Earnings Call Transcript
Preferred Bank (PFBC)
Earnings Call Transcript - PFBC Q3 2022
Operator, Operator
Good afternoon and welcome to the Preferred Bank Third 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 also note, today’s event is being recorded. At this time, I would like to turn the floor over to Jeffrey Haas of Financial Profiles. Please go ahead.
Jeffrey 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, 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. I'm very pleased to report that we have another record quarter. Third quarter net income was $35.2 million or $2.40 per fully diluted share. This quarter's earnings was aided by the federal deposit rate increases and our asset-sensitive balance sheet. Additionally, the large loan increases on June 30 are fully reflected in the September quarter. This quarter, return on equity is over 23%. Loan growth has moderated to 8.5% for the quarter; this is not unexpected given the current economic conditions. Year to date loan growth was 14.1% excluding PPP. Deposit growth was 3.5%. While deposit costs have increased, we expect deposit costs to accelerate starting from September, and this trend will continue in the fourth quarter, as deposit cost increases are much less than our loan yield increase. We experienced a 60 basis point expansion in our net interest margin. Our credit quality remained stable, and our classified assets are moderately reduced. This quarter, we had no charge-offs, but we had a $2.4 million recovery. Together with $2.7 million of new provisions, our loan loss reserve has increased to 1.33% of total loans. The bank's operating costs have increased due to inflationary conditions and the bank's growth in asset size. However, since we had a large increase in revenue, the efficiency ratio has decreased to just over 25%. At Preferred Bank, we recognize the macroeconomic factors heading into a recession. At present, our top priority is our credit quality and the management of deposits and deposit costs. We have done well so far and will continue to stay alert in the future quarters. Thank you very much. I'm ready for your questions.
Operator, Operator
Our first question today comes from Gary Tenner from D.A. Davidson. Please go ahead with your question.
Gary Tenner, Analyst
Thanks. Good morning. So, last quarter Ed and Li, I think you said that you thought third quarter net expansion would be less than it was in the second quarter. Obviously, we had some more tightening than I think was expected or rate hikes expected at that point in mid-July, but as you think about the fourth quarter now potentially with 275 basis point hikes, can you provide your outlook on NIM given the commentary in the press release regarding deposit cost acceleration since September?
Li Yu, CEO
Okay. The final answer is, we have no idea, but I have to tell you what we know. First of all, like you said, the September quarter is at 75 basis points. We are fully priced in for the fourth quarter. If in November, we see another 75 basis points hike, that will be two-thirds priced in for the fourth quarter. December is uncertain at this point. That will determine the revenue expansion. The cost increase has accelerated significantly. People are paying various rates for deposits, especially for interest-bearing demand deposits like money market accounts. The rates paid by major banks for TCDs is now over 3.5%. They really set the bar for smaller banks. Sooner or later, deposit rates will increase. In the fourth quarter, we will have about $400 million in deposits maturing, which will be repriced. There will be many deposits that will be early withdrawn as they seek higher rates. The magnitude and pace of increase, we are really at the mercy of our competitors. The best we can do is keep alert and manage. However, I believe we will see NIM continue to expand, but not to the same level as the third quarter. On a more challenging note, in the first quarter, we may have to reprice one of the loans due to the changing market conditions.
Gary Tenner, Analyst
In terms of that specific issue, are we talking about one specific OREO or are we talking about that portfolio at large?
Li Yu, CEO
The others all seem to be in contract waiting to close.
Gary Tenner, Analyst
And what's the size of the one that you're suggesting you may have to reprice?
Li Yu, CEO
$21 million.
Edward Czajka, CFO
$22 million.
Li Yu, CEO
$22 million, yes.
Gary Tenner, Analyst
Okay. Thank you. I appreciate the detail there. Historically, Preferred has been a very much loan and spread driven revenue story. Even with the growth in the third quarter, which is low by Preferred’s standards, it is quite a bit stronger than what we've seen elsewhere. Given broad expectations of a slowing economy, particularly regarding real estate activity, where do you think loan growth will be in the fourth quarter and frankly, as we move into early part of 2023?
Li Yu, CEO
Well, as we enter October, the pipeline does not provide enough clarity for precise predictions. However, it greatly depends on how the economy develops. From our marketplace observations, new real estate transactions have significantly diminished, and many of the loans coming to us are subject to much higher standards. Therefore, I wouldn't have high hopes for future loan growth. If we can maintain our third quarter performance, I would consider us very lucky. The actual amounts will depend on the commercial industrial and C&I loans in the fourth quarter, which we cannot control. I apologize for the unclear response.
Gary Tenner, Analyst
Understood. I appreciate the detail you're able to provide. Thank you.
