Good day, and welcome to the Preferred Bank Third Quarter 2021 Earnings Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. 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.
Thanks, Jason. Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the Q3 ended September 30, 2021. With me today from management are Chairman and CEO, Lee Yu President and Chief Operating Officer, Wellington Chen Chief Financial Officer, Edward Cieca Chief Credit Officer, Nick Pai 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.
Thank you very much. Good morning, ladies and gentlemen. I am very pleased to report our 3rd quarter net income of $26,000,000 or 1 0.77 dollars a share. Both are new records for our preferred bank. Likewise, the return on average assets of 1.8% and return on equity of 18% are also the recent year's highs.
This quarter, we have experienced significant deposit increases. Quarterly deposits increased nearly $400,000,000 on the annualized basis, a little over 33%. Important thing is that the quality of the deposit growth is good. 70% of the deposit growth are in the area of interest bearing demand deposits. Another 20% is in the area of interest bearing demand deposit and money market.
Okay. Deposits cost improved moderately from the previous quarter, and I do expect that the trend will continue that moderately improve in the Q4. Loan for the quarter increased $77,000,000 or 7.1 percent annualized. This is lower than our previous quarters. And we're looking to our pipelines.
We found that this quarter we originated $260,000,000 of new loans. However, the $260,000,000 on new loan is in line with previous quarters, slightly better. However, the payoff for the quarter increased to $210,000,000 okay, which is roughly as bad compared to average $150,000,000 in the previous quarters, okay. Long year moderated a little bit, okay, and likely to continue to moderate, I mean compression moderately compressed in the coming quarter. The net interest margin come in 3.36%, which is lower than previous quarter, but that was the result of oversized deposit growth.
This quarter's bright light is in the non interest income. We had $1,100,000 increase for the quarter, largely due to the increased LC fees. Looking ahead, LC fee likely to be satisfactory in the 4th quarter, but probably will be slightly less than the Q3. Our operating expense to my personal surprise, coming at 30.4%, we started to feel the inflation wage increase pressure. And I guess the full effect of inflation will gradually show up in the later quarters.
Our credit quality is stable. There are no deferred payment loans under the tails yet at this time. PPP loans has been reduced to $65,000,000 And the non performing loans were steady. Altogether, we had only 7 non performing loans, 2 of them including 2 of them are the mortgage product. We are highly encouraged by the 3rd quarter operating results.
Under the intensive loan competition environment, which we now get used to and also under the slow progress in controlling the delta virus and under the inflationary, although it's called transitional, but we don't know how long this transition is going to be. But I do see all these facts will gradually improve in the coming days. And we here in Preferred Bank are quite optimistic about our 2022 year. Thank you very much. I'm ready for your questions.
Our first question comes from Matthew Clark from Piper Sandler. Please go ahead.
Hey, good morning.
Good morning.
Maybe just on the loan growth outlook and the pipeline, it sounds like the production is still very strong. The payoffs are obviously a little disappointing in some respects. What are your thoughts on payoffs going forward? And how would you describe the pipeline? I think last quarter you mentioned it was satisfactory, but any other kind of additional color as to what you might mean by that would be helpful.
At this point in time, it's early October. I think our pipeline is probably equally, if not slightly better than the Q3, which as I indicated, Q3 actual pipelines was better than previous quarters. But there are elevated, I think, payoff activities. And this low interest environment is very prolonged and many people are doing loans at the yield rate less than our net interest margin, but fixed for 10, 5 or 10 years, which we think will be detrimental to the future, okay, given the fact the Fed is about to taper and maybe the lift off was somewhere sometime close from close in site. So maybe the situation we choose not to compete because of these reasons, okay?
So we just want to maintain going forward that our portfolio is not sure sighted.
Okay. So maybe that elevated payoff activity continues, maybe do a little bit better in production. So maybe the growth rate is somewhere in between this quarter and your prior expectations of kind of low double digit or teens, mid teens?
As you probably can guess, it's very hard to predict at this point in time. But we certainly that I mean, our guest experiences, we always have growth, okay? We certainly would try to reach the level of previous quarter. We'll try very hard, okay. We'll continue hiring people, I mean, adding staffs.
We will continue to move forward looking for new loan opportunities. And but somehow, the market has to cooperate, too. The activity of I mean, the slowness of the delta control certainly will be a factor affecting the transaction level now.
Okay, great.
But we will this is our priority to loan growth.
Yes. Okay, great. And then just the other one for me was on the letters of credit fees and the sustainability of that activity. Is that something you think you can replicate going forward? Do you feel like it was a little outsized?
