Preferred Bank Q1 FY2025 Earnings Call

Good day, and welcome to the Preferred Bank First Quarter 2025 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note that 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, Jacob. Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the first quarter ended March 31st, 2025. 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'd like to turn the call over to Mr. Li Yu. Please go ahead.

Thank you. Good morning. Preferred Bank's first quarter net income was $30 million or $2.23 a share. This quarter's net income was negatively impacted by an outsized reversal of interest income related to the elevated level of non-performing loans. It was also negatively impacted by a charge-off of our real estate owned loan, OREO, in the amount of $1.3 million. The non-performing loans totaled $71 million at quarter-end, of which $66 million related to one relationship and two credits. This event was previously disclosed in early March. The two loans have a collateral value which will protect the loan amount, and there are no loss compounding identified at this time. Total credit trend seems to be okay. The total classified loan portfolio has reduced by $30 million from the previous quarter to roughly 20%, with very few migrations into this category during the quarter. The reversal of interest has also impacted our net interest margin, which is reported at 3.75% for this quarter. Without this effect, we internally estimate the net interest margin would have been much closer to the 4.06% reported last quarter. This quarter, we had a negative loan growth of $6 million, equal to approximately 0.1% of our total loan portfolio, but our deposits increased 2.6% on a linked-quarter basis and the deposit cost is reducing as planned. Looking ahead, loan demand does not seem to improve much mainly because we're currently under the uncertainty of a tariff war with the whole world. This tariff situation is truly unpredictable and brings many uncertainties ranging from supply chain changes, cost increases, inflation, to empty shelves and empty products in warehouses, all of which can affect each and every one of our customers differently. We have already started to monitor our loan portfolio, beginning with a thorough review of our trade finance segment, which equals a little over $200 million of our loan portfolio. As time goes on in the next ensuing months, realizing the many uncertainties and their implications that arise from the tariff war, we will continue our review process diligently. Thank you. I'm ready for your questions now.

The first question comes from Matthew Clark with Piper Sandler. Please go ahead.

Hey, good morning, everyone. Just wanted to start on the margin outlook from here. If you had the average margin in March, excluding any reversals, just kind of a normalized margin in March, I'm just wondering if it was, how much might it be below the 4.06% and then spot rate, if you had it at the end of the month ideally, but I'll take the average for the month if you had it?

Hey, Matthew, this is Ed. Unfortunately, I don't have the March spot rate, but the margin for the quarter excluding the non-accrual reversals would have been 3.94%. So it's holding up much better than we had anticipated.

And that 3.94% is for the quarter, but do you have it for March?

I don't. I think I can get that for you.

Okay. And then just on the non-performing relationship, can you just let us know which of the two is being sold at par? Just trying to get a sense for the dollar amount of that $66 million or $67 million? And then on the other piece that's not being sold, it sounds like you're pretty confident in the collateral value, but can you give us more color as to why and kind of the timing of that resolution process?

Matthew, I will have Nick Pi answer the question. Okay?

Hi, Matthew. This is Nick speaking. For the two credits, one of them is pretty desirable land in a good area. A lot of builders have tried to offer to purchase, and currently, the property is under contract for the note sale, which we expect to close very shortly. And the other one…

Okay, you might have mentioned that we have non-refundable deposits.

Yes. And for that particular deal, we just received non-refundable deposits. So the deal is quite certain to close within a very short period of time.

On that credit, Matthew, you wanted to know, first of all, the appraisal value is still very good. The loan-to-value is in the 50s. In the meantime, we're setting the note at par.

Correct. This year. So Matthew, I'll just give you additional color that we just received, the most updated appraisal report in April, and the value came out similar to before with a loan-to-value around 62%. So with the note sale, I believe— The other one is currently in bankruptcy court. The Bank's Council and the Bar's Councils all agree to file a motion to the Bankruptcy Court for selling this particular property. This is an apartment with 188 units and a good value to support the credit. We believe through the Bankruptcy Court process this is the best way for the bank to resolve this. We think these two loans will be resolved within a quarter or two.

Okay. And the size of the one in terms of dollars, the size of the one that's in bankruptcy?

One under note sale to be closed soon is around $28.5 million. The other one in bankruptcy court is $37 million.

Okay. Thank you. And then just shifting gears to the expense run rate, Ed, I'm assuming you don't have any more write-downs on OREO from here. How should we think about the run rate in Q2?

So, as you see, we came in at about $23.4 million. As I've discussed previously, we have an outsized personnel expense line item, which is employer pay taxes due to the incentive compensation payout in Q1. That happens every Q1. In addition, as you've pointed out, the $1.3 million write-down puts Q1 normalized at just over $21 million in terms of the run rate. Going forward, I would estimate it to be $21.5 million to $22 million for the next couple of quarters and probably accelerating after that.

Okay, great. And then just last one for me, if I may, on the buyback. It didn't look like there were any shares repurchased this quarter, probably for obvious reasons, but what's your appetite for buying back the stock here?

Okay, based on the report that this department gave me, we bought back altogether 532,000 shares during the first 24 days of the months' scale, and there was only one day purchase in March. All this number is done in April, and we have a total of $65 million available under our buyback program. We have spent about $40 million, so we have $23 million left to purchase.

