Earnings Call Transcript - PFBC Q2 2022

Operator, Operator

Good day and welcome to the Preferred Bank Second Quarter 2022 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 do note, that this event is being recorded. I would now like to turn the conference over to Jeffrey Haas of Financial Profiles. Please go ahead.

Jeffrey Haas, Presenter

Thank you, Joe. Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the second quarter ended June 30, 2022. 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 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. Thank you for attending our earnings conference call. I'm very pleased to report that the second quarter of the year was a record quarter in net interest income, net income, earnings per share, loans, and deposits. Credit quality and efficiency ratio was stable. Net income for the quarter was $28 million or $1.87 a share. For the six months, it was $54 million and $3.61 a share. We are the beneficiary of recent interest rate hikes, and we believe that we'll continue to benefit from future rate increases. A highlight of the quarter is the loan growth, which grew $329 million or 28.6% annualized. For the first half of the year, the loan growth was 22.4% annualized. We’ve analyzed the outsized loan growth in this quarter, and we have found that it was a combination of two factors: reduced pay-off, pay-down activities and strong origination activities during the quarter. In fact, during the quarter, April and May were extraordinarily strong. However, activities tapered off beginning June. As of today, the pipeline appears to be returning to the level of 2021. Deposit growth was $98 million or 7.3% for the quarter. During the quarter, we have seen that competition for deposits has intensified, mainly led by the major banks. We believe the deposit costs will continue to increase, in fact, accelerate in the remainder of the year. This is also true because our customers are primarily business people and savvy investors; they are very good with their money. With recession looming, our focus is also on credit quality. We have already begun to deep dive into our portfolio, and so far, we have not noted any deterioration. We're currently in the third week of our regulatory examination, and I'm hopeful that nothing significant will arise through this examination. The non-performing assets increased mainly because we prepaid senior loans on the property before closing. Today, this property will carry on roughly 50% below appraisal value. All other areas of credit quality such as classified assets and past due accounts all seem to have improved from the previous year. For the quarter, we have provided $2.9 million of provisioning that was mainly related to the large loan production we have. As of June 30, the bank's total loan portfolio consists of 13% fixed-rate loans and 87% floating-rate loans. Most of these floating-rate loans do have rate floors. On June 30, 76% of our total loan portfolio was now fully floating with the net rate changes. With the anticipated July Federal Reserve action, we believe that by the end of June or July, only 2% or 3% of our total loan portfolio will not be floating. With this, we believe our interest income for the remainder of the year will increase. We also noted deposit costs will definitely increase. We do believe the increase in revenue will be more than enough to offset the cost increases. Our $32 million share repurchase program is progressing well. As of today, we have completed $24 million of the $32 million that was set aside to repurchase. We hope the whole program will be completed in the third quarter. Thank you very much. I'm now ready for your questions.

Operator, Operator

Our first question will come from Matthew Clark with Piper Sandler. Please go ahead, sir.

Matthew Clark, Analyst

Hey, good morning, gentlemen. Maybe starting on the margin, do you happen to know the average margin in the month of June? And is it fair to assume that the margin expansion in Q3 will be greater than Q2 now that you're fully off the floors? And you get the benefit of the new loans in the new pipeline at higher interest rates?

Edward Czajka, CFO

Well, the first one is easy to answer—the second one not so much, Matthew, but yes, the June margin came in higher than the average for the quarter. You're certainly correct on that, about 20 basis points higher than the quarter. As for Q3, we still expect margin expansion, as Mr. Yu alluded to in his comments, indicating that interest income will increase at a faster pace compared to interest expense. So, we certainly expect some margin expansion in Q3; likely it will not be to the extent we had in Q2, but certainly, it will be expanding.

Li Yu, CEO

Matthew, just to add mathematically, Q3’s leverage meaning loan increases versus deposit increases looks slightly closed in this particular quarter. So, that may be a factor to consider for the leverage.

Matthew Clark, Analyst

Okay, great. And then, do you happen to have the spot rate on interest-bearing deposits at the end of June as well?

Edward Czajka, CFO

I do not, Matthew. I apologize. I realized that was the one schedule I did not have in front of me; the other information I knew from memory. So, I apologize.

Matthew Clark, Analyst

Okay. Okay, we can follow up. And then on non-interest expense in terms of the run rate, what's your expectation for the back half of the year?

Edward Czajka, CFO

Well, obviously, our run rate for Q2 was a little higher than I had previously mentioned, but I would expect Q3 to be similar to Q2. The wildcard there is going to be OREO expenses. You saw during the quarter, we had just under $500,000 in OREO expense; to the extent that does not repeat, you'll see it down slightly, but we still have pressures. Salary pressures are still ongoing. Obviously, we're in a very inflationary environment. I don't have to tell a lot of people that; fortunately, lease costs are fixed, etc. But things will continue to go up as we continue to operate in this environment. But we were pleased to see that even though we went over 17 on the expense side, we still landed at 29% on the efficiency ratio.

Matthew Clark, Analyst

Yes. Okay. Thank you.