I think Q3 is a little outsized, but Q4 will be better than the second quarter, but probably lower than the Q3 a little bit.
Okay, great. Thank you.
The next question comes from Gary Tenner from D. A. Davidson. Please go ahead.
Thanks, hello. A quick follow-up on the letter of credit fee question. Lee, based on kind of your comments, does the Q4 represent sort of a baseline that you might think about a letter of credit fees going kind of a seasonal impact that would diminish going to the Q1 of 'twenty two?
The nature of letter credit is when you open it, you're on a fee, okay. So actually, it is there a certain degree of from a certain degree the volatility built in, okay. But looking at the situation to the best we can tell, Q3 will be slightly less similar. Q4 will be slightly than Q3. And then I hope in the Q1, so far it looks like we'll be closer to Q1 at this time.
But obviously, we hope to pick a few more deals and record more fee income.
Okay. And last quarter, I think, Ed, you kind of highlighted payoffs as one of the risks of being an offset to the production as more of a transactionally oriented bank. And I think this quarter, obviously, we saw that. Is there any room in the production side? I think you talked about some new hires a few quarters ago.
Just thoughts on the ability to kind of try to outrun some of the payoffs?
Let me put it this way. It's like talking to our shareholders. We'll do our best, okay? And the only thing I can say is that looking at our past experiences, we're always trying to put production is one of our top priority. But anything at this point in time, the crystal ball is kind of murky at this point in time.
Payoff doesn't come in with a lot of notice ahead. It just happens. I mean, it just suddenly you receive a demand. It is a payoff. So sometimes it's quite surprising to us.
The payoffs happen. We do our best in the weekly basis, try to update our list of payoffs. And we do our weekly basis, try to update our pipeline and that is a bank copy then every week.
Okay. And then finally for me, looks like you put a couple of $100,000,000 to work in the securities portfolio during the quarter, but with the deposit flows you mentioned, the cash balances increased by similar amount. So just any comments about maybe thinking about putting more of that to work at some shorter term yields that might be not as attractive as loan yields, but won't lock in the rate for that period of time we're talking about that other banks are doing?
Yes. It's a difficult challenge, Gary, as you can imagine, in this rate environment to try to go after yield. So we're not going to necessarily do that. But yes, we put about $200,000,000 to work, and it's very short monthly Ginnie floaters. So we're not taking interest rate risk there.
We'll probably we may do a little bit more of that. But at this point, we don't want to go long in the bond portfolios. We'd like to lend it out as our first option. And to add on to your previous question regarding hires and production, I think you have already seen within the Q3 production numbers some of the effect of new hires that we have taken on this year. So we certainly look forward to increasing that as we go forward.
But as Mr. Yoo said, it's top priority. We're doing our best.
Sorry, Ed, if I cut you off earlier.
The next question comes from Steve Moss from B. Riley.
Maybe just on loan pricing here, kind of curious as to what are the where new money yields are these days? And also loan yields ticked up quarter over quarter. I know there's a little bit of an uptick in fees, but that doesn't seem to account for the increase in yield quarter
over quarter? Well, you had the number right in front of you, Ed.
Yes. So the if you recall, Steve, last quarter, we had an interest adjustment downward about 2 almost $2,300,000 So that was really yes, that was the driver. But overall, loan yields are excluding that, just looking at that a few minutes ago, overall loan yields are holding up fairly well. The challenge with the margin is the rest of the earning assets and the cash that we have.
Right.
Okay. And then in terms of the yield on the Ginnie Mae's you guys put on, just kind of curious what's the rate there?
You're going to ask that question in public, 45 basis points.
Okay. And what's the appetite? I mean, you're sitting on, call it, over $1,000,000,000 in cash in terms of adding more in the upcoming quarter? How are you thinking about that in the short term?
We would obviously try to deploy that, but we have to weigh in the interest rate and I mean the trends going forward on the whole situation. And also we as the operator must be cognizant about once the tapering happens and once the sort of I wouldn't say tightening or normalization is happening, would the high liquidity that every bank is having will be holding on or some of them will be going away. So we just have to be careful about these items. Some of the items is precautionary. And so I mean some of the situation we're doing is really preventive medicine.
So it's not going to be we're not going to be chasing the last dollars in risk of this kind of nature. Okay.
That's fair. And obviously consistent with what you guys have done in the past. And I guess maybe just in terms of expenses here, I'm assuming you talked a little bit about inflationary pressures. Just kind of curious as to how you guys are thinking about expenses for the Q4 and maybe a little bit into 2022?
