Good afternoon, and welcome to the Preferred Bank 2022 first quarter 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 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 Larry Clark of Financial Profiles, Inc. Please go ahead, Larry.
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, our 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 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. This time, I'd like to turn the call over to Mr. Li Yu. Please go ahead.
Thank you. Good morning, ladies and gentlemen. I'm very pleased to report our first quarter net income of $26 million or $1.74 per fully diluted share. This is a 23% increase from 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 we have 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.
Deposit 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 to better usage, and 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 also higher loan increase versus the lower deposit increase that changed the leverage. Again, under the current rate-rising scenario or environment, looking ahead, we're quite positive about our margin expansion, okay? 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 had a $1.96 billion deposit portfolio that is of time certificates of deposit. 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 improvement in our credit posture. Two of the larger legacy loans on nonaccrual basis has been with the bank for over two years. Finally, after months and months of court battles, we finally was awarded the right to repossess these assets, and this was just before the quarter end. Now our loan portfolio is pretty pristine with only $2.2 million of non-accrual loans as of March 31st, 2022.
There was a charge-off in the quarter, but 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 and the quarters to come, okay. 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 first quarter conference phone call in the January conference phone call. I like to apologize for the misguidance, okay.
The actual number for the first quarter will be the beginning of a new norm. I also like to alert you with our share counts and on the fully diluted outstanding shares. It has increased this quarter along with the price increase of our stock, and it will continue to change along with the value of our stock changes. 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.
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 are using a speakerphone, please pick up your handset before pressing the keys. 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 Gary Tenner with D.A. Davidson. Please go ahead.
Thanks. Good morning. Follow-up leading to your comments on the expense level as the new norm. You know, if you kind of annualize 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, you know, kind of further upward pressures we go through the course of the year, do you think?
Well, obviously it's quite unpredictable with the expense going in the future. There's several forces related to it. The number one, obviously inflation. What it will 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 them come due, and they are subject to increases nowadays. 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. We certainly hope that the expense will be higher because we're successful. Generally speaking, first quarter was slightly higher than the second quarter. In this inflationary environment, it is, you know, we have to have a little more flexibility of thinking.
Okay. Thank you. Just on the recruiting effort side, I mean I know you guys are, you know, always looking to add quality people. Is there a particular geography, or market that you're, you know, particularly focused today on any-
We are recruiting all from our geography right now, okay? We're adding people all over, but also that we are eyeing a couple of new areas to put a new branch in. If we decided in 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.
Okay, great. Thank you for that. Then just last question for me. In terms of kind of operating leverage, I mean, you know, you provided some good detail on the asset sensitivity as it did last quarter in terms of the adjustable rate assets. It would seem to me that, you know, you're still gonna 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 what you'd expect?
You mean efficiency ratio?
Yeah.
I would like to say there are two situations. One is you have a net increase in net interest income. Okay? Which as a result of the growth, and as a result of the margin expansion, these two will create higher net interest income. Obviously you have higher expenses. 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%-about 35% between the months this time.
All right. Thank you for taking my questions.
Our next question comes from Matthew Clark with Piper Sandler. Please go ahead.
Hey, good morning. Could we just start with, on the loan side of things, you able to quantify the new loan commitments in the quarter, how that compared to last, and payoffs as well? 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.
You know, prior quarter, we had a $360 million new loan outstanding, and not the commitment, outstanding, okay, for quarter end, okay? Then we have a $250 million payoff, okay. This particular quarter, the payoff has reduced from $250 million to $180 million, with approximately the same activity in the origination side. This is the mathematics.
Okay. Any color on the pipeline this quarter coming out of the quarter?
Pipeline is good. Not any worse than the first or second quarter.
Okay. Okay.
But-
And then-
As I said earlier, nowadays the underwriting standard is higher because of various stress testing, valuation situation in light of the inflation and in rate increases, and also that we have always in the back of our mind that after inflation there will be a recession. We have always tried to alert ourselves at Preferred Bank that good loans, bad loans are made at a good time, so we'll have to be extremely careful now.
Okay. On the margin outlook, kind of thinking through the remix, as it relates to deposit growth relative to loan growth, I mean, 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?
