Earnings Call Transcript - PFBC Q3 2025

Operator, Operator

Good morning, and welcome to the Preferred Bank Third Quarter 2025 Earnings Conference Call. Please note that this event is being recorded. I would now like to turn the conference over to Jeffrey Haas with Financial Profiles. Please proceed.

Li Yu, Chairman and CEO

Thank you. Good morning. I'm very pleased to report to our shareholders that we have a record earnings per share of $2.84 a share for the third quarter of 2025. Our net income for the quarter was $35.9 million. Both numbers compare very handsomely with previous quarters. This quarter, our credit quality has improved. Nonperforming loans have been reduced from $52 million to $17 million, largely because of one loan of $37 million that we have foreclosed and moved to Other Real Estate Owned, but the good news is that this OREO was sold as of today, sold in October, for a reasonably good gain. We tried very hard to close it on September 30, but didn't make it. All other metrics of credit quality seem to be stable. I took a look at all the charge-offs for the year, which totaled a very acceptable $1.8 million. This quarter, we had some reasonable loan growth and deposit growth, with loan growth of 2.3%, or $133 million, and deposit growth of 2.5%, or $151 million. It seems to us that in the marketplace, our shareholders or our customers have really become a little more optimistic in their businesses, but still remain quite cautious because there are a lot of uncertainties still remaining in our economy. Looking forward to the fourth quarter of 2025, we think there will be some reasonable loan growth, hopefully matching the numbers from the third quarter. Our net interest income and net interest margin both improved in the third quarter from the previous quarter. We have kept our operating overhead or noninterest expense pretty steady compared to previous quarters. Because of the increased net interest income, our efficiency ratio is now less than 30%. All other aspects of the operation seem to be pretty stable. During the third quarter, we repurchased $6.3 million of our own shares. Having said all the good things about this quarter, we have to admit that we found ourselves making a mistake in the past in calculating the diluted earnings per share numbers as of June 30, 2025, which resulted in underreporting the net income for the first half by $0.05. However, this number has been properly updated in this report's year-to-date number. Thank you very much, and I’d like to answer your questions now.

Operator, Operator

The first question comes from Gary Tenner with D.A. Davidson.

Gary Tenner, Analyst

I was hoping you could update us a little bit on just where the loan portfolio should stay from a floating rate component. I think as we've gone through the last several quarters of having the rate cuts late last year and then the one in September, I think you would have cleared at least some portion of the floors you have in the portfolio. So could you talk about the variable rate or the floating rate bit of the portfolio and where the floors are at this point?

Li Yu, Chairman and CEO

Ed?

Edward Czajka, Chief Financial Officer

Yes, Gary. As of September 30, about 29% of the book is either fixed rate or long adjustable, and 71% is floating. Of that 71%, 98% has floors on them, although as we've discussed before, some of those are not in the money. We have about $1.6 million of loans with floors that would kick in within the next 100 basis points of decline. Right now, we only have about $55 million that are at or below the floor where the floor is kicking in. So we still have a ways to go for many of these loans before the floors start to become meaningful.

Gary Tenner, Analyst

Great. And then just as it relates to the buyback, I know there was some activity this quarter. Can you talk about just price sensitivity around the buyback?

Li Yu, Chairman and CEO

Well, we sort of measure the buyback against the income level we have and the share price we have. From quarter to quarter or month to month, we will review our position to come to the point of how much we want to do the buyback. It has something to do with our growth rate as well. As you know, when the growth rate becomes stronger, our buyback may slow down a little bit. But we are measuring it based on—there's no set formula for it.

Gary Tenner, Analyst

Okay. Fair enough. Go ahead, Ed.

Edward Czajka, Chief Financial Officer

No, I was just going to add to that for everyone else on the line as well. We have been active in the month of October. We repurchased 128,000 shares in October because we had some price softness over the last few weeks for $11.2 million.

Gary Tenner, Analyst

Appreciate that. If I could just ask one more question. In terms of the loan yields in the quarter, was there any noise in that number? Or was it a pretty clean number?

Unknown Executive, Executive

I think that's pretty...

Edward Czajka, Chief Financial Officer

Yes. The noise was in the prior quarter, Gary.

Operator, Operator

Our next question comes from Adam Kroll with Piper Sandler.

Adam Kroll, Analyst

This is Adam Kroll on for Matthew Clark. So maybe just to start on the margin. I was wondering if you had the average margin in the month of September and the cost of deposits.

Edward Czajka, Chief Financial Officer

The margin for September was $3.87. Cost of deposits was $3.36.

