Preferred Bank (NASDAQ:PFBC) Q2 2023 Earnings Call Transcript

Preferred Bank (NASDAQ:PFBC) Q2 2023 Earnings Call Transcript July 20, 2023

Operator: Good morning. And welcome to the Preferred Bank’s Second Quarter 2023 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask question. [Operator Instructions] Please note, this event is being recorded. I would like now to turn the conference over to Jeff Haas of Financial Profiles. Please go ahead.

Jeff Haas: Thank you, Allan. Hello, everyone. And thank you for joining us to discuss Preferred Bank’s financial results for the second quarter ended June 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 that 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 their 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.

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Li Yu: Thank you. Good morning. I am very pleased to report that the second quarter net income of Preferred Bank was $37.9 million or $2.61 a share, okay. For the quarter, our deposit has increased $181 million under a very, very challenging environment. During the quarter, we have seen strong movement of deposits from lower cost deposits to higher cost deposits, and thankfully, as of June 30th, this movement seems to have moderated. Our bank’s uninsured deposits is 39.9% at June 30th, while liquidity coverage was 41.2%. Since early March, we have been working very hard to help the customer to restructure their deposits to be under the schedule FDIC insurance limit by using CEDAR and using ICS, okay. And we will continue to do so, but during the quarter, we have learned a lot of comments that are quite heartwarming.

Loan growth for the quarter was $61 million. The high interest rate environment has obviously depressed loan demand, okay? And the further increase in interest rate will likely to further depress demand. Our credit quality was stable. At June 30th, our total non-performing loans is less than $1 million, where the total non-performing assets is 0.33 basis points, okay. Classified assets is pretty stable compared to previous quarter and there were no charge-offs during the quarter. We made additional provisions to increase our reserve ratio to 1.4%, and during the quarter, we also written down our OREO assets for $1.9 million. Recently, we have received a lot of increase regarding our exposure in the city of San Francisco, okay, which we have a total loan exposure of $114 million in the city.

As you all know, San Francisco is a tale of two cities, where you have trouble downtown commercial area, connected financial district, connected underlying a little bay area is in trouble, while the other part of the city is at least business as usual. Our total exposure in those trouble area is $34 million as of June 30th. Preferred Bank has a very asset sensitive loan portfolio. Therefore, our net interest income has been resilient these quarters. We have always operated with a simple business model. We have always kept our margin reasonable and our operating costs low. With our strong operating cash flow, we will begin to buy back our own stock. At June 30th, total stock repurchase was 281,000 shares. As of yesterday afternoon, the total repurchase a little over 500,000 shares, okay.

Thank you very much. I am ready for your questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Matthew Clark from Piper Sandler. Go ahead.

Matthew Clark: Hey. Good morning. Thanks for the questions. Maybe just starting with the margin, can you give us the spot rate on deposits at the end of June and then maybe the average margin in the month of June as well?

Li Yu: Ed, do you want to…

Edward Czajka: Sure.

Li Yu: Okay.

Edward Czajka: Yeah. The total cost of deposits for June, Matthew, was 3.24, and the margin was just below 4.5.

Matthew Clark: Okay. And that 3.24 is the month of June or is that the end of June?

Edward Czajka: That’s the month.

Matthew Clark: Okay. Okay. And then thinking through the funding side of the equation and assuming you still have some loan growth, even though it’s likely to slow. It seems like you don’t need to borrow given all the cash on the balance sheet, I mean, is that the lever you are willing to pull, if necessary, if deposit growth doesn’t materialize, are you willing to take down cash to fund loans?

Li Yu: Well, we probably do not need to borrow from Federal Home Loan Bank as other reserve bank anymore. But our cash flow is over $1 billion, right, by June 30th. So that should be more than enough to handle any loan growth, which I don’t really expect to be any significant life [ph] at all?

Edward Czajka: Yeah. We have one of the highest cash to deposit and cash to assets ratio in our peer group. So I think we would be comfortable funding some incremental loan growth with — out of our cash.

Matthew Clark: Okay. Great. And then just on expenses, I mean, you had the OREO write-down, but that’s unlikely going forward from here. So what are your thoughts on the expense run rate in the second half?

Li Yu: You…

Edward Czajka: Yeah.

Li Yu: … take a stab at that?

Edward Czajka: Yeah. I — and looking at the first blush, I am looking at a run rate going forward of probably around $19 million a quarter ex-OREO costs.

Matthew Clark: Yeah. Okay. Great. Thank you.

Operator: Our next question comes from Andrew Terrell with Stephens. Go ahead.

Andrew Terrell: Hey. Good morning.

Edward Czajka: Good morning.

Li Yu: Hi.

Wellington Chen: Good morning.

Andrew Terrell: I wanted to ask on the $34 million of loans in Downtown San Francisco that are mentioned. What types of properties are these? How many make up that $34 million? Is it one or two or a handful of credits and then any color on the LTV amounts or operating stats, as well as the reserve against that $34 million?

