Preferred Bank (NASDAQ:PFBC) Q3 2022 Earnings Conference Call October 20, 2022 2:00 PM ET
Company Participants
Jeffrey Haas – Investor Relations, Financial Profiles, Inc.
Li Yu – Chairman and Chief Executive Officer
Edward Czajka – Chief Financial Officer
Wellington Chen – President and Chief Operating Officer
Nick Pi – Chief Credit Officer
Conference Call Participants
Gary Tenner – D.A. Davidson
Andrew Terrell – Stephens
Adam Butler – Piper Sandler
Tim Coffey – Janney
Eric Specter – Raymond James
Operator
Good afternoon and welcome to the Preferred Bank Third Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note, today’s event is being recorded.
At this time, I would like to turn the floor over to Jeffrey Haas of Financial Profiles. Please go ahead.
Jeffrey Haas
Thank you, Jamie. Hello everyone, and thank you for joining us to discuss Preferred Bank’s financial results for the third quarter ended September 30, 2022. 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 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
Thank you very much. Good morning, ladies and gentlemen. I’m very pleased to report that we have another record quarter. Third quarter net income was $35.2 million or $2.40 per fully diluted share. This quarter’s earnings was contributed to – aided by the federal deposit of federal reserves, the rate increases, and our very sensitive asset sensitive balance sheet. Also, the large loan increases on June 30 is also fully reflected in the quarter of September. This quarter, return on equity is over 23%.
Loan growth has moderated down to 8.5% for the quarter. It is not unexpected and with the current economic condition. Year to date loan growth was 14.1% ex-PPP. Deposit growth was 3.5%. Deposit costs has increased, but deposit costs increase will continue to accelerate starting from September and since we will be continuing to accelerate in the fourth quarter because deposit cost increases much less than our loan yield increase, we had a 60 basis point expansion in our net interest margin.
Our credit quality remained stable. Our classified assets is moderately reduced. This quarter, we have no charge-offs, but we have a $2.4 million recovery. Together with the $2.7 million of new provisions, our loan loss reserve has increased to 1.33% of total loans. The bank’s operating cost has increased because of the inflationary condition and also the banks growth in asset size.
However, since we had a large increase in revenue, the efficiency ratio to actually decrease to a little bit over 25%. We at Preferred Bank recognized the macroeconomies heading into a recession. At present time, our top priority is our credit quality and the management of deposits and deposit costs. We have done well so far and we will simply be – continue to be alert in the future quarters.
Thank you very much. I’m ready for your questions.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question today comes from Gary Tenner from D.A. Davidson. Please go ahead with your question.
Gary Tenner
Thanks. Good morning. So, last quarter Ed and Li, I think you said that you thought third quarter net expansion will be less than it was in second quarter. Obviously, we had some more tightening than I think expected or rate hikes expected at that point in mid-July, but as you think about the fourth quarter now potentially 275 basis point hikes, a full quarter of the September hike, can you, kind of position the NIM outlook given the commentary in the press release regarding deposit cost acceleration since September?
Li Yu
Okay. The final answer is, we have no idea, but I have to tell you the things what we know about. First of all, like you said, the September quarter is at 75 basis point. We fully priced in the fourth quarter. And in November, if it is 75 basis point, will be two-thirds priced in the fourth quarter. And December is anybody’s guess at this point in time. That will be the revenue expansion.
The cost increase has accelerated quite a bit. And if you know that over the marketplace. There’s – I mean, people is paying all over the place rate for the deposit, especially in the interest bearing demand deposit like money market or so on. And the TCD rates paid by the major banks is now over 3.5% now. I guess they really set the bar for all the small guys, but sooner or later, the deposit will increase.
In the fourth quarter, we will have about $400 million deposit, which is TCD will be maturing, will be repricing. And there will be many deposits TCD will be early withdrawal and then pay a [indiscernible] we open for a higher rate, okay. The magnitude, the pace of increase, we are really at the mercy of our competitors. So, the best we can do is, keeping alert and managing, okay. But I like to say that I will see that NIM probably will be continuing to expand, but not to the same level of the third quarter.
On the other negative side in the first quarter, we also will see that we probably would be – we have to reprice one of the [indiscernible] we had, okay. And because the market condition has changed, appraisal value is getting to – we will conduct appraisal to reflect a more better value in the situation.
Gary Tenner
In terms of that specific, were you saying we’re talking to one specific [OREO] [ph] or are we talking about that [portfolio broadens] [ph]?
Li Yu
The others all seems to be in contract waiting to close.
