Preferred Bank (PFBC) Q1 2020 Earnings Report, Transcript and Summary

Good day and welcome to the Preferred Bank First Quarter 2020 Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference call over to Mr. Tony Rossi of Financial Profiles. Mr. Rossi, the floor is yours, sir.

Thanks, Mike. Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the first quarter ended March 31, 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 Chief Credit Officer, Nick Pi. 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 would like to turn the call over to Mr. Li Yu. Please go ahead.

Thank you very much. Good morning, ladies and gentlemen. The events in the first quarter 2020 is truly astonishing, but I am very pleased to report that for the quarter, Preferred Bank's net income was $16.2 million or $1.08 per share. Although this seems to be a little less than the previous quarter, but that is really because that we decided to build up our liquidity reserve and make a big provision in the quarter. On the net interest income basis, our net interest income for the quarter is better than previous quarter and the same quarter last year. For the quarter, deposit grew $103 million. Loan growth was $168 million. A big portion of the loan growth is coming from customers' increased drawdown of their unused credit line, which we estimated to be between $100 million $120 million. Part of it is drawdown credit line to funds stayed with the bank, so which also helped the deposit growth. At quarter-end, we estimated the available credit line for customer drawdown is little bit over $400 million, but many of those credit line is under a borrowing-based formula. So, the actual amount is probably between $300 million to $350 million. And as of March 31, we have on balance sheet liquidity of $720 million, and we have off balance sheet liquidity of another $650 million. So, we can satisfy if need should arise. For the quarter, our net interest margin actually improved a little bit from previous quarter. This is very welcome news as we all know that the first quarter had rather large federal rate cuts. These rate cuts has drastically changed the interest sensitivity of the Bank. As of March 31, 14.9% of loans are fixed rate loans. 19.4% of the loans are floating rates without floor, and 65.7% of the loans are floating rates with floor. Of those floating rates with floor, all but $28 million or 1% are rate -- operating at the floor right now. So, with the continuation of high -- I mean, repricing of our TCD portfolio downwards, we feel that our net interest margin has hit the bottom on March to 18% [ph], and gradually improving from that point and on. Our first quarter efficiency ratio was 34.9%. Recently, S&P Global issued a study on ranking for all the banks between $3 billion to $10 billion. They ranked Preferred Bank number-one in the nation for efficiency ratio. With our cost control and gradually improving net interest margin, we see our operating matrix are favorable. Well, for whatever it is worth that S&P also rated us as number-1 overall in the nation. There are no signs of credit deterioration at this point in time, but we know the nation is currently entering into recession stage and our lifestyle has changed, at least for an extended period of time. The recovery maybe slow. So with this in mind, we decided to build up our credit reserve. First step is to adopt CECL, which increased our reserve for $8 million. Next step was providing $5.3 million loan loss provision for the first quarter. At this point of time, all 13 branches of our bank is operating for business. Observing the stay-at-home order, 45% of our staff is working from home. We're able to handle the customers' needs through increased usage of digital banking. Our loan activity was able to handle the many deferment request by our customers and was able to handle the first phase of the PPP program request. We are gearing up today and going forward for the second phase of PPP and upcoming Main Street Lending Program. We're just so pleased that the banking industry and us become part of the solution this time. The dark days of our nation will be over soon, I hope. And we are committed to be a factor, a contributor to our recovery. Thank you very much. I'm ready for your questions.

Thank you, sir. [Operator Instructions] Our first question will come from David Feaster of Raymond James. Please go ahead.

Hey, good afternoon guys. I just wanted to start on the provision. Could you maybe just talk a bit about some of the factors in the model that drove the $5.3 million provision for the pandemic? And then maybe as the economic outlooks have seemingly deteriorated further in the second quarter, maybe how you think about additional reserve build going forward?

Well, we would obviously ask Nick to answer your first question. For your second question, you and I can join to answer that, right?

Sure, yes. David, this is Nick speaking, and our CECL model covers mainly three portions. The first portion is quantitative side, we use PDLG model to figure out the quantitative side and also we use flex factor to provide reasonable and supportive forecast for the future 12 months, and also with the 6 months revision period. And also, the second part is, the qualitative side, we have different nine factors. Definitely, a few factors reflect the current macro and micro economic situation, and also the third-parties individual evaluation on those problem loans. So, as of March 31, we adjust our qualitative side as well as flex factor on the quantitative side to reflect the current pandemic situation. So, in $5.3 million reserve in Q1, I'd like to say that around 71% is really the pandemic situation related.

David, to answer your second question, you see that we most probably every quarter, I mean we will review the situation and look at the economic condition and also obviously look at our loan portfolio. And most probably, we'll be continuing this increase to our reserve. You see, with all those deferments, okay, all the so-called affected loan so far is deferred for six months, that is generally in the early part of October. And so far, on that portfolio, any weakness at all, will probably show up in late fourth quarter, early first quarter next year. So, you wouldn't have a real reading on the situation. You can only judge by general situation of the economy, of the activities by doing prudent things. But we decided to continuously beef up our reserve.

