Earnings Call Transcript - PFBC Q2 2021

Operator, Operator

Good afternoon and welcome to the Preferred Bank Second Quarter 2021 Earnings Conference Call. 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.

Jeff Haas, Financial Profiles

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.

Li Yu, CEO

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 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 is 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 modest interest cost savings in the two quarters ahead. Our credit metrics have improved. Classified assets are down. Quicker sized assets are 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 in a conversation I have had with one of our private shareholders yesterday. Specifically, he is questioning me as to why we are not having a loan loss reserve release during the quarter like almost every other banks. I told them, first of all, of course, the CECL’s mathematics, 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.

Operator, Operator

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

Matthew Clark, Analyst

Hi, good morning.

Li Yu, CEO

Hi, how are you?

Matthew Clark, Analyst

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 in 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?

Li Yu, CEO

On the new production this quarter, 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. That is because 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.

Matthew Clark, Analyst

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 are driving that growth and your thoughts on your ability to maintain low double-digit loan growth into next year given your pipeline?

Li Yu, CEO

Wellington, do you want to volunteer on that?

Wellington Chen, President and COO

Sure. Matthew, this is Wellington. Most of the growth that we have seen is in multifamily residential. We also have the single mixed-use warehouse type of properties, a lot of warehouse ownership.

Matthew Clark, Analyst

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 you might remain at this level or might we see a little bit of growth?

Ed Czajka, CFO

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 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.

Matthew Clark, Analyst

Okay, thank you.

Operator, Operator

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

Andrew Terrell, Analyst

Hey, good morning.

Li Yu, CEO

Yes. Hi, Andrew.

Andrew Terrell, Analyst

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?

Ed Czajka, CFO

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.

Andrew Terrell, Analyst

Perfect. Thank you. And I did want to switch back over to kind of the new hires 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 the type of institution you are hiring away from? Is it larger, smaller, similar size? Just any color on the hires?

Li Yu, CEO

Andrew, our hiring is basically opportunistic. So, we have several regions we have, whenever we find qualified personnel, we try to get them paid, and if we are lucky enough, we then come to terms for them to join us. It is not specifically that we are targeting any region at all, but rather across all the regions, we are continuously cultivating people coming to us, mostly our tenants coming from banks above the range of our size. In other words, a little bit smaller than we are, a little bigger than we are.

Andrew Terrell, Analyst

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?

Johnny Hsu, Deputy COO

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.

Andrew Terrell, Analyst

Okay, perfect. Thanks for taking my questions.

Johnny Hsu, Deputy COO

Sure.

Operator, Operator

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

Steve Moss, Analyst

Good morning.

Li Yu, CEO

Hi, good morning.

Steve Moss, Analyst

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?

Li Yu, CEO

In general, we just have too much liquidity. We have roughly 22% of total assets invested in cash on different types. Obviously, that’s earning a grand – less than 10 basis points. 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 got some in the late second quarter started to do it. But as you know the choices have not been a whole lot of them if we consider risk. So Ed, do you want to echo in and add more on that?

Ed Czajka, CFO

Yes. No, it’s – Steve, as you know, it’s a tough time in this rate environment. Spreads are tightening, so you really don’t get paid for going long at all. So what we have been doing is we have been 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 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 these are base hits; these aren’t home runs, as you know.

Steve Moss, Analyst

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?

Ed Czajka, CFO

Well, I can talk about the pricing. I think Wellington can probably talk about the market better. We’re trying to 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.

Wellington Chen, President and COO

Yes, Steve. This is Wellington. We are very selective in our deposit gathering. Between our deposit officers, who are focusing on individual deposits, and our commercial lending officers, who are 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 opportunities to build our core deposit.

Li Yu, CEO

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 believes 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 with the long-term growth. So this institution will continue to cultivate deposits not just because it’s not profitable right now, but rather for the long-term stability, the growth, the value of our franchise. Yes.

Steve Moss, Analyst

Right. No, absolutely. And in terms of maybe just trying to gauge 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?

Li Yu, CEO

We have previously been telling everybody that we think this second half of the year will be a little bit better than the first half of the year. But this business is, after many, many years, really kind of hard to predict, especially in the early part of the quarter. Much of what we can do will materialize in the mid-quarter and so on. But the early indication is that our momentum is there. And I would say I hope that the new office as well will be the added muscle that we need to bring to a higher level than the previous quarters, of course, that we still have to probably be 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.

Operator, Operator

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

Tim Coffey, Analyst

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?

Li Yu, CEO

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

Ed Czajka, CFO

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

Li Yu, CEO

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

Tim Coffey, Analyst

Okay. Sorry...

Ed Czajka, CFO

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

Tim Coffey, Analyst

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

Ed Czajka, CFO

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 come 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 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.

Tim Coffey, Analyst

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

Operator, Operator

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

Gary Tenner, Analyst

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?

Li Yu, CEO

No. I mean, actually, it’s really a strategic move on 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 sell these out on a long scale.

Gary Tenner, Analyst

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

Li Yu, CEO

There are two SNC loans that were being downgraded.

Operator, Operator

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

David Feaster, Analyst

Good morning, everybody.

Wellington Chen, President and COO

Hi, David.

David Feaster, Analyst

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.

Li Yu, CEO

Let me tell you what the origination effort is, 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 are really a one-off type of thing. So sometimes it’s just certain customers sold their property, or they went public, they don’t need us anymore. All these kinds of things happen.

David Feaster, Analyst

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?

Li Yu, CEO

C&I growth is probably the hardest in coming in. You have an officer who even works on the deal, may be as long as one to two years before they can get to the C&I. We get customers transferred to us. Unlike a real estate transaction, it’s a limited transaction basis, it costs the relationship. But C&I is purely a relationship and it has a lot to do with timing. One of the situations we are facing right now is I’m trying to decide is, on the temporary basis, 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 our operating model that much. You talk about the regular customer type of C&I, it’s basically priced much below the real estate loans. And then you talk about the SNC C&I loans; loans in the low twos is the standard in our situation. Realize our net interest margin is right around 350. These things, if you do a few of them while if you do a whole lot of them, 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 and rates we can get. At this point in time, I am not projecting to see a whole lot of gigantic C&I loans because it’s uneconomical at this point in time.

David Feaster, Analyst

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...

Li Yu, CEO

Yes, it is not up to us. It is up to the CECL mathematics. You are well aware of. 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 strongly, that puts Preferred Bank in a better position because we have more reserves compared to some of our peer groups. But if it is not, those are strong, then I would say, there is more than a 50% chance that we will have some reserve going forward – reserve release going forward, but still have to go through the calculation of all the economic factors, all the Q factors, all the internal downgrading of the loans and these all kinds of complicated things.

David Feaster, Analyst

Got it. Thank you.

Operator, Operator

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.

Li Yu, CEO

Thank you very much. Although we have a very noisy quarter, looking at the normalized basis, we really have a record earnings quarter. We like to think that all the operating metrics are 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. Certainly, we’d like to continue to do that. We just hope that the economy will be growing at the same condition as we’re seeing right now, and I would hope – the pandemic will be over soon, and I certainly will hope everybody will stay safe and stay healthy. Thank you very much.

Operator, Operator

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