Gary Tenner
And what’s the size of the one that you’re suggesting you may have to reprice [Multiple Speakers]?
Li Yu
[$21 million] [ph].
Edward Czajka
$22 million.
Li Yu
$22 million, yeah.
Gary Tenner
[$22 million] [ph]. Okay. Thank you. I appreciate the color there. And then historically Preferred’s been a very much of loan and spread driven revenue story. And even the growth in third quarter, which is low by Preferred’s standards, is quite a bit stronger than most that we’ve seen. So, given broad expectations of a slowing economy, particularly as it relates to real estate activity, where do you think loan growth looks like in the fourth quarter and frankly as we go out to at least that early part of 2023?
Li Yu
Well, it’s October. The pipeline is, kind of a – it does not tell us enough of a crystal ball, okay. But again, it has to do with what the economy is to develop. And what we know is in the marketplace, at least on the real estate side, the transaction or new transaction is much reduced, and many of the loan portfolio came to us as is subject to a much higher standard, understandably the cash flow tax will be completely different [there] [ph]. So, we are not going to [indiscernible] a high hope for [future loan growth] [ph].
If we will reach the third quarter, I consider we’re very, very lucky. But then the actual amount will also depend on the fourth quarter’s commercial industrial and C&I loans. They will drawdown, their usage in the fourth quarter will sort of like pick up a little bit, which we’re in no control. Sorry about the [indiscernible]. That’s the only way I can answer that.
Gary Tenner
Understood. I appreciate the color you’re able to provide. Thank you.
Operator
Our next question comes from Andrew Terrell from Stephens. Please go ahead with your question.
Andrew Terrell
Hey, good afternoon or I guess good morning.
Edward Czajka
Good morning.
Andrew Terrell
So, I wanted to start on some of the deposit growth. It was good to see this quarter. Can you just talk about how you think just overall deposit growth trends over the next few quarters? And then I know it looks like we saw some migration from non-interest bearing to interest bearing accounts, do you think we should see like a similar level of, kind of deposit mix shifts moving forward or do you think I guess commensurate with deposit cost acceleration? Do you expect the mix change in the deposit composition to accelerate from here?
Li Yu
Well, I would do some explanation in that and I’ll ask Wellington to answer some of the question you asked, okay. Well, first of all, is that at this juncture that we manage deposit, we try to stay above our current level. Remember, we don’t want to lose any deposits. That’s our most primary goal. And if we have to grow a little bit, than we would do. So, the matter is, wherever the deposit is coming from, from my point of view, I want to keep it because under the current situation, we don’t know if the Fed’s heightening what [indiscernible].
What situation can happen. And secondly, with consumer, all kinds of customers’ behavioral has changed. Preferred Bank’s customer basically are wealthy individuals and business owner businesses. They are very savvy with their money and they have many choices with their money.
So, the question is that, whether they want to put into a different type of [indiscernible]. We do not know any web management, but we’re facing much more competition from the market side. So, our job is to stay on top of it – on a daily basis, which you read, literally do stay on a daily basis with our deposit base.
One of you want to add to that?
Wellington Chen
I couldn’t add any more, Mr. Yu, that’s very strange to the point.
Andrew Terrell
That’s great. I appreciate it Mr. Yu. Maybe for Ed, do you have the spot cost of deposits either interest bearing or total at the end of the quarter?
Edward Czajka
Yes. Total cost of deposits including DDA would be 96 basis points at the end of the quarter. That was the run rate in September.
Andrew Terrell
Okay. And then where are you – I know you mentioned the, kind of market rates from some of the larger banks for time deposits, where are you pricing new, kind of one year CD rates at?
Edward Czajka
Right around 3 to 3.5.
Andrew Terrell
Okay.
Edward Czajka
Depending on the client relationship side, etcetera.
Wellington Chen
We just raise it. We have to continue raising.
Li Yu
We almost changed our rates on a weekly basis. That’s how fast the market is changing now.
Andrew Terrell
Yes, certainly quick rate environment. Maybe just one more for me. I wanted to ask just kind of looking at the step up in loan yields quarter-on-quarter, obviously nice to see, but just thinking about a lot of the prime based commercial real estate loans on your balance sheet. I’m curious, have you looked at, kind of up updated debt service ratios for your clients? And are there any areas specifically whether segments of the portfolio, geography where you’re becoming a little more concerned just given the, kind of magnitude of shift upward in prime rates?
Li Yu
Nick, you want to answer the first?
