Earnings Call Transcript - PFBC Q3 2023

Operator, Operator

Good afternoon, everyone, and welcome to the Preferred Bank Third Quarter 2023 Earnings Conference Call. Please also note, today's event is being recorded. At this time, I'd like to turn the floor over to Jeff Haas of Financial Profiles. Please go ahead.

Jeff Haas, Moderator

Thank you, Jamie. Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the third quarter ended September 30, 2023. 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. Good morning, ladies and gentlemen. I'm very pleased to report another quarter of record income. For the third quarter, Preferred Bank earned a net income of $38 million or $2.71 a share. Compared to the second quarter, net income and net interest income both increased and our expenses decreased. For the quarter, we have seen a little bit of loan growth. Loan demand continues to be low as our customers seem to be much more cautious these days, and our underwriting standards remain elevated. On the deposit side, there was an increase of $94 million for the quarter. We have seen deposit costs slow down, and looking forward to the fourth quarter, we think the trend will continue. Credit quality remained generally stable. We had a small increase in total criticized assets, but we have a bigger increase in the nonperforming loans. The nonperforming loan increase is basically the migration of two loans from a lower classification to the cool category. Loan number one is a $16.1 million loan that was borrowed by one of our very good borrowers for many years. Unfortunately, the gentleman passed away recently, and the large and complex estate has caused a delay in the resolution of this loan. We just notified that the property is in escrow, and the borrower is expected to close it in the later part of October and pay Preferred Bank off. There is another $2.2 million loan in the same category related to discussions among the beneficiaries for a large and complex estate. This loan was secured by a property with a loan-to-value ratio of less than 20%. I am happy to report that we have received full payment yesterday. We also expect another large loan, which is classified and in the criticized category, over $23.5 million, to be paid off today. We have confirmed this with the lending bank that took over this role. For the quarter, we made a provision of $3.5 million. The charge-off for the quarter is $80,000. Last quarter, there were no charge-offs. Therefore, our total allowance has increased to 1.46%. We believe that this allowance number is among the top levels among our West Coast peer group. Our operating costs remain under control, with an efficiency ratio of 25% for the quarter. Since the second quarter of 2023, we have been actively buying back our own stock. As of today, a total of 720,000 shares have been repurchased with a total consideration of approximately $42 million. The buyback is highly beneficial and accretive to the EPS for our remaining outstanding shares, and we plan to continue this activity under the current program. Additionally, with the large amount of buyback and dividends, Preferred Bank's tangible capital ratio has actually increased to 10.1%. The bank has been reporting earnings quarter-by-quarter, beating consensus estimates. Quarter after quarter, we see the future estimates going up, and we are very pleased with that. We will continue to hedge ourselves to operate the bank efficiently and prudently. Thank you very much. I'm ready for your questions.

Operator, Operator

Our first question today comes from Matthew Clark from Piper Sandler.

Matthew Clark, Analyst

Just starting on the margin, do you have the spot rate on deposits, either total or interest-bearing at the end of September? And then the average NIM in September and any expectations for the fourth quarter? It looks like you're pretty much in line with your prior guidance of $4.40.

Edward Czajka, CFO

Yes, that's always good to see, Matthew. Thank you. In terms of the spot rate, the margin for September was $4.34, so kind of in line with the entire quarter. The total cost of deposits was $3.62 million for the month of September. In terms of the margin going forward, I think you can probably extrapolate what's been happening over the last quarter or so and project that into Q4 and Q1 of next year. I would estimate somewhere in the neighborhood of $4.15 to $4.25 for Q4 and somewhere between $3.90 and $4 for Q1 of '24, notwithstanding any actions by the Fed.

Matthew Clark, Analyst

Okay. Got it. And then just shifting gears to expenses. Good to see no additional OREO-related costs or very minor costs this quarter. What's kind of run rate expectations for the fourth quarter? And then should we assume some seasonal increase in 1Q?

Edward Czajka, CFO

In answer to your second question, yes, you'll see a seasonal increase in Q1 of next year. My expectations for Q4 would be somewhere in the range of $19.5 million to $19.8 million.

Matthew Clark, Analyst

Great. Okay. And then just on credit, could you share some of those isolated issues that are resolving themselves as it relates to nonperformers and criticized? But can you remind us of your SNC exposure? And what might be criticized within that portfolio? It sounds like one of them that's resolving itself, the $23-or-so million is within that SNC book. Just the overall status of that portfolio?

Li Yu, CEO

Nick, do you want to answer that?

Nick Pi, Chief Credit Officer

Yes. For SNC loans, they have submitted to the bank for their second semiannual review in around September, and there's only one small loan, around $2 million in exposure, that has been downgraded. Other than that, the rest of the SNC loans are stable without any credit issues at this time.

Edward Czajka, CFO

The total SNC relative to total loans is about 11%.

