Preferred Bank Q4 FY2023 Earnings Call

Good day and welcome to the Preferred Bank Fourth Quarter 2023 Earnings Conference Call. Please note, today's event is being recorded. I would now like to turn the conference over to Jeff Haas with Financial Profiles. Please go ahead.

Thank you, Rocco. Hello, everyone and thank you for joining us to discuss Preferred Bank's financial results for the fourth quarter ended December 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; and Chief Credit Officer, Nick Pi. 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. Good morning, ladies and gentlemen. Thank you for coming to our earnings conference call. I'm pleased to report that the Bank's fourth quarter net income was $35.8 million or $2.60 a share. We closed out the year with record earnings of $150 million or $10.52 a share. We attribute this to our active margin management and our continuous cost control. During the fourth quarter, credit quality remained stable. We have a reduction in total criticized loans. However, we have an increase in nonperforming loans. The increase in nonperforming loans is due to one real estate relationship that was previously classified and is now in the foreclosure process, which means we'll be closer to the ultimate resolution. The loan-to-value ratio of this real estate relationship is 70%. The collateral is industrial property fully occupied with cash flow insufficient to support the loan. We are currently projecting there will be no losses on this particular nonperforming loan. During the fourth quarter, there were no loan charge-offs. The provision for the fourth quarter was $3.5 million, which leads to a reserve on the loan losses totaling 1.49%. For the year 2023, our loan and deposit increases for the new production were below our historical level, however, were in line with industry averages. Looking forward, with the projected rate decreases, we believe loan demand will recover gradually. Hopefully, towards the end of the year, it will be closer to our historical level of demand. Likewise, we are projecting that deposit costs will continue to moderate. During the quarter, the bank generated a significant amount of free cash flow for the year 2023. We used $50 million of the cash flow to buy back roughly 800,000 shares of our own capital stock, and the rest was used to enhance our capital position. We have also announced an increase in dividends by 27% beginning in 2024. In January, we also announced a new buyback program of another $50 million of capital stock. We are very mindful of looking for opportunities to return capital to our shareholders. Going forward, in the year 2024, we will be carefully balancing ourselves between growth, capital enhancement, and shareholder return. Also during the first quarter, we began to restructure our security portfolio. We sold $29 million in securities for a $929,000 loss, which does not affect the capital position as they are already marked. We will buy back similar securities for better yields. We at Preferred Bank believe that the banking industry is beginning the process of returning to normal. With that, we certainly hope that we will return to our historical level of growth. Thank you very much. I'm ready for your questions.

And today's first question comes from Matthew Clark at Piper Sandler.

Can you provide the average margin for December, specifically regarding year-end spot rates on total or interest-bearing assets? Additionally, could you share details on CD repricing, particularly what is upcoming for renewal and the associated rates?

Matthew. Yes. You have all that.

The spot margin for December is 4.24%, compared to 4.15% for the quarter in December. Looking ahead to the first quarter, I would anticipate a similar decrease in the margin as we saw in the fourth quarter compared to the third. However, it does seem to be stabilizing, as Mr. Yu mentioned, the increases in deposit costs are definitely moderating. Regarding CDs that are coming up for repricing, we have just over $1.1 billion of CDs that will reprice in Q1.

And the rates that they're coming off at and what you're putting people in this state?

The average rate that's coming off at is 4.65%. So that's why it's my belief this moderation in terms of deposit cost will take hold in the first quarter, because we're not seeing the kinds of differences between maturing CDs and renewal CDs.

Okay. And then with the expectation for a few rate cuts this year, assuming that's on the conservative side. How are you thinking about moving deposit costs? I assume there will be some lag with the CDs given how larger the CD book is, but how active might you be on kind of non-CD books?

We have made some changes to our larger corporate money market accounts by linking them to Fed funds. This means that when the Fed funds rate decreases, those money market accounts will also decrease automatically, which is important given that a substantial portion of our loan portfolio is affected by this. As we look toward the end of the year, our primary focus will not be on net interest margin but rather on net interest income. Historically, as Mr. Yu mentioned, when rates decrease in a healthy economic environment, our loan volume increases significantly. This increase in loan volume will enhance our earnings and contribute to net interest income moving forward, rather than just the margin alone.

Okay. And then one of your competitors a lot larger guided down on NII by 4% to 6% with 6 rate cuts this year and also assuming, I think, 3% to 5% loan growth. I think we currently have you in the low single digits for the year and you have, I think, 80% of your book variable. Your competitor has about just under 60%. So I mean, again, it kind of depends on the rate outlook but any sense for the NII decline this year based on your rate forecast?

