Earnings Call Transcript - PFBC Q1 2024

Jeff Haas, Financial Profile

Thank you, Nick. Hello everyone. Thank you for joining us to discuss Preferred Bank's financial results for the first quarter ended March 31, 2024. With me today for management are Chairman and CEO Li Yu, President and Chief Operating Officer Wellington Chen, Chief Financial Officer Edward Czajka, and Chief Credit Officer, Nick Pi. 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 in 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. I'm very pleased to report that Preferred Bank's first quarter net income of $33.5 million, or $2.44 per fully diluted share. This quarter, our loan growth was annualized at 4% and deposit growth was 6.5% annualized. This quarter, our net interest margin is 4.19%, which is a slight decrease from the previous quarter. Looking ahead to the second quarter, we believe NIM will likely also compress, but we don't think it's going to be very significant. It's going to be mild compression. The reason for the compression in the first quarter is a continued increase in the cost of deposits. As of March 31, total criticized loans are $87.6 million, which is $3.6 million higher than the $83 million at year-end. I know there's a mistake somewhere, but you have to round off three numbers. Non-performing loans have reduced from $28.7 million at year-end to $18.2 million in the first quarter end. This quarter, we had a charge-off of $3.5 million related to loans that were previously identified with loss content and fully reserved for them. This quarter, our provision is $4.4 million. The reserve allowance now stands at 1.49%. On the business side, we have just opened a new branch in the Orange County, Irvine area. This is a full-service branch staffed with a team of deposit personnel and a team of loan personnel. We have also, as of right now, opened a Sunnyvale loan production office in the Silicon Valley area. We plan to continue to add relationship personnel for the remainder of the year. Since the third quarter of last year, we have been trying to reduce the sensitivity of our loan portfolio, and as of today, we believe it is a much better balance with our deposit composition. With the current changes in the trend of interest rate movement, we will monitor the situation and make the necessary adjustments to manage our interest rate risk even better. Thank you very much, and I'm ready for your questions.

Operator, Operator

We will now begin the question and answer session. The first question comes from Matthew Clark with Piper Sandler. Please go ahead.

Matthew Clark, Analyst

Good morning, everyone. Maybe, Ed, just to start on the NIM. Trying to get some visibility into the second quarter, do you have the average NIM for the month of March and the spot rate on deposits at the end of March?

Edward Czajka, CFO

I was ready for you, Matthew. The NIM for March was 4.11%. The spot rate on deposits was 4.04%.

Matthew Clark, Analyst

Okay. And that 4.04% was at the end of the month, or was it the average in March?

Edward Czajka, CFO

That's the average for the month of March, yes.

Matthew Clark, Analyst

Okay, got it. And then, I think you all hired some producers in the fourth quarter, and you had some good growth in both loans and deposits. I want to get a sense of your pipeline of loans and deposits and your growth outlook for the year.

Li Yu, CEO

Well, first of all, I don't think we have hired too many people in the fourth quarter, but also in the first quarter. You know, when you add relationship officers, usually it takes about one and a half to two quarters before they start to materialize. And also, as you probably know in our business, for every ten people you hire, you hope everyone works, but that’s not necessarily the case. But we hope there will be some stars that balance out the whole situation. With the pipeline, do you want to explain the pipeline first?

Edward Czajka, CFO

Well, thank you, Mr. Yu. Matt, our pipeline is pretty healthy. I think that we are really, as Mr. Yu mentioned, focused on taking care of our existing customers. Right now, there's quite a bit of opportunity for them. And that's our priority. So, in turn, yes, that's what we are focusing on. The pipeline is pretty healthy.

Matthew Clark, Analyst

Okay. And then the other question I had was about the CD repricing. Can you remind us what you have coming due over the next couple of quarters regarding the rate differential and when that gap might close completely?

Edward Czajka, CFO

Yes. So, we have Q2 maturities of about just $100 million at an average rate of 4.9%. So, we don't see a lot of differential there with respect to what's going to be maturing and what's going to come back on. Q3, that number dips a little to $374 million in terms of maturities. So, we don't expect a lot of movement as far as TCD rates going up dramatically from the portfolio rate that we're at right now.

