Preferred Bank - Q3 2024
October 21, 2024
Transcript
Operator (participant)
Good day, and welcome to the Preferred Bank Third Quarter 2024 Earnings Conference 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 zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Jeff Haas of Financial Profiles. Please go ahead.
Jeff Haas (Director)
Thanks, Wyatt. Hello, everyone. Thank you for joining us to discuss Preferred Bank's financial results for the third quarter ended September 30th, 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 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 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, Jeff. Good morning. I'm very pleased to report that Preferred Bank third quarter net income was $33.6 million, or $2.246 a share. The highlight of this quarter is a successful reduction of our nonperforming loans, which resulted in no charge-offs, but $800,000 of interest recovery. Criticized loans, however, has increased quite largely due to one relationship. And currently, we believe this increase in criticized loans is a temporary event. Net non-interest expense has increased somewhat unexpectedly, but that was the reason that we had made a valuation charge of $1.7 million on our OREO. This OREO is currently in escrow and scheduled to be closed later this month. Loan demand seem to have increased and payoff slowed down.
Our net increase in loans for the quarter is a little bit over 10% on the annualized basis. Deposits, however, has decreased slightly from last quarter in the amount of $11 million. Admittedly, that Preferred Bank has started to monitor the deposits portfolio since early September to not competing for the higher cost deposits. As a result, cost of deposit has reduced slightly in the third quarter from the second quarter. Net interest margin improved due to obviously, the deposit cost increase due to the net interest, I mean, recovery, and also because of change in the leverage in our loan to deposit relationship. Efficiency ratio of 30.6% is a little higher than previous quarters, but if we disregard the non-recurring event of the valuation charge on the OREO, the efficiency ratio would be about 28.5%, approximately.
As of September 30th, Preferred Bank's loan portfolio consists of 26% fixed rate loans and 74% floating rate loans, with most of them having a floor. We believe our loan sensitivity is in reasonable balance with the sensitivity of our deposits portfolio. I do like to point out our TCD portfolio has a different nature, that it will reduce in a smaller amount in the earlier months, but catch up and reduce, cost reduce in a bigger dollar amount at the later stage of the TCD. We are happy to see that finally we see the federal government's rate cut, and we project that probably there will be continuous moderate rate cuts going forward. We'll stay, obviously, very focused on that. Thank you very much. Now 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 one on your telephone keypad. If you're 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 two. 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 and Senior Research Analyst in Equity Research)
Hey, good morning, everyone. Thanks for the questions. Wanted to start on the margin and get a sense for what the average was in the month of September, you know, with or without the recovery, and then the spot rate on deposits at the end of September, if you had it, if not, the month of September.
Edward Czajka (CFO)
Hi, Matthew. The margin for the month of September, excluding the recovery, was 4.03%. Cost of deposit spot at the end of September, 3.96%.
Matthew Clark (Managing Director and Senior Research Analyst in Equity Research)
Great. Okay. And then, on the floating rate loans, the 74%, I think, of the total mix is floating. I think you mentioned in the release that most of them have floors, but can you give us some more details on specifically how much of that those floating variable rate loans have floors and where those levels are?
Edward Czajka (CFO)
Right. So of the 76% or 74%, excuse me, that are floating, 99% have floors. However, they're at various stages, Matthew, as you and I have discussed previously. But we have approximately 22%, 23% of those floors are within 75-100 basis points of their actual rate, and the remainder of those are over 100 basis points from their current stated rate.
Matthew Clark (Managing Director and Senior Research Analyst in Equity Research)
Okay. Thank you. And then what, what's your outlook on your loan and deposit beta this cycle, this easing cycle? You know, assuming we get the rate cuts that the forward curve is suggesting, where do you think we match what you did on the way up, or do you feel like it might be a little less than that on, you know, either side of the balance sheet?
