Preferred Bank - Q1 2024

Transcript

Operator (participant)

Good day and welcome to the Preferred Bank first quarter 2024 earnings call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by 0. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then 1 on a touch-tone phone. To withdraw your question, please press star, then 2. Please note this event is being recorded. I would now like to turn the conference over to Jeff Haas from Financial Profiles. Please go ahead.

Jeffrey Haas (Senior VP)

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 from 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 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 (Chairman and 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 previous quarter. Looking ahead, the second quarter NIM likely will also compress, but we don't think it's going to be very significant. It's going to be a mild compression. The reason for the compression in the first quarter is continued increase in cost of deposits. As of March 31, total criticized loans is $87.6 million, which is $3.6 million higher than the $83 million at year-end. I know there's a math mistake somewhere, but that's because you have to round off three numbers.

Non-performing loans have reduced from $28.7 million at year-end to $18.2 million in first quarter-end. This quarter, we have a charge of $3.5 million related to loans that previously identified with loss content and fully reserved for. This quarter, our provision is $4.4 million. The reserve or allowance now stands at 4.0, I mean, 1.49%. On the business side, we have just opened a new branch in Orange County, Irvine area. This is a full-service branch staffed with a team of deposit personnel and a team of loan personnel. We also, practically, as of right now, this minute, opened up a Sunnyvale Loan Production Office in the Silicon Valley area. We plan to continue to add relationship personnel in the remainder of the years. Since third quarter last year, we have been trying to reduce the sensitivity of our loan portfolio.

As of today, we believe it's a much better balance with our deposit composition. With the current changes and trend of interest rate movement, we will obviously monitor the situation and make the necessary adjustments to control our interest rate risk even better. Thank you very much, and I'm ready for your questions.

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star, then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our roster. The first question comes from Matthew Clark with Piper Sandler. Please go ahead.

Matthew Clark (Managing Director)

Hey, good morning, everyone. Maybe Ed, just to start on the NIM, I'm trying to get some visibility into 2Q, if you had the average NIM in the month of March and the spot rate on deposits at the end of March?

Edward J. Czajka (CFO)

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

Matthew Clark (Managing Director)

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

Edward J. Czajka (CFO)

That's the average for the month, yeah.

Matthew Clark (Managing Director)

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

Li Yu (Chairman and CEO)

Well, first of all, I don't think we have added too many people in the fourth quarter, but also in the first quarter, okay? When you add the relationship officers, usually it takes about 1.5-2 quarters before they can materialize into their portfolio start to materialize. And also, as you probably know in our business, that for every 10 people you hire, you hope everyone works, but not necessarily, okay? But hopefully, that we'll land some stars that balance out the whole situation. With the pipeline and one of the things you want to explain the pipeline first, okay?

Jeffrey Haas (Senior VP)

Well, thank you, Mr. Yu. Matt, our pipeline is relatively pretty healthy. I think that we are really, as Mr. Yu mentioned, that really focused on taking care of our existing customer. Right now, there's quite a bit of opportunity for them, and that's our priority. In turn, yeah, that's where we are. The pipeline is pretty healthy.

Matthew Clark (Managing Director)

Okay. I'm sorry. The other question I had, I think, was oh, yeah, around the CD repricing. Can you just remind us what you have coming due over the next couple of quarters in the rate differential and when that gap might close completely?

Edward J. Czajka (CFO)

Yeah. So we have Q2 TCDs of about just under $1 billion maturing. They're 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, with respect to what's going to come back on. Q3, that number dips a little bit to $374 million in terms of maturities. So we don't expect a lot of movement from the standpoint on the deposit side from TCD rates going up dramatically from the portfolio rate that we're at right now.

Matthew Clark (Managing Director)

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

Li Yu (Chairman and CEO)

Well, obviously, these things are coming in and out and at different times, at different stages of work. Some of those criticized loans will migrate into the non-performing area, and obviously, it is our job to identify them in the very early stage to provide a proper reserve on the whole situation, okay, so that the loss content has been accounted for and will not be affecting the future years, okay? So with your question, Nick, do you have anything to add?