Okay. That is very helpful. Thank you. And then just on the margin, I mean you guys have done a phenomenal job managing the margin. And I appreciate the color on the proportion of fixed rate and variable-rate loans at floors. But just taking out into consideration and looking at that, just reading kind of in between the lines in your commentary and the press release, it kind of sounds like there could be some pressure here in the second quarter and then maybe improve after that over the remainder of the year?

You see, there are three other factors. Ed will add on more detail to it. There are three factors other than the pure interest rate and margin. First factor is pay-offs, loan payoffs or loan paid, all loan gets paid off. They usually -- those won't carry higher rate. Second factor is the new loan at the rate or the coupon rate or floor rate is. Third factor is competition situation for deposits. There is only second factor we can control, which is we control our margin for the new loans. And I can say that it's an expansion situation compared to previously. But the first and third factor, we cannot control. There seems to be that pay-off of the first quarter is slowing down, okay? But -- so therefore, we are generally more optimistic as compared to previously. But the exact calculation of that is difficult. Ed, do you want to add on to that?

Yes. No, I think you've said it all. I think with the slowdown and the pay-offs, that's going to help maintain the margin in addition to what you already talked about in terms of the CDs repricing. When this thing first hit in mid-March, we saw kind of a considerable spike in CD rates across the Board, competition and everywhere. Since then, it's come down about 40 to 50 basis points in the last month or so. So, that certainly bodes well for us going forward with the CD portfolio continuing to reprice. If we don't get pressure on the asset side, I think it's safe to say we'll probably see some expansion later in Q2 and Q3.

Okay. That's extremely helpful. Last one from me. Loan growth is really strong, even exclusive of the drawdowns in C&I. I guess, what are you hearing from your clients or what's the pulse of your clients? And, how do you think about, or I guess how C&I drawdowns been early in the second quarter in that $350 million that you mentioned that were remaining and just general thoughts on loan growth in your pipeline going forward?

Okay. I will turn it to Wellington to answer the question.

Hi, Dave. This is Wellington. Obviously, looking at our loan pipeline has slowed down. And because borrowers or customers are more careful about what are they acquiring and what type of projects they want to take on. At the same time, internally, we are being -- due to COVID-19 factor, we are taking extra caution and being even more selective of what type of customer, the type of loan that we want to get into right now. Last thing we want to do is book a new loan and then have to do the payment deferment.

So, just to answer part of your question about the drawdown, as I've stated in the press release, as of today, the drawdown ever since the beginning of April is in slowdown.

And next we have Steve Moss with B. Riley, FBR.

Good morning. Just want to follow up just in terms of the CECL assumptions. Just wondering -- in particular, if you could give us color so like what you were thinking for like the unemployment inputs and perhaps just GDP inputs as well? And how should we think about reserve -- the loan loss provision for the second quarter relative to the first?

Hi, Steve. This is Nick again. Our Q side, qualitative side, we do link with those macro economy situation, but we are not directly reflect to our reserve because of some of the employment or whatever. We do not really have that many of consumer loans. We're not directly impacted, maybe indirectly. However, we do have flex factor as well as Q factors under the external economy situation. We base on those and we have different scale: low, moderate, severe and extremely high, different levels to make our reserve refinements.

Okay. And then just as we think about the provision here for the second quarter, I mean likely to see obviously more reserve build, just kind of like. Do you think it's reasonable just to assume the first quarter level, just any color around that would be helpful?

Actually, it's very hard to tell at this point in time. But you can believe that we have determined to be on the more prudent side going forward today. I mean, equally as this quarter, including a big change in the economic assumption, okay. Next quarter, whether economic assumption will be so drastically change or not, we have to see what the situation carries. But we -- on the general section, we decided to be.

Okay. And then in terms of the, just on the funding side, and I think you said 40 basis points lower from -- for CD rates, just wondering what exactly that rate is, can you just refresh my memory here?

Well, I'm just talking in generalities what we see in our market, Steve. We saw one-year CDs spike up to around 110, 115 when this first broke, when the lock down first happened. I think that was around mid-March, because I think there was a general sense that banks were -- all banks were going to go out and get liquidity because all the lines were going to start getting drawn. Well, that abated. That really didn't happen that, whatever you want to call it, panic or whatever you want to call it, abated. And so, now, we're seeing one year in the 65 to 70 basis point range, so.

Okay, that's helpful. All right. Well, thank you very much. Appreciate that.

The next question we have will come from Gary Tenner of D.A. Davidson.

Thanks, good morning. Wanted to try to get a better handle on the kind of intra-quarter workings on the margin and how to think about it going forward. Given the expansion in the quarter, is it fair to assume that the margin actually expanded still more than that over the first couple of months over the year before then falling below that number towards the end of March?

Yes, obviously, okay, that's the case. Ed, you want to add onto it?

Yes, January, February were probably just slightly north of the 370 number and then we didn't get the drastic cuts until middle of March, and then the final one, I believe, on March 18. And so, the effect was certainly muted within the first quarter. But we were in a situation where deposit costs were continuing to decline and then asset yields were holding steady, and then of course, middle of March asset yields fall down. And so, what we saw was the benefit of January and February, as you said, with the decline in March in terms of the overall margin.