Edward Czajka (CFO)
I would say a lot of it, Matthew, depends on the pace. If we get a steady 25, 25 bleed out every couple of months, that is really, for us, an ideal scenario because it will allow us to better match the repricing of liabilities with the repricing of the assets. So if we get a steady downward trend in that, in that regard, I would expect the margin to hold up better than it would under a 50 and 50 scenario.
Matthew Clark (Managing Director and Senior Research Analyst in Equity Research)
Okay, great. And then did you buy back any stock this quarter, and what's your appetite going forward?
Edward Czajka (CFO)
We did. We bought back, I think, a hundred and some thousand shares. I apologize. I don't actually have that number. We actually have not been in the market for a while because the price-
Li Yu (Chairman and CEO)
I think it's $110,000.
Edward Czajka (CFO)
$110,000. Yeah. We haven't been in the market for the last few weeks because the price has exceeded what we're wanting to pay right now.
Matthew Clark (Managing Director and Senior Research Analyst in Equity Research)
Got it. Thank you.
Operator (participant)
Our next question comes from Andrew Terrell with Stephens. Please go ahead.
Andrew Terrell (Managing Director and Research Analyst)
Hey, good morning.
Li Yu (Chairman and CEO)
[crosstalk] Hi, Andrew.
Andrew Terrell (Managing Director and Research Analyst)
Just to follow up on the floating rate loans, the 74% of total, can you just remind us the split between prime versus SOFR or any other indices in there that those are tied to?
Edward Czajka (CFO)
Of the 74%, probably 90% of those are prime-based, with the remainder being SOFR or Treasury-based.
Li Yu (Chairman and CEO)
Maybe not as high as 90%, but close, okay, maybe in the 80%s now. Maybe.
Andrew Terrell (Managing Director and Research Analyst)
Okay.
Li Yu (Chairman and CEO)
We haven't really calculated that yet, you know.
Andrew Terrell (Managing Director and Research Analyst)
Yeah. Okay. But fair to think that the vast majority are prime.
Li Yu (Chairman and CEO)
Right.
Andrew Terrell (Managing Director and Research Analyst)
I wanted to ask on the... When I look at the end-of-period composition of deposits, the interest-bearing demand deposits came down pretty hard this quarter. I think off about $330 million or so, and it looks like there might have been some mix change into time deposits. But I was hoping you could maybe just elaborate a little bit on some of the fluctuations we saw within the interest-bearing demand deposits.
Li Yu (Chairman and CEO)
Yes, we are switching some of the higher price for the, interest-bearing deposit demand of money market, and then, try to time it up and replace it with TCDs at the, at the rate that we feel is more favorable. Now, we have started to do that in early September-
Edward Czajka (CFO)
Yeah.
Li Yu (Chairman and CEO)
Before the rate cuts now.
Edward Czajka (CFO)
Yeah, Andrew, a number of some of the money market deposits that we had were considered to be brokered deposits, and those were paying a higher cost than brokered CDs were. So we basically flipped from a brokered money market to brokered CD at the same time, not increasing our total brokered.
Andrew Terrell (Managing Director and Research Analyst)
Got it. Okay. That makes sense. I appreciate it. Can you remind us just for the fourth quarter, we've got kind of the launching point for where the spot rate was on deposits. Can you remind us the amount of time deposits that are coming up for renewal in the fourth quarter? And I appreciate it, it probably fluctuates some depending on what the Fed does here in November and December. But you know, where you're kind of trying to renew new CDs at today from a yield or a cost standpoint?
Edward Czajka (CFO)
Yeah. So we have almost $1.2 billion of CDs maturing in the fourth quarter at an average rate of 5.07%. And today, we are paying anywhere from 3.45% up to-
Li Yu (Chairman and CEO)
Four point-
Edward Czajka (CFO)
Four and a half.
Li Yu (Chairman and CEO)
4.4% and a half. Yeah,
Edward Czajka (CFO)
in that range. So we would expect to see some pretty good savings, because that's a big chunk. That's 36% of our CDs maturing in that quarter.
