Good afternoon, and welcome to the Preferred Bank Q3 2022 Earnings Conference Call. All participants will be in a 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 and then one. To withdraw your questions, you may press star and two. Please also note today's event is being recorded. At this time, I'd like to turn the floor over to Jeffrey Haas of Financial Profiles. Please go ahead.
Thank you, Jamie. Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the Q3 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 J. 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.
Thank you very much. Good morning, ladies and gentlemen. I'm very pleased to report that we have another record quarter. Q3 net income was $35.2 million or $2.40 per fully diluted share. This quarter's earnings was contributed to, aided by the Federal Reserve, the rate increases in our very sensitive, asset-sensitive balance sheet. Also, the large loan increases on June 30th are also fully reflected in the quarter of September. This quarter, our return on equity is over 23%. Loan growth has moderated down to 8.5% for the quarter. It is not unexpected under the current economic condition. Year-to-date loan growth was 14.1% ex-PPP. Deposit growth was 3.5%. Okay?
Deposit cost has increased, but the deposit cost increase will continue to accelerate starting from September and seems to continue to accelerate in the Q4 . Okay? Because deposit cost increase is much less than our loan yield increase, we had a 60 basis point expansion in our net interest margin. Our credit quality remained stable. Okay? 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 bank's growth in asset size.
However, since we have a large increase in revenue, the efficiency ratio has actually decreased to a little bit over 25%. We at Preferred Bank recognize the macroeconomy is 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 certainly continue to be alert in the future quarters. Thank you very much. I'm ready for your questions.
Ladies and gentlemen, at this time, we'll begin the Q&A . To ask a question, once again, you may press star and then one on your touch-tone telephones. If you are using a speakerphone, we do ask that you please pick up your handset prior to pressing the keys to ensure the best sound quality. To withdraw your questions, you may press star and two. Once again, that is star and then one to join the question queue. Our first question today comes from Gary Tenner from D.A. Davidson. Please go ahead with your question.
Thanks. Good morning.
Good morning.
Last quarter, Ed and Li, I think you said that you thought Q3 NIM expansion will be less than it was in the Q2. Obviously, we had some more tightening than I think expected or rate hikes than expected at that point in mid-July. As you think about the Q4 now, you know, 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?
Okay. The final answer is we have no idea, but I have to tell you the things what we know about, okay? First of all, like you said, the September quarter is at 75 basis points will be fully priced in the Q4. In November, if it is 75 basis points, will be two thirds priced in the Q4. December is anybody's guess at this point in time. That will be the revenue expansion. The cost increase has accelerated quite a bit, okay? If you know that, over the marketplace there's a, I mean, people is paying all over the place rate for the deposit, especially in the interest-bearing demand deposit, like money market and so on. The CD rates paid by the major banks is now over 3.5% now.
I guess they really set the bar for all the small guys there. Sooner or later, the deposit will increase. In the Q4, we will have about $400 million deposit, which is, CD will be maturing, will be repricing. There will be many deposits CD will be early withdrawal and then, and pay a penalty or reopen for a higher rate, okay? The magnitude, the pace of increase, we are really at the mercy of our competitors. The best we can do is keeping alert and managing, okay? I like to say that I will see that NIM probably will be continuing to expand, but not to the same level of the Q3.
On the other negative side, in the Q4, we also will see that we probably will have to reprice one of the REOs we have, okay? Then because the market condition has changed, appraisal value has changed, we will conduct appraisal to reflect a more better value of the situation.
In terms of that specific, were you saying we're talking to one specific REO or are we talking about that portfolio broadly?
The others seem to be under contract waiting to close, you know.
Okay. What's the size of the one that you're suggesting may have to reprice?
$21 million.
$22 million.
Huh?
$22 million.
$22 million, yeah.
$32 million. Okay. Thank you. I appreciate the color there. Then, you know, historically, Preferred's been a very much a loan and spread-driven revenue story. You know, even the growth in the Q3, which is, you know, low by Preferred standards, is quite a bit stronger than most that we've seen. You know, 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 Q4 and, frankly, as we go out to, you know, at least the early part of 2023?
Well, it's October. The pipeline is kind of a, you know, it does not tell us enough of a crystal ball, okay? Again, it has to do with what the economy is developing. What we know is in the marketplace, at least on the real estate side, you know, the transaction of new transactions is much reduced. Many of the loan proposals came to us as is subject to a much higher standard. Understandably, the cash flow test will be completely different than that. We are not going to have high hopes for huge loan production. If we will reach the Q3, I consider we're very lucky, okay?