Nick Pi (Chief Credit Officer)

No, really. Just give you a little bit more color about those two loans related together. We sold the note at the par plus a little bit smaller premium on that. So just like Mr. Yu mentioned, it's migration in and out for credit. So I believe we didn't notice any significant trend of credit side.

Matthew Clark (Managing Director)

Great. Thank you.

Operator (participant)

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

Andrew Terrell (Managing Director)

Hey, good morning.

Wellington Chen (President and COO)

Good morning, Andrew.

Andrew Terrell (Managing Director)

My first question was around just the loan yield expansion you saw this quarter, 7 basis points sequentially. It was up pretty nice. I was just curious, was there any kind of outsized interest recovery or anything like that more one-time in the 1Q loan yields, or was this more just the function of loan growth and kind of churn in the portfolio towards higher rates?

Edward J. Czajka (CFO)

Yeah. Good question, Andrew, and good pickup there. 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 (Managing Director)

All right. Just a little above 200,000?

Wellington Chen (President and COO)

Yeah.

Li Yu (Chairman and CEO)

Yeah, these things happen each quarter. We hope that we have some prepayment penalty each quarter, although it was varying degrees. I'm just not trying to be cynical at all.

Andrew Terrell (Managing Director)

Understood. Got it. Yeah, we'll hope for more. I was looking at a comment from your earnings release around the rate sensitivity position and kind of some adjustments within the loan portfolio to maybe dampen out that sensitivity. But looking back at the annual report, I think you guys are disclosed down 7% to NII with -100 basis points in short-term rates. Has that moderated significantly as of the 3/31? Or can you just speak a little more to how the balance sheet is tempered in terms of rate sensitivity?

Edward J. Czajka (CFO)

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

Li Yu (Chairman and CEO)

Oh, I'll fix it with the situation.

Edward J. Czajka (CFO)

Or, or, or.

Li Yu (Chairman and CEO)

No, I can give you a rough number right now. I cannot tell you the exactly down 100 basis points or what. We haven't got a chance to do that. I think previously, we were disclosed to you our I mean, rate-sensitive asset loans. It's about in the 80-some percent, okay? 87%. I can't quote you exactly.

Edward J. Czajka (CFO)

It's about 80.

Li Yu (Chairman and CEO)

Now we're down to about mid-70%, okay? Or maybe slightly lower than mid-70, okay? So if you compare to the—I mean, liability-sensitive liability we have, okay—that we're in pretty good balance right now.

Andrew Terrell (Managing Director)

Yeah. Okay. Yeah, the mid-70s was, yeah, definitely a big move. That's really helpful. I appreciate it. And then maybe one on the expense base, just expectations on kind of the 2Q expense run rate. I know. There's it looks like maybe a new LPO opening. Just curious on how you see expenses turning in the second quarter.

Edward J. 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, prime location in Orange County in the Culver Center in Irvine. In addition to that, the Silicon Valley LPO, both of those require staff as well as lease costs. So I think going forward, I think the $20 million you saw this quarter is probably a fairly plus or minus going forward for next quarter.

Andrew Terrell (Managing Director)

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

Li Yu (Chairman and CEO)

Thank you.

Operator (participant)

Again, if you have a question, please press star, then one. Our next question comes from David Feaster with Raymond James. Please go ahead.

David Feaster (Managing Director)

Hey, good morning, everybody.

Wellington Chen (President and COO)

Good morning.

David Feaster (Managing Director)

You touched on the two NPAs, but 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 (Chairman and CEO)

Okay. Let me state that from way back, let's say in 2022, okay, or a little bit earlier, when we started to worry about the rates and credit and so on and the inflation and so on, if I have seen a thought that with this period, almost two years gone by, with the charge-offs we have and the loss we have had and the level of NPLs and the level of criticized assets is as of today, I wouldn't be so happy those days, okay? But as you know, that one of the tricks in dealing with the credit is try to identify early and try to fully reserve that, okay? So that's our basic principle. But talking about with our customer's concern, most of our customer started to turn a little bit more positive. And basically, obviously, inflation is one factor that is down.