It's going to largely depend on volumes, Matthew. I would like to be able to tell you with a level of certainty what we expect it to be. In terms of net interest income, there are too many variables to call that right now. You have your models and a lot of the guys have their models and know what our balance sheet consists of. So certainly, see a decline in net interest income if there are 6 rate cuts. We're not necessarily convinced there will be 6, however, we're prepared for it.

In fact, Matthew, that's something of difficulty we're facing. There are so many uncertainties we’re having here. You are aware that our loan portfolio is very asset sensitive. Yet, many of them or the majority of them have rate floors. To the extent that when it's coming down, some of them will be less affected than the others. So hopefully, from past experience, with new loan productions, we can actually contribute increased net interest income enough.

Got it. Okay. And then on expenses, a nice decline here. I don't know how sustainable that is necessarily. So just any guidance on the Q1 run rate?

Yes. I'm expecting it to come in anywhere between 19% to 19.5% in Q1. As you'll recall, it typically is a higher quarter for us in Q1 every year.

Yes, understood. And then lastly, on the buyback, it sounds like a bit of a balance. You were pretty active in finishing the $50 million in just three quarters. Maybe it's a little bit spread out, but is the expectation that you likely get it done by the end of the year with the latest $50 million?

We certainly hope that we will buy back a large amount of it, which means that our operating cash flow will allow us to do that. But we keep on looking at ourselves between where we're actually earning, what our projected forward operations look like, and balancing it with our capital ratio.

Yes. The previous $50 million, Matthew, we purchased at an average of just over $58 a share, and with today's price being what it is, you can see that the value proposition isn't quite the same as it was. However, there's still value there.

And our next question today comes from Tim Coffey with Janney.

Just a follow-up on your comments about rate cuts and business demand. I'm wondering how many rate cuts, let's say 25 basis points, do we need to spur demand for more loans?

That's a great question, Tim.

Tim, based on our conversation with our customers, it is really that if you have 1 or 2 rate cuts, and they are also seeing their cuts ahead, they will be more aggressive with their new investments. By the fourth quarter, we had a little bit more production. You can see that it's already indicating that some of our more progressive customers are already engaged in some transactions. So, when they feel that the rate has peaked, they can catch the opportunity. We think that demand generally will increase, but it also has to do with the size of the rate cut, whether it's 25 basis points, 50 basis points, etc. Everyone is predicting this; we hope we have the crystal ball. But the general trend is that sooner or later, you will get there; it's a matter of time.

Our next question comes from Gary Tenner with D.A. Davidson.

I wanted to ask a follow-up on the kind of the loan outlook question, and you just addressed it a little bit with the commentary in the fourth quarter. How much of that fourth quarter activity do you think was folks trying to get transactions in before year-end? And how has that translated to the pipeline, at least for first quarter activity levels?

I will have Wellington answer the question first.

Gary, that's a good question. I think that it's interesting because we pretty much raised ourselves last year to really continue to take care of our good customers. Our customers are always looking for opportunities. So whether it's a year-end situation, I'm not so sure. They want to capture it and close it whenever there's a good opportunity.

Okay. And just in terms of the pipeline heading into the first quarter, most of last year was right along your loan growth, as you pointed out before the strong fourth quarter. So what does the early part of '24 look like from what you can tell?

Okay. This is Li Yu. First, the pipeline is better than the past third quarter. So far, it's only 26 days into the year. It seems to be a little bit more active than the third quarter. But whether it will end up at the same level as the fourth quarter, we do not know because the first quarter is typically rushed at quarter-end, year-end. It seems to be better than the third quarter.

Appreciate that. And then if I may ask one more. Ed, can you just remind us what amount of rate cuts do you need until floors in your variable portfolio start to matter?

At this point, it's probably about 100 to 125 basis points of rate cuts before they start to matter as we've gotten with the...

As an average.

As an average, yes. Some will be immediate, and some will be further than that for sure. But yes, it's around 100 to 125 basis points.

Thank you. This concludes our question-and-answer session. I'd like to turn the conference back over to the management team for any final remarks.

Well, thank you very much. We think we have a good year by our standard. We certainly would like to maintain that relative profitability compared to the industry going forward. Hopefully, we will also be doing shareholder-friendly things in this new year. Thank you very much.

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.