Matthew Clark, Analyst

Okay. And then just on credit, can you remind us of the non-performer that you're able to sell at par? What type of credit was that? Obviously, great to see. And then just the incremental increase in criticized loans. I know it wasn't a big number, but I would just like some color there?

Li Yu, CEO

Well, obviously, these things come in and out and fall under different stages of law. Some of those criticized loans will migrate into the non-performing area. Our job is to identify them in the early stage and provide a proper reserve for the whole situation. The loss content has been accounted for and will not affect future years. So, in terms of your question, Nick, do you have anything to add?

Nick Pi, Chief Credit Officer

No, really. Just to give you a little more color about those two loans, they were sold at par with a small premium. As Li Yu mentioned, there is migration in and out in terms of credit. I believe we didn't notice any significant trend on the credit side.

Matthew Clark, Analyst

Great. Thank you.

Operator, Operator

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

Andrew Terrell, Analyst

Hey, good morning.

Nick Pi, Chief Credit Officer

Good morning, Andrew.

Andrew Terrell, Analyst

My first question was around just the loan yield expansion. You saw this quarter, it increased by seven basis points sequentially. I was just curious if there was any outside interest recovery or anything like that, something more one-time in the first quarter loan yields, or was this more just the function of loan growth and churn in the portfolio towards higher rates?

Edward Czajka, CFO

Yes. Good question, Andrew. We actually had a prepayment penalty on a fairly large credit in the month of March, a little over $200,000, and that helped to drive yields just a little bit.

Andrew Terrell, Analyst

All right, just a little above $200,000.

Edward Czajka, CFO

Yes.

Nick Pi, Chief Credit Officer

Yes, these things happen each quarter. We hope that we have some prepayment penalty in each quarter, although it's very interesting. I'm not trying to, it's just -

Andrew Terrell, Analyst

Understood. Got it. Yes, we'll hope for more. I was looking at a comment from your earnings release regarding the rate sensitivity position and some adjustments in the loan portfolio to dampen that sensitivity. But looking back at the annual report, I think you guys disclosed a down 7% to net interest income with negative 100 basis points in the short term rates. Has that moderated significantly as of March 31? Can you speak a bit more to how the balance sheet has tempered in terms of rate sensitivity?

Edward Czajka, CFO

It has tempered. I can't give you the number right now on the down 100 scenario, Andrew. Suffice to say what Mr. Yu was alluding to earlier is a number of things, including doing a few more fixed-rate loans than we've done in the past. With respect to loans that are renewing or coming up for renewal, if they are remaining floating rate, we are moving the floors up from where they were previously.

Li Yu, CEO

I'll fix that situation. Now, I can give you a rough number. I can't tell you exactly about the down 100 basis points and so on. We haven't gotten a chance to do that. I think previously, we disclosed that rate-sensitive loans were around 87%. I can't quote you exactly now, but we're down to about mid-70% or maybe slightly lower than mid-70%. So if you compare that to the sensitive liabilities we have, we believe we're in pretty good balance right now.

Andrew Terrell, Analyst

Yes, okay. Yes, the mid-70s is definitely a big move. That's really helpful. I appreciate it. And then maybe one on the expense base. Just expectations on the second quarter expense run rate. I know that it looks like maybe a new LPO is opening, and I'm just curious about how you see expenses trending in the second quarter.

Edward Czajka, CFO

So, a number of things that Mr. Yu and Wellington alluded to; we have the new Irvine office, which is in a prime location in Orange County at the Culver Center in Irvine. Additionally, the Silicon Valley LPO requires staff as well as lease costs. Moving forward, I think the $20 million you saw this quarter is probably a fair estimate for the next quarter, plus or minus.

Andrew Terrell, Analyst

Okay. Very good. Thank you for taking the questions this morning. I appreciate it.

Li Yu, CEO

Thank you.