Nick Pi
Yes, definitely there will be some pressure on the [TCR side] [ph]. However, during the last quarter, all the management team on the loan side has gone through all C&I loans, CRE loans with our officers one-by-one with a certain [indiscernible] and we didn’t recognize any issue at this time. Definitely, there are some of the loans that we need to watch a little bit closely, but we don’t notice any severe trouble at this time.
Li Yu
Well, another situation, Andrew, you know the great majority of our loans, right, at least over 90% of the loans is personal guaranteed. So, whereas when we do our underwriting, we have fairly considered a personal cash flow, and then their capability and [indiscernible] that was instilled behind [indiscernible]. So that’s one added [protection for our bank] [ph].
Andrew Terrell
Okay, perfect. Well, congrats on a good quarter and thanks for taking my questions.
Li Yu
Thank you.
Operator
Our next question comes from Adam Butler from Piper Sandler. Please go ahead with your question.
Adam Butler
Hey, good morning, everybody. This is Adam covering for Matthew Clark.
Edward Czajka
Hello, Adam.
Adam Butler
Getting started with non-interest expenses. I saw that it increased this quarter, mainly due to kind of inflationary pressures. Is that a good run rate to assume going forward?
Edward Czajka
Yes. And going forward, we hit [17.4] [ph] this quarter. That’s with a real estate charge of 300,000. So, on a regular run rate, you could make the case closer to [17.1] [ph], but looking forward, we’ll likely have some more on that. And on a regular run rate, I would say high 17s, mid-to-high 17s going forward, because we’ll continue to have expense increases. We’re going to have lease cost increases, still additions to personnel, etcetera.
Adam Butler
Okay, great. Thanks. And do you guys have the weighted average rate on new loans in September?
Edward Czajka
Weighted average rate, new loans in September.
Li Yu
Well, we [guided] [ph] for the quarter. [Multiple Speakers] Yes. For the quarter, new loan is, new loan that we’re getting is when we see [indiscernible]. 5.99%.
Adam Butler
Okay, great. Thank you. That’s all my questions.
Li Yu
Okay. Thanks.
Operator
And our next question comes from Tim Coffey from Janney. Please go ahead with your question.
Tim Coffey
Thanks. Good morning, gentlemen.
Li Yu
Hi, Tim.
Tim Coffey
Most of my questions have been answered, but I did have a one for you, given kind of your geographic reaching specialty, is that, we’re hearing from different parts of the country that certain banks are starting to pull back from what we consider, kind of core loan products like commercial real estate and certain construction loans right now. Are you seeing that from your competitors right now?
Li Yu
Well, what do you see is [indiscernible]. Are you seeing it? I see that basically that generally everybody seems to be more cautious, okay. And there’s certainly research and settlement is universally including us is being more helpful at – like office product, in a certain long area that would be very helpful. So, again, [loans one off] [ph], you have to see the LTV of the loan and also the sponsorship and they’ll cash flow. Okay.
So, but generally speaking, I see a lot more reluctance for our competitors and including ourselves in doing a new loan.
Edward Czajka
Yes. That’s very tricky. I mean, the market is pretty much, everyone is very cautious. So, pullback is probably a strong word, I think, cautious is…
Tim Coffey
Okay, okay. Yes, and geographies I’m talking about aren’t necessarily ones that you’re in right now. So, it could be different markets that they’re seeing. Okay. All right. Well, thank you very much. That was my question.
Li Yu
Thank you.
Operator
[Operator Instructions] Our next question comes from Eric Specter from Raymond James. Please go ahead with your question.
Eric Specter
Hey, guys. Just wanted to follow-up on the NIM. How do you guys think about managing rate sensitivity here in light of accelerated betas and how would you prefer doing that? Is that putting in more floors on your loans, adding swaps, doing more fixed rate lending? I’m just curious, just kind of your thoughts on managing rate sensitivity going forward?
Li Yu
We have many of our loans, which we have previously disclosed at [indiscernible]. You can please refer to the last quarter’s press release. It’s outlined there that; I mean how much loan we have at the [floor] [ph] on the whole situation. So, a majority of our floating rate loan kind of flow, I guess this practice will continue and in fixing the product will definitely come sometime in the future. But the timing of it is it cannot be predicted right now. It had a lot to do with the [Fed act] [ph]. A lot to do is the economy situation. So, we were – it’s definitely in our plan, but the timing of it is natural.
Edward Czajka
Well, I was just going to add on the deposit cost side, which you already talked about it. It’s really just a balancing act. It’s more art than science really is managing the deposit costs in an upward environment like this versus your deposit growth and managing the cost at the same time. It’s just a very tricky thing to try to do, but fortunately with the assets into the balance sheet, we have a little cushion.