Li Yu (Chairman and CEO)
And then nowadays, the CD pattern is that everybody is paying higher rates for three months to CDs, and then sort of like moderate down all the way to one year level. And I guess everybody is now in our immediate peer group is watching and making very frequent moves from time to time, so we just have to react to that.
Andrew Terrell (Managing Director and Research Analyst)
Yeah, totally understood. I appreciate it. And then maybe I'd just, I'll take a stab at it. I know it's probably a complex number to arrive at, but just any sense on, given some of the timing dynamics from the floating rate loans versus the CD repricing that'll occur in the fourth quarter, any sense on kind of where the margin shakes out, in the short term, the fourth quarter?
Edward Czajka (CFO)
That's a really good question, and like you said, Andrew, it really depends on the timing. But, you know, given where we're at right now, I guess I would expect to see the high threes, you know, north of three eighty-five for the fourth quarter.
Andrew Terrell (Managing Director and Research Analyst)
Yeah. Got it. Okay, so maybe some normalization, and then as the deposits reprice, stabilization from there?
Edward Czajka (CFO)
Right.
Andrew Terrell (Managing Director and Research Analyst)
Okay, thank you for taking the questions. I'll hop back on the queue.
Li Yu (Chairman and CEO)
Thank you.
Operator (participant)
Our next question comes from Gary Tenner with D.A. Davidson. Please go ahead.
Gary Tenner (Managing Director and Senior Research Analyst)
Thanks. Good morning. Thought I'd kind of shift over to the other side of the balance sheet. You know, you've had improving loan growth each of the last two quarters. And I think the press release noted some increased activity as the Fed cut rates in September. So could you talk about kind of pipelines and activity levels from a lending perspective as we're looking into the fourth quarter?
Li Yu (Chairman and CEO)
Okay. Well, I'm thinking, you want to answer the first and see any-
Wellington Chen (President and COO)
Yeah. So you mentioned per the earnings release, the loan demand has been, you know, surging since the Fed dropped the rate, and we believe, and the loan activity is there. I think the biggest issue for us, not just the demand, is the payoff. Competition, payoff from competition or customer, you know, selling the assets and what have you. So we are basically not just entertaining the new loan demand, but at the same time, to defend our existing good loan relationships.
Li Yu (Chairman and CEO)
Anything to add, Johnny?
Wellington Chen (President and COO)
No, I think Vincent said it right. With the anticipated rate decreases, we need to defend our portfolio.
Li Yu (Chairman and CEO)
Gary, that marketplace, obviously, toward the real estate side has changed greatly because the rate change. And all our rates, I mean, including the fixed rates, I mean, loans being offered is now more lower basis than before. And certainly, that is expected to improve the transactions on the marketplace. To what extent, what time to cut in, really, the economy itself has to tell us if later or not. We're still waiting for, you know, what the economy to pay off.
Gary Tenner (Managing Director and Senior Research Analyst)
Great, I appreciate that. And then, you know, with the commentary about tightening up, I guess, on the rate paid on deposits in the quarter, you know, kind of flat deposits versus the loan growth and that loan deposit ratio moving up to 95% or so, could you talk about how you're thinking about kind of managing, you know, that side of things from the ability to fund loan growth on a go-forward basis, but maintaining discipline pricing on the deposit side?
Li Yu (Chairman and CEO)
I guess that the deposit fear that we all have seems to be eased up quite a bit, okay? That building up deposits is something that become more of a normal event. So to support the loan growth, we obviously compete whenever we see the marketplace open. But, you know, so Preferred Bank has always been, you know, competitive in getting deposits. So we think we'll get the necessary number to fund the growth.
Gary Tenner (Managing Director and Senior Research Analyst)
I think on the expense side this quarter came a little bit higher just because of the OREO charge in the quarter than what you had, I think, guided to on the July call. Could you give us a sense of kind of where the fourth quarter operating expense line might shake out?
Li Yu (Chairman and CEO)
Ask that.
