Preferred Bank (NASDAQ:PFBC) Q1 2022 Results Earnings Conference Call April 20, 2022 2:00 PM ET
Company Participants
Larry Clark – Investor Relations, Financial Profiles, Inc.
Li Yu – Chairman and Chief Executive Officer
Edward Czajka – Executive Vice President and Chief Financial Officer
Nick Pi – Executive Vice President and Chief Credit Officer
Wellington Chen – President and Chief Operating Officer
Conference Call Participants
Gary Tenner – D.A. Davidson
Matthew Clark – Piper Sandler
Steve Moss – B. Riley Securities
Andrew Terrell – Stephens Inc.
Timothy Coffey – Janney Montgomery Scott
David Feaster – Raymond James
Jordan Hymowitz – Philadelphia Financial
Operator
Good afternoon. Welcome to the Preferred Bank 2022 First Quarter Earnings Call. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note, today’s event is being recorded.
I would now like to turn the conference over to Larry Clark of Financial Profiles, Inc. Please go ahead, Larry.
Larry Clark
Hello, everyone, and thank you for joining us to discuss Preferred Bank’s financial results for the first quarter of 2022.
With me today from management are Chairman and CEO, Li Yu; President and Chief Operating Officer, Wellington Chen; Chief Financial Officer, Ed 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 related 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 would like to turn the call over to Mr. Li Yu. Please go ahead.
Li Yu
Thank you. Good morning, ladies and gentlemen. I’m very pleased to report our first quarter net income of $26 million $1.74 cents per fully diluted shares. This is a 23% increase on the same quarter of previous year.
Loan growth was a highlight for this particular quarter. It increased 4% on a linked-quarter basis and annualized at 16%. The fourth quarter loan origination momentum has carried over to the first quarter, but with payoff activity moderating a bit which resulted in this performance in the quarter.
Looking ahead, we are very encouraged by the applications for new loans that is received so far. Although these applications will be subject to higher standards of underwriting, we do believe that second quarter results could be quite positive.
The positive growth for the quarter was moderate at 1.6% linked quarter or 6.4% annualized. This is well within our expectations in light of Fed’s activities. The higher loan production versus the lower deposit increases has allowed us to deploy some of our excess cash through better usage, which we think is proper financial statement engineering.
Our margin has improved from the previous quarter by 14 basis points. This is partially because of the higher deposit – a higher loan increase versus lower deposit that changed the leverage.
Again, under the current rate rising scenario, our environment, looking ahead, we’re quite positive about our margin expansion. Preferred Bank has a very asset sensitive balance sheet and I have included some of the components of our assets for your information in the press release.
On the liability side, we have $1.96 billion of deposit portfolio that is time certificate of deposits. These deposits carry an average life of 7.3 months, which means they will be repricing at a much slower pace than the interest-bearing transactional account. We have made the improvement in our credit posture [indiscernible]. Two of the larger legacy loans on a non-accrual basis has been with the bank for over two years.
Finally, after months and months of court battles, we finally was awarded to repossess these assets and this all just before the quarter end. Now, our loan portfolio is pretty pristine, with only $2.2 million of non-accrual loans as of March 31, 2022.
There was a charge-off in the quarter. The charge-off is related to the charging off of the previously fully established reserve on those legacy loans. There are no income statement effect.
It is almost certain that under current inflationary environment that our operating expense will increase and continue to increase in the months or the quarters to come. But Preferred Bank has always been very focused on controlling our expenses. And we have reason to believe that our increases will be not any higher than the industry norm.
The first quarter non-interest expense was a little higher than previously guided to you in the January conference phone call. And I’d like to apologize for the missed guidance here. And the actual number for the first quarter will be the beginning of new norm.
Also, I’d like to alert you with our share counts on the fully diluted outstanding shares. It has increased this quarter, along with a price increase of our stock, and it will continue to change along with the value of our stock changing.
All in all, we at Preferred Bank are happy with the first quarter and we hope we can do even better in the quarters to come. Thank you and I’m ready for your questions.
Question-and-Answer Session
Operator
[Operator Instructions]. The first question comes from Gary Tenner with D.A. Davidson.
Gary Tenner
Follow-up, Li, to your comments on the expense level as the new norm. If you kind of annualized the first quarter, you’re around $65 million. That’s 7%, 8% growth on top of 2021. Is that the general perspective on the full-year increase in expenses that you would expect? Or is there any kind of further upward pressures would go through the course of the year, do you think?
