Preferred Bank (PFBC) Q3 2020 Earnings Report, Transcript and Summary

Good day and welcome to the Preferred Bank Third Quarter 2020 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Jeff Haas of Financial Profiles. Please go ahead.

Thank you, Jason. Hello everyone, and thank you for joining us to discuss Preferred Bank's financial results for the third quarter ended September 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 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 that 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 very much ladies and gentlemen. Thank you for joining our earnings conference call. I am very pleased to report Preferred Bank's third quarter net income was $17.1 million or $1.15 per share. These numbers compare favorably with the prior two quarters. In fact, on the pre-provision pre-tax basis, third quarter net income and the nine months net income was a record high for our Bank. The quarter's improvement is largely due to a significant reduction in deposit costs and continued overhead control. Many people have always considered Preferred Bank is an asset sensitive bank. But if you recall, about two quarters ago. I have already reported to you in our press release, and we are reaching a liability sensitive bank. I'm just very pleased, that we have something to show you in this quarter. Deposit costs will continue to decline in the fourth quarter, but not at the same magnitude and the same pace as the third quarter. For the quarter, our net interest margin was 3.54%, a 3 basis points reduction from previous quarter, mainly due to a larger balance sheet and much increased excess cash on hand. However, on the ex-PPP basis, net interest margin actually improved to 3.61% from 3.59%. Third quarter deposits continue to grow 1.5% or $64 million. However, our loan has declined $14 million. I guess the prolonged shutdown - lockdown in our main trade area, which is a Los Angeles, New York and San Francisco, and finally affected the deal flow pipeline. And new opportunities of loan seems to be - also seems to be less attractive, under the current environment. Today, much of our attention and focus is on credit matters. As of June 30th, we have some nonperforming loans, total a little less than 50 basis points. We have decided to charge-off a portion of them, and we have also decided to reserve whatever exposure we can see the full amount, and on a very conservative basis. Meanwhile, for the quarter because of - for the quarter, our loan for loan-loss provision was a larger number of $9 million dollars. So as a result, our credit bill continues. Total reserve to loans now stand at 1.58%. On the deferment side, total loan that received modification under the CARES act was $610 million. Balance at June 30, was $467 billion and balance at September 30 was $199 million. In the third quarter, we had a 53% reduction. We've also reached out to practically all of our borrowers inquiring about their plans, and we are very encouraged to learn, a great majority of them indicated, that they are planning to resume their scheduled payment very soon. Therefore, deferment balance at December 31 could be a very modest amount. For the third quarter, our return on equity was 13.7%. We at Preferred Bank is elated about this, not because the number represents after a significant loan-loss provision. Not because it represents the culmination of over one year's work, to restructure and reposition our loan portfolio and our balance sheet. But rather, we believe bigger earnings will give us bigger muscles to fight the uncertainties ahead. Thank you so much and I'm ready for your questions.

We will now begin the question-and-answer session. [Operator Instructions] First question comes from Nick Cucharale from Piper Sandler. Please go ahead.

Hi guys. How are you doing today?

Hello Nick.

Thank you.

So you mentioned the increase in capitalized origination costs, due to higher loan production versus the second quarter. Can you quantify that impact? And bigger picture, can you share your outlook for operating expenses?

Hi, Nick, this is Ed. I'll take that one on. Loan originations were relatively flat on a quarter-to-quarter basis, when we look at Q2 versus Q3. But what we really saw, was the PPP loan fees that came in, and that's why we had the outsized, capitalized credit costs under salary expense, and also that had a benefit, slight benefit under loan fee income as well. In terms of going forward, non-interest expense wise, we really don't make it a rule to give any kind of forward guidance. But obviously, I think we did an excellent job with respect to expense control in the current quarter. I would look for that to continue, as you know, that's what we're all about, and we actually breached 30% efficiency ratio in this quarter. So I thought that was pretty impressive. But in terms of going forward, I think it's going to be fairly similar, probably up a little bit from Q3.

Sounds great. And I agree with your assessment. So this was the second quarter we saw C&I paydowns dampen the growth you achieved in the real estate book. You had the big draw on commercial lines in the first quarter, and now we're back towards the end of the 2019 level, with respect to balances. Is your sense, that commercial paydowns are in the final innings?

Well, I didn't quite really get the question. I mean you are asking really based on whether the C&I balances continue through - actually C&I balance this quarter have reduced about $67 million, okay, mostly in the customers pay down, okay. So our net production, actually we have a little bit of net production. While new production versus the payoffs shows a balance of about $40 million, but because of the C&I existing customers less usage of loan amount. So the quarterly total loan balance reduced by $14 million.

