Preferred Bank (PFBC) Q2 2021 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Preferred Bank Second Quarter 2021 Earnings Conference Call. [Operator Instructions] 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.

Thanks, Chad. Hello, everyone and thank you for joining us to discuss Preferred Bank’s financial results for the second quarter ended June 30, 2021. With me today from management are Chairman and CEO, Li Yu; President and Chief Operating Officer, Wellington Chen; Chief Financial Officer, Ed Czajka; Chief Credit Officer, Nick Pi; and Deputy Chief Operating Officer, Johnny Hsu. Management will provide a brief summary of the results, and then we will open up the call to your questions. During the course of this conference call, statements made by management may include forward-looking statements within the meaning of the Private 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 very much. Good morning, ladies and gentlemen. Preferred Bank’s second quarter net income was $21.2 million, or $1.44 a share. This quarter, we had some non-recurring items. The first of all is correcting an interest income item, which related mostly to 2020 events. And the second one is a expensing an amortized discount on a term loan – on the sub-debt loan that was previously existing, which we called then. And third one is loss on a sale of a loan paid. Without these three items, on a normalized basis, our net income would be $1.58 or $1.59 a share and our return on equity will be over 17%. On a same basis, net interest margin for the quarter was 3.47%, a 14 basis points drop from the previous quarter. Under the low interest rate environment, we continue witnessing that new loans being made at less of a rate than the old loans paid off and we also have many customer renegotiations on rates, for instance, since the whole lot of SNC loan rates have been renegotiated, also, the large excess liquidity also weighing on the net interest margin. Our loan, however, has grown 11% for the quarter. During the quarter, we have seen a vibrant loan pipeline, but we also see increased payoff activities. Looking ahead, we believe the pipeline will continue to be reasonably satisfactory. This is especially true for many of our newly hired loan officers will be closing loans in the ensuing quarters. We also see a modest interest cost savings in the quarters – two quarters ahead. Our credit metrics has improved. Classified assets, is down. Quicker sized assets, is down. Deferment of loans as of June 30 is only $1.5 million. And for all the inference and principle that we have granted deferment to our borrowers, we have collected back 67% already. This quarter, we have a little bit of charge-offs, but that was charging off the previously reserved loans. So when there is a charge-off, there is a corresponding reduction in reserves. This quarter, we are recording loan loss provision. I must report to you at this time that a conversation I have had with one of our private shareholders yesterday. Specifically, he is questioning me as why we are not having a loan loss reserve release during the quarter like almost every other banks okay. I told them, first of all, of course, the CECL’s mathematics, okay, but I also told them from a personal point of view and looking at the glass half full basis that I am kind of pleased that we didn’t have any release this quarter. The most recent economic forecast that was reported by Wall Street Journal yesterday was a forecast by Morgan Stanley’s Chief Economist, who indicated the economic expansion will continue at a reasonably good rate growing into – well into 2022. We echo her sentiment. You see there is not a whole lot we can do about the current low interest rate environment. And then there is not a whole lot we can do about the inflation pressure. What we feel will be dedicated to continue to provide top-tier profitability to our shareholders. Thank you very much. I am ready for your questions.

Thank you. [Operator Instructions] And the first question will be from Matthew Clark with Piper Jaffray. Please go ahead.

Hi, good morning.

Hi, how are you?

Good. Thanks. First one, just on the loan yields and trying to get a sense for what kind of rates you are getting on new business, I think last quarter you mentioned that new business is coming on about 90 basis points below the portfolio yield. I think your core loan yield this quarter was about 4.99% if we exclude the PPP and the interest income reversal. I guess, what is the weighted average rate on new production this quarter?

On the new production this quarter that it is really a sort of like abnormal quarter. New production yield rate comes in 4.05% where the pre-op rate comes about 60 basis points higher than that, okay. That is because that we have some large SNC loans being re-priced 50 to 75 basis points lower. So, it’s kind of changed the mixture of the thing. Our own portfolio type of loan, we are doing basically right around about 4.3, 4.4 level.

Okay, great. And then just on the growth in commercial real estate this quarter, that was most of your incremental growth, can you give us a sense for the underlying property types that’s driving that growth and your thoughts on your ability to maintain low double-digit loan growth into next year given your pipeline?