Edward Czajka (CFO)
Yeah, not much change, Gary. I would look at us to go between 20.5%-21% for Q4. Might be slightly below that, but I would doubt it.
Gary Tenner (Managing Director and Senior Research Analyst)
Thank you.
Edward Czajka (CFO)
Sure.
Operator (participant)
Our next question comes from David Feaster with Raymond James. Please go ahead.
David Feaster (Director and Senior Equity Research Analyst)
Hey, good morning, everybody.
Li Yu (Chairman and CEO)
Good morning.
David Feaster (Director and Senior Equity Research Analyst)
You know, maybe could we just touch on the credit side a little bit? I was hoping you could give a little bit of color on the increase in criticized, and appreciate the commentary about some of those already being resolved. Just kind of curious what you're seeing there, and then just broadly, what you're seeing on the credit front, within the CRE world and anything you're watching more closely.
Li Yu (Chairman and CEO)
Nick, add on to it and correct me later. Okay, let me first, follow up what we have written down. Actually, if it wasn't for the one relationship, we have a good reduction in the quarter with our so-called criticized loan and nonperforming loans, okay? That one relationship is found out to have a little payment, laziness or irregularity, so we proactively tried to downgrade it, okay? After downgrading that, four of the seven loans has been brought current. The other three of them, we were told, will be current, depending on their successful, the completion of their, their capital costs, okay? Some of the loans, it is a relationship with several different loans, all have different partners. They have different investment size, so they were going through capital call downs, most of them.
So the other three, we were told we should complete the capital call in this month, they hope. Okay. So we had this customer for many years, even before the pandemic days. And throughout that period of time and throughout the high interest rate time, they have always been paying, okay? So they're running to finally a little bit slowness recently. And all these loans are guaranteed by several very substantial people. So, and we have a low LTV in the mid-sixties, and then a reasonably high, under the current circumstance, reasonably high DCR. And DCR will be better than one point one after the next two rate cuts. Right. And the property itself is pretty good. It's retail property, I mean, neighborhood shopping center, basically, and multifamilies. All of them still command a good cap rate nowadays.
In fact, retail shopping center cap rate has been improving. So these are the things we get, so we kind of feel this thing will be. We'll get the result very soon. Nick, you want to add to that?
Nick Pi (Chief Credit Officer)
Just for your information, David, for these two retail centers, actually, they both are around 95% occupancy. So the property itself is pretty good. And just like Mr. Yu mentioned, that if we exclude this one-off situation, the rest of our criticized loans should be around $52 million, which is much less than the last quarter, I believe. So, you know, since pandemic, we only watch our credit very closely. And presently, I believe that the credit quality is still considered very stable and we're selling it this time.
David Feaster (Director and Senior Equity Research Analyst)
Okay. That's helpful. That's really good color. And then maybe going back to the growth front. I mean, again, it's great to see the growth. It's encouraging to see what you guys have been able to do, especially the acceleration. You know, but I hear that there's still a lot of competition on the West Coast. I'm curious if you could touch on the competitive landscape. You know, you guys have been really disciplined on your loan pricing. I'm curious where loan pricing is in your market. Are you starting to hear some prepays and payoffs, just given the competitive landscape? And kind of how that plays into your thoughts on growth next year. Would you expect to kind of reaccelerate, or, or could that be a headwind and kind of keep us here around that, you know, low double digits, high single digit type of pace?
Li Yu (Chairman and CEO)
The general feeling is that we feel with the reducing rates, the new loans opportunity will increase. Likewise, is the pace of the payoff, because that's easiest for the competition, just to try to pirate loans from other institutions. And we hear people are starting to price their loans about as much as 1% before on the fixed rate loans. So we are facing this every day. We have faced this for my life with this bank is thirty-two years plus, almost every year, matters like that happen. It is up to us as a team is, you know, adjust ourselves from time to time on the marketplace. On the production side, Wellington and Johnny has added a number of new producers.
