Preferred Bank (PFBC) Q1 2023 Earnings Report, Transcript and Summary

Good day, and welcome to the Preferred Bank First Quarter 2023 Earnings Conference Call. [Operator Instructions]. Please do note that this event is being recorded today. I would now like to turn the conference over to Larry Clark of Financial Profiles. Please go ahead, sir.

Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the first quarter ended March 31, 2023. With me today from management are Chairman and CEO, Li Yu; President and Chief Operating Officer, Wellington Chen; Chief Financial Officer, Edward 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 FDIC. If any of these uncertainties materialize or any of these assumptions prove incorrect, Preferred Bank's results could differ materially from its expectations as set forth in these statements. Preferred Bank assumes no obligation to update such forward-looking statements. At this time, I'd like to turn the call over to Mr. Li Yu. Please go ahead.

Thank you. Good morning. I'm very pleased to report the first quarter net income of $38.1 million or $2.61 per share. We are satisfied with the results that was achieved during this very stressful quarter. The events of March truly humbled all of us in the banking industry. Personally, I'm very sad to see 2 good-sized banks went away in just a matter of hours especially when both these bank have certain expertise in certain sizable industries, and they have been servicing or serving these industry ace fully diligently in the past 20 to 30 years, only to see those customers are the first one to run, okay? In any event, the home matter taught us a lot. And personally, personally, I have the following observations, the text for definition of transactional accounts being a core deposits need to be revisited. True, the alcohol deposits, but only during the good time. But in stressed environment, they seem to be the first to run. I'm so very pleased with our PCD portfolio, not because we know exactly how much it cost us and how much -- how long we can get them. But during this difficult period, we have not seen one TCD ramp us or the run almost okay? The golden rule of not borrowing short and lend long or investment loan ideals. But I want to tell you to do this, it is really a difficult process. Throughout the years, I don't know how many times we have to face the disappointment of our offices, knowing their loans will be taking out a loss to a low fixed rate mortgages. But now as we look back, it seems to worse all the agony in order to have a better barrel defense. We now must respect the regulator or government risk even more as a banker. If you recall in 2021, when we were all convinced, the country's inflation was transitory. To be practical, how many of us, you and us, how many of us is preparing for a near 500 basis point interest rate increase in . And now as managers of a public traded bank, we will face each quarter like now with the earnings beat or miss. I can't help us think sometimes the things that may be good for short-term fixed may or may not probably may not be necessarily good for the long-term health of the bank's operation and the balance sheet. I wish all of our investing public will pull more weight into the banks balance sheet, consistency in the long-term operational goal. Having expressed my personal opinion, I now must report to you on deposit situation. During the 3 days in March, March 9, March 11 and March 12 and March 13, okay? The 3 working days. Preferred Bank also experienced deposits outflow. The good news is we have a total of less than 10 accounts that pull the money out. The bad news is that 3 of them is very precised. For the quarter, our deposit reduced or decreased by 2.7%. As of yesterday evening, which is April 18, we have our deposits increased 1%, back increased 1%. We're working very hard to gain back the deposits we lost because most of them having a borrowing relationship with us. But I do want to tell you that during the process we have received many, many heart warming phone calls from our deposits from our customers, telling us they face in banking industry. Telling us that facing us, telling us that we have a good balance sheet, and we have good capital and especially we've good earnings. With their confidence without blessing and I also believe it's our shareholders wish. We will continue to maintain a flexible balance sheet. We'll continue to maintain good liquidity. We continue to control our overhead like we always do. And we will continue to operate Preferred Bank with a simple business model. Thank you very much. I'm ready for your questions.

[Operator Instructions]. And our first question here will come from Matthew Clark with Piper Sandler.

First one for me, just on the available liquidity, the cash and the borrowings that are available of $1.5 billion relative to the uninsured amount of deposits, I think roughly half of your deposits are about just under $2.7 billion. I guess what's the plan? Or what's kind of the targeted coverage you're looking to get to? Do you -- are you looking at -- it sounds like you're looking to pledge more loans, but is there something to be done on the security side to knowing it's only about 6% of assets to be able to pledge those.