Wellington, volunteer – you want to volunteer on that?

Sure. Matthew, this is Wellington. Most of that what we put up is multifamily residential, we have the single mixed-use warehouse type of properties, lot of warehouse ownership.

Understood. Great. And then last one, maybe for Ed, on the expense run-rate going forward and given the build-out of the LPO in Texas, can you give us your thoughts on the run-rate going forward, whether or not that you might kind of remain at this level or might we see a little bit of growth?

Well, I would venture to say, I mean we did I think a really good job holding it under $15 million this quarter. And as you recall, I probably guided a little higher than that in the previous calls. And so I am going to be consistent with that, Matthew, and say it’s going to definitely go up north from here. I would say, in the low to mid-15s, somewhere in that neighborhood, simply because we have a number of things that are going on, but one of which is hiring that we have been doing. As we mentioned in the previous call, this has been so far – and Wellington should probably talk about that as well. It’s been a pretty good call – year for recruiting this year. So, to the extent that happens, seller expense will increase, but we will see better top line growth as well.

Okay, thank you.

Thank you. And the next question will come from Andrew Terrell with Stephens. Please go ahead.

Hey, good morning.

Yes. Hi, Andrew.

Hey, I just wanted to ask, how much of the total portfolio today is considered syndicated or SNCs and then any kind of specific industry concentration within that?

It’s about – I think it’s right around 11% of the book, Matthew. There are no industry-specific concentrations. These are typically credit type facilities for these larger organizations. We do have, as we have talked about in the past, we have about I believe $50 million or $60 million in the entertainment industry, but those are not production credits, those are primarily library based.

Perfect. Thank you. And I did want to switch back over to kind of the new higher front just briefly. Are there any specific geographies you are more focused on hiring or is it really coming out across the board? And any kind of incremental color on kind of the type of institution you are hiring away from? Is it larger, smaller, similar size? Just any color on the hires?

Andrew, that – we have previously that I talked about it our hiring is basically opportunistic. So, we have – maybe – several regions we have, whenever we found a qualified personnel that we tried to get them paid and then if we are lucky enough, we then coming into terms for them to join us, okay. And it is not specifically we set targeting any region at all, but rather than all the regions we have we are continuously cultivating people coming to us, mostly our tenants coming from bank above the – within the range of our size. In other words, a little bit smaller than we are, little bigger than we are, okay.

Perfect. Thank you. And then just last one for me, it looks like the end of period PPP loans were essentially flat to the prior quarter, just any kind of updated thoughts or expectations on a timeline for forgiveness for the remainder of these loans?

Andrew, this is Johnny. On the PPP loans, we are going through the forgiveness process right now. And we haven’t started on the second one yet, second batch, because that guideline hasn’t come out yet, but we still have around $50 million that we are expecting to be forgiven from the first batch.

Okay, perfect. Thanks for taking my questions.

Sure.

The next question will be from Steve Moss with B. Riley Securities. Please go ahead.

Good morning.

Hi, good morning.

Starting off with maybe just the appetite to deploy excess liquidity here, just kind of curious from the release there, how much – what are you thinking in terms of securities purchases if any and just what yields you maybe expecting there?

In general, we just have too much liquidity. We have roughly 22% of total assets invested in cash on different type. Obviously, that’s earning a grand – less than 10 basis points, okay. So, we know that our effort is to invest in. And obviously, first choice is the loan, but we are looking at the securities side and we actually get some in the second – late second quarter started to do it, okay. But as you know the choices has not been whole lot of them if we consider risk. So Ed, you want to echo in and pluck more on that?

Yes. No, it’s – Steve, as you know, it’s a tough time in this rate environment. Spreads tightening, so you really don’t get paid for going long at all. So what we have been doing is we have been kind of mixing up between cash alternatives, very, very short monthly adjusters, agency type stuff. And we have put quite a bit into that, over $100 million into that and then we have been picking off here and there munis and corporates as we find value here and there. But it’s – as you know, it’s a long slog, but the mortgage product yields almost 5x what the overnight IOER rate is, so that certainly helps. But there is – these are base hits, these aren’t home runs, as you know, so.

Okay, right. Now that makes sense. And then just on the other side of the balance sheet, deposit growth remains strong. Just kind of curious as to where you guys are pricing CDs these days and just that deposit environment?