Okay. Did you say you did buyback stock in the first quarter though?

No, there was just one day—3/31 was the only day we were in the market, but we were in the market for the entirety of April.

Okay. Thank you.

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

Hey, good afternoon. I heard some of the comments in the prepared remarks, just uncertainty maybe impacting the kind of net growth expectations for the loan portfolio. Just hoping to unpack that a little bit more, where you're seeing demand from a client perspective, where it's a little softer right now? And then maybe specifically, do you still feel like you can grow the loan portfolio in this environment or is a flat-to-down expectation more appropriate?

Obviously, as a guy operating a bank, I hope we can continue to do that. We are poised to do so. But as you know, I've experienced many different things, including the 2008 meltdown when subprime home loans can mushroom into a total financial system meltdown. This tariff business is multifaceted and depending on its direction, it could seriously affect many of our borrowers' property values. We're taking a close look at that. Likewise, many of our current customers, whether they're C&I customers or in realty, seem to prefer a wait-and-see approach. When this wait-and-see period will end, we do not know. However, it could be that by later in the second quarter, things might pick up. We are poised, we have a large relationship staff busy working to bring in loans, but we just have to be very careful with it.

Yeah, understand. For the second NPL loan, you talked about one being in bankruptcy court. I think you said it was a $37 million note. Do you have a recent appraisal on that as well? And if so, like a refreshed LTV?

Yeah, that appraisal is also pretty favorable. I believe we did one back in November last year, still within six months, and the value can support a loan-to-value around 71%.

I read the briefing of the court information between the lawyers' communication. There is a cash offer sitting out there from these parties at $49 million, which is well sufficient to cover our exposure. We're the first trustee.

Okay. Understood. Thank you for taking the questions.

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

Hey, thanks, everybody. Good morning. I have two questions. The first is with the commentary around trade finance, the $200 million portfolio. It would seem to me that the nearest risk or the near-term risk is more that those trade finance loans could get paid down as less activity occurs. Is that a reason why you're looking at it near term?

You mean the trade finance segment? It's happening in and out depending on each customer's situation. Some of them currently are operating normally, while others are a little bit heavy in China but are well-stocked with inventories right now. So far, we don't have any abnormal activity in the portfolio.

And then second question, just on the loan interest revenue given that $3 million of interest reversals. So, loan interest revenue was down $10 million sequentially. You had that $3 million, and I assume a couple of million dollars just with a lower day count. Is the rest of that delta, call it, $5 million lower quarter-over-quarter simply the full-quarter impact of the rate cuts in 2024?

Yes, exactly.

Can we get a sense of how…

Also, as we are renewing loans and originating loans, they typically come off a higher base. When they come to renew, they're usually coming down a little bit in terms of yield. So that's part of the effect as well.

Okay. Got it. Thank you.

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

Great. Thank you. Good morning, everybody. Mr. Yu, just a follow-up on the comments you made about having been through a couple of cycles before. Grant, this might be the most telegraphed cycle as it turns out to be one that you've probably ever seen. So I'm wondering how you are positioning the bank right now?

Well, being that it just started having this trade finance, I mean the tariff situation, I guess it caught everybody off guard. Most of our customers, and indeed many community banks' customers, are smaller businesses. If they are in the import/export business, they're operating on different profit margins. Very few of them can absorb the tariffs on the table right now, which are 20% to 25%. The question is whether the importer can absorb that; if they do, it will be inflationary to our economy. If they absorb that, it may lead to decreased demand. We are having our loan officers out discussing with each of our trade finance customers to understand how they are reacting to the matter. We are learning from each case. The best way to describe how to position the bank is to know more about what each customer is doing right now, and hopefully, if some negative situations arise, we will be affected less. Nobody can escape the larger situation, but that's how we're addressing it.

No, I think you did. Thank you. That's very helpful. And then just on the underwriting front, I hear you; it's a fluid situation, and the outcome is highly uncertain. But has anything changed regarding underwriting loans right now?

Yes, we are paying more attention to certain segments of our loans. In California, for example, industrial property has been the lowest vacancy and most secure lending product for the past 10 to 15 years. Unfortunately, many of the transactions are already slowing down, and buyers and sellers are concerned about their tenants. We've heard early indications showing pressure on cap rates, which hasn't happened yet, but everybody is worried about it. We, as lenders, have to approach this carefully, demanding more margin, more cushion, and a higher debt coverage ratio now.

Yeah. All right. That's helpful. And then one final question for Ed. Ed, are there any material time deposit rollovers coming up in the next several quarters?

Every quarter, Tim, every quarter. That's about $1.16 billion at an average rate of 4.28. Our offering rates are in the mid-to-high 3s now.

I'm sorry, is that for the current quarter?

That's for Q2. Currently, yes. That's correct. For one way. And I'm going to steal some of your time here, Tim, and get back to Matthew Clark. I do have the spot rate for March. The margin was 3.84%. Excluding the reversals, loan yields were 7.55 for March. Sorry, Tim.

No, that's all good. Those were all my questions. I appreciate your time. Thank you.

We thank you very much for attending the conference. Personally, I think I'm a little paranoid about the tariff situation, maybe just because my background includes more recessions than most of you probably can. But there's nothing wrong with being too careful. We'd like to be a little more careful. Thank you.

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