The actual amount will also depend on the Q4's, I mean, commercial industrial C&I loans, their drawdown, their usage in the Q4 will sort of like peak up and down a little bit, which we're in no control at this point in time. Sorry about the wishy-washy answer. That's the only way I can answer now.
Understood. I appreciate the color you were able to provide. Thank you.
Our next question comes from Andrew Terrell from Stephens. Please go ahead with your question.
Hey, good afternoon, or, I guess good morning.
Morning.
I wanted to start just on 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? 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?
Well, I would do some explanation. I also will ask Wellington to answer some of the questions you have. Okay? Well, first of all is that, you know, at this juncture that we manage deposits, we try to stay above account level. In other words, we don't wanna lose any deposits. That's our most primary goal. Okay. If we can grow a little bit, then we will do. The matter is wherever deposits are coming from my point of view, I want to keep it because under the current situation, we don't know the Fed's tightening, what events, what situation can happen there. Secondly, all consumers, customers' behavior has changed. Preferred Bank's customers basically are wealthy individuals and business owners businesses.
They are very savvy with their money. They have many choices with their money. The question is that whether they wanna put into a different type of account, we do not know any of their management. We're facing much more competition from the market side. Our job is to stay on top of them on a daily basis, which we literally do stay on a daily basis with our deposit base. Wellington, you wanna add to that?
I couldn't add any more, Mr. Yu. That's very straight to the point.
No, 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?
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.
Okay. Where are you at, 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?
Right around 3-3.5.
Okay.
Depending on the client relationship size, etc.
We just raise it.
Yeah.
Yeah. We have to continue to raise it. We're almost do-
Yeah.
We almost change our rates on a weekly basis.
Yeah.
That's how fast the market is changing now.
Yeah. Certainly a 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-over-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 updated debt service ratios for your clients? And are there any areas specifically, whether it's 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?
Well, Nick, you wanna answer the first, and I'll-
Yes. Definitely, there will be some pressure on the DCR side. 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 dollar amount over a million. 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.
Well, another situation, Andrew, you know, the great majority of our loans, right, or at least over 90% of the loans is personally guaranteed. Okay? Whereas when we do our underwriting, we have heavily considered the personal cash flow and their capability and their networks in stand behind the loan. That's one added protection for our bank.
Okay. Perfect. Well, congrats on a good quarter, and thanks for taking my questions.
Thank you.
Thank you.
Our next question comes from Adam Butler from Piper Sandler. Please go ahead with your question.
Hey, good morning, everybody. This is Adam covering for Matthew Clark.
Hello, Adam.
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?
Yeah. You know, going forward, you know, we hit 17.4 this quarter. That's with a real estate owned charge of $300,000. On a regular run rate, you could make the case that it was closer to 17.1. Looking forward, we'll likely have some more on that. 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 gonna have lease cost increases, still additions to personnel, et cetera.
Okay, great. Thanks. Do you guys have the weighted average rate on new loans in September?
What's that? Weighted average rate, new loans in September.
Well, we
Just for the quarter.
We got it for the quarter.
We got it for the quarter.
Yeah, for this quarter.
Yeah.
For the quarter, new loan that we're getting is. Let me see, I have it right here in my hand.
Five, five nine nine. Five nine.
5.9%
Okay, great. Thank you. That's all my questions.
Okay, thanks.
Our next question comes from Tim Coffey from Janney. Please go with your question.
Thanks. Morning, gentlemen.
Morning.
Hi, Tim.
You know, most of my questions have been answered, but I did have one for you given kind of your geographic reach and your specialty. Is it 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?
Well, what do you see, Wellington, right now? Okay. Are you seeing it? I see that basically generally everybody seems to be more cautious.
Right.
Yeah.
Okay? There's certainly certain segment is universally, including us, is being more careful at, like, office product, you know. You know, certain loan area that we're being very careful. Okay. Loan is one-off. You have to see the LTV of the loan and also the sponsorship and their cash flow. Okay?
Yeah.
Generally speaking, I see a lot more reluctance for our competitors and including ourselves in doing a new loan.
Yes, that's very true.
Okay.
I mean, the market is pretty much everyone is very cautious.