Well, the – I can talk about the pricing. I think Wellington can probably talk about the market may be better. We’re trying to stay – keep our pricing as low as possible without impacting growth going forward. But as you know, there is a lot of money in the system right now. The Fed has put a lot of money into this system. And so we do want to grow deposits because we will eventually deploy them, but we’ve got to do it in a real cost-effective manner. We’ve been working very hard to try to bring those costs down.

Yes, Steve. This is Wellington. We are very selective on our deposit gathering. Between our deposit officer, who are focusing on individual deposits, and our commercial lending officer, focusing on business DDA deposits, we just try to be very selective and continue to keep on pricing down or the cost and all that, but having said that, we are always out there looking for the opportunities to build our core deposit.

Steve, this is Li. One of the things that – I hold a slightly different view that I didn’t make you know. I’m an old line person that always believe franchise value is in the deposits you build, and you build deposits first, even though it’s short-term disadvantage that you have to bite the bullets in order to have the muscle there to help to the long-term growth. So this institution will continue to cultivate deposit is not just because it’s not profitable right now, but rather for the long-term stability, the growth, the value of our franchise. Yes.

Right. No, absolutely. And in terms of maybe just trying out your loan expectations here, Li has spoken that pipeline impression should be satisfactory here. Do you think – back-end loaded this quarter, do you think you hold the pace on loan growth or maybe we could see a little bit of a step-up in the second half of this year?

We have previously been telling everybody that we think this second half of the year will be a little bit more than the first half of the year, okay? But this business is after many, many years, it’s really kind of hard to predict, especially in the early part of the quarter. Much of it we can, we will materialize in the mid-quarter and so on. But the early indication is that our momentum is there. And I would say it – I will hope that the new office as well will be the added muscle that we needed to bring to a higher level than the previous quarters, of course, that we still have to probably careful about the whole thing. I have a Chief Credit Officer sitting right beside me, whose sole job is to say don’t decrease the things.

Alright. Well, thank you very much for all that and next quarter.

And the next question is from Tim Coffey with Janney. Please go ahead.

Yes. Thank you. Good morning, everybody. I wonder if you can provide an update – if you had an update, on how the loan growth is going in the Texas operation?

Well, Texas operation in general has been progressing just along the same line that we are previously forecasting, okay? And I guess, previously have reported to them how much they were expecting to produce for the year?

No, we have expressed how much they are expecting. But last quarter, they contributed about 10% of our loan growth.

Okay. In Texas, our operation, it’s two sided. Volume-wise speaking is obviously is a very, very satisfactory considering the process that they go through. But we have to also started to be a little bit choosy about the pipe because the yield and these kind of things as we go forward.

Okay. Sorry…

They don’t have to battle the payoffs, new portfolio.

Yes, that’s true. And Ed, just kind of circle back on the liquidity question. Just philosophically, what – how long do you think you’re going to be carrying that excess liquidity?

That’s a great question. So you know what I’ve always found, first thing, the one of the thing I’ve always found, Tim, is when liquidity is really strong is when rates are lowest. Liquidity starts to dry up, rates go up. And you know that always happens. And so it’s ebbed and flowed over the last 10 – we’ve really held excess liquidity for the last 10 years since the financial crisis ended, quite honestly. And it’s just built and built and built. And we’ve never came to a situation where we felt yields were going to finally go down or – I guess we could have done it in February, March of last year if we were really brilliant. But we’ve never felt comfortable to be in a situation where rates were going to fall pretty meaningfully, and we could put some money to work pretty effectively and make use of that money. So we’re just going to keep putting money to work as we can, slowly chip away, but we’re not going to make huge meaningful inroads. I mean we – our liquidity went up $150 million on average just in the linked quarter, from quarter-to-quarter. So when you look at that, that’s the real deleveraging impact on the margin, but we will continue to chip away at the money as we can, but we’re not going to do anything really substantial.

Great. Okay. No, that’s great color. I appreciate it. Those are my questions. Thank you very much.

[Operator Instructions] The next question will be from Gary Tenner with D.A. Davidson. Please go ahead.

Thanks. Good morning. I just had a question, I think most have been answered. But regarding the loss on sale loans this quarter, I think $261,000, it was closer to $400,000 last quarter. Just any color on that and any visibility as to additional sales as we go through the back half of the year?