Li Yu
Obviously, it’s quite unpredictable with the expense growing in the future. There’s several forces related to it. The number one obviously inflation. What would it do to all of us, especially in the wage category. And also, affecting us with the renewal of our premises on the leases. Some of it has come due and they are subject to increases nowadays. But one other variable is that the success of our recruiting effort, you see the more successful we are, the higher the expense level will be. So, we certainly hope that the expense will be higher because we have CECL.
So, generally speaking, first quarter was slightly higher than the second quarter. But in this inflationary environment, we have to have providers [indiscernible] flexibility of thinking.
Gary Tenner
Just on the recruiting effort side, I know you guys are always looking to add quality people. Is there a particular geography or a market that you’re particularly focused today?
Li Yu
We are recruiting all from our geography right now. So, we’re adding people all over. But also that we are eyeing couple of new areas to put a new branch in. If we have decided the location and so on, then we’ll be hiring a group of people in that particular location. I have better information to report probably next quarter.
Gary Tenner
Just last question for me, in terms of kind of operating leverage, you provided some good detail on the asset sensitivity as you did last quarter in terms of the adjustable rate assets. It would seem to me that you’re still going to generate some positive operating leverage, but with the increase in expenses, reasonable to expect that efficiency ratio to kind of stay over 30%. It dipped below it for a period of time last year. Is that is that what you would expect?
Li Yu
You mean efficiency ratio?
Gary Tenner
Yeah.
Li Yu
I would like to say there’s two situation. One, you have an increasing net interest income, which as a result of the growth and as a result of the margin expansion, these two will create a higher net interest income. And then, obviously, you have high expenses, but we hope the combination of the two will be right around 30% level, we hope. Within a certain range, obviously. We have been bouncing back between 28% to about 35% between the months.
Operator
Our next question comes from Matthew Clark with Piper Sandler.
Matthew Clark
Can we just start on the loan side of things. Are you able to quantify the new loan commitments in the quarter, how that compared to last, and payoffs as well. And then maybe it’s a three-part question, just any commentary on the pipeline and how that compares to the prior quarter or a year ago?
Li Yu
Prior quarter, we had a $360 million new loan outstanding and that’s the commitment outstanding for the quarter end. And then, we have a $250 million payoff. So, this particular quarter, the payoff has reduced from $250 million to $180 million with approximately the same activity in the origination side. So, this is the mathematics.
Matthew Clark
Any color on the pipeline this quarter, coming out of the quarter?
Li Yu
Pipeline is good, not any worse than the first or second quarter.
As I said earlier, nowadays, the underwriting standard is higher because of various stress tests and value situation in light of the inflation and rate increases, and also we have always embedded at the back of our mind that, after inflation, there’ll be a recession. So, we have always tried to alert ourselves at Preferred Bank that good loans and bad loans are made at a good time. So, we’ll have to be extremely careful now.
Matthew Clark
On the margin outlook, kind of thinking through the remix as it relates to deposit growth relative to loan growth, do you feel like loans to earning assets might continue to march higher, assuming deposit growth kind of trails or do you feel like deposit growth should come back and start to better fund the loan growth?
Edward Czajka
To Mr. Yu’s comment earlier about the loan growth coming in lower than previous quarters and within our expectations, I think you touched on something I think we’ll see throughout the year. With the M1 supply seemingly going to start shrinking when the Fed ends its QE and also starts to raise rates, we’re okay with the lower level of deposit growth and then fully more utilizing the cash in the balance towards the loan portfolio. Obviously, expanding the margin and leveraging the balance sheet.
Matthew Clark
Just on the provision, there was a comment in the release that part of the basis for reducing reserves was an improving economic outlook. And I would have thought that would have been to the opposite in terms of commentary and assumption. Should we assume that that kind of reverses itself here in the upcoming quarter, an increased provision?
Li Yu
I will ask Nick to answer that. I will add on.
Nick Pi
Federal Reserve side, even though the current economy seems like at okay stage, but still we have a lot of other uncertainties that we have concerns, such as labor power shortages, high inflation, supply chain interruptions, all those kinds of things, quick rate increase environment and the higher energy cost. And also, Mr. Yu mentioned increases the possibility of a future recession. So, even though under that kind of a situation, for this quarter, we still bet on a little bit more reserve on the qualitative side. As Mr. Yu mentioned, we try to take a more cautious posture at this time.
Edward Czajka
Yeah, I think it’s probably safe to say the release might have been larger had we had more rosier economic predictions within the CECL model, rather than what it came out to.
Matthew Clark
The last one for me just on the letter of credit fees. How should we think about that activity in a rising rate environment and a slowdown in the macro environment?
