Good day, and welcome to the Preferred Bank Fourth Quarter 2022 Earnings Conference 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 a touch-tone phone. 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 Jeffrey Haas of Financial Profiles. Please go ahead.
Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the fourth quarter ended December 31st, 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.
Thank you very much. Thank you, ladies and gentlemen, for attending our earnings conference. I am very pleased to report that we have