Hi, Matthew. This is Ed. You know, 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 sheet towards the loan portfolio, obviously expanding the margin and leveraging the balance sheet.
Got it. Okay. 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 kind of the opposite in terms of commentary and assumption. Should we assume that kind of reverses itself here in the upcoming quarter and creates?
I would-
a provision?
I will ask Nick to answer that. I will add on. Okay?
Sure. Hi, Clark, this is Nick. For the 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, you know, all those kind of things, quick rate increase environment and the higher energy cost. Mr. Yu mentioned increase the possibility of a future recession. Even though under that kind of situation, we for this quarter we still add 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.
I guess we're scared.
Okay, Nick.
Go ahead, I'm sorry.
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.
Understood. Okay. 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 you know slowdown in the macro environment?
I think it would be probably pretty stable.
No, I mean.
On the LC.
Yeah. It's also. You know, you said stable, but I'd like to say it sometimes it's very unpredictable. Because LC is such that a customer has a need to come in.
Yeah.
To open a LC for me.
Yeah.
We charge them fee.
Right.
The activity is, you know, depends. It is really customer specific. I mean, it's hard to relate to any economic conditions now.
We tried to track the pattern on that. We haven't gained success on predicting it yet.
Understood. Thank you.
Our next question comes from Steve Moss with B. Riley Securities. Please go ahead.
Good morning.
Hi.
Let me just start off with deposit pricing here. In the release you guys talk about, you know, CDs repricing at a slower pace. Just kind of curious here, you know, what are you guys thinking for, you know, 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.
Well, Ed, do you want to answer that? What's your-
Yeah. I'll start off. In terms of, you know, deposit growth going forward, I think we're okay with the lower level. 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. 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 40-50 basis points on a one-year CD.
What I think you're gonna see this time around, you know, you hear this all the time, this time it will be different, right? This time around, with the economy and the consumer and businesses do still have a lot of cash on hand. I think it's gonna take some time to whittle that out of the system going forward. As that happens, I think you'll slowly see banks start to raise their offered rates. At the present time, we're just really not seeing a lot of movement. It's a little bit like a Goldilocks moment right now for at least the time being.
Do you have anything to add, Mr. Yu?
Okay. I mean, 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.
Yeah. No.
Okay.
On the wholesale side, a lot of those are negotiated rates anyway, so those still are fairly low as well.
Okay. Got it. That's helpful. Then in terms of just, you know, on the loan pipeline being strong, just maybe what types of lending opportunities are you seeing? I mean, 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. Just when we think about loan growth for the year, you know, obviously a really strong pace here. You know, are you guys thinking, you know, low teens type number ex PPP?
You wanna answer that?
Sure. We're always looking for new talents, as Mr. Yu mentioned earlier. Whether it's you know we're looking for talents will take the lead of where we're gonna expand, whether it's Southern California, Northern California, or elsewhere. In terms of we're looking at the market and pipeline right now. I think in a post-pandemic, there are a lot of opportunity. People are looking to acquire property and looking to reposition. A lot of opportunity in multi-family and industrial type of facilities.
Great. Just in terms of the tighter underwriting standards here, just remind us as to, you know, kind of what the debt service coverage or loan to values you guys are looking at these days?
Loan to value is our current data around 55%-56%. This year, definitely, as Mr. Yu mentioned that we're very conservatively underwriting the loans with consideration of future rate increase. Currently it's around 1.2 and above.
Okay. Just one last question and a small one in terms of the OREO properties that you guys took over here. You guys made comments about resolving it shortly. Just kind of curious as to how quickly you think you can liquidate them.
Well, we hope it's done yesterday. We had offer. The property is well sought after. Broker is telling us that they feel that the price is very advantageous to us under the current market now. Yeah.
Great. Well, thank you very much. Appreciate that.
Our next question comes from Andrew Terrell with Stephens. Please go ahead.
Hey, good morning.
Hi. Andrew.
Hey. Maybe, Ed, just to start off, hear some of your comments on kind of the deposit growth expectations and just the overall kind of leverage of the balance sheet. Just, 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?