Edward Czajka
I think it will be probably pretty stable.
Li Yu
You said stable, but I’d like to say sometimes it’s very unpredictable because the [indiscernible] customer has a need to come in. They open [indiscernible], so we charge them a fee. So, the activity is depends, it is really customer specific. It’s hard to relate to any economic conditions. We tried. We tried to [indiscernible] pattern on that. We haven’t been successful on predicting it yet.
Operator
Our next question comes from Steve Moss with B. Riley Securities.
Steve Moss
Maybe just start off with deposit pricing here. In the release, you guys talk about CDs repricing at a slower pace. Just kind of curious here, what are you guys thinking for CD rates with the 50 basis point hike coming up here in May in all likelihood? Also, just how you’re thinking about deposit betas more broadly?
Edward Czajka
I’ll start off. In terms of deposit growth going forward, I think we’re okay with a lower level. But in terms of deposit betas and rate changes going forward, Steve, we’re seeing an interesting thing – at least in my opinion, I’m seeing an interesting thing in the market. We’re really not seeing much movement at all on the retail side of things. Wholesale funding has moved a lot. It started moving in January. But the retail funding is still – we get rate surveys every two weeks that we go through very extensively. And we are still seeing very few banks move beyond 40 to 50 basis points on a one-year CD. And so, what I think you’re going to see this time around, you hear this all the time, this time, it will be different, right? But this time around, with the economy and – the consumer and businesses do still have a lot of cash on hand. And so, I think it’s going to take some time to whittle that out of the system going forward. And as that happens, I think you’ll slowly see banks start to raise their offered rates. But at the present time, we’re just really not seeing a lot of movement. So, it’s a little bit like a Goldilocks moment right now at least for the time being.
Nick Pi
Ed and I, we review this weekly. And so far, we are holding very well on the consumer side – on the retail side, I should say.
Edward Czajka
Also, a lot of those are negotiated rates anyway. So, those still are fairly low as well.
Steve Moss
In terms of just on the loan pipeline being strongest, maybe what types of lending opportunities are you seeing? Obviously, you had good commercial real estate growth here this quarter. Just kind of curious, like, the underlying types of properties you guys are lending on or you expect to lend on here going forward? And just when we think about long growth for the year, obviously, a really strong pace here. Are you guys thinking low teens type number ex-PPP?
Nick Pi
We’re always looking for new talents, as Mr. Yu mentioned earlier. So, whether it’s – we’re looking for talents, and talents will take the lead of where we’re going to expand, whether it’s Southern California, Northern California or elsewhere.
And in terms of the – we’re looking at the market and pipeline right now, I think post pandemic, there are a lot of opportunity, people are looking to acquire property and we’re looking to reposition, and so a lot of opportunity in multifamily and industrial type of facility.
Steve Moss
In terms of the tighter underwriting standards here, just remind us as to kind of what the debt service coverage or loan to values you guys are looking at these days?
Wellington Chen
Loan to value, with our current data, is around 55% to 56%. And this year, definitely, as Mr. Yu mentioned that we’re very conservatively underwriting the loans, with consideration of future rate increase. So, currently, it’s around 1.2 and above.
Steve Moss
One last question. Small one in terms of the OREO properties that you guys took over here. You guys make comments about resolving it shortly, just kind of curious as to how quickly you think you can liquidate them.
Li Yu
We hope it’s done yesterday. Thankfully, the property is well sought after. So, broker is telling us that they feel that the price is very advantageous to us under the current market.
Operator
Our next question comes from Andrew Terrell with Stephens.
Andrew Terrell
Maybe, Ed. Just to start off. I hear some of your comments on kind of the deposit growth expectations and just the overall kind of leverage of the balance sheet. I’m looking at there’s still quite a bit of excess cash, it seems like, on the balance sheet today. I guess just given the move in interest rates we’ve seen so far, any appetite or willingness to take kind of a bigger swing into the securities book here.
Edward Czajka
I’ll say, at this point, the answer is probably a no. We took a little bit of a swing last September and bought almost $200 million of monthly Ginnie floaters, which have actually performed pretty well. But to the extent we can more utilize the cash into the loan portfolio – and then remember also that cash is also going to move up in rate too, as the IOER rate moves in lockstep with Fed Funds, we’ll see that cash benefit as well. So that’s a nice production of that. So we are not going to forego deposit growth, let me be clear on that. We still believe in deposit growth, and that does form the foundation of the bank, the franchise value of the bank. So, we will get deposit growth this year, but we will not be as hard pressed for deposit growth this year.