Well, my guess is they're going to be higher. But Ed has a different flavor. Maybe No, Ed.
No. I agree with you this time, sir. They will likely be higher. The sub-fifteen-four percent this quarter, I think, was pretty good given the environment that we're in. But clearly, as we go forward, wage pressure will continue to weigh on expenses.
So they will likely increase incrementally going forward.
Steve, wage pressure is that when you people start to take your people away with a high offer and then the new hires coming in at the level higher, we are forced to somewhere along the line making adjustment for all the staff, okay? So these things as we go forward, we'll make rational adjustment. It only reflects on the expense level of the time going forward. And I think every bank would face that kind of pressure.
Okay. All right. Well, thank you very much for all that.
Yes.
The next question is from Andrew Terrell from Stephens. Please go ahead.
Hey, good morning.
Hi. Good morning.
I was hoping maybe we could get an update on how business is trending over in Texas with your Houston office. Are things still on track to kind of hit the I think it was $150,000,000 of outstandings by the middle of next year? And then outside of that, any thoughts on maybe kind of new market expansion opportunities at this point?
Well, one thing I want to add, I'll answer that first, okay? Please. Okay. We have some turnover in Houston, okay. I mean, the leader of the team, which not a producer, more or less a visionary person has chosen to take another position with another bank.
So following him is 1 or 2 other producers. Okay? Right now, we have 3 loan staff at this point of time in Houston. They are continuing producing, okay? The total level of expectation in the next 6 months is moderated down, but still will be very much in line with the Dell expenses, the payroll related to that.
We are currently hiring and looking for new staff to beef up the Houston operation. So when the new staff coming along, it will be reaccelerated, okay? So Waiwat, anything to add?
No, I think you covered basically. And just to mention that the loan pipeline from Houston still looks pretty robust. We still have a pretty good inventory going. And people over there are holding the fork and holding the production.
Okay. Thanks. And any thoughts on kind of potential kind of new market expansion?
We are working on it, but we cannot say anything until we're successful landing some team of people.
Okay. I think the valuation of shares has kind of improved a bit relative to where you were repurchasing at during the Q3. Any kind of change in appetite for buybacks moving forward? Or should we still expect share repurchases?
Well, Ed, do you want to report on that?
Sure. Andrew, we have in place with the repurchase plan is a hard cap, a hard ceiling of $65 a share. And so we ran into that around mid late September. And so we not terminated, but we have not been active in the market since that time.
Obviously, that if our share continue to improve, okay, we will go to the Board and seeking for their approval to increase the limit on the whole situation. But given that the ability to generate earnings and beef up our capital level and additional the fund should be replenished the capital account easily.
Understood. Okay. Thank you. Mr. Yu, how are you feeling about the reserve at around 1.4% today?
Do you think there's kind of further room to work this down? Are you comfortable with where it's at today?
I can only answer in that just saying and then I'll have Nick answer that a little bit later. First of all is that if you remember the pre pandemic level, okay, the CECL day after CECL conversion, our level is at 150, okay? So last year, I think the banking industry has been very prudent is putting whole lot of reserve on a situation. So many of the factors that depend on each bank's viewpoint has is different, but everybody started to recognize improved economic conditions. So everybody's model and CECL model has they depend on economic condition.
So when it will return back to the pre CECL level, I mean, day after CECL level, we do not know. But I think it's quite a quality hold steady. If the economy does not deteriorate, one day we get to that level. Nick, anything to add?
I totally echo Mr. Yu's comment. With the improvement of economic conditions related to our CECL forecast as well as on the qualitative side, we tentatively believe that there will be somewhat less stress on the reserve requirement in the future quarters. However, definitely, as Mr. Yu mentioned, you will definitely also depending on lots of moving factors such as loan growth, migration of credit quality and also GDP unemployment rate, all those etcetera, etcetera.
Uncertainty of pandemic. Right.
So definitely, based on our best guesstimate, for the long run, our reserve should be gradually reduced to
around
1.3% level plusminus depends on all those moving factors. So we're hard to see how we're going to handle this during the next few quarters. It's eventually moving in that range.
Understood. Okay. Thank you for taking my questions.
There are no more questions in the queue. This concludes our question and answer session. I'd like to turn the conference back over to Lee Yu for any closing remarks.
Well, thank you very much for interest in our bank and we appreciate your support. And we are not looking we are back and now looking for a home running every segment of our operations, but we do look for overall having above average in put us in the high performing category. So we'll continue our effort toward the directions. Thank you.