Okay. Your total capital ratio is up nearly 80 basis points from the end of the year. You continue to have strong internal capital generation, as you pointed out, even in spite of the big reserve builds. Can you help us think about your capital priorities, and specifically, if and when you may revisit a buyback?

We really are not, compared to our peer group. We have a low effect of our capital ratio. We have a designated peer group among our people set. So - and at this point of time, our attention really has focused upon the uncertainties ahead of us. We just want to be well prepared for any kind of things that can affect us. We will revisit that, providing that our loan growth does not restart. To restart the loan growth, there is no need to buy back stock. We can create more income for our shareholders, by growing the bank.

Okay. And then lastly, the tax rate came down quite a bit this quarter, seems to be more a matter of timing, rather than a structural change. How are you thinking about the tax rate going forward?

Nick, I'll take that one. This is Ed. Yes, the tax rate came down in Q3, and that was a true up to the 2019 tax returns. So we would look for a somewhat similar tax rate in Q4, albeit up probably just a little bit. And then for 2021, excluding what happens with respect to the upcoming election, we would expect to head back to the - right around 29, 29.5 ETR.

That's great. Thanks so much for taking my questions.

The next question comes from Gary Tenner from DA Davidson. Please go ahead. Hello Gary, is your line on mute?

Sorry about that. Good morning. Couple of questions for me, I just wonder if you could provide any details on the charge-offs in the quarter? I didn't quite catch any detail that you have provided?

Yes, we had two long - two larger loan, there was a bunch of a little bit - little insignificant. With the larger loans that was - is placed on non-accrual in the second quarter, okay [ph]. And these loans are currently in the prolonged collection process, although indication is that the latest appraisal value which was a while ago is still - will cover the loan but we believe the market value has slide down a bit. And because of uncertainty of the collection process of the main product [ph], we decided to proactively impact our [indiscernible] and reserve whatever exposure we can comply. So, I hope it's - sort of like a proactive move in preparing for 2021.

Okay, great. And on the previous question, in terms of comp, I think you said that you had the benefit this quarter that drove comp lower, because the PPP fees came in this quarter. But wouldn't the deferred count have been better than the second quarter from a PPP perspective?

Well actually a majority of it was - a lot of the fees received and the bookings took place in Q3. So it was after the end of June, when a lot of that took place. In addition to that, Gary, with respect to comp expense, bonus expense was also lower this quarter as well. And as you know, bonus expense incentive comp expense is a component of the Bank's overall profitability.

All right. Thank you.

The next question comes from David Feaster from Raymond James. Please go ahead.

Hey, good morning everybody.

Hi Dave.

Mr. Li Yu, I just wanted to follow up on your comments at the start, where you had kind of made it sound like you're - that new loan opportunities might be a bit less attractive in the current environment. Did I understand that correctly, and maybe just why is that? Is it structure, is it just pricing, is it just uncertainty in the market? Just curious, your thoughts on loan demand and your appetite for new credit?

Actually, you mentioned just about every possibility. But let me clarify. I mean new opportunity for hotel loan, you don't want to do it, okay. New opportunity for retail loan, the chances you want to do it, is less than 50%, okay. Even in the old days seems to be fine. And new opportunity for some specialized product, office and so on, and become is - it's less of a - remain attractive, especially in some of the areas that we're operating at. And today, with a prolonged interest rate situation, people are also looking for loans that are priced to the unreasonable level. We believe the loan pricing is less dynamic interest margin. And so that makes us eliminate lot of the opportunities that we looked at.

David, I want to add to that - to what Mr. Yu said. A lot of the economic activity going on in the United States is very regionalized right now and very localized. If you look at what's going on in the south and economic activity there, the Midwest, far more than what's taking place in California. I mean, LA County is still in one of the strictest lockdowns in the entire country still.

And New York.

As well as New York. And so, as we look at lending opportunities, we have to look at our local economy and what's going on there, as opposed to what may be more of a macro thing to look at.

That's a good point. So probably, I mean you guys are still - like you said originations have been flattish. So probably some - exclusive of PPP, which is obviously going to decline, probably some flattish to maybe modest contraction in loan balances in the short run?

Well actually, because we are a sort of like a one-off type of loan company. It depends on the special loans that come to us, okay. Early indication, the fourth quarter, maybe have some production. But it is - we don't know the payoff situation was coming later in the quarter and so on. So if you look at it as - we try our best. But right now is the - key situation is for us to manage our credit, and to keep our profitability up.

Yes. And kind of along those same lines, you guys have done a tremendous job defending the margin, and tremendous job reducing deposit costs. And ex PPP, it was actually up quarter-over-quarter like you alluded to. But you had mentioned that the incremental reduction in deposit cost is probably going to be less in near term. Do you think that you can continue to support loan yields and outpace - the deposit costs will outpace the declining loan yields that we could see margin flat to up, or would you may be expect some further NIM compression, just given the pricing challenges that you had mentioned?

