Preferred Bank Q1 FY2021 Earnings Call

Good afternoon and welcome to the Preferred Bank first quarter 2021 earnings conference call. All participants will be in a listen-only mode. 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. Hello everyone and thank you for joining us to discuss Preferred Bank's financial results for the first quarter ended March 31, 2021. 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 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 would like to turn the call over to Mr. Li Yu. Please go ahead.

Thank you. Good morning. Preferred Bank's first quarter income was a bank record of $21.2 million or $1.42 per share, compared to prior quarter quite favorably because this quarter we have only 90 days as compared to the fourth quarter of 92 days. In addition, in this quarter we have a quarterly specific payroll taxes on bonus distribution payout. This quarter featured strong deposit growth on an annualized basis of over 25%. We are thrilled to have these additional deposits because it gives us more opportunities to grow and to do many things. But we have also noticed the excess cash flow is moderately compressing our capital ratios, return on assets, net interest income, and net interest margin. First quarter loan growth was $104 million or 10.4% on an annualized basis. We have noticed through our various contacts with our customers that they are generally more optimistic about the future of our economy and are now planning or already taking action to commit to more business expansion transactions or investment transactions. Some of them are even feeling the potential for inflation and want to commit their resources to assets at this point in time. To meet this increased demand, we have added a team of four relationship officers and a total of six in Houston, Texas. In California, we have added five relationship officers and will continue to look for new talent throughout the year. We are working in New York and other locations for new relationship officers. Internally, we are convinced that the next interesting movement will be upward rather than downward. So with that, we are actively preparing ourselves to have our balance sheet become very asset sensitive. As of March 31, our credit matrix seems stable. The total deferred COVID-19 related loans was down to $25.8 million, which is quite moderate. Operating expenses were slightly higher, but considering the quarter-specific payroll taxes, it is not much different compared to previous quarters. As you are well aware, our business model is based on high-touch service relationships with our customers, and we are eagerly waiting for the economy to open up so we can reach out to our customers more actively. Thank you very much. I am ready for your questions.

Thank you very much. I am ready for your questions.

No questions there?

Our first question comes from Matthew Clark from Piper Jaffray. Please go ahead.

Hi. Good morning everyone.

Hi.

Good morning.

If we could just first start on the margin and the contribution from PPP. I don't know, I don't think it's that material. But I was trying to focus on the core margin, excluding PPP, if you have the contribution in interest income this quarter?

The best answer would be by Ed, okay.

Yes. I would say, Matthew, due to the fact that PPP totals about $94 million, the rate including fees was about 2% in the most recent months. So it's pretty negligible against a $4 billion portfolio. So I would say probably maybe a basis point on the margin.

Okay. No worries. That's fine. Okay. And then on the outlook for the margin, you guys put up some pretty good growth. And maybe you can speak to the rate on new originations? And I know you have a lot of floors on your existing portfolio, but given the growth, is it fair to assume that we should see some incremental pressure on the margin just from the new business?

Okay. Matt, margin prediction has become a situation that we watch all the time. For instance, just to statistically mention, for the first quarter we have a payoff rate that is 90 basis points higher than the rate of new loans being done. This has widened from the previous quarter of 32 basis points and it's a growing trend in a low-interest rate environment where loan extensions lead people to price their loans lower on the competition side. Many of our existing loans have floors, yes, and many of those floors were established two or three years ago. Our customers are coming back and renegotiating those floors. In many cases, we have to agree to the changes they want. These two factors going forward indicate that we may experience additional negative pressure on the margin, NIM, not net interest income. However, the positive force is the continued reduction of interest costs plus potential interest cost reductions through refinancing our subordinated debt and other pools. Strong growth will mitigate some of the margin compression situation.

Yes. That's great. NII is clearly the focus. And then just on the C&I growth, which was also very strong this quarter, could you provide some sense of where that came from, perhaps by industry type or business type this quarter?

Okay. Do you want to mention that? I have some specifics, but do you want to mention that first?

Yes. Sure. Hi Matt. This is Wellington. As Mr. Yu mentioned, our clients are bullish and very happy and they see opportunities. Some existing client relationships come from business expansion and also establishing new relationships that have added to the base of our industry. For example, we have seen growth in areas such as produce packaging, healthcare professionals, data centers, and communication. These are just a few examples, along with building materials like pipes and fasteners.

Just to also add, new clients represented most of the growth, but they also increased usage by existing clients, in the neighborhood of $40 million.

Okay. That's helpful. Thank you. And then just on the non-interest expense side of things, maybe for Ed. In terms of the run rate, it sounds like you guys have hired some additional relationship officers, which likely puts a bit of upward pressure on that compensation line. How should we think about the overall run rate and the potential for additional hires for the rest of the year?