Operator, Operator

Our next question will come from Gary Tenner of D.A. Davidson. Please go ahead.

Gary Tenner, Analyst

Good morning. Just wanted to follow up a little bit on the margin questions. And even in an environment of presumably some slower pace of loan growth, your interest income is likely to go up pretty significantly just from the rate side. So, Ed and Li, as you talk about the outlook for NIM expansion for the third quarter when you get the full benefit of the June hike and most of a quarter's worth of a presumed 75 basis point hike next week, I'm surprised to see that it would be that combination doesn't lead to a little better expansion in Q3 than Q2. So, could you maybe just give us some sense of what your deposit rates look like for right now in terms of CDs or other deposits because that seems to imply a pretty significantly elevated deposit beta, kind of the second quarter into the third quarter?

Li Yu, CEO

Okay. First, during the Q2 period, there were two rate increases in May and June, and many of our loans operated lower than those rates at the time. So, not every loan was affected, and especially the June increase affected less than one month. As I reported earlier, now 76% of our total loan portfolio is fully floating. We're expecting these loans will see an increase that is not reflected in the second quarter. So, likely, the third quarter expansion will be good, but as I also said earlier, deposit costs are something that I will control all the time. The reason is that you see major banks, for instance, Citibank and HSBC, their deposits probably always carry the highest rates in the nation. If you look at their records, Citibank is offering deposit accounts effectively paying 3%. And Goldman Sachs Markets Bank has TCDs at 2% with upside adjustments. So, with this situation in mind, I expect every bank will see increases in deposit costs. Water always seeks its lowest level; it's just a matter of how fast each institution reaches that particular level. As I also reported, we cater mainly to business clients. Our investor profile is different than many banks, which are more consumer-oriented. So, I expect a little faster pace in our cost adjustments.

Edward Czajka, CFO

And Gary, on the CD side, I think you asked about one-year, we're offering 1.18% right now on one-year CDs. To add on to Mr. Yu’s point, we know the CD portfolio and its dynamics as it rolls off and rolls back on, but it's that large money market interest-bearing transaction account portfolio where we have some larger clients. And as Mr. Yu mentioned, they do manage their funds very closely, so we have to keep up.

Li Yu, CEO

To illustrate this, beginning in April, we had customers breaking their CDs, paying the penalty, and putting the money into treasury papers, which are making 2%. Now we also see customers breaking their OTCDs, wanting to hold their funds in accounts while waiting to reinvest when rates change. Many have reinvested, while many have not. So, these actions are tough to quantify at the early stage of the quarter. I don't mean to be evasive, but that's the fact.

Operator, Operator

Our next question will come from Andrew Terrell with Stephens. Please go ahead.

Andrew Terrell, Analyst

Hey, good afternoon or good morning.

Li Yu, CEO

Hi, Andrew.

Andrew Terrell, Analyst

And maybe just ask the margin question in a little different fashion. You gave us the month of June was about 20 basis points higher than the Q2 average, which would put us just a little bit south of 4% on the net interest margin in June. Do you think in Q3 2022 for the full quarter average, you will still see expansion from that just shy of 4% level?

Edward Czajka, CFO

Oh, absolutely, yes. No, there's no question. I didn't want to be misunderstood on the earlier comment. I just wanted to temper the fact that we will see margin expansion, but will we see 30 basis points of margin expansion? I don't know. I'm not necessarily expecting that much, but it will be good.

Andrew Terrell, Analyst

Yes. Okay. I guess for Mr. Yu, kind of a bigger picture question. With even more rate hikes coming, you're already putting up really solid profitability; I would think you'll become even more profitable, and capital is already in a solid spot. So, I guess my question is more on the reinvestment side. Where are you focused on making investments today? And are there any investments that may have been kind of longer-term that you're now more comfortable focusing on and spending on just given the improved rate backdrop and the improved profitability profile?

Li Yu, CEO

We actually think we are consciously stepping forward. First of all, we know we're accumulating capital at a faster pace, but in the meantime, I have to worry about the economy and whether a recession is coming or already here, or how long and how severe it is. In this game, I cannot afford to make mistakes. So, likely, we're going to be cautious in holding capital before we commit to it. When we are ready to do this, increasing dividends will happen. We will seek additional buybacks, and we will also probably invest some of our money in securities. I hope the prices will be much more attractive. So, these are the areas that we would target.

Andrew Terrell, Analyst

Okay, that's helpful. I appreciate it. And then another one for me, kind of on rate sensitivity. We've heard some other institutions talk about tempering, especially asset-sensitive institutions, discussing tempering their rate sensitivity as we progress through the cycle. Is this something, given how asset-sensitive you are, that you would consider doing as we approach a much higher rate cycle?

Edward Czajka, CFO

Andrew, can I ask how—you just talked about rate tempering. Can you elaborate on what that means?

Andrew Terrell, Analyst

Yes. I mean, I think things are being done in a variety of fashions, but just trying to— I would assume mainly just the swaps, but just tempering rate sensitivity with that lever?