Operator, Operator
Our next question comes from Andrew Terrell from Stephens. Please go ahead with your question.
Andrew Terrell, Analyst
Hey, good afternoon or I guess good morning.
Edward Czajka, CFO
Good morning.
Andrew Terrell, Analyst
So, I wanted to start with some of the deposit growth. It was good to see this quarter. Can you just talk about how you think overall deposit growth trends over the next few quarters? And then I know it seems like we saw some migration from non-interest bearing to interest bearing accounts; do you think we should see a similar level of deposit mix shifts moving forward, or do you expect the change in deposit composition to accelerate from here?
Li Yu, CEO
Well, I will explain and then ask Wellington to provide some additional insights. At this juncture, we manage deposit levels but aim to stay above where we currently are. We don't want to lose any deposits; that's our primary goal. If we have to grow slightly, we will. The source of the deposits is less important than retaining them, especially given the unpredictable outcomes of Fed actions. Additionally, customer behavior has changed; Preferred Bank’s clientele primarily comprises wealthy individuals and business owners who are very savvy with their money and have many options. This means we face much more competition. Consequently, our job is to closely monitor our deposit base on a daily basis. Would you like to add anything, Wellington?
Wellington Chen, President & COO
I couldn't add any more, Mr. Yu; that's perfectly to the point.
Andrew Terrell, Analyst
That's great. I appreciate it, Mr. Yu. Maybe for Ed, do you have the spot cost of deposits, either interest bearing or total at the end of the quarter?
Edward Czajka, CFO
Yes. The total cost of deposits, including DDA, was 96 basis points at the end of the quarter. That was the run rate in September.
Andrew Terrell, Analyst
Okay. And where are you – I know you mentioned the market rates from some of the larger banks for time deposits; where are you pricing new one-year CD rates?
Edward Czajka, CFO
Right around 3 to 3.5%, depending on client relationships.
Wellington Chen, President & COO
We just raised it; we have to continue raising.
Li Yu, CEO
We are changing our rates almost on a weekly basis; that’s how fast the market is changing now.
Andrew Terrell, Analyst
Yes, certainly a quick rate environment. Maybe just one more for me. I wanted to ask about the step-up in loan yields quarter-on-quarter. It's nice to see, but have you looked at updated debt service ratios for your clients? Are there areas of concern in specific segments of the portfolio or geography given the significant upward shift in prime rates?
Li Yu, CEO
Nick, would you like to answer that?
Nick Pi, Chief Credit Officer
Yes, definitely there will be some pressure on the TCR side. However, during the last quarter, the management team on the loan side reviewed all C&I and CRE loans with our officers one-by-one, and we didn't recognize any issues at this time. There are definitely some loans that we need to monitor closely, but we don't see severe trouble currently.
Li Yu, CEO
Well, Andrew, you know that the majority of our loans, over 90%, have personal guarantees. Therefore, when we do our underwriting, we consider personal cash flow and their capability. That's an added protection for our bank.
Andrew Terrell, Analyst
Okay, perfect. Well, congrats on a good quarter and thanks for taking my questions.
Li Yu, CEO
Thank you.
Operator, Operator
Our next question comes from Adam Butler from Piper Sandler. Please go ahead with your question.
Adam Butler, Analyst
Hey, good morning, everybody. This is Adam covering for Matthew Clark.
Edward Czajka, CFO
Hello, Adam.
Adam Butler, Analyst
Getting started with non-interest expenses. I saw that it increased this quarter, mainly due to kind of inflationary pressures. Is that a good run rate to assume going forward?
Edward Czajka, CFO
Yes. We hit 17.4 this quarter, which includes a real estate charge of $300,000. So, you could make a case for a regular run rate closer to 17.1. However, looking forward, we will likely encounter some more increases. On a regular run rate, I would estimate mid-to-high 17s going forward, due to ongoing expense increases, including lease cost increases and personnel additions.
Adam Butler, Analyst
Okay, great. Thanks. And do you have the weighted average rate on new loans in September?
Edward Czajka, CFO
The weighted average rate for new loans in September...
Li Yu, CEO
For the quarter, new loans that we are getting is, when we see 5.99%.
Adam Butler, Analyst
Okay, great. Thank you. That's all my questions.
Li Yu, CEO
Okay. Thanks.
Operator, Operator
And our next question comes from Tim Coffey from Janney. Please go ahead with your question.
Tim Coffey, Analyst
Thanks. Good morning, gentlemen.
Li Yu, CEO
Hi, Tim.
Tim Coffey, Analyst
Most of my questions have been answered, but I did have one for you. Given your geographic reach and specialty, we're hearing from different parts of the country that certain banks are starting to pull back from what we consider core loan products like commercial real estate and certain construction loans. Are you seeing this from your competitors currently?