And in terms of the rate floors, at last count of the prime based loans, roughly three quarters of them have floors on them. And then in terms of swaps, we have not entered into any swap type agreements at this point.
Eric Specter
Okay. Thank you for the color. And then you deployed a portion of your cash this quarter, but you still have a large portion of your assets in cash and how do you think about deploying liquidity going forward? Is this earmarked to potential deposit flows? And then just kind of curious if you have a targeted cash ratio?
Li Yu
I just read the – from your investment side, which I’m your customer and telling me cash is key. Okay, this unsettled environment all need to be careful. So, I guess I’m following your firm’s advice.
Edward Czajka
I think at some point there will be opportunity for increasing the investment portfolio. I don’t think we’re there yet though.
Eric Specter
Okay. Got it.
Li Yu
You should [indiscernible] that. Okay.
Eric Specter
And then just kind of curious of your thoughts on capital. You completed your share repurchase during the quarter. How do you think about that going forward? And are you taking more cautious outlook or hoarding capital ahead of like a recessionary period? How are you thinking about that?
Li Yu
Well, first of all, in a recessionary period, especially when people like [indiscernible] says it’s a serious [recession] [ph], you want to keep your capital, okay. And not only us, I think majority of our shareholders and I think our regulators, everybody, including our Board of Directors, want us to be hold on to our capital. When the situation eases and obviously we have to [be before that] [ph].
Eric Specter
Okay, got it. And then one last question. Just curious about your Houston LPO and how the pipeline is kind of developing there and your appetite for additional de novo opportunities near-term given the backdrop?
Li Yu
Wellington, do you want to talk about it?
Wellington Chen
Sure. Eric, Houston, they continue to contribute. I think we have a full team over there. So, our plan, of course, graduating from LPO to full service branch. So that plan is still ongoing. So, it’s been good for us. And what was the other question?
De novo, again, as Mr. Yu mentioned before, as – we look at the opportunities, de novo is strictly based on the human talent. We’re not going to go anywhere because we feel like it’s a bit of geographic location, whatever, unless we have a local team available. It’s an opportunistic situation.
Eric Specter
Okay. Got it. Well, thank you. Congrats again on a great quarter and I’ll step back.
Li Yu
Thank you so much, Eric.
Operator
And our next question is a follow-up from Andrew Terrell from Stephens. Please go ahead with your follow-up.
Andrew Terrell
Hey, thanks for taking the follow-up question. Kind of in the same vein maybe as capital, but you’re earning a lot more money now with higher interest rates and obviously incredibly profitable. The efficiency ratio is 25%, I’m just curious how you’re thinking about, kind of maybe using some of this – some of like, kind of the higher profitability or higher level of income in terms of reinvestment of the franchise. Are there any targeted areas that have been kind of earmarked that you may be able to accelerate in terms of, kind of franchise investment standpoint, love to hear any thoughts there?
Li Yu
You want to answer the first.
Edward Czajka
Well, I think as Mr. Yu you talked about, going into this environment, capital is king and we are obviously putting a lot more into the coffers. I think one of the first things we’d probably revisit to dividend level that would be at the board. They would want to do that. I’m sure fairly soon. The other thing is to keep capital to the extent we can and then perhaps once we have some clarity in terms of where the economy is going, it might be time to reinstitute what we did this year in terms of perhaps buying some stock back.
Andrew Terrell
Okay. And is there a, kind of targeted capital ratio or level you’re looking to?
Edward Czajka
Well, not the short term situations, we just – within the next six to nine months, we just want to hold on to what we have. And we’d like to use some of the capital if we can, I mean, if it is – if the methodology allows us to – is to somehow reserve a bit more. So, as we go along, that’s when the economy is clear, the lending is not hard. Again, we obviously will be doing things that’s probably more progressive. At this point in time, we want to be treating safety as our number one issue.
Andrew Terrell
Yes, understood. Okay. I appreciate the follow-up.
Operator
And ladies and gentlemen, at this time, we’ve reached the end of today’s question-and-answer session. I’d like to turn the floor back over to the management team for any closing remarks.
Li Yu
Well, thank you so much. We’re very lucky to the questions asked to us about capital planning. So, I mean, we can afford to be more conservative as we’re very lucky to be able to have the [process] [ph] we will have in this quarter, and we certainly will be putting our full attention in managing our sales going forward. Okay. Thank you.
Operator
And ladies and gentlemen, with that, we’ll conclude today’s conference call. We do thank you for joining today’s presentation. You may now disconnect your lines.
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