Andrew Terrell
Maybe looking at just the core loan yields were on kind of the margin down, I think, maybe 10 basis points or so this quarter. Anything unusual in the kind of core loan yields, whether it’s interest reversal, lower fees or anything. Just anything maybe non-core in the loan yields this quarter?
Li Yu
No, we don’t have it.
Edward Czajka
No. But I will say we did see a small uptick after the rates – after the mid-March Fed hike. And we saw that also on the cash side, so that’s beneficial.
Andrew Terrell
One last question for me, Mr. Yu. I know, historically, you’ve not been very active in kind of bank M&A. Trying to get kind of updated thoughts from you, whether you were seeing anything kind of interesting on the M&A front, whether there was any appetite, if it kind of plays into your thinking about running the bank moving forward, just any kind of updated thoughts on bank M&A would be helpful.
Li Yu
Number one thing is that maybe it’s our DNA. We’ll leave it on the conservative side of our acquisition situation. So, we look and there’s continuously obviously intermediaries that will introducing deals to us, for various reasons, either pricing or the talents or the geographies, we have not had much success. There’s couple of deals we’re getting close to step number two, but it seems to be – didn’t materialize any further.
In our calculation about the accretion requirement is probably one of the tougher in the industry. One of the reason is that when we can internal regenerate more than 15% of growth as average, the need for acquisition to increase the balance sheet is not that imminent, and therefore that we choose the most profitable way of organic growth.
So, needless to say, when the organic growth started to fading or stop, we have to think about how to make this institution more profitable. And I hope the acquisition we make will be profitable because, as I know it, not every acquisition work out very well. It just doesn’t show up in financial statements in bold letters.
Andrew Terrell
Any kind of color you can provide on just what that – you mentioned the internal kind of EPS accretion or I don’t know if it’s IR threshold that you need to meet or tangible book value earn back. Any kind of color or specifics you can give there on the financials you kind of try and target.
Li Yu
Obviously, there’s things I’m looking at. I don’t look at IR that much. I just look at the accretion of the EPS. And then also the important thing to me is how much is dilution of the book value and the payback on the situation. Inflation is – you really take a target, you’re pre-paying for whatever their earnings are for many, many years and hope you can make it back through efficiency and combined operation, and we must be cognizant that not everyone’s going to be perfectly executed. So we’re just looking at very careful as the book value dilution side of it.
Andrew Terrell
Congrats on a great quarter.
Operator
Our next question comes from Tim Timothy Coffey with Janney.
Timothy Coffey
Ed, the press release has got some really great color on the asset sensitivity of your balance sheet and you are one of the more asset sensitive banks on the West Coast. I’m wondering, can you quantify what the gain to net interest income would be, say, off of a 50 basis point move higher?
Edward Czajka
Off the top of my head, unfortunately, I can’t right now. I can tell you that in a 100 basis point shock, I think we’re about 9% to 11% higher on an annualized basis.
Timothy Coffey
Can I ask a question about the cadence of loan growth in the quarter? Did the increase in rates pull forward any business towards, say, the March month relative to January/February?
Li Yu
I think the increased rate actually has created more opportunity to us because previously that – we’ll lose mainly the payoffs is to the people with often low rate, fixed rate loans in 10 years sometimes. Some of them is doing 10-year, 5-year interest only, paying interest only. We’re losing to these deals. When we’re thinking about rates, it’s going to change. And why are you getting into the fixed rate situation? Well, we’re pondering about that, we keep on losing loans or losing competition, competition for loans on that reason. And then, thank God, everybody started thinking, they should not be making low rate, fixed rate loans anymore. So, we become an equal basis of competition, where our – I think our competitive advantage of high touch one-on-one service, delivery and customer relations start to come back benefiting us.
Timothy Coffey
Is it your expectation that pipeline fallout will decrease going forward if based on rates?
Li Yu
Yeah, I will say that it will decrease. I know that the one caveat is that we have to underwrite it more carefully.
Timothy Coffey
Speaking of that, the reserve levels of the ratio, do you feel like it’s prudent to start increasing that ratio right now? Or do you need to wait for more information before doing so?
Li Yu
Are we talking about our credit quality situation?
Edward Czajka
Yeah.
Li Yu
I’m going to answer in different ways about it. I just reported to our board, we will be starting internal loan review again in the late second quarter, early third quarter, in light of two situations. One is a continued high inflation, what would that do to many of our customers’ industry or customer specific. And we also to project as to the inflation situation, when a recession situation come, which of our customers are likely to be affected. So, we can take more active moves in relating to these things. And a bank-wide review will be starting in late second quarter or early first quarter because we do have examination scheduled in late second quarter. We’d like to take care of the – examine it first.