Yes, we don't have complete visibility on the Houston LPO personnel for instance during this first quarter, so that represents about half the quarter. Additionally, the payroll tax expense was fairly high in Q1, as it is each year because we pay our incentive compensation every February. So that's a bump of about $500,000 to $600,000 on the run rate. I would estimate going forward, we will probably be around 15, as my guess.

Okay. Great. And then maybe just lastly on the loans that were sold. Can you provide some color regarding what exactly was included in the amount sold and the property type and situation in general?

Sure. We had one SNC loan that was downgraded to substandard and we decided not to keep this loan in our portfolio due to its substandard status, so we sold it.

The next question comes from Gary Tenner from D.A. Davidson. Please go ahead.

Thanks. Good morning. I wanted to get a little bit of clarity regarding your comments about working to be more asset sensitive. You talked about floors a little bit, but could you provide an update today on the amount of your portfolio that's floating? How much of your portfolio is subject to floors? And how in the money those floors are? Any commentary on what you are doing to become more asset sensitive, as you noted in the press release, would be appreciated.

Ed, do you have that handy?

Yes. Hi Gary. Of the total book, and again this is as of year-end, I apologize for not having the update ready for March 31 because it requires a lot of data work. But of the total book, 82% is floating rate, while 18% is either fixed rate or tied to CDs and secured by CDs. Of the floating rate, over 99% have floors. In terms of upward movement, the first 25 basis points only moves about $50 million of the portfolio. The next $50 million moves another $42 million. The next 25 basis points moves another $12 million. After we reach 75 basis points, we will start to see a majority of the portfolio reprice. You can assume we are roughly 50 to 75 basis points under water on the floors.

That's great. I appreciate the insights. Regarding loan growth for the year, you talked about the new hires. It was a good quarter ex-PPP this quarter. What are your expectations for growth for the remainder of the year based on your pipeline and what you are seeing from customers right now?

Well, my outlook has always been a bit uncertain. I like to think that the sentiment among all our staff is that business is increasing, and people are more active. However, quantifying it on a percentage is difficult. Historically, we have always maintained reasonable organic growth and are dedicated to continuing at least that historical level. However, many variables in the economy may impact when things will open and how quickly they may pick up speed. I cannot provide a specific quantification, but I do feel that the growth will continue in the next few quarters.

Just in regards to the Houston LPO and the hires there, what's the focus in terms of lending? Is it C&Is, or is it across real estate? What's the target?

Yes. Outside of California, we started off with commercial real estate and, gradually, as we have moved into the community, we are incrementally getting more C&I. In California, with the two new loan officers or five new loan officers, four of them focus on C&I.

Okay. So Houston initially will be more commercial real estate-focused. That makes sense.

Yes.

All right. Thank you for taking my questions.

Our next question comes from David Feaster from Raymond James.

Hi. Good afternoon everybody.

Hi David.

I would just like to get an update on the Houston LPO. That's pretty exciting. Just curious to hear maybe how the contribution was in the quarter? How is the pipeline trending? And just I guess kind of the early read on that.

Well, do you want to answer, or should I answer that?

We can both answer that. I believe that our pipeline, during our initial pipeline meeting about a week ago, we presented over, I would say, ten doable deals. So now it's just a matter of getting their back-office people in place and starting to put the deals together. After this meeting, we have a weekly pipeline meeting with them. So it looks like so far, the officers we have there understand the market. They have a customer base and seem to have portable customers.

Okay. David, number-wise speaking, there is no contribution from Houston in the first quarter. As of today, we have not booked any loans yet, but a couple of them are ready to be closed.

Okay. That's encouraging. Growth will clearly be there. But just maybe more broadly, given some recent consolidation and disruption in Texas and across the country, does that create an opportunity for more de novo-type expansions? And what markets are at the top of your priority list?

We have people-specific expansion. In other words, we always seek out the bankers and their teams. Then we go to the area where their expertise is, having relationships in those regions. I'm not certain which area will open up first, but we are reviewing several areas right now. So we are not sure which one will materialize first, but there are about three to four regions under active review.

Yes. Okay. And then maybe just following up on your commentary around new loan yields. How are new loan yields trending? You mentioned a 90 basis point spread. Was that primarily a result of the mix or continued pressure on pricing? Has the peaking of the curve allowed you better pricing in conversations?

I dislike quantifying my answers. However, based on the information I received a couple of days ago and upon initial review, this quarter, the mix seems to be one issue. It shouldn't be as broad as a 90 basis point spread because last quarter was 32 basis points. Yet, with day-to-day updates, it indicates there are other deals coming in, so it should be less than 90 basis points. The trend likely will continue to experience some compression in terms of discounting due to competition, with some large lenders pricing their loans below our net interest margin.