Another factor is the rate is stabilized, although everybody would like to see it down a little bit. We all know from this point on now, sooner or later, it's going to be lower. It's a matter of whether it's half a year or one year or whatever it is. Sooner or later, we'll be back on that. From what I read for all the big banks reporting numbers, their credit postures are also better than internally expected or what, okay? Generally speaking, I think the marketplace is starting to feel, see the light at the end of the tunnel. In fact, many of our more opportunistic customers are starting to think about new investments.

David Feaster (Managing Director)

Okay. And that's.

Li Yu (Chairman and CEO)

I wonder if that's all the questions you have. I mean, any additional thing related to that?

David Feaster (Managing Director)

That's great color. Does that mean does that indicate that maybe you're having a bit of maybe less cautiousness and maybe that we should see growth start to accelerate? It sounds like demand is starting to improve. You alluded to improving pipelines. It seems like you've strategically decelerated growth from the conversations that we've had. Does it sound if I'm reading between the lines that maybe we could see you're a bit less cautious today, and we could see growth re-accelerate in the back half of the year?

Li Yu (Chairman and CEO)

Well, I don't want to be really associated growth being less cautious, okay? I think that if I try to put it right, the situation is that it finally seems to be that we can take on the opportunity that will be presented to us, and we have to be ready. As you know, your ad personnel, that their production will come maybe three to six months later, so that's not immediate effect on that. The general feeling is that, as I said, to me, I personally believe the big picture is that rates are finally coming down, and sooner or later, it will stabilize into a new norm situation, which will be reasonably lower than it is today. Although every pricing activity is adjusted to the new rate, and every pricing is new, the inflation number, product number, things will start to sort of normalize themselves.

With our current strengths of the economy, I personally believe the business opportunity has increased, and there will be less risk doing transactions today as compared to one year ago.

David Feaster (Managing Director)

That makes sense. Makes a lot of sense. Thank you for that color. And then last one from me, maybe just following up on the branch expansion LPO. I love seeing the continued expansion and investment. I'm curious, how do you think about de novo expansion priorities at this point? What other markets are interesting to you? And just kind of curious how you think about as you continue to expand, where are you focused?

Li Yu (Chairman and CEO)

David, our expansion really has two different directions. One is that the areas we think we have a lot of business, okay, or we want to be. Another situation is that when we have the personnel. And Preferred Bank is small institutions, so almost we can go anywhere and get a reasonable amount of business with a new operation. And therefore, if we are finding the banker has the book of business, we tend to build a team around him and, I mean, settle down with the operation there. Having said that, and Silicon Valley is one of the areas that we have wanted to be there, and then we have never been able to get the right personnel in the last 10 years so on. Finally, the situation comes. Wellington's able to locate a couple of people he thinks will be fitting to our needs and so on.

We are starting that particular offering. It's the right place for us, and probably the people are the right people now.

David Feaster (Managing Director)

Okay. That's helpful. Maybe just if I got to squeeze one more, you've been real active repurchasing stock. Curious maybe with potential for organic growth to accelerate and the move in the stock that we've seen, here's your capital priorities and your appetite for additional buybacks?

Li Yu (Chairman and CEO)

We have always been letting our shareholders know that growth in the normal situation is our preference as it represents the best long-term value. But within the last 3-4 years, starting from the pandemic with the inflation and so on, while the bank is making over 20% return with the alternative cost in 5% range, okay, it does not seem a good idea that had the idle cash, which we're not doing much loan. Nobody's doing much loan those days. With idle cash staying there making 5%, buyback on stock represents a pre-tax 33% return. So economics tells me that our shareholders will like it better over the long term if we do that.

David Feaster (Managing Director)

Makes a lot of sense. All right. Thanks, everybody.

Operator (participant)

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. As I said that we're very happy with the quarter, and hopefully that I personally believe that finally things started to getting stabilized. Going forward, I hope it can only be better for the banking industry. Thank you.

Operator (participant)

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