Li Yu: Okay. We have seven loans comprised of $34 million. Of these seven loans mostly they are residential properties. There is one office property. The dollar amount is a little less than $900,000. With these seven loans, we have just reviewed and they are not classified or criticized, mostly the residentials.

Andrew Terrell: Okay. Understood. And then on the classified assets, it looks like those are pretty stable quarter-on-quarter, any changes in special mentions that occurred in the second quarter?

Li Yu: Well, Nick, do you want to answer that?

Nick Pi: Special mention loans, the size of that is pretty similar as Q1 is around $60 million at this time.

Andrew Terrell: Okay. Got it. And then just a clarification point maybe on the buyback, I know the full authorization was for $150 million, but if I recall, I think, the initial release said that, there was kind of the first leg of the repurchase program was for $50 million. It sounds like you guys are pretty active on the buyback front even coming into the third quarter. I am just curious, is there any kind of incremental authorization you need to utilize the remaining $100 million or the further $100 million in the plan or can you utilize the full $150 million of the shareholder approved buyback?

Li Yu: We — I don’t think we need any further all those, because our regulatory approval is for $150 million.

Andrew Terrell: Yes.

Li Yu: More so it is our directors — Board of Directors determination offering to use our cash flow again.

Andrew Terrell: Okay. Understood. I appreciate it. Congrats on your quarter.

Li Yu: Thank you.

Operator: Our next question comes from Gary Tenner with D.A. Davidson. Go ahead.

Gary Tenner: Thanks. Good morning. Excuse me. On that buyback question, I don’t think I saw it in the press release, I apologize if I missed it, but of the $281 million purchased in the or repurchased in the second quarter, what was the average purchase price?

Edward Czajka: It was around $55 and just to bring everyone up to speed currently, we have repurchased about 501,000 shares for about $28 million through today or through yesterday so.

Gary Tenner: Okay. Thank you, Ed. And then just any additional color you can provide. You made the comment that the deposit migration has slowed. Your non-interest-bearing deposits are, I think, been around 16% or so, 15 — yeah, 16% of period end balances. Do you have any level of confidence that you can maintain that level or is there still some movement that you think pushes that number lower?

Li Yu: For the month of June, that migration — that level of non-interest-bearing deposits has been reasonably stable, okay? What I was mentioning about the other cost increases, because we do have a large TCD portfolio, okay? And then the portfolio that will be mature and reprice or replace the total amount is a little bit over $1.2 billion in the third quarter with the cost of replacement probably between 1% to 1.25% higher interest cost that is assumed that we only have one bond in the July quarter. So likely that cost will increase in the third quarter, but relatively mild, okay? And if we do have one rate increase in the third quarter, I think, the effect to the net interest margin will be quite mild.

Gary Tenner: Thank you for that. And since you mentioned the amount of time deposits that are going to mature in the third quarter, could you give us the number for the fourth quarter as well?

Li Yu: Yeah. We have not prepared for that yet, I guess.

Edward Czajka: Next quarter, Gary.

Gary Tenner: All right, guys. Thank you.

Edward Czajka: Sure.

Operator: [Operator Instructions] Our next question comes from David Feaster with Raymond James. Go ahead.

David Feaster: Hey. Good morning, everybody.

Edward Czajka: Good morning, David.

Li Yu: Hi.

David Feaster: Maybe just touching on the loan side. In the press release, you talked about higher rates impacting demand, but in the past, you have also — you have been pretty conservative. I am just curious how much of the slowdown in growth do you think truly is slowing demand versus less of an appetite for credit? And then just kind of what’s the pulse of your borrowers across your footprint, where are you seeing good risk adjusted returns at this point and where are new loan yields coming in?

Li Yu: Well, okay. Well, just — Wellington, you add something then I add to you, whatever comment is.

Wellington Chen: All right. Hello, David. This is Wellington.

David Feaster: Hi

Wellington Chen: I think that, I mean, you hit the nail on that. It’s both demand and as well as the appetite, okay.

David Feaster: Okay. And so where are you still seeing good opportunities today? I mean, are there any markets or segments that are still look good from your standpoint?

Li Yu: David, right now, with current environment you are almost all only to have at least 10% debt yield, okay, in order to qualify. There’s just no, I mean, if it is not a whole lot of it either loans that qualify that for those kinds of things. So naturally, there will be less applicants and when we are still doing things is, we have a group of very loyal customers, when they want to do something, they come to us and we try our very best and try to work with them to try to fulfill their needs. And that’s not to say next quarter when necessary planning to a certain degree of loan growth, because this time I doubt how many of our industry. I mean, our fellow bankers can have accurate crystal ball regarding the actual loan increase in the third quarter or fourth quarter, okay? It’s so unclear as far as we are concerned.