Great question, Andrew, and 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. To the extent we can more utilize the cash into the loan portfolio. Remember also, that cash is also gonna move up in rate too. As the IOER rate moves in lockstep with Fed funds, we'll see that cash benefit as well. That's a you know, a nice production of that. We are not going to forgo deposit growth. Let me be clear on that. We still believe in deposit growth, and that does form the foundation of the bank or the franchise value of the bank. We will get deposit growth this year, but we will not be as hard pressed for deposit growth this year.
Mm-hmm. Mm-hmm. Understood. Okay. That's helpful. I appreciate it. Maybe looking at just the core loan yields while we're 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?
No, we don't have it. Good to you.
No, but I will say we did see a small uptick after the rates after the mid-March Fed hike. We saw that also on the cash side. That's beneficial.
Yep. Okay. One last question from me, Mr. Yu. I know historically you've not been very active in kind of bank M&A. Just wanted 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.
Yeah. Number one thing is that maybe it's our DNA, okay? We live it on the conservative side of our, I mean, acquisition situation. We look and there's continuously obviously intermediaries that was introducing deals to us, okay? For various reason, either pricing or the talents or the geography. We have not got much success. There's a couple deals we're getting close to step number two, but it seems to be didn't materialize any further. Our calculation about the accretion requirement is probably one of the tougher in our industry. One of the reason is that when we can internally generate, I mean, more than 15% of growth as average, and the need for acquisition to increase the balance sheet is not that imminent, and therefore we choose the most profitable way of in
I mean, organic growth. Needless to say, when the organic growth started fading or stop, we have to think about how to make this institution more profitable. I hope the acquisition we make will be profitable because as I know it, not every acquisition work out very well, okay? It just doesn't show up in financial statement enough in bold letters.
Mm-hmm. I hear you. 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 IRR 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?
Well, obviously there's the two things that I'm looking at. I don't look at IRR that much. I just look at accretion of the EPS. Then also the important thing to me is how much is dilution of the book value, okay? The payback on the situation. You know, in an acquisition you really take a target, you're prepaying for whatever the earnings for many years and hope you can make it back through combined efficiency and combined operation. We must be cognizant that not everyone's gonna be perfectly executed. We're just looking very carefully at the book value dilution side of it.
Yep. Understood. Okay. I appreciate you guys taking my questions and congrats on a good quarter.
Thank you.
Our next question comes from Tim Coffey with Janney. Please go ahead.
Great. Thank you, and thanks for taking my questions. 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?
Off the top of my head, I unfortunately can't right now. I can tell you that in a 100 basis point shock, I think we're about 9%-11% higher on an annualized basis.
Okay. That's helpful. 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?
I guess the increased rate actually has created more opportunity to us because previously that most we lose many the payoffs is to the people offering low rate fixed rate loans. In 10 years sometimes, okay? Some of them is doing a 10-year, five-year interest only, 10 years interest only, okay? We're losing to these deals when we're thinking about rates, it's going to change. Why getting to the fixed rate situation, while we are pondering about that, we keep on losing loans or losing competition. I mean, competition for loans on that reason. Thank God, everybody started thinking, I mean, they should not be making low rate fixed rate loan anymore. We become an equal basis competition where our, I think, our competitive advantage of high touch one-on-one service delivery and your customer relations start to come back, you know, benefiting us.
Okay. That's good to hear. Is it your expectation that, you know, pipeline fallout will decrease going forward if based on rate?
Yeah, I would say that it would decrease. Although that the one caveat is that we have to underwrite it more carefully.
Right. Okay. That makes sense. 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?
Are we talking about our credit quality?
Yeah. Yeah
Okay.
Loan review. Mm-hmm.
We actually. I'm gonna answer in different ways about it, okay? I just reported to our board says we will be starting internal loan review again in the late second quarter, early third quarter in light of two situations. I mean, one is a continued high inflation. What would that do to many of our customers' industry or customers specific? We also to project after the inflation situation, when the recession situation come, which of our customers likely to be affected? We can take proactive moves in relating to these things. The bank-wide review will be starting in late second quarter or early third quarter because we do have examination scheduled in late second quarter. We'd like to take care of our examiners first.