Thank you very much. It is a 2-way to approach we're doing it. Scheduled to be converted to -- I mean what is that?

Enhanced insurance coverage.

Yes, I mean, ICS, okay, and see this, okay? Do we have a schedule for the second quarter now is a little bit -- right around $600 million of customers, we will be converting them to SEDAR and converting them to ICS. That should reduce our so-called uninsured deposits #2 right around about 35% to 36%. Okay, assuming the same amount of total deposits. And in the meantime that we have roughly estimated about the $600 million additional borrowing capacity from Fed. Federal home loan bank as of now, okay. So will that also bring up our also called the total capacity or liquidity to $2.7 billion or $2.5 billion because expect -- so two number is -- will be very close. I don't know whether there's any importance as a bank. You have to cover every uninsured dollar with the -- with so-called our off-balance sheet liquidity. But I do think the most important thing is you have to have a good operation to earn your customers' trust. But we will be getting -- on June 30, 2 numbers will be converged to each other.

Okay. Great. And then just kind of a related question. In terms of your -- the incremental kind of balance sheet composition, composition going forward, is this higher cash level likely to kind of stick around? I know it's above average to begin with. But I guess what I'm also trying to get at is how do you think borrowings were up in the quarter. Is that -- do we kind of -- do borrowings continue to increase from here with some potential deposit pressure or -- and I guess, it somewhat also depends on your loan growth outlook. I mean, balances were slightly lower. So I'm just trying to get a sense for the moving parts of the balance sheet going forward.

Well, based on what I understand from the industry today, okay? And based on what I'm reading, especially from you guys and all the other information I'll see that the countries that deposit situation is probably more of a concern to everybody as compared to the loan area. Okay? True. Loan demand is down as everybody has reported every paper, every service reported. But I think the uncertainty of deposits will last for a period of time. And we, at the Preferred Bank, we'll be closely watching the trend in the second quarter, okay? We're now in no hurry in putting up a whole lot of loans just to earn extra dollars, okay? For -- as compared to the -- as versus the -- maintain the good liquidity and safety. And frankly, let me be a little bit funny that I think we're making enough money to weather this.

Clearly.

Yes, no doubt. And then just on the cost of deposits or spot rate on deposits at the end of March. I don't know if you have that ad or even the monthly average for the month of March on deposit costs as well as the average NIM in the month of March?

The net interest margin in March was $467 million. Cost of deposits was $263 million.

Okay. Great. And then last 1 for me. Just some cautionary commentary on office commercial real estate in the press release, not a surprise. Since everybody is talking about it. But can you size up your exposure there and also give us some additional details and characteristics, owner versus nonowner, average loan size, what's downtown kind of considered metro downtown or more at risk? And how LTVs are at origination versus maybe some new appraisals you're getting in, rent rolls, what your plans are for borrowers that renew that want less space I could go on. But any granularity there would be helpful.

Okay. We have roughly about 10% of our total loan portfolio in office property, office loans, okay. But -- of this amount, roughly $8 million is in the downtown area. We have faithfully have been tried to avoid especially Los Angeles anti area for the past 20 years. And most of our office properties in the urban, suburban area that in California, especially in Los Angeles, it's a big, really suburban So there's little communities everywhere and basically the property there is a lot more stable than the downtown area. And when we have the $8 million in downtown area is really in San Francisco that was leased and in the long-term lease to, I think, one of the famous university over there. It is very, very, how should I say, underwritten quite well is loan-to-value ratio probably less than 40% in any event. But I would have as Nick to bring you up to date with some of our underwriting features that we do that on this sort of property.