Li Yu, CEO

Well, obviously, when we reach this later stage of the increase, we will think about our pricing level in different manners, and we will adjust our offerings to make it more market competitive. We may consider holding more fixed-rate loans by that time, but we must be careful every month, every week, and every month going forward. By the end of this year, we need to take seriously how to reposition our product portfolio.

Andrew Terrell, Analyst

Okay, great. Thank you for taking my questions. I appreciate it.

Operator, Operator

Our next question will come from Steve Moss of B. Riley Securities. Please go ahead.

Steve Moss, Analyst

Good morning. Maybe just one last question on liabilities repricing. It sounds like obviously you're seeing changes in customer behavior. Just wondering what's the duration of securities of the CD book these days? Kind of sounds like it's probably shortened?

Edward Czajka, CFO

I believe it's between five months and six months right now, Steve.

Steve Moss, Analyst

Okay. And then—that's helpful. And then in terms of just on the loan pipeline here, you guys had a great quarter of loan growth. Do we see some of that carryover here into the third quarter before maybe tapering off to more typical levels? Just kind of wanted to get a feel for near-term trends?

Li Yu, CEO

Why don’t you answer that first?

Nick Pi, Chief Credit Officer

We look at it, and the second quarter was extraordinary; I think that our pipeline continues to be quite healthy, but it will not reach the same levels as in the second quarter. It will probably taper down to, I would say, as Mr. Yu mentioned earlier, the level of 2021.

Steve Moss, Analyst

Okay, great. And then just kind of curious on loan pricing, where are you guys falling on new loan pricing?

Li Yu, CEO

Loan pricing would be anywhere within the ranges discussed, which is the most happening in our operations. Typically, the floor will be the starting entry rate.

Steve Moss, Analyst

Okay, great. And then in terms of just kind of—I hear Mr. Yu on terms of concern about the reserve and being more cautious about the economic outlook. So how are you guys thinking about the reserve? Are you going to expect to add more qualitative factors to the reserve as we go forward, or just kind of provision expense probably tracks loan growth?

Li Yu, CEO

I will let Nick answer that, but I want to tell you our qualitative number is already confirmed as high compared to the industry.

Nick Pi, Chief Credit Officer

Yes. Currently, we are higher than our peer groups at this time. To answer your question, Steve, we will continue to apply a cautious posture when reviewing both quantitative and qualitative factors and also try to be a bit conservative with our exposure, considering the broad economic factors and any negative indicators such as GDP drops and supply chain disruptions. We're seeing some improvements in retail sales and initial hiring that exceeds expectations. While we still see some pressures, we are cautious about our reserves and adjustments. Mr. Yu?

Li Yu, CEO

Thank you. I have nothing more to add.

Steve Moss, Analyst

Okay. One last one for me. Just on the order property here, I'm just wondering about the status of disposition. You guys mentioned a desirable property; is that something that could be off your books in the near future?

Li Yu, CEO

Nick, I would like you to answer that.

Nick Pi, Chief Credit Officer

Yes. We are finalizing the title now and will work aggressively with a local reputable broker to prepare the house for sale. I believe it will officially be on the market this coming Friday. We hope to eliminate this OREO property by Q3 or Q4.

Li Yu, CEO

By the way, this property is a luxurious house above 10,000 square feet with great features. So, in general, it's quite a desirable property.

Steve Moss, Analyst

I hear you there. All right. Well, thank you very much. I appreciate it.

Operator, Operator

Our next question will come from Tim Coffey with Janney. Please go ahead.

Tim Coffey, Analyst

Great. Thank you. Thanks for letting me ask some questions. If loan growth is going to revert to say that 2021 level, does that imply a low double-digit kind of annualized growth rate?

Li Yu, CEO

Yeah, we certainly were guiding for 2021 to high-single to low-double. So, hopefully, we can maintain the same level of growth as in 2021, which is a low-double-digit.

Tim Coffey, Analyst

Okay. Okay, great. And then, Ed, what's the appetite for bringing on more broker deposits? If you take that line going all the way back to the last rate hike, it's been kind of in a narrow range, but this situation seems a bit different right now.

Edward Czajka, CFO

Did you hear me chuckle when you mentioned broker deposits, Tim? We have no appetite right now. That's why I think when you look at Q3 and the deposit growth we managed to get, we left all brokered money that matured in Q3 to run off. We didn't replace any of it. We're certainly not prepared to pay 3% for one-year money from the wholesale market. Obviously, the retail market has not caught up to that. It's a very interesting dynamic to watch, but as of right now, we have no appetite for brokered money which could certainly change in the future, but we obviously have limitations and we want to stay well below those limitations anyway.

Tim Coffey, Analyst

Okay, understood. Those were my questions. Thank you very much.

Li Yu, CEO

Thank you.

Operator, Operator

This will conclude our question-and-answer session. I would now like to turn the conference back over to Mr. Li Yu for any closing remarks.

Li Yu, CEO

Thank you very much. As usual, we will stay on the phone, and if you have any further questions, please call us back. Thank you for your attention. Bye-bye.

Operator, Operator

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