Okay. So again, to follow on that then, the second quarter, we'll see the full quarter's impact over the March cuts and even though you had the expansion for the full quarter in the first quarter, second quarter should likely be the bottom and then beginning to get offset by lower funding cost, is that fair?

Yes. Look, general planning is a way.

I'm sorry?

Generally, that's the pattern.

Okay. Sorry about that. The other question I had I think had already been answered, so thank you.

Thank you, sir. [Operator Instructions] Next we have Tim Coffey of Janney?

Thanks. Good morning, gentlemen.

Hi, Tim.

In the release, you said that you were offering deferrals mostly to the hotel and restaurant portfolio through the end of March. I'm wondering into April, did you expand the criteria of who you might offer deferments to?

Who want to answer that? Nick, you want to answer that?

Sure. Just to give you a little bit more color regarding our total deferred payment request as of today, total we have a request from borrower in a number of loans, 43. And total amount is around $239 million. So, among those requests, some of them is request for interest only, some of them request for principal defer. And also, a portion of their request is for deferring both principal and interest, okay? And for the hotel portion, I would like to see more -- specifically, special purpose hotel is part of them. Special purpose is $140 million, around 28% of our hotel portfolio at this time.

Okay. And the deferments you said were six month terms?

We are offering three months to start. And then, we have, I mean, provide another three months later on as an option there. So, yes, they are started to have some deferral other than the hotels, namely in the -- I mean, in the retail area. And we also see some apartments, okay, smaller apartments, complexes having started to have that deferral request. Demand is usually insignificant or usually capital -- mostly happens in New York area and the loan amount is like $1 million or $2 million, okay, have few tenants that cannot pay.

And remind me again how much of the multifamily portfolio is in New York?

Well, I don't know if it's in New York. It is one that we have it?

I don't have breakdown for that. I only have deferral amounts [ph].

Okay, all right. Not a problem. Thank you. And then where are you on the PPP program? I know you mentioned in the press release that you started to accept applications. I'm wondering if you had any numbers on how many have been approved for funding before the funds ran out and how many you might have in the pipeline right now?

Okay. Wellington, you take the question, yes.

Hi, Tim. This is Wellington, as you know that we were not SBA approved lender going into the first round, so because we have an obligation really to take care of our customers. So, we went ahead and contract a third-party processor to take the application and process our customer. As well, about over a week -- little bit more than a week into the PPP program, we finally got SBA approval after PPP lender. So, from there on we also started internal processing. Unfortunately, we only had -- a little bit less than a day really to take care the application internally along. So, we all gear up for the second round and right now looking at the total app, we're looking at just under about 300 altogether total application between us and the third-party.

And the question is how much has been so called approved for funding and how much is additional thing that's likely happening?

Yes, approval funding, how much approval funding is 40 applications. And in additional loans in the queue, ready for a second round is about 250.

Okay. And do you have any dollar amounts on the 40 that were approved for funding?

Yes, on the 40, it's about $24 million.

Okay. Would you think the average application on the other $250 million would be about the same?

It will be lower. Lower on the average, because of 40 applications. So, if you have a one big sized loan approved, it'd kind of skew the average.

Right. And then just on your appetite to hold these on the balance sheet, I can't imagine is all that big, given what the yield is. So, would you kind of look to resolve them as quickly as you possibly can?

We obviously, that -- number one thing is that we like to service our customer. Whenever request come in, we immediately try to process that. That is why the reason that we engage a third-party processor, let them earn all the fees to process for our customers in the beginning. So, we think we can handle all that. We don't have that many requests at this point in time, although they're continually coming. I don't think the fee income will be so materially changing the second quarter picture that much, and I don't think the net interest margin here, that greatly affected anything in the second quarter because of their proportion, okay? It's only 1%, that's only affected net interest income.

Tim, to add on to that, I think in terms of the size, we'll probably hold them on the balance sheet and then try to get them work with our customer, help our customer to get these taken care of, starting in June.

Okay. Andrew, if I can, what is the fee to the third-party processor? Is it…

We have zero.

I'm sorry, what is that?

We have zero fee income. They earn all the fee income.

Okay. Got it.

Once they do, yes.

Okay, I understand. All right. Well, thank you. Those are all my questions.

And next we have a follow-up from Gary Tenner of D.A. Davidson.

Thanks. I just had a follow-up on the PPP question. I guess I was a little confused. Of the loans that the third-party processor went through the application process for, will those still be on your balance sheet, or are those going to be not even through Preferred Bank ultimately?

Yes, those will be on our balance sheet, Gary.

Those will be. Okay. All right, thank you.

We're showing no further questions at this time. We will go ahead and conclude our question-and-answer session. I would now like to turn the conference call back over to the management team for any closing remarks.

Well, thank you very much for joining our earning conference. This is truly a very-very challenging quarter for everyone, okay? And right now, I join every one of you, hoping everyone staying healthy and safe and hope that our country gets better soon. Thank you.

And we thank you, sir, to the rest of the management team also for your time today. Again, the conference call is now concluded. Thank you again, everyone. Take care, and have a great day. At this time. You may disconnect your lines.