Nick Pi, Chief Credit Officer

It's 11%, correct.

Matthew Clark, Analyst

Okay. And then just on office commercial real estate, thanks for the additional color in the release on that. But can you—I think one of the more popular questions these days to be around the reserve associated with that portfolio. I would assume there's only some portion of that portfolio that you're more concerned about? Maybe it's the pure office or maybe not, maybe it's just the central business district, which is pretty nominal.

Li Yu, CEO

Well, we have, obviously, the business has shifted, with a little amount we have in that. And basically, they are very small properties, a very small office being well occupied. I don't think we have any classified assets in office property, right?

Nick Pi, Chief Credit Officer

No, not at this time.

Li Yu, CEO

Not—that's about the best I can answer. And also on stay good, I cannot answer any more than that.

Nick Pi, Chief Credit Officer

And also give you a little bit more color, Matthew, on our office products. We have recently conducted a stress test on the office side that shows all those ratios are pretty good. So we do not expect any immediate issues about our office projects at this time. Some of the loans are below; we think a handful of those credits have a little bit weak DCR ratio. However, we do have very strong individual guarantors behind it. So global cash flow, I can cover, these are no issues whatsoever at this time.

Operator, Operator

Our next question comes from Tim Coffey from Janney.

Tim Coffey, Analyst

Just a question on the nonaccrual loans. If you were to account for payoffs that you anticipate getting this week, what would that nonaccrual number be? Because I'm assuming it would be less than 19%.

Li Yu, CEO

The 19 plus 2.2.

Edward Czajka, CFO

17 would be—

Nick Pi, Chief Credit Officer

Minus 2.2 would be right.

Edward Czajka, CFO

A little under 17%, a little under 17%.

Tim Coffey, Analyst

Okay. Great. And then if we think about loan growth over the next 12 months, where are some of the biggest headwinds that you're seeing right now?

Li Yu, CEO

Well, I think interest rates are still the biggest headwind. Based on what we see, our borrowers all seem to be stable and affluent, but like everybody else, they just don't want to commit to any actions as the interest rate picture is not clear.

Tim Coffey, Analyst

Okay. You said your underwriting was remaining stable. I'm wondering, are there any places that you're starting to tighten your underwriting?

Li Yu, CEO

We have tightened it before. When I used the word elevated, I mean we are more selective on location and much more picky on the guarantor. I guess the other metrics, we can lower it down a little bit, I mean, requirements, but we're maintaining an elevated standard in these two categories now.

Tim Coffey, Analyst

Okay. Also on cap rates in your footprint, are you starting to see commercial real estate cap rates starting to move our budge at all?

Nick Pi, Chief Credit Officer

Yes, as per the most recent appraisals, the cap rates have gone up a little bit because of the current CRE market situation, but they have not gone out of control. So valuations still maintain pretty well for our bank because normally, we maintain our loan-to-value ratio around 55%. So even with a slightly high cap, I believe our cushion is still there and our credit should be performing well.

Operator, Operator

Our next question comes from Andrew Terrell from Stephens.

Andrew Terrell, Analyst

If I could start maybe on the nonaccruals this quarter. I appreciate all the commentary you provided there. I think you provided the LTV for the second smaller loan, sub-20%. For the $16.1 million loan that you referenced, do you have the LTV for that specific credit?

Nick Pi, Chief Credit Officer

Yes. That credit's most recent appraisal shows that the value is around under 50%.

Edward Czajka, CFO

And Andrew, just to clarify, that's a classified loan, not a nonaccrual loan.

Nick Pi, Chief Credit Officer

That's classified.

Andrew Terrell, Analyst

Okay. Okay. Got it. And then if I can move over maybe to deposit growth. You guys had some good deposit growth this quarter. It's good to see. I hear some of the commentary around loan growth and the challenges there right now. Could you talk about the pipeline for incremental deposit growth? What you're seeing there? And then more specifically on the pricing front, where new time deposits are being priced at today?

Li Yu, CEO

So far, what we see is for us, and even in the immediate marketplace we're dealing with, deposit rate offerings have been stable. I don't think there’s much that can change essentially their deposit rates offering to their customers. Therefore, the fluidity of the interbank deposit transfers is much limited this quarter compared to the previous quarter. I guess it's a matter of opening up new accounts in our offices, meeting new people, and opening up new content costs, the $94 million increase. Therefore, we do not foresee any big deposit rate changes in the next quarter—meaning fourth close quarter—if the Fed does nothing.

Andrew Terrell, Analyst

Okay. And what's the level that new CD deposits are being priced at today?

Li Yu, CEO

We have priced at $5.03 after the CD amount. That's the highest rate we have, but there are different categories at lower levels. So it’s ranging from $4 to that.

Operator, Operator

Our next question comes from Eric Spector from Raymond James.