No. I mean, actually, it’s really a strategic move for our side, okay? Because we had a couple of SNC loans being downgraded, okay? And heading into examination, we do not want to carry this come across, okay? But it’s more also that when strategic situation rather than financial related. We – as you know, looking at our back history, we don’t have – we sell these out in a long scale, okay?

Okay. So just something that’s kind of very specific to a couple of credits ahead of an exam.

There is two SNC loans that were being downgraded.

Great. Thank you.

And the next question is from David Feaster with Raymond James. Please go ahead.

Good morning, everybody.

Hi, David.

I just wanted to get a sense of some of the puts and takes with loan growth, just to get a better understanding of some of the underlying change. I mean, payoffs and paydowns have been a significant headwind like we talked about. Just curious if you could quantify like how payoffs and paydowns have trended and maybe the underlying strength of your originations? Just some detail there would be helpful.

Let me tell you what the origination effort is, okay? And I have the numbers right here, okay? For the second quarter, we have originated a total of – okay, just after our bragging, where are the number? Okay, we’ve reduced $428 million of commitment without streaming about $305 million. But the payoff is nearly $200 million, okay? So obviously, this number changes from time to time. You see we are not a product type of a bank. We are relationship type of, one-off type of bank, all of our loans, all the deposits really a one-off type of thing. So sometimes it’s just certain customer sold their property, or they went public, they don’t need us anymore, okay, all these kind of things happens.

Okay. That’s helpful. And then – so in our recent meetings, we talked a lot about C&I growth being a major focus. And we did see some growth in the quarter. You guys have done a great job expanding C&I. Just curious any updates on this segment, what you’re hearing from your C&I clients and just your strategy for continued C&I growth going forward?

C&I growth is probably the hardest in coming in – you have an officer who even work on the deal, may be as long as 1 to 2 years before they can get to the C&I. We get customer transferred to us. Unlike a real estate transaction, it’s a limited transaction basis, cost the relationship. But C&I is purely a relationship and it has a lot to do with timing. And one of the situation is that what we are facing right now is I’m trying to decide is, on the temporary basis, giving how should we control our C&I – you see, C&I is not being priced to a level that is, how should I say, does not fit to our operating model that much. You see – You talk about the – I mean, regular customer type of C&I, it’s basically the price much below the real estate loans. And then you talk about the SNC C&I loans, loan is in the loans, in the low twos is – that’s a standard of our situation. Realize our net interest margin is right around 350. So I mean – these things is just if you do a few of them while if you do a whole lot of them on the situation and then your financial performance will be coming down. So we have to from time to time, adjust our C&I appetite based on the relative yield, the rates, we can get. At this point in time is that I am not projecting to see a whole lot of gigantic C&I loans because it’s uneconomical at this point in time.

Okay. And then just any thoughts on the reserve, you touched on this in your prepared remarks, but just any – I guess, how do you think about provision expense going forward? Would you kind of expect – it sounds like you’d prefer to grow into the reserve, just any thoughts on kind of what a normalized...

Yes, it is not up to us. It is up to the CECL mathematics. You are well aware of, okay? But if I have to make a prediction because there is a lot of unknown factors. For instance, the vibrant – I mean, the delta is coming stronger and stronger. So if that’s happening very strong, that puts Preferred Bank in a better position, I mean, because we have more reserves compared to some of our peer group. But if it is not, those are strong, then I would say, there is more than 50% of chance that we will have some reserve going forward – reserve release going forward, but still have to go through the calculation of the all the economic factors, all the Q factor, all the internal downgrading of the loans and these all kind of complicated things.

Got it. Thank you.

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

Thank you very much. Although we have a very noisy quarter, okay? But looking at the normalized basis, we really have a record earnings quarter, okay? And we like to think that all the operating metrics is still intact. We still – the bank can produce – have been producing more than 10% loan growth and controlling our cost, and have reasonable net interest margin compared to our peer group. And above all, we have probably a very favorably positioned profitability in our ROE, okay? Certainly, we’d like to continue to do that. The – We just hope that the economy will be growing at the same condition as we’re seeing right now, and I would hope – the – I mean, pandemic will be over soon, and I certainly will hope everybody will stay safe and stay healthy. Thank you very much.

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