Yes. Thank you, Mr. Yu. Matthew, our entire portfolio at this time, our asset quality is pretty stable up to date and also resilient. And the key thing that we used to underwrite our loans, a little bit different as other banks are bit of a different as those regional banks, we request for 2 major areas to be considerate, okay? The first is the location. Just like Mr. Yu mentioned that we avoid Metro LA, downtown area, and we try to do more office loans near the residential needs or some other urban area. And the other thing is that we need to have strong sponsorship behind it. That's always our credit underwriting major 2 areas other than the normal underwriting process. So with all those strong sponsorship behind it. So even though the property has a little bit weak in the cash flow, however, their global cash flow, their liquidity is very strong at this time. So we do not see any immediate threat to our office product or some other CRE side.

So -- to further on that, we don't have any nonaccrual or classified or even 30 to 89 days. Have been lost in the office sector.

And our next question will come from Andrew Terrell with Stephens.

Maybe just following up on the last point. I think it's pretty reassuring to hear that only $8 million or so that would be considered true kind of downtown type office. I guess, the 10% of total loans are office properties. Can you size up maybe the chunkiness within that? Like what's the size of the largest 1, 2 or 3 type loans in the office category?

Well, the largest 2 or 3 years on average about $40 million 3 of the I mean, and our average -- total average loan is $4.1 million in our office properties, with average LTV of 61% at the entrant place. Many of them is coming in -- I mean in the early days. Each ones is underwritten with a complete underwriting process individually, especially those larger loans. The office building that is -- one of the office building in the $50 million range is in one of the hardest areas in Los Angeles core, the City, which we have the creative and entertainment combination, the first floor are all upscale -- I mean they have upscale the good restaurants that is assuming business. The second third floor is rented out to a new criticized type of company with LC support from a major bank. So that's one. And also that we have a very rational, very reasonable sponsorship behind it. The next largest one is in -- is one of the buildings [indiscernible] the owner of that is rearranges office building, make that office building near fully occupied and underwritten. The owner of the of the us building is very, very, very substantial, very, very successful. And his credit in Los Angeles is it's tough notch. Okay? Its cash flow is huge. So these are the top 2 as you have wanted to know, okay? And I might explain the third one is in a very rich area of Newport Beach, where a group of people bought office building and my view, that group of people have dealt with us for many, many, many, many projects there. And a substantial group of people bought the office building and vacated everything and it's going to demolish it and convert into apartments. It is in the process of getting doing that. So it's -- right now, it's really empty. But because the nature, when they come into us, it's a office building, we put in the office building category. And also the fourth one is in the same category. Okay? So these are the larger ones, but predominantly or building -- majority of our loan is smaller ones, let's say, in San Francisco downtown or as San Francisco area of the and the Brooklyn, if you know this area, the lifestyle and the things in those areas are all small commercial office unit sometimes has a retail downstairs sometime upstair. But if you know them, the real estate over there is it's really good. It's not like Manhattan.

Okay. Very good. I really appreciate all the extra color there. I want to go back to the deposit flows. For the quarter, I was wondering if anything specifically -- I guess if you could quantify maybe the drop in the interest-bearing demand deposits, I think, down $540 million or so quarter-on-quarter. Was any of that a move to time deposits? Or were those just exits out of the bank line. I'm just trying to get a sense of how much was more kind of geography across the deposit segments versus maybe relationships loss or those that left the bank?

Ed, do you want to answer the first Okay. Maybe I add to it.

Yes. The -- from what we know and what we've looked at, Andrew, it's not so much relationships as it is paring down balances. And to Mr. Yu's point earlier, a lot of those were really centered in just a very few accounts. These depositors or clients that we call them have some form of fiduciary obligations with respect to their funds. And so in what they felt was their best interest, they moved them out following what happened with Signature in Silicon Valley. However, we have been in constant contact with all of them and are working to either get them into a reciprocal deposit program to bring them back or going through and going through very diligently with their senior leadership and our senior leadership and going over what we're doing as a bank to mitigate all the risks that have been brought forth through these 2 bank failures. And so we feel very good about that process and what we're going through. And also to Mr. Yu's point, a number of them have credit relationships with us. And so we fully expect to have a lot of that back.

