Preferred Bank (PFBC) Q2 2020 Earnings Report, Transcript and Summary

Good day, everyone and welcome to the Preferred Bank’s Second Quarter 2020 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. 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; and 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 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 earnings 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 under the current interest rate environment. For the quarter, return on assets was 1.26% and return on equity was 12.65%. At June 30th, 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 have 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 that deleveraging -- a leveraging of a balance sheet which also has a negative effect on 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 over $500,000 of interest income reversal that also affects the margin. Compared to the first quarter, our loan yield decreased 47 basis points and our deposit cost decreased 43 basis points. We expect going forward deposit cost to continue to decline because of the maturity and the repricing of our time certificate of deposit portfolio. At June 30th, total modified loans amounted to $467 million. Toward the later part of the quarter, activities for new modification have greatly slowed down or moderated. In fact, as of June 30th, there's only $4 million more new requests in progress -- or in process. And during the quarter, many have returned or were being reinstated to normal status. And between July the 1st and July the 20th, there's another $25 million being reinstated. Of deferment -- modification [ph] is generally for three months. 40% of the modification loans -- modified loans are from partial modification, which is for interest only or principal only, 60% is for the full PMI modification. Modification generally is for three 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 -- or the magnitude of the new provision will depend on quarter-by-quarter evaluation of the economic condition, the status of virus and the 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 less than 33%, the declining trend of deposit cost and that all of our floating rate loans was for the operating at floor, we see a very comfortable with our operating metrics. Thank you very much. Now, I'm ready for your questions.

[Operator Instruction] And our first question comes from Timothy Coffey from Janney. Please go ahead with your question.

I just want to start first with the non-accrual 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 non-classified loans are mainly classified top [ph] of the loans, which we have recently downgraded to classified non-accrual. That's why, the first loan actually is fully secured by real estate. And during the past couple of months is the borrower trying to sell, to dispose the properties and pay back the loan. However, the sell was not so successful because of the COVID-19 pandemic, it has been delayed. We’re 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 negatively affected by 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's working with the Bank for refinancing and provide additional collateral to cover the risk.

Okay. What were the book values of the first two loans.

It’s in LA.

Book value.

Dollar amount.

Book value? The first one is $16.8 million, the second one is $6.32, and the third one is 1.13 million.

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

Yes.

And where’s the second one?

The second one is also in LA 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 sufficiently -- you have provided sufficiently…

Yes.

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

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

Okay. I was kind of wondering if that’s 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 rate, Tim, do you mean the ending rate as of June 30th or during the quarter?

As of June 30th.

As of June 30th, 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. 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 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 are way down as well.

And then, just Mr. Yu, the debt payoff of $161 million, were those properties -- or were those loans refinanced to other institutions or why were those so elevated?

Some of them is a construction loan payoffs, okay? Some of them is being refinanced by other institution in a rather low rate. Some of them is outright sales, customers sold [ph] property.

In this current environment, do you expect that number to stay the same or change either way in the coming quarters?

I will give you my thoughts after Wellington gives you his thoughts about what he expects, because we each -- we think sometimes slightly differently.

Hi, Tim. This is Wellington. For the third quarter, the payoff, no, it's not 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 no factor right now.

Well, Tim, my thought is that we will be seeing in the third quarter on the origination level and on the payout that both reduced. One of the situation is judging from the activity of tail end of 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 the sale were to occur in short order?

Actually, this is question is kind of optimistic. From a normal sales point of view, okay, it should have happened way back, long time ago. But, we have a -- customer's kind of a somewhat -- hang up to the things they want to have. Every time when a deal is being made, either backed off by some parties. You see this property is really qualified as a deferment. But since it was late before the guideline was issued, we really cannot give them the deferment going forward. So, this thing is also hanging up there. So, we obviously are using the utmost of our energy try to encourage him to get rid of the property.

It's very helpful. I know there were a few moving pieces with respective 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 continued repricing on the liability side?

Yes. Ed can do that. Ed, he’s got it already for you.