So, on the CRE side, obviously, we went through many, many drills. We probably will plan to do the same drill in the third quarter and looking at it as what product line – for the market situation, what product line is – continue to be the favored investment. But it’s safe to say, just speaking from common sales, in my past experience, in early stage inflation, there’s many, many of our customers, astute customer is really trying to acquire real estate because they think over the long term and they have the holding power – they think over the long term assets is the best protection for the inflationary situation. So, while we are also cognizant about that, but we still have to do assets review on the thing.
Edward Czajka
To answer your question depends on the results of the review that Mr. Yu spoke of, Tim, whether how we look going forward relative to the ACL.
Operator
[Operator Instructions]. Our next question comes from David Feaster with Raymond James.
David Feaster
Mr. Yu, I just kind of wanted to follow back up on your commentary kind of talking about the competitive landscape. It sounds like it’s a bit more rational than it has been. But as you think about your adjustable rate loans, how effective – have you been able to fully push through that 25 basis point increase on the $1.4 billion of loans that reprice immediately. And I guess, just with the competitive landscape, how do you think about your ability to push through the next couple of rate hikes, like, if we do get a 50 basis point rate hike at the next two meetings, would you expect to see more payoffs and paydowns as competitors price lower? Or I guess, just how do you think about your ability to push through higher rates on these?
Li Yu
Each cycle is different. But, however, in this cycle, what I can see is our margin, meaning the index number, is competitive with other competitors and what they offer. In other words, if the loan is worth the people or staff, everybody is offering people or staff. So, right now, for other people to offer much lower index number to the loan, I don’t see many of our competitors is doing that. There’s always been few over there, but I don’t see a majority people would be doing that. And I just think they are equally as sensible as we are. So, I actually do not think that we will lose a lot of business because many of the things will push to higher rate due to the loan. More so, if anybody wants to do that, it’s because the economics of their [indiscernible].
David Feaster
Are you starting to see new loan yields improve? Have you seen like an inflection in new loan yields across the portfolio?
Li Yu
In the last few quarters, I have told you that our old loans paid off as rate is generally anywhere from 75 basis points to 50 basis points higher than the loans being made. This quarter, the number is narrowed down to $0.26 or $0.27. And I have a feeling on the situation, the second quarter, the new loans will carry a better rate.
David Feaster
On the C&I growth in the quarter, that was great to see. Just curious whether you think that that was a function of drawings on existing lines as borrowers are starting to build inventories? Or are you seeing an increased demand for new lines? And then just what are you hearing from C&I clients and how was the C&I proportion of your pipeline? Has it increased at all or it’s still kind of that 70/30, I think we talked about…
Wellington Chen
It’s not necessary. Not much on the existing line drawdown. We had a couple of good wins under new C&I relationship. And really, that’s where it’s mainly coming from, the growth.
Operator
Our next question comes from Jordan Hymowitz with Philadelphia Financial.
Jordan Hymowitz
Before I ask my question, Li and team, I just want to say, I’ve covered you guys for 20 something years since the IPO. You’ve done not only a great job, but the integrity and thoughtfulness and your willingness to say when things are better or worse is really refreshing. You guys deserve a great kudos. So, good job.
Li Yu
Thank you. Made my day.
Jordan Hymowitz
I have a question for you on the follow up to the other gentleman’s M&A question. And I’m not saying you should or shouldn’t do M&A. It’s a different thing. But with RBB’s Chairman now resigning because of improprieties, there’s rumors that that may or may not go on the market. Who knows? But would that be a property at a certain price that you might be interested in?
Li Yu
Well, number one, we are aware of the situation. And I have a lease among the group of firms that was represented here today, at least two or three has contacted me on this particular thing, except that none of them knows them as well as I do. Many of the board members, my friend. And obviously, the former chairman, former president and CEO was a longtime friend of mine, too. So, I know the situation. And it’s a matter of their expectation. And it’s a matter to the – after they have stabilized the situation, whether their business level, how much still represents a vibrant, ongoing business, sort of like slow growth business. So, it depends. It depends on the on the price. Unless I can deliver you guys, you’re the shareholder, deliver to you a better future year by year, why should I do that?
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Li Yu for any closing remarks.
Li Yu
Thank you so very much for joining our conference. You have any questions, please call Ed or I. Mostly Ed than me. Anyways, but we’d love to answer that. Thank you so much.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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