Yes. Okay. Very good. And to the point, I think it was mentioned at the start of the call, deposits quarter-to-date, up 1%. I guess within that, should we expect that the bulk of that just is driven by time deposits. And what I was specifically getting at is the NIB flows since quarter end. Does it feel like there's been any kind of deceleration in the drawdown of NIBs?

Most definitely since the end of the quarter, Andrew, and that's a good question. What we've seen since the end of the quarter is really more of a business as usual, I would say. And so that's why we see the tick up of 1% from the end of the quarter. And obviously, I think we'll have much better news to report at June 30 with respect to this subject.

Johnny, why don't you want to add to that? I mean [indiscernible] nature of deposits increase in the first half -- I mean, of the quarter. The first half to month.

Yes, I think the nature of deposit inflows is just like I said, this is as usual for a lot of our clients, not -- and we're working on regaining back some of deposit loss like I said, but this is business usual clients coming in.

And our next question will come from Gary Tenner with D.A. Davidson.

This is Clark Wright on for Gary Tenner. Quickly, if I could. You previously indicated you had asked regulators for approval with regard to $150 million stock buyback. Could you provide any color on how you were thinking about capital and the buyback right now, given your valuation near tangible book value and the potential for getting that buyback approved by regulators?

Let me, first of all, I mean, describe the process. In order to get the regulators approval, they require us to share the approval for the buyback, okay? That's the state of California with State Bank. Yes. So we have completed our proxy statement, which has just been released and then asking a shareholders' approval for $150 million buyback authorization and from that point on, we will afford to decide when, how much amount will be the buyback happening and when they decided they want to do that, we will ask the Board regulator to approve. Usually, it takes about -- DPM takes about 2 weeks to in the past 2 months to approve it, okay? So in any event, that's a process. So we are getting ourselves ready to do that. But in the meantime, that's from the legality aspect. From the operation aspect is that I must tell you that in the last phone call, I'm fully confident that we're going to buy back the stock, okay, because so cheap in our opinion. You must know we're selling in 5.2x of 2023 earnings, okay, that's obviously, I mean, advantage for us to buy back we will. But right now, we have a bigger picture of the liquidity issue and the so-called unstableness in the public's vision about the banks. So most likely, in second quarter, we will be looking very carefully to make sure that the liquidity issue is done, we don't need any additional liquidity to do that? Okay. But long term, that will happen. Obviously, one thing will not happen is our stock price doubled, maybe we don't do that, okay. We hope that's the case. But most likely looks like with our trajectory of our stock value is concerned, it will be very beneficial to our shareholders.

And then just in terms of loan growth for the full year, how are you thinking about it just given the economic uncertainty and fourth quarter contraction, about first quarter contraction balances?

Well, loan growth has 3 dimensional situation. I mean again, I cannot give you any guidance on that, because I truly do not know. On the micro side, you have a reduced loan demand, especially right after this meltdown or the -- I mean, crises -- so-called crises, it changed a lot of people's investment priorities. You see the things slow down, okay? And -- although the payoffs still continued and by those familiar names, you wonder why they still want to do that, but it's still paying us off with a 5% 10-year mortgages, 5-year mortgage, maybe it's because it can I mean, they committed a time ago. But again, that's something as we see as a corporate strategy, we don't match that, okay? That's a micro situation. So we really don't know after May, when the Federal Reserve has indicated if they are holding the rates stable versus what -- whether that will spur up the investment, I mean, activity of our customers, okay? And so that's one thing in the security. The macro side is, again, under the current liquidity environment, will we be able to get substantially more deposit like we used to do, okay? The question is also how much you have to pay for it. Right now, everybody is competing for these deposits fearlessly, okay? So these are the things we're facing. If you ask me in May, I will tell you our vision better. Right now, I have no clarity on this point. I'm sorry about that.