Adam Kroll, Analyst

Okay. Perfect. And then how are you thinking about the margin in the fourth quarter, assuming we get a rate cut later this month in December as well? What do you have coming due on the CD side and the rate that that’s rolling off versus what’s coming on today?

Edward Czajka, Chief Financial Officer

Okay. Well, there's a lot in that packed in there. But I'll start. First off, we've got about $1.27 billion of CDs maturing at an average rate of 4.10% in Q4. CDs are now coming on in the mid- to high 3s, so we'll expect some benefit there. In terms of the margin for Q4, given the rate cut we had in September and what we're likely to have in Q4, we are not as asset sensitive as we have been in the past, not only because of the larger portion of fixed rate and longer-dated adjustable rate loans but also due to the fact that many of our corporate deposit clients whose interest rates on interest checking and some money market accounts are directly tied to the Federal funds rate. So when Federal funds does move, we do get to move a fairly sizable chunk downward in terms of the pricing. That has been very beneficial in managing the margin. It has not been declining even though we've been in a declining rate environment.

Adam Kroll, Analyst

Got it. That's super helpful. And then last one for me. I’d be curious to know just what you're seeing on the credit migration front within criticized and classified.

Li Yu, Chairman and CEO

Well, credit migration seems to be in a pretty reasonable situation. Nick, do you want to answer that?

Nick Pi, Chief Risk Officer

Yes. In Q3, I believe our asset quality will be in line with our expectations. All the probable loans and our solution side are also developing as we expected. So we do not have any serious issues at this time. Management is closely monitoring some of these situations that are currently happening.

Operator, Operator

Our next question comes from Andrew Terrell with Stephens.

Andrew Terrell, Analyst

I wanted to check in first just on loan growth. This year, I heard the comments that you're hoping to start off next year at this high single-digit loan growth rate. But I'm curious the extent to which you have visibility in the fourth quarter, just how pipelines are shaping up. It sounds like reading between the commentary that you'd expect slower growth in the fourth quarter, but I just want to make sure I've got that right.

Li Yu, Chairman and CEO

We think there will be growth in the fourth quarter. We hope that we’ll do as much as in the third quarter, but it is still October, slightly early, okay? The activity level seems to be maintaining at the pace of the third quarter. Internally, we hope that maybe with the interest rate cut in the later part of the third quarter, the first quarter will be even more helpful to our loan growth. All this is still kind of up in the air, especially with every holiday season being very much different for us. Some holidays, people seem to be busy closing loans left and right. Other holidays seem to have people vacationing more than ever. So, it is something that is pretty hard for us to have a very clear picture, but the general trend is upwards.

Andrew Terrell, Analyst

Okay. Great. That's good to hear. And then, Ed, if I could check in with you on just expenses. You guys have been running, if I back out the OREO for the past couple of quarters, in that low $21 million territory. Just wanted to get a sense of your expectations for the near-term expense run rate, if that's still a fair approximation. As we look out to 2026, anything we should be aware of budget-wise or just a check-in on the rate of expense growth, or just general expectations.

Edward Czajka, Chief Financial Officer

Well, yes. As you said, we had a small OREO piece for this quarter, so we came in at $21.5 million on noninterest expense. I would expect to see around $22 million to $22.5 million going forward, and then probably going up anywhere from $250,000 to $500,000 a quarter in '26.

Andrew Terrell, Analyst

Great. I appreciate it. And then I've actually got a question around the deposit composition this quarter. You had a really strong growth in the interest-bearing demand category, but a little less so in some of the time buckets. I'm curious if there was any contemplated mix shift that you guys did or if that’s just how deposits came in this quarter. Just any color on the flows in the specific deposit buckets would be helpful.

Li Yu, Chairman and CEO

On a strategic basis, we certainly like to increase our demand deposits and low-cost demand deposits. But it's becoming harder and harder to obtain nowadays because all the institutions that have large cash balances all like to be paid more for their money. This is a trend where more cash is being moved from DDA accounts and noninterest-bearing DDA accounts to interest-bearing DDA accounts. Our job, I think, is to manage the cost of interest-bearing DDA accounts properly and going forward from a strategic perspective. Other than that, it's banking normally. We accept whatever we have at reasonable costs and take it when it's available, hoping that it becomes the funding base for growth.

Edward Czajka, Chief Financial Officer

Andrew, with this quarter's fairly strong deposit growth, we were able to let some of our brokered CDs run off and not renew as well, so that was advantageous.

Andrew Terrell, Analyst

Yes. Got it. Okay. If I could actually just sneak one more in, do you have the specific dollar estimate of the expected OREO gain in the fourth quarter? Probably in the $3 million to $4 million range.