Pullback's probably a strong word. I think cautious is.
Yeah.
Okay. Yeah, and then the geographies I'm talking about aren't necessarily ones that you're in right now. You know, it could be different markets that they're seeing. Okay. All right. Well, thank you very much. That was my question.
Thank you.
Once again, if you would like to ask a question, please press star and then one. To withdraw your questions, you may press star and two. Our next question comes from Eric Spector from Raymond James. Please go ahead with your question.
Hey, guys. Just wanted to follow up on the NIM. How do you guys think about managing rate sensitivity here in light of accelerating 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 kinda your thoughts on managing rate sensitivity going forward.
We have many of our loans which we have previously disclosed that there's. You can please refer to the last quarter's press release. It's outlined there that, I mean, how much loan we have as a floor, okay, on the whole situation.
Yeah.
A majority of our floating rate loan has a floor. Okay? I guess this practice will continue. In fixing the product will definitely come sometime in the future, but the timing of it cannot be predicted right now. It has a lot to do with the Fed acting. It has a lot to do with the economic situation. It's definitely in our plan, but the timing of it is not sure. Did any strap?
Well, I was just gonna add on the deposit cost side, unless 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 costs at the same time. It's just a very tricky thing to try to do. Fortunately, with the asset-sensitive balance sheet, we have a little cushion. In terms of the rate floors, our 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.
Okay. Thank you for the color. You deployed a portion of your cash this quarter, but you still have a large portion of your assets in cash. How do you think about deploying liquidity going forward? Is this earmarked to potential deposit flows? Just kind of curious if you have a targeted cash ratio. Yeah.
I just read the from your investment side, which I'm your customer, and telling me cash is king. Okay? In this unsettled environment, we all need to be careful. I guess I'm follow your firm's advice.
I think at some point there will be opportunity for increasing the investment portfolio. I don't think we're there yet, though.
Okay. Got it.
You should. Sorry about that. Okay?
Just kinda curious your thoughts on capital. You completed your share repurchase during the quarter. How do you think about that going forward, and are you taking a more cautious outlook or and hoarding capital ahead of, like, a recessionary period? Or how are you thinking about that?
Oh, well, first of all, in a recessionary period, especially when people like Jamie Dimon says it's a serious recession, you wanna keep your capital, okay? Not only us, I think majority are shareholders. I think our regulators, everybody, including our board of director, want us to be, you know, hold on to our capital. When the situation eases, then obviously we have to deploy that.
Okay. Got it. One last question. Just curious about your Houston LPO and how the pipeline's kind of developing there and your appetite for additional de novo opportunities near term, given the backdrop.
Johnny Hsu, you want to talk about it?
Sure. Eric, Houston, they continue to contribute. I think, you know, we have a full team over there. Our plan, of course, is graduating from LPO to a full-service branch. That plan is still ongoing, so it's been good for us. What was the other question?
De Novo.
De Novo, again, as Mr. Yu mentioned before, as we look at the opportunity, de novo is strictly based on the human talent. We're not gonna go anywhere because we feel like it's a good geographic location, whatever, unless we have a local team available. It's an opportunistic situation.
Okay, got it. Well, thank you. Congrats again on a great quarter and, I'll step back.
Thank you so much.
Okay. Bye.
Our next question is a follow-up from Andrew Terrell from Stephens. Please go ahead with your follow-up.
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 you're 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 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 a kind of franchise investment standpoint? Love to hear any thoughts there.
You wanna answer that first or?
I think as you know, Mr. Yu talked about, you know, 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 would probably revisit the dividend level. That would be at the board. You know, they would wanna 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.
Okay. Is there a kind of targeted capital ratio or level you're looking to?
Well, not the short-term situation. We just within the next six-nine months. I said within the next six-nine months, we just wanna hold on to what we have. We like to use some of the capital if we can and if the methodology allows us to is to further our reserve a bit more. As we go along that when the economy is clear, the lending is not that hard, then we'll be doing things that's probably more progressive. At this point in time, we wanna be treating safety as our number one issue.
Yep, understood. Okay. I appreciate the follow-up.
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.
Well, thank you so much. You know, we're very lucky to field the questions asked to us about capital planning. I mean, we can afford to be more conservative, and we're very lucky to be able to have the profit that we're having in this quarter. Certainly, we will be putting our full attention in managing our sales going forward. Okay. Thank you.
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.