Yes. Where do you see the most competition? Do you find it coming mostly from larger banks or smaller community banks?

Larger banks.

Okay. All right. Thanks everybody.

Our next question comes from Tim Coffey from Janney.

Great. Thank you. Good morning everybody.

Hello Tim.

Mr. Li Yu, I wanted to ask about your comments on the deposit growth in the quarter. Would that be any different from what Wellington described in terms of the loan growth, regarding client activity and new client introductions to the bank?

The deposit inflows primarily came from our existing clients. In this quarter, we did not onboard any new clients that represented significant deposit bases. The inflows reflect that our customer base's financial condition is improving.

With the tax filing date being pushed back, do you anticipate any significant outflow in deposits beyond what we typically see in Q2?

I hope—in a selfish manner, I hope that we lose a couple hundred million dollars in deposits during the tax date because that would improve our net interest income.

Yes, that would definitely help.

It should reduce. likely to reduce a bit.

Okay. And then, Ed, as we evaluate the time deposits maturing this next quarter, is there anything you can share regarding the volume and potential price differentials?

I can. Tim, it’s just under $500 million maturing over the second quarter at an average rate of 95 basis points. We’ve also recently lowered our offered CD rates again, so that will be the beta for the quarter.

Great. Thanks, Ed. And then Mr. Yu, regarding the Houston LPO, you have a really experienced team leader there. The goal you set of loan origination of $150 million by the middle of next year—are you getting a sense that you could exceed that goal or is it too early to tell?

So far, this is a goal that our Houston leader has set for us. If we set it too high, it could discourage our staff. However, we will do everything we can to assist them. If they can produce $500 million in deals in the first year, we in Los Angeles can take it easy. Judging from prior experiences in starting new offices, we think that’s a reasonable goal and we hope it can be exceeded.

Okay. All right. Great. Thank you very much for that. Those were all my questions.

Our next question comes from Andrew Terrell from Stephens.

Hi. Thanks. Good morning.

Hi Andrew.

Good morning.

The trend was pretty positive this quarter and it was nice to see the negative charge-off number. Could you remind us what the outlook is for the loan loss reserve moving forward as we progress throughout this year?

Let me first clarify that the loan loss provision is a seasonal calculation, okay. In 2020, we provided a loan loss provision of $26 million with charge-offs of $5.4 million. The remaining amount must have been allocated for two key areas: the general macroeconomic situation and what we call reserves for proactive downgrades. Some of these provisions were made proactively, and I believe some credits may be upgraded in future periods due to general economic improvements. It is conceivable that we may release some reserves later this year. However, I cannot provide a specific timeline as it depends on the seasonal calculation. Personally, I am happy we did not have to tap into the reserves in the first quarter.

Just like Mr. Yu mentioned, the outlook for this year is not expected to resemble last year's scenario. Our loan portfolio quality remains stable, as shown by the declining volume of deferment requests and limited downgrade changes, nonperforming assets, and past-due loans. For this year, we believe we won’t need the same level of reserves as we saw last year. There will be revisions to the reserves as well.

Okay. That's extremely helpful insight. Thank you. Regarding liquidity on the balance sheet—obviously there’s a lot of liquidity and you’re not alone. If deposit flows in, it can sway the near term. Could you remind us over the longer term where you like to manage cash balances, specifically as a percentage of total earning assets?

It's a double-edged sword. There are times we are actively seeking deposits because loan growth is tight and the deposit market is competitive. Currently, it appears the country is flush with cash, as I've observed in other banks' reports. however, as an operator, my focus is different than that of a financial engineer. To me, deposits are akin to capable staff. You need to secure them when they become available. Even if it results in short-term negatives, it will pay off in the long term. My hope is to gradually reduce deposit costs while respecting customer relationships, as once we let go of certain deposit relationships, it may be difficult to regain them when we need them.

Okay. Understood. Thank you guys for taking my questions, and congrats on a great quarter.

Thank you.

Thank you for your understanding and for the questions, and congratulations to the team on a successful quarter.

Hi. Good morning, guys.

Hi Steve.

I just have one question here. Most of my questions have been asked and answered. Regarding the stability of your interest-bearing savings and checking deposits—were those repriced lower here than CDs?

The majority of the repricing within that category took place in 2020 when rates were coming down rapidly. Therefore, there has been no repricing recently in money market or savings account categories.

Going forward, any repricing will be very moderate, as we are already close to the low average rates in our peer group.

Got it. Okay. Well, that’s my only remaining question. Great quarter. Thank you very much.

Thank you.

Thanks Steve.

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

Thank you very much. I hope we are really in the last leg of this pandemic. I pray that everyone stays safe and we return to what I hope is a new boom cycle for our economy. Thank you very much.

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