Well, 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 deleveraging of the balance sheet during the quarter where we’ve taken out a lot of deposits, taken on a lot of cash with earning 10 basis points and loans are not growing. That certainly has 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 3.70. I think that was 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 the floors. So, I think from -- 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. Please go ahead with your question.

I guess just following up on the margin here in terms of the 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 this,, 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 returns than our 10 basis points of the Fed. And then, we've incrementally added here and there to the bond portfolio as we see small glimmers of opportunity.

And then, in terms of -- going back to non-accruals, kind of curious on the property types for the $16 million -- $16.8 million non-performer and the third loan. Are those just as a commercial real estate -- kind of curious as to any color there?

Nick, why don’t you answer that?

Yes. The loan is actually covered by field properties, which is more high-end residential desirable area.

Okay. And then, in terms of your hotel exposure, just kind of curious -- give any color around what you're seeing for occupancy at those hotels, whether maybe 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 bit longer dissipation on that. We have the patience. Our hotels, basically speaking, some of the hotels closed. They -- somehow the owner decided [indiscernible] just keep it open. But the one that's opened, the reason, the report that we're getting is that anyone ranging from 35% to 50% of occupancy. There are certain hotels because they are special locations and because their contract with the government, 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 two categories. One category is in metropolitan city, New York proper, San Francisco proper, and Los Angeles, basically speaking. They are basically flag [ph] hotel -- national flag hotel and operating there. And then, other segment of hotel is in a choice of beach side location. We have a boutique hotel in Newport Beach, boutique hotel in Redondo Beach right on the water. One of them is on Hermosa right on the sand, and one in Malibu, very small, but right on the sand too and Venice. [Ph] All these hotel is property value the best we know is holding up very well because of choice of location. And a third thing about a hotel is that the deleverage rate that I gave you on the report is deleverage at the date -- at the time of origination. Some of them actually is since appreciated right before the pandemic. But one of the situation I must point out is that substantially all the hotels has recourse. And we'd like to think as 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 will be one or two [indiscernible] there, but we're not expecting to have a serious problem over there, at least as of the date.

That's helpful. And I guess, I’m going to 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. The portfolio, probably if I have to guess, around 80-20.

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

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, we can probably expect expenses to be somewhere between where they came in for Q2, which is roughly $14.5 million to $15 million, somewhere in that neighborhood.

I'd also like to add on that, Ed, a little bit. Okay. First of all, if that -- if you noticed that we have substantially exceeded all the forecasts in terms of I mean pre-tax pre-provision income, and pre-tax provision revenue, all the forecasts, I mean, that was put out by all you good people, okay. The second situation is my closing remarks, going forward, we have a low efficiency ratio. But the important thing is deposit costs on the declining trend. And we expect, other than the re-pricing of certain loans, we expect the loan yield to be relatively stable. So, with these three factors, I am comfortable with the operating metrics.

One more, certainly [indiscernible] 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 are forecasting this time unemployment [ph] rate is around 11% to 12%. And definitely, this number can go very, very large as some of the major employment center after reopening, definitely based on the pandemic situation, if they shut down, so we definitely, we look for much, much higher numbers. And also GDP contraction we forecast is around 5% to 6% additionally. So, we closely watch these two numbers down the road. And we'll make adequate reserve in the Q3 over 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 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, because really there's no pipeline on such thing and it largely depends on the customer usage. But for the third quarter, we’ve seen continued slightly increase as of July 21st, today as compared to the quarter-end. And obviously that -- we have to moderate the increase, if it is going any magnitude, we have to moderate that, okay and balancing between paying less interest and slowdown deposit growth. You see, for every dollar we deposit, we're taking -- we're taking we're actually losing money if it is other than DDA which we do have growth on that base. So, the question is that, unlike the old days, you'd like to grab the top of every way which we can, we like to grab it, obviously with some caution. So, I don't know how best to answer that. It's kind of a really a moving thing.

That's great. That's incredible. And then, I guess, just thinking the deposit growth, decreasing deposit cost and then the floors that you 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 repriced faster than loans and we could actually see core NIM expansion from here, or, I mean, should we expect additional modest contraction?