Okay. Loan yield reduction in the third quarter, okay, is in the neighborhood - well actually, yield is in a single-digit situation. So I'd like to think in the fourth quarter, that probably that the reduction in interest costs, okay, will be offsetting the loan yield reduction at least.

Okay. Okay. That's helpful. And then last one for me, you guys have done a terrific job on the deferral front. Deferrals they are down significantly. I guess, how have deferrals trended since not that 9/30 level, like where are they today. How much of the balances are second deferrals versus those that are still on first deferrals, and kind of does that $27 million deferral target that you guys put out in your presentation, is that still holding true?

Well, why don't I let, Johnny, do you want to take on that question, and I'll add on to it?

I think - hi David, this is Wellington. I think that the deferrals you saw on the second - already on the second, that's included. So this is it.

Okay. Okay. Like after your conversations, there is - nothing has really changed in that $27 million kind of target that you laid out after all the conversations with your borrowers, we're still thinking minimal at the end of this...

Actually David, if you read the text of our press release, it indicated there are still $4 million of new request for deferrals, okay, as of September 30th, okay. So the question of deferrals sometimes are coming, but the number is very minor. You see many of our customers has been paying out of their pocket for a period of time. But since the lockdown is lasting more than you and I originally anticipated, okay. So the question some of them is finding - I mean, starting to have difficulty. In many cases, the new deferral we're blending, is only - principal only, or partial interest, okay. So if you look at - these deferral from deposits, 40% of our deferral is partial deferrals. So we look at everything, study everyone and try to exceed the underwriting principles in granting our deferrals.

Okay, that's helpful. Appreciate all the color guys. Thank you.

The next question comes from Tim Coffey from Janney. Please go ahead.

Thanks. Good morning everybody and thanks for hosting the call today.

Thank you.

I guess so - thanks. I want to follow up a little bit on the loan demand from your clients. So if the restrictions were lifted tomorrow, I mean, would you expect to see a resurgence in demand for credit on your borrowers, or is it more that your borrowers are just kind of hesitant right now, to make new investments and things of that nature?

Well, my impression is that - my impression, that there is a lot of money on the sidelines, okay. And the people are just waiting to jump into it, okay. I mean, Wellington, do you want to add on that?

Oh, I mean, I agree. I think that there are a lot of money on the sideline. They are waiting for opportunities, and is it going to spike up overnight? Probably not, because we're going to be also be cautious too, and wrap it up gradually. But I think that there is definitely pandemics done tomorrow. Then we have to look at our competitor as well too, to know how the market react, and we have to look at what's the - again, as Mr. Yu mentioned earlier, the pricing of the loan.

Sure. Okay. All right, that's helpful. Thank you. And just circling back on the deferrals. You know with the positive trajectory of the deferrals, are you done reserving, or is it too a little too early to make that call?

Well, we have no - I mean talk of the reserve is overall is for the future, okay. Let me ask you answer you by saying this. You know I have reached out to several of our shareholders. I said well, given our situation, our deferral doesn't look that bad, okay. In fact, you could say, it looks reasonably good. But what do you want me to do, under the uncertainty? Because there may be a second wave on the backseat. And today, the government official will come out saying that, oh maybe six months before everything is happening, so what about if New York is locked down for another six months, and won't let anything happen? So the majority of my shareholder tells me, says, we are in the long game. We should manage the bank in the safest and most conservative basis under the current environment. So I guess - I mean, we will make some additional further reserve - credit [indiscernible]. But again, we will open our eye to see what the market condition is. I know we are into a climate, most of the bank is reporting reduced provision, and so on so forth. But since we have mandated my shareholder [ph] - is that, they want us to play it safe. Especially, by playing it safe, we still have a 13% return on investment, and seems to me, they're happy with that.

Okay. That's helpful. And then just if I could on CDs that might be repricing in this quarter, if you know, what the yield on those, or the cost of those are, and where the market rate is right now?

They are...

I know the number. [Indiscernible] the $434 million should be - that would be renewed in the fourth quarter. Okay. The rate on that is 1.60, okay. And currently, our CD rate is in a 60 to 70 basis points range. So there will be some savings. But mind you, this $434 million is not really evenly renewed during the fourth quarter. Some of - I guess, a bigger portion will be in December.

Okay. All right. That's very helpful. Thank you very much.

The next question comes from Steve Moss from B. Riley FBR. Please go ahead.

Good morning. I guess just starting with - just going back to credit here for a moment. With regard to the provisions quotes, kind of curious, how much was the specific reserve for the two larger credits here?