Li Yu, Chairman and CEO

Probably in the $3 million to $4 million range.

Operator, Operator

Our next question comes from David Feaster with Raymond James.

David Feaster, Analyst

I just wanted to switch back to the loan growth side. Excluding the OREO transfer, you're in the low double digits. It sounds like you're expecting growth to remain relatively stable, which is really strong. I'm just curious, could you touch on how demand is trending, perhaps providing a little color on the pipeline, how new origination yields are, and where you're seeing more opportunities today? Is this a function of gaining share or might some of that uncertainty that we've talked about in the past lead to more confidence in the economy? Just curious what you're seeing from that perspective.

Li Yu, Chairman and CEO

Do you want to answer that first? I’ll add to it.

Unknown Executive, Executive

Yes. The loan growth for the third quarter was as Mr. Yu mentioned, our existing customers are confident and there’s more activity. We’ve seen an increase in C&I activity. Additionally, other activities are with new relationships that we've been building on over the years, and it sometimes takes a while to bring them in-house. We're also looking at CRE activity, construction loan advances, and that's why we're optimistic about the fourth quarter being similar to the third.

Li Yu, Chairman and CEO

Do you want to add anything, Johnny?

Unknown Executive, Executive

Yes. I think you’re right. We see our teams able to see more deals coming through the pipeline. With more deals being reviewed and with the rate cuts, we’re seeing a bit more optimism from borrowers and thus, more opportunities for us.

Li Yu, Chairman and CEO

So I guess you have a feeling for the situation. But obviously, the common-sense logic is that with the rate cuts, hopefully, there will be two rate cuts before the end of the year, and many transactions that were previously not doable are now much more doable in terms of financing. There are some borrowers who are finally willing to sell because they can get a slightly better pricing scenario. We are hopeful that especially in the CRE side, there will be some growth.

David Feaster, Analyst

That’s a great point. Could you touch on the competitive dynamics? Also, in the past year or so, payoffs and paydowns have been a headwind. Has that slowed at all? Or, to your point, more people selling could introduce payoffs and paydowns as a bigger headwind as we look forward? Just curious about your thoughts.

Li Yu, Chairman and CEO

In my past 34 years, payoffs have always been a painful situation for us. I expect it to continue. It's expected that it may accelerate because many of the loans at other institutions are priced at a higher interest rate than what is currently on their books. Obviously, many borrowers are looking to lower their interest burden by refinancing, which I predict will become a national sport. While we are dealing with payoffs, we hope to also capture some of the additional origination that will come alongside.

David Feaster, Analyst

Okay. And you have been really active managing your asset sensitivity, and you’ve done a great job getting ahead of this. It sounds like it's much less significant than it has been in the past. You’ve got the floors that should also help. Are there any other actions you plan to take to manage your asset sensitivity, or do you feel that most of that is already covered? Would you expect, for instance, to put more into the securities book or do more fixed rate, or just any of those types of maneuvers? Or are you comfortable with where you're sitting now?

Li Yu, Chairman and CEO

I think most of the actions we continue to take are proactive interest rate management. If you remember, we were once a 90% floating rate loan bank, and now we are down to nearly 70% floating rate loans, which took about 1.5 years to achieve. We started this process a while back. The trend is to do the best we can in assessing interest rate trends and making adjustments from time to time, either by switching to more fixed rate loans or more floating rate loans. This is constantly in our DNA. It’s what helps us maintain acceptable returns on equity and investment. In the meantime, obviously, between the securities, given their yield and the marketplace, we will make the necessary adjustments from time to time. But by and large, that is likely less than 10% of our balance sheet, so it’s not as critical compared to managing the loan portfolio.

David Feaster, Analyst

Do you think, as we look over to next year or even into 2027, that any of these moves to reduce some of that rate sensitivity might limit some of the upside in the margin? Or do you still see potential for improvement? Given your current composition of rate sensitivity on the balance sheet, do you still think it’s possible to achieve margins above 4%?

Li Yu, Chairman and CEO

Actually, if you analyze our sensitivity level, we are reasonably balanced. In the short term, we are a bit rate sensitive. In the intermediate term, because our deposit portfolio includes a large time certificate deposit, we are really a rate liability-sensitive asset. That is why we’re in a position to improve earnings in the third and fourth quarters because of this balancing factor. In the future, of course, there’s no set formula. I don’t think anyone has a playbook in banking on how to handle these things other than staying alert and doing your best.

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, Chairman and CEO

Thank you very much for your interest in Preferred Bank. We’re very pleased that we were able to report a very good quarter of results, and we hope it will continue for our shareholders. Thank you.

Operator, Operator

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