The leverage factor aside, okay, actually [indiscernible] leverage factor you can actually really -- [indiscernible] the discussing 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, okay. So, [indiscernible] we should think NIM to be relatively stable. As I said previously, we said, I think deposit cost is improving, loan yield will be generally stable. Loan yield is always depend on the payoff, the rate is always higher than 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 to do a lower rate loan, do you want to match. And selectively we’ll match. So these two factors always bring the [indiscernible] a bit. But when the pandemic is going on, we think it's going to be [indiscernible].

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 two to four-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 re-deferral rates as we go through the third quarter?

As you said, we have the three months deferral, okay? We deferral -- what we’re seeing basically are the one that seriously affected, some are very small amount, around $4 million. Those things, if they come in with a request, we know that you have to [indiscernible] to do that, I mean, under the safety and soundness guidelines of course. The next thing is that there's number of hotels that is not opening. So, we're granting the deferral. For the hotel that's opening, I mean operating and we're seeing some kind of activity, cash flow, we're asking deferral 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, we expect them to return to the [indiscernible] in the third quarter. But, thankfully we have not seen too many new requests. [Indiscernible] referral basis is staying in [indiscernible].

And then, I guess the last one for me, more of a -- maybe more of a strategic question. I mean, we’re in the midst of a pandemic, which is changing not only customer behaviors, but you 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 evolving client behavior, just curious on any changes in strategy or thoughts going forward?

Well, we just had a Board meeting yesterday, started to think about that. I think previous to that, in one quarter, you just remember, at the end of second quarter -- first quarter was just when the lockdown had been started and we just had one quarter event. And I think within this one quarter were the [indiscernible] PPPs, deferment, new loan and [Technical Difficulty] closing up then certain branches short term because testing positive or these kinds of things. So, we were pretty busy just to keep ahead above the border. [Ph] So obviously going forward, if everybody has to work home, you know that staff realignment will be some of the issues that we'll be looking into it because obviously that the origination activity has to continue. And also [Technical Difficulty] activity maybe because the fact that everybody's looking on the changes somewhat in situation. There is something for a small institution like us, we have not gone around and really have the luxury of getting to that yet. But sooner or later,, it's going to happen to every [indiscernible].

And our next question comes from [Technical Difficulty]. Please go ahead with your question.

So, we saw that [indiscernible] $23 million to the trouble debt restructurings in the multifamily category. Could you share with us some details on this situation? And what type of modifications [indiscernible] and in what geography?

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

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

In New York it’s only $350 million around. The rest are in either North California or Southern California.

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

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? Do you have readily available?

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

Did you hear that, Tim?

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. So, what are your internal expectations for when those might be forgive, is it by year-end or in the early next year? Just kind of what are your thoughts there?

Well, I think our expectations would be that certainly majority of them are forgiven. We obviously hear things coming out of the Fed and other places talking about automatic forgiveness for those loans under a certain dollar threshold. We're fortunate and 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, 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 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 downgrade to those loans that have previously been classified into non-accrual status?

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, hence that's for the Q3 or Q4 thing. So, we have to watch that closely. But up to now, we haven't seen any other issues on our credit, our portfolio.

Putting a loan on deferral or modifications certainly doesn't stop the process of kind of reviewing and thinking about internal risk rating. So, you're just saying that you're kind of [indiscernible] until after that period is over?

Actually on deferment, every one of them has gone through our internal procedure, looking at qualified [ph] deferment on that. And also in the loan proceed, we about -- we already started that we will continue our full bank review on all the loans, but yet, each under deferment and any additional loans that any one of us feel that we need to have a further dive into that. That's possible, even with -- we also look at even loans in this review. 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 is slight 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 a normal life because most of us are facing situation, we all get our good customers, our people like that they will be generally -- the credit will be good in normal circumstances. We just don't hope that there's increased number of credit just being become a problem because the virus. People lost their livelihood or wealth because of the virus. And cross our fingers and pray. Thank you.

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