $945,000 that you highlighted in the release is related to the termination of that plan versus the annual bonuses and the stock vesting?

I believe it was about $400,000 of that. The rest was attributed to RSA vesting and incentive cash flow and sales.

The $400,000 looks like it's not going to be repeating even year after year…

Yeah, right, that's what I was getting it. Okay, perfect. Then just last one. Can you talk about what drove the quarter-over-quarter decline in tangible common equity? I think tangible book declined $0.60, $0.65 or so. Just curious what drove that decline.

I think I think Ed better explains that. That's a great accounting to go through; I have a little accounting background but I don't understand it, okay.

Okay, so I'll try to do this in 25 words or less, but I don't think that will happen. So in the deferred compensation plan back in 2010 and we have disclosed this in the proxy each year, certain executives purchased the Series A preferred shares, which were later converted into the common shares in August of 2010. Those shares were held in reserve until such time as the executives’ retirements, termination of the plan, or the termination of employment of the executive. What happened is the plan was terminated. Upon termination, those shares were issued the executives. What we did is in lieu of issuing all of the shares and then having the executive have to pay the income tax on it, what we did is elect to withhold a certain number of shares at the bank and use that to pay the employees or executive's income tax. When we do that we need to make entry to treasury stock. It is as if the bank is repurchasing those shares from the executive. And so that's why we had a debt to equity at the very beginning of January and that's why the tangible book value didn't grow.

Got it. Okay, so, now that the plan has been terminated there should be no more hits to book?

That is yes.

Yes.

Okay, perfect. All right, thank you, guys. I appreciate it.

Okay.

Okay. This concludes our question-and-answer session. I would like to turn the conference back over to management for closing remarks. Please go ahead Mr. Yu.

Thank you so much for attending the conference, okay. As I said, we feel pretty good about the remainder of 2017 and we certainly will try to deliver the results that our shareholders will expect out of us. Thank you so much.

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