On the CRE side, obviously, we went through many drills before. We plan to do the same drill in the third quarter and looking at it as what product line is fall out of the market situation. What product line is continued to be the favored investment. It's safe to say, and then it's just speaking from common sense in my past experience, when in early stage of inflation, there's many of our customers, astute customer, is really in 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. While we are also cognizant about that, but we still have to do our assets review on the thing.
Great. Okay.
So I think-
I appreciate the color. Yeah.
Depends on the results of the review that Mr. Yu spoke of, Tim, whether, you know, how we look going forward, relative to the ACL.
Right. Yeah. Okay. No, that's great. I appreciate the color. Those are my questions. Thank you very much.
Again, if you have a question, please press star, then one. Our next question comes from David Feaster with Raymond James. Please go ahead.
Hey, good morning, everybody.
Hi, David.
Mr. Yu, I just kinda 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. You know, 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? I guess just with the competitive landscape, how do you think about your ability to push through the next couple 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 pay downs as competitors price lower? I guess just how do you think about your ability to push through higher rates on these?
Each cycle is different, okay? However, in this cycle, what I can see is that our margin, meaning the index, okay, number is competitive with other, I mean, competitive when the offer is prime plus half. In other words, if the loan is worth prime plus half, everybody's offering prime plus half, okay? Right now, for other people to offer much lower index number to do the loan, I don't see many of our competent competitors is doing that. There's always been few over there, but I don't see a majority of people will be doing that, okay? As they say, I just think they are equally as sensible as we are, okay?
I actually do not think that we'll lose a lot of business because many of the things will push the higher rate due to the loan. More so, if anybody wants to do that, it's because the economics of their own thing, okay? I mean, it's owner-driven.
Okay. Are you starting to see new loan yields improve? Have you seen, like, an inflection in new loan yields across the portfolio?
In the last few quarters, I have told you that our old loans payoff rate is generally anywhere from 75 basis points-50 basis points higher than the loans being made. This quarter, the number is narrowed down to 26 or 27 cents, okay? I have a feeling on the situation, the second quarter, the new loans will carry a better rates.
Okay, that's helpful. Just, you know, on the C&I growth in the quarter, that was great to see. Just curious, whether you think that was a function of drawings on existing lines as borrowers are starting to build inventories, or are you seeing increased demand for new lines? Just what are you hearing from C&I clients and how is the C&I proportion of your pipeline? Has it increased at all or still kind of that 70/30 I think we talked about last time?
Ed, after Wellington's comment. Okay?
Hi, David. It's Wellington. It's not necessary, not much from the existing line drawdown. We had a couple good wins on the new C&I relationship, and really that's where mainly it's coming from the growth.
Okay.
Did you-
All right. That's helpful.
Yeah.
Yeah. Thanks, everybody.
Our next question comes from Jordan Hymowitz with Philadelphia Financial. Please go ahead.
Hey, thanks, guys. Before I ask my question, Li Yu and team, I just wanna say I 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. Good job. And after-
Thank you.
the commercial for you guys.
Thank you.
I have a-
Thank you, Jordan.
Made my day.
I have a question for you on the follow-up to the other gentleman's M&A question. I'm not saying you should or shouldn't do M&A, that's a different thing. With RBB's chairman now resigning because of the proprieties, there's rumors that that may or may not go on the market. Who knows? Would that be a property at a certain price that you might be interested in if-
well, and I have at least among the group of firms that was represented here today, at least two or three has contacted me on this particular thing. Except none of them knows them as well as I do. Okay? Many of the board members are my friend, okay? Obviously, the former chairman, former president and CEO was a long-time friend of mine too, you know. I know the situation, okay? It's a matter of their expectation. It's a matter to after they have stabilized the situation, whether their business level, how much it still represents a vibrant ongoing business or sort of like, you know, slow growth business. It depends on the price. Unless I can deliver to you guys, you're the shareholders, a better future year by year, why should I do that?
Okay. Thanks so much. Congratulations, and I appreciate it.
Thank you.
This concludes our question and answer session. I would like to turn the conference back over to Mr. Li Yu for any closing remarks.
Thank you so very much for joining our conference. If you have any question, please call Ed and I, okay? More so Ed than me, okay, but anyways, okay. We love to answer that. Thank you so much, okay.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.