Li Yu, CEO
What you're observing is correct; I see the same trend. Generally, there is increased caution in the market. Research and assessment are typically more stringent. We are indeed seeing more reluctance among competitors, including ourselves, in approving new loans.
Edward Czajka, CFO
Yes, it's very tricky. The market is cautious; it’s more about being careful than a full pullback.
Tim Coffey, Analyst
Okay, understood. Thank you very much.
Li Yu, CEO
Thank you.
Operator, Operator
Our next question comes from Eric Specter from Raymond James. Please go ahead with your question.
Eric Specter, Analyst
Hey, guys. Just wanted to follow up on the NIM. How do you think about managing rate sensitivity here in light of accelerated betas? How do you prefer to do that - adding floors on your loans, using swaps, increasing fixed-rate lending? I'm just curious about your thoughts on managing rate sensitivity moving forward.
Li Yu, CEO
Many of our loans, as previously disclosed, have floors on them. The majority of our floating rate loans are structured with this in mind. We also plan to incorporate fixed-rate products in the future; however, the timing is uncertain and depends on Fed actions and economic situations.
Edward Czajka, CFO
Managing deposit costs is a delicate balancing act, particularly in an upward environment. It's more of an art than a science. Fortunately, our current asset balances provide a cushion. Regarding rate floors, at last count, roughly three-quarters of our prime-based loans have floors. We have not entered into any swap agreements at this time.
Eric Specter, Analyst
Okay. Thank you for the insights. I noticed that although you've deployed a portion of your cash this quarter, you still have a large portion of assets in cash. How do you intend to deploy liquidity going forward? Is this earmarked for potential deposit flows? Do you have a targeted cash ratio?
Li Yu, CEO
Given the current unsettled environment, cash is essential. I value the advice about maintaining liquidity.
Edward Czajka, CFO
At some point, there will be opportunities to increase the investment portfolio, but I don't think we're ready for that yet.
Eric Specter, Analyst
Got it. Regarding capital, you completed your share repurchase during the quarter. How do you think about that going forward? Are you adopting a more cautious outlook or hoarding capital ahead of a recessionary period?
Li Yu, CEO
In a recessionary period, especially when there are serious recession warnings, maintaining capital is crucial. Not only do we intend to conserve capital, but we believe our shareholders, regulators, and Board of Directors also support this decision.
Eric Specter, Analyst
Understood. One last question about your Houston LPO: how is the pipeline developing there, and what is your appetite for additional de novo opportunities in the near term, given the current backdrop?
Wellington Chen, President & COO
In Houston, we continue to experience positive contributions. We have a full team over there, and our plan is to transition from LPO to full-service branch, which is progressing well. Regarding de novo opportunities, we will evaluate them based on the availability of talent; we won't expand unless we have the right local team.
Eric Specter, Analyst
Got it. Thank you, and congrats again on a great quarter.
Li Yu, CEO
Thank you so much, Eric.
Operator, Operator
And our next question is a follow-up from Andrew Terrell from Stephens. Please go ahead with your follow-up.
Andrew Terrell, Analyst
Hey, thanks for taking the follow-up question. Kind of in the same vein as capital, you're earning a lot more money now with higher interest rates and clearly very profitable. With the efficiency ratio at 25%, I'm curious how you're thinking about possibly using some of this higher income in terms of reinvestment of the franchise. Are there targeted areas earmarked for potential acceleration in franchise investment?
Li Yu, CEO
Would you like to answer that first, Edward?
Edward Czajka, CFO
As Mr. Yu mentioned, entering this environment, capital is key. We're putting much of our earnings aside. One of the first things we might revisit is the dividend level with the Board of Directors; I'm sure that will happen soon. Additionally, the goal is to retain capital; once we have clarity on the economy, we may consider resurrecting our stock buyback plans.
Andrew Terrell, Analyst
Is there a targeted capital ratio or level you're looking to achieve?
Edward Czajka, CFO
In the short term, we want to hold onto what we have over the next six to nine months. We would like to utilize some of our capital where feasible. Ultimately, once the economy stabilizes, we can explore more progressive strategies. For now, safety is our top priority.
Andrew Terrell, Analyst
Yes, understood. I appreciate the follow-up.
Operator, Operator
And ladies and gentlemen, at this time, we've reached the end of today's Q&A session. I'd like to turn the floor back over to the management team for any closing remarks.
Li Yu, CEO
Well, thank you so much. We're thankful to have received questions regarding capital planning. We're fortunate to have performed well this quarter, and we will focus on managing our sales moving forward. Thank you.
Operator, Operator
And ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for joining today's presentation. You may now disconnect your lines.