Eric Spector, Analyst

This is Eric on the line for David Feaster. We're on the CD front. I'm just curious if you could provide some color on the maturity schedule.

Edward Czajka, CFO

Well, generally speaking, most of the CD maturities are within a year. So we have essentially a constantly rotating maturity schedule of the entire portfolio. For the fourth quarter, I think we have about $400 million to $500 million that will be maturing.

Eric Spector, Analyst

Okay. And then that's laddered out kind of similarly by quarter?

Edward Czajka, CFO

Yes.

Eric Spector, Analyst

Okay. And then just curious on the demand front, it looks like growth was primarily from residential mortgage and residential construction. Just curious about your appetite for residential growth at this point and what's driving the growth there.

Li Yu, CEO

On the demand side? Well, we're highly dependent on our customers on a daily basis, meaning the commercial customers, business customers that are dealing with us. After the last scale that we had in March with the meltdowns, everybody is putting so much attention on uninsured deposits. We're a business bank, and we're dealing with businesses. The deposits are essentially uninsured, and they don't want to break it up into two pieces into ICS—they think they can operate that way. We have several very large customers, their deposits, they sign up all the conversions to ICS, but not being broken down. They don't want to actually use it, but they want to have the activity to turn into ICS when they need it. The fact is that for community banks or regional banks too, if that issue doesn't get resolved, everybody will have to worry about the large DDA they're getting from our customers and changing the nature of liquidity and coverage. We don’t have an answer. As for the pure dollar amount of DDA, we’re just seeing that small migration into the higher-cost area but hope that the pace has slowed down. In fact, I hope the pace will end in this quarter, but time will tell.

Eric Spector, Analyst

Okay. I just wanted to touch more on the loan demand side. The growth this quarter was driven by residential mortgage and residential construction. Just curious what drove the growth there?

Li Yu, CEO

Yes. We—obviously, the outcome of the commercial real estate market, which is our biggest loan category, depends on the maturity schedules of paydowns. We also have a number of construction loans being paid down. These are the changes from quarter to quarter. We have never treated the mortgage as the main cause of our new generation. In fact, we previously disclosed that our internal goal is to keep our mortgage product to less than 10%.

Eric Spector, Analyst

Okay. I appreciate the color. And just wanted to get an update on the SBA department expansion in the Houston LPO. Are you looking at additional expansion opportunities, and any color there would be helpful?

Li Yu, CEO

Can I bring in another level, in changing from a more macro basis? To me, at this point in time, doing a new normal is a lot less profitable than buying back the stock. New loans will give us long-term growth, but since the loan demand is not there, we'd like to concentrate our efforts on managing our liquidity, managing our profitability, and managing our return to our investors. Opening new locations is not an immediate endeavor at this point in time.

Operator, Operator

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

Gary Tenner, Analyst

A bunch of my questions have been answered, but I just wanted to ask in terms of balance sheet management. You've continued to allow the AFS portfolio to run off and paid down the FHLB debt this quarter. As you think of the liquidity on the balance sheet, which is ample, any thoughts in terms of putting any of that to work in the securities portfolio in anticipation of locking in some yield potentially for the longer term?

Li Yu, CEO

This is something we are continuously looking into. We continue to discuss this amongst ourselves. It seems that every time we do something, we were wrong there because three months ago, we were talking about large treasury paper, and I'm glad we didn't.

Edward Czajka, CFO

There will come a time.

Li Yu, CEO

Yes, sometime. Just for us, that's not a major income source. It's small diversification. So we choose to be more cautious so that it wouldn't lead to a lot of adjustments or write-downs of our portfolio.

Edward Czajka, CFO

And Gary, the profitability of the overall bank is really one of the main drivers behind having such a large cash position that we've had over the last 10 years. We have not had to go after that last dollar of income and put that money at risk. We find ourselves in a very good position right now with our liquidity because we haven't done that and with respect to our tangible capital levels as well.

Gary Tenner, Analyst

Yes. I mean, certainly, it's been a huge advantage to have a small portfolio in this environment and not thinking so much about current profitability, but down-the-road profitability. But I appreciate the thoughts on that. And then I missed some of the numbers regarding the buyback. I have the total shares purchased the last couple of quarters, but what was the average price per share?

Edward Czajka, CFO

The average price per share through the total buyback is just a hair over $58 a share.

Operator, Operator

And ladies and gentlemen, at this time, we'll be concluding today's question-and-answer session. I'd like to turn the floor back over to Mr. Yu for any closing remarks.

Li Yu, CEO

Well, thank you very much. Everything in this quarter seems to be more stable than the previous quarter. I'm happy to see that some of the legacy loans are getting resolved gradually. These things do take time, but I'm also pleased to see that the new migration into the category is very limited. So with that, I hope that we can continue to operate this way. Thank you.

Operator, Operator

And ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for joining. You may now disconnect your lines.