In fact, you will notice that in the last few earnings conference calls, we mentioned about new teams and new locations being added up. So actually, we have more of a body count, especially in the loan production side. So we're expecting that we'll be fully competitive in turning more stones in the marketplace, okay? So it's a matter of finding more loans to combat the possibly increasing pace of loan payoffs.
David Feaster (Director and Senior Equity Research Analyst)
That's a good, that's a good point. You know, and I if I recall, you know, one of the places that you've been focused on, Silicon Valley. I'm curious if you could give us an update there, and then, you know, what other opportunities, what markets are you interested in, and where are you having success hiring?
Li Yu (Chairman and CEO)
Silicon Valley has just started. Usually, it takes about six months for any loan to be bought, but there are a few loans already being bought in Silicon Valley, okay? We feel that the growth of Silicon Valley will be more of sort of like steady growth in the first two years, and probably, if we're lucky enough, it will take off after two years, okay? There are many other places. We mentioned that we enlarged our Manhattan operation to be a full branch, okay? We hope that we're operating now in Manhattan, in the center of the town, in one of the fine locations, we think. We're expecting activity there to be equally as vibrant as last few years and hopefully even improving. We're constantly looking for new location, but it's predicated on the people.
If we can find the bankers that has a track record, we will build an operation around the person, and finding people, as you know, David, is probably one of the most challenging things that facing community bankers.
David Feaster (Director and Senior Equity Research Analyst)
Yes, absolutely. Absolutely. Thank you. And then if I could squeeze one more in, Ed, I was hoping... appreciate all the color on the margin. Kind of assuming the forward curve, though, I mean, how do you think about the trajectory next year? I mean, just given you got pretty huge repricing opportunities like you talked about. Just kind of curious, like, when do you think we trough? Is it kind of a mid-2025? And do you think NII growth, that you guys are going to be able to drive NII growth in 2025 even with cuts?
Edward Czajka (CFO)
Well, that's a crystal ball question, David, but I'll take a stab at it. You know, as I said earlier, the pace of rate changes is really critical. If we get 25 basis points a quarter, 25 basis points every two months, whatever the case may be, that's kind of a good situation for us. And in that, it allows us to move liability prices somewhat commensurate with asset yields. And so to the extent we can do that, the margin will remain more intact than it otherwise would have if we had accelerated rate cuts. That being said, what I've always thought is that, you know, I look back to the last quarter before the rate cuts, the rate increases started, and that was the fourth quarter of 2021, and we posted a 3.28 margin.
That was with zero interest rates. If we land to a level where we're around three to three and a half Fed funds, I don't see why we cannot maintain a margin north of three fifty, perhaps three fifty to three seventy-five, when it kind of all shakes out. If this sort of ends in mid-2025 or late 2025.
Li Yu (Chairman and CEO)
Don't promise too much.
Edward Czajka (CFO)
I'm not, I'm not promising. I'm just giving-
Li Yu (Chairman and CEO)
You can't find the market. You can only compete with the market.
David Feaster (Director and Senior Equity Research Analyst)
No, that's, that's great. That's great. It's, it's just super, super helpful to help us think through it and manage expectations, so I appreciate the color.
Edward Czajka (CFO)
You're welcome.
Operator (participant)
Again, if you have a question, please press star then one. At this time, we'll pause momentarily for questions. Okay, this concludes our question and answer session. I would like to turn the conference back over to Li Yu, Chairman and CEO, for any closing remarks.
Li Yu (Chairman and CEO)
Thank you. To manage the constantly changing interest rate environment is certainly one of the things that our job or my, you know, competitor's job also. But over here in Preferred Bank, we have done a few things. If you remember, just at the beginning of 2023, our fixed-rate loans at the low teens level were probably 11%-12%. And since then, we have been working on selectively turning our loans to fixed rate and hopefully in the declining interest rate environment, that will give us better protection going into the future. Okay. In fact, we feel so. Okay, so we'll stay on top and be alert on that. Thank you. Thank you so much.