David Feaster: Okay. That makes sense. And then maybe just going back to the funding side. I know you guys — you talked last quarter about really going and trying to get some of the depositors that we are diversifying and moving out after the failures that just kind of panicked. Where are you at in bringing some of those guys back or have you had success bringing them back, and I guess, could that be a tailwind for core deposit growth going forward?

Li Yu: We are actually seeing that we — I mean a lot of the customers that had either reduced or left us — shouldn’t say left us, quite reduced, has been replenished their numbers, I mean, with us, okay? And we have not been going on, as you know and try to get a whole lot of new customers, okay, because number one, it doesn’t seem to be there’s a whole lot of opportunity in the marketplace, and number two, can you imagine the competition?

Edward Czajka: Yeah.

David Feaster: Yeah. A good point. And then last one, I just wanted to touch on the SBA department and kind of where we are with the build-out and the early read on that. And just look, the timing of that could be pretty good, just curious where we are there and whether you are still planning to sell or any appetite to retain?

Li Yu: Johnny, do you want to answer that?

Johnny Hsu: Yeah. On the — David, on the SBA department, we are currently an application part. We currently submitted our application for the delegated authority. So we anticipate ramping up the SBA section of our business second half of this year and going forward. And which still — yes, we are still looking to sell where we originate on our — in our portfolio — in that department.

David Feaster: Okay. That’s helpful. All right. Thanks everybody.

Operator: Our next question comes from Tim Coffey from Janney. Go ahead.

Tim Coffey: Thank you. Good morning, everybody. I have a question on the provision, relative to the credit metrics in terms of portfolio and actual charge-offs or not existing charge-off, net charge-off in the quarter. It seemed to be fairly large. If credit trends can remain consistent, do you see reserving at the same level going forward?

Li Yu: Well, personally, I mean, the guru of that is mix. Personally, I think, he is on the very, very, I mean, caution side regarding that, okay. Nick, do you want to give little more color on that?

Nick Pi: Yeah. Tim, there’s a lot of things like ahead of us still, I believe, monitoring policies, rate increases or acuities and a lot of things like high interest cost or pulling back consumer spending or maybe a commercial investment, a lot of things going on there. So a lot of people talking about probably we are going to have a soft landing, but we really don’t know until what happens during the second half of this year. So we try to maintain a more like moderate risk posture at this time. So also a CRE crisis or something like that, everybody is expecting for that. Up to now, we are still okay. However, to be a conservative side, we try to allocate a little bit more on the queue side to cover the CECL limitations.

Tim Coffey: Sure. Okay. Makes sense. I appreciate that color. And then, Ed, do you have any — how should we think about margin going forward? Is June reflective of kind of what you would expect to see the rest of the quarter?

Edward Czajka: That’s a great question, Tim. Obviously, some of it is going to depend on what the Fed ends up doing at their upcoming meeting. So if we get a quarter point hike, I think, it would sustain and kind of hold the margin relatively flat for another month or so. Otherwise, I would see some further compression, I would say, probably, in the neighborhood of $440 million for Q3, somewhere around there.

Tim Coffey: Okay.

Li Yu: You very, very predicting that. There’s a leverage factor and how much can you deposit, how much you…

Edward Czajka: Yeah. Yeah. Obviously, yes. A lot of other factors too. Yeah.

Tim Coffey: Yeah. To the extent — you did speak of deposits during 2Q to the extent you did see some volatility, was the biggest downside volatility earlier in the quarter or was it spread out across quarter?

Edward Czajka: Volatility in terms of deposit pricing or balances or…

Tim Coffey: Balances.

Edward Czajka: I think a lot of that growth happened toward the end of the quarter on the deposit side.

Tim Coffey: Okay. Okay. And then this for Li, as you — you mentioned you have a very asset sensitive balance sheet, a lot of your loans repriced in a fairly short amount of time. To — I imagine the competition for those types of borrowers has gotten intense. Are you having to offer any concessions to retain those customers?

Li Yu: Yeah. We, obviously, that we have — I mean, in order to get the rate sensitive, certainly, holding rate customers it is challenged, especially. If you remember and I’d like to joke about a little bit that we know so much business, especially public business that for the fact, because difference is that we have been kind of the persistent in trying to follow our model and doing floating rate loans with the floor and the floor is for downside protection. What we are doing by that and I think that, I have mentioned many times before, many times we just have to get hit by the face, losing loans opportunity to our competitors, okay? But this is a role we choose. We choose to be — to match assets and liability better. So we just stick with that, okay?

Tim Coffey: Okay. Well, great. Thank you. Those are all my questions. I appreciate your time.

Edward Czajka: Thank you.

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: Well, thank you. This is truly one of the most challenging quarters we have in our history and going to the quarter with the cloud over our head, okay? So we hope the big picture get better and we hope that the rate increase and soon that inflation will be more in place. It seems to be — we start to see the light at the end of the tunnel, okay? If that’s the case, I am obviously happy for everybody in our industry that we will be able to do things in the more normal ways, okay? Having to do that, that we are happy so far, we — I think we are doing fine. Thank you.

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