No worries, understood. Lastly, SBA production and demand trends, it looks like you had a gain on sale of SBA and resumed selling. Maybe if you could just point to some of the demand trends that are going on and as well as the gain on sale premiums?

Okay. [indiscernible] do you want to answer the SBA?

SBA definitely, again, as we mentioned earlier, that this is a new initiative, we are trending very carefully, methodically and especially during the current situation. However, we are moving forward. We do have a pretty solid SBA pipeline. And we think that for small business and it's something that we will continue to move forward.

And our next question will come from David Feaster with Raymond James.

Maybe just following up on -- I know you don't -- the loan question is hard to answer, but maybe just asking a little bit different way. I mean, you've done a phenomenal job actually pricing loans and getting paid for the risk that you're taking. And I guess you not having as much of an appetite for credit here, but where and demand, especially given the structure and the standards in pricing that you have. But where are you still seeing good risk-adjusted returns? What segments are still able to make projects pencil and is it a market or geography? I'm just curious, where are you still seeing good opportunities at this point?

Well, what we are seeing right now is really not so-called category type of situation. We're seeing the individuals. We still have customers that they have -- individual customers that they have projects they want to continue to do okay? Right now, it seems to be -- by the way, I wanted to tell on the C&I side, right now, we don't see C&I being the big growth factor as of right now, because the interest rate situation, okay. But on the real estate side, we're seeing -- there are still projects going on. People need to get it purchased or get it developed, they get it on. So these are the individual cases. They will be subject to much intense individual underwriting of the loan. So these are the risk return opportunity. Unless there's a good return, we won't do it. We'd rather just keep a good liquidity into the situation right now. Now long term, as you all know, there's so many zillion dollars, billion and billion dollars of so called CMBS fall-offs from the current maturities, okay? It is the report of everyone, including you that many of them would be either remargined or foreclosed or whatever, rearranged, okay? And traditionally, if past is any experience in future once every few years, we face situation at that. There's a lot of value changes and these things become variable. We're ready to pick a few of the remargined items.

That makes sense. And so some of those CRE projects that you're talking about, how is pricing in those types of deals? What are you able to price those types of things at right now?

Basically prime-based lenders, usually is prime plus -- I mean, we go up and down from prime plus half. That's what we do now.

Okay. And then you guys have been one of the most rate-sensitive banks around. You guys have done a phenomenal job. And Ed, you and I have talked about it before. I'm just curious how you think about managing your rate sensitivity at this point in the cycle and potentially maybe taking some rate sensitivity off the table? And how do you think about doing that?

We have several initiatives of doing. One of them is if some of customer wants to convert their loans into fixed rate. We will now start to consider it, but the rate has to be, I mean, acceptable to us, okay? So there are a number of them has been started to try to thinking about converting okay. That's one of them. Second of them, almost all of our floating rate loans, as you know that we have a floor. Currently, the floor is averaging over 6% averaging. There are some older loans that is in the 4% rate, that newer loans in the 7% range, right maybe 5% as up 5%. Eric, here the number, we came back. That serve is a so-called a management tool during a rate decreasing environment. That's why I think Ed has provided you previously with a chart shows you during the rate reduction time, Preferred Bank's earnings actually increased, okay?

That makes sense. And then I guess just last one for me. Maybe just given some potential revenue headwinds, just given the rate environment, rising deposit costs and those types of things. Obviously, you guys run an incredibly efficient institution. But there are some headwinds, right? I mean you got inflationary pressures rising at the IT costs, you guys are continuing to invest in the future with the Texas expansion and the SBA build-out and all those types of things. I'm just curious how you think about expenses in the near term? And any commentary on that front?

We are continuously looking at opportunistically. We have previously committed to a couple of new branches. One of them is just signed a lease. We will get into that. But basically, the growth really has to come from the adding of the personnel, which is a continuous and the broadest task, and we will continue to do that. As long as any opportunity for the expansion in sort of like a big office or big operation type of thing, we hope that you will fall on labs. I didn't see anything right now.