Operator, Operator

Our next question comes from David Feaster with Raymond James. Please go ahead.

David Feaster, Analyst

All right. Good morning, everybody.

Li Yu, CEO

Good morning, David.

David Feaster, Analyst

You touched on the two MPAs. I was hoping to get your thoughts on credit more broadly. You've got a track record of being aggressive managers of credit. I'm curious, what are you seeing more broadly in the health of your clients? Are you seeing any signs of stress? And just any thoughts on credit more broadly from your perspective?

Li Yu, CEO

Okay, let me state that from way back, let's say in 2022, when we started to worry about the rates, credit and inflation, if I had seen or thought that, almost two years down the line, with the charge-offs we have had, the loss we had, and the level of non-performing loans and criticized assets as of today, I wouldn't have been so optimistic. But as you know, the trick in dealing with credit is to try to identify early and fully reserve for them. That's our basic principle. Talking about our customer's concerns, most of our customers are starting to turn a little more positive. Obviously, inflation is one factor that is decreasing, and another factor is stabilization of rates, although everybody would like to see a decrease. We all know that, sooner or later, rates will go down. From what I read regarding all the big banks reporting numbers, their credit posture is better than expected based on internal expectations. Generally speaking, I think the marketplace is starting to see the light at the end of the tunnel. Many of our more opportunistic customers are starting to think about new investments.

David Feaster, Analyst

That's great color. Does that indicate that maybe you're having a bit less cautiousness and that we might see growth start to accelerate? It sounds like demand is starting to improve. You mentioned improving pipelines. It seems like you've strategically decelerated growth from the conversations we've had. Are you less cautious today and do we expect to see growth re-accelerate in the back half of the year?

Li Yu, CEO

I don't want to associate growth with being less cautious. I think the more appropriate situation is that we finally seem able to take on opportunities presented to us and we have to be ready. As you know, our personnel's production typically takes three to six months to materialize. So that's not an immediate effect. The general feeling is that, as I said, I personally believe that rates are finally coming down and eventually will stabilize into a new norm situation, which will be reasonably lower than today. Each pricing activity is adjusted to the new loan, new rate, new inflation, and product numbers, and things will start to normalize themselves. With our current economic strengths, I personally believe that business opportunities have increased and there will be less risk in conducting transactions today compared to a year ago.

David Feaster, Analyst

That makes sense. That's really helpful. Thank you for that color. Then lastly for me, following up on the branch expansion and LPO, I'm excited to see the continued expansion and investment. I'm curious how you think about de novo expansion priorities at this point. What other markets are interesting to you? Where are you focusing your efforts?

Li Yu, CEO

David, our expansion has two different directions. One is in areas where we think there's a lot of business to capture, and another is when we have the right personnel. Since Preferred Bank is a small institution, we can operate in various locations and generate a reasonable amount of business. Therefore, when we find a banker with a book of business, we tend to build a team around them and set up operations there. Silicon Valley is one area we've wanted to be in for some time, and we finally located a couple of people who seem to fit our needs. We're starting our operation there; it's a good place for us and likely with the right people.

David Feaster, Analyst

That's helpful. And I'd like to squeeze one more in. You've been active in repurchasing stock. Given the potential for growth to accelerate, I'm curious about your capital priorities and appetite for more buybacks.

Li Yu, CEO

We have always let our shareholders know that growth, in normal situations, is our preference as it represents the best long-term value. However, in the last three to four years, beginning with the pandemic and inflation, while the bank is making over a 20% return with alternative costs in the 5% range, it does not seem wise to have idle cash. With idle cash yielding around 5%, the buyback of stock represents a pre-tax 33% return. Economics tells me that our shareholders might prefer us to take this approach over the long term.

David Feaster, Analyst

That makes a lot of sense. All right, thanks everyone.

Operator, Operator

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. As I said, we're very happy with the quarter, and hopefully, I believe that things are starting to stabilize and will only improve for the banking industry moving forward. Thank you.

Operator, Operator

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