Well, I think we reserved additional $6 million or so - approximately $6 million, other than the charge-off.

Right. Okay. So then absent that specific reserve, your provision for the quarter will have been closer to $3 million, just as we kind of think about economic impacts, is that kind of a fair way to think about it?

I think the charge-off really has no economic impact, reserve is the one that has really an impact. In other words, [indiscernible] basis, if we make a reserve of $5 million, provision will be $5 million, okay. And the next quarter charge-off is just a reduction of the reserve that was previously made up.

Right. Just trying to think about the - just the driver of the provision going forward, if economic forecast remained relatively stable, the biggest driver going forward will be whatever you may have in terms of specific reserves?

Could you be a little bit more specific about that? So I mean okay.

Hang on. I'm sorry, let me - Steve. I'm sorry, I want to correct what Mr. Yu said earlier, apologies. But these specific reserves assigned to those two specific credits, was $3.3 million, when we're looking at the overall provision of $9 million. So the specific was $3.3 million and then the charge-off on the two, was $3.5 million.

Charge-off is already done okay, so it has already taken us additional $3 million.

I just wanted to clarify that. Yes. And so, back to your question, Steve.

We will look at [indiscernible] and charge-off of the $3 million.

Yes, '06 [ph].

Okay. So then just, as I think about the drivers of your provisioning forecast - of the provision going forward, if economic forecast continues to generally improve, barring some exceptional specific reserves, probably should see a meaningful reduction in the loan loss provision going forward?

Well yes. If economic forecast is showing the improvement, we would definitely reduce the provision, okay. If the deferment works out to be like we project it to be, and there are no new surprises, the whole situation may be somewhere in 2021, we could release the reserve, okay. But given the situation as of today, I don't think any economist, has given a definite answer of how economy is going to be - is doing that well. And as I stated earlier is that, the majority of the constituents of us is expecting us to play it safe right now.

Right. So okay the...

The short-term - we knew the property would still continue to put - [indiscernible]. But we were definitely making the adjustment; I mean - I mean whenever - I mean, it's indicating so.

Okay, that's helpful. That was - I just wanted to try to hit down a little further into that. The rest of my questions have been asked and answered, I appreciate that. Thank you.

Thank you.

The next question comes from Andrew Terrell from Stephens. Please go ahead.

Hey, good morning everyone. So most of my questions have been asked and answered already. Maybe do you guys have the balance of classified and criticized loans this quarter?

We do. Just a second.

I do. Just hang on, got a lot of paper here. Hang on, here it is. Classified is $59 million, and then overall criticized would be the special mention plus the criticized, about $139 million, added together.

That's helpful. Thank you. So within the table you guys provided in the release, that breaks down the loan portfolio by bucket, and gives the loan-to-value and debt service coverage. This is extremely helpful breakdown by the way, if I compare this quarter versus kind of last quarter, most of the real estate bucket saw an uptick in loan-to-value by about 3% on average. I'm curious, is this more just an ebb and flow of the portfolios, or are you getting updated appraisals on properties right now? And if so, how are those valuations comparing to the previous ones in place?

You want to answer the first?

Yes, I would say at this point, Andrew, it's really a combination of both. There is certainly churn through there, even though the portfolio only moved $14 million. There is a fairly decent amount of activity that goes in there, with respect to pay-offs and new originations, as well as renewals. So on the renewals, depending on the length and size appraisals are updated. Other than that it's, as you said, it's the ebb and flow.

All right, thank you. And just last one from me, have you guys started submitting applications for the PPP forgiveness? And do you have any, just ballpark estimate of when you anticipate recognizing the fees?

Johnny, do you want to answer that?

Yes. We did submit forgiveness applications already, and few have come in, in early October. So we expect that to be continuing throughout the fourth quarter.

The fees are currently being amortized over the life of these loans right now. So, the fee recognition at the end of this, won't be that significant, because we will also have deferred costs to recognize.

And also our total - PPP is only $74 million. There is $4 billion of loan portfolio. So in relative sense, it would not affect things that much.

Got it. Okay. Thank you for taking my questions.

Next question is a follow-up from Nick Cucharale from Piper Sandler. Please go ahead.

Just a quick follow-up on the NIM. So point to point, you had a big increase in cash balances at September 30th, relative to June 30th. We are only a few weeks into the fourth quarter here, but has that excess liquidity started to come down materially at this point?

No. Slightly, hopefully on mark. Now on the cash inflows and that's DDA. We're kind of sitting there right now, happy, but not happy about that.

Upside down.

That's very helpful. Thanks.

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

Well thank you so very much for your attending the conference. And we hope now - we hope we can continue our operation under the current metrics, which - that gives us give us these kind of profitability and the situation we would like to have. Thank you so much.

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