Okay. So we kind of talked about like an $18.5 million to $20 million kind of quarterly run rate. Is that still pretty reasonable?

Yes. Probably going to be just $20 million, maybe just slightly north of $20 million, David.

And our next question will come from Tim Coffey with Janney.

Ed, I was wondering, can you kind of talk a little bit about the brokered CD market right now and how that -- if that has any kind of interest at this point? I mean given the stuff that you've already done conference call to date.

I'm sorry, what's the question, again, Tim, specifically on broker?

Yes. Are you looking to add more? Or do you feel like you've done enough?

No. No, we're not looking at more, we've done what we're going to do. And yes, to Mr. Yu's point, we took out the FHLB advance as well. I don't envision us replacing that once that matures. But obviously, we don't know the future, but given everything we know right now, if things progress out the way we expect to, we won't renew that one. But the broker market is actually calmed down since the crisis.

Yes, it has hasn't. And then if we start to see kind of rates roll over back half of this year, do you think that you'll start seeing a bigger pipeline in terms of loans?

Yes. Our -- Its kind of a rate-sensitive situation. On the lower rate situation, our production is really jumping up.

And our next question will be a follow-up from Matthew Clark with Piper Sandler.

I just wanted to get an update on kind of the health of your variable rate borrowers given that you got 80%, 85% of your loans variable rate, you've seen loan yields up 300 basis points from the lows. Just wanted to get an update on how debt service coverage ratios look and how you might be working with certain segment of those borrowers to kind of deal with the increased debt service?

At present time, that I know, okay, we are not having any, but I'd rather have Nick answer that.

Just like Mr. Yu mentioned that we do not see anything happening at this time. No, I don't have any information on that.

Matthew, I think it's -- that's a good question, and it actually leads me to another point I'd like to bring up. But it's interesting, as Mr. Yu talked about the CMBS debt cliff that's coming due, $1.5 trillion or whatever it is over the next 3 years. With those assets repricing up, the debt repricing up, I think it's very notable that our portfolio has already gone through that. As opposed to most banks portfolios are still waiting for that cliff, ours because we're 80% prime-based have already seen that, and to the fact that delinquencies are almost zero, non accruals are almost 0, I think, bodes well for the fact of our credit quality and our underwriting and for the fact that this cliff that everyone talks about may not be as devastating as it originally as thought.

Great. Yes. And then just last one for me, some clarification on the noninterest expense run rate outlook. Ed, I think you mentioned maybe slightly above $20 million run rate. I assume that's the high end of the range you're anticipating this year?

I would call that the middle part of the range, Matthew. As mentioned, there's inflation and wage inflation continues as well. So.

Okay. Do you want to reset that range or...?

No. I'm good with it.

[Operator Instructions]. This concludes our question and answer session today. I would like to turn the conference back over to Mr. Li Yu for any closing remarks.

Thank you for your interest. But it is interesting to have everybody asking about the upcoming CRE crisis, especially in this office building area. But I want to recall my personal experience seems to be last 4 years, first started with retail, okay? That big problem that we will have in the electronic, I mean, merchandising. And then, of course, pandemic and the hospitality situation comes along playing, then probably a combination of something. And now obviously, it's office leading it. Although it sounds funny, it looks like a flavor of the year. But in any event, last two when we are fortunate that our underwriting standard -- underwriting procedure as we previously explained to you, how do we underwrite our hotels, underwrite our retail, basically, we avoided the mall situation. We emphasize on the neighborhood center, so that everybody needs every day enough. So I hope this time, [indiscernible] will be equally as fortunate without the portfolio, okay? Thank you very much. And okay, it's truly be a very, very eventful quarter, and thank you for your attention.

The conference has now concluded. Thank you very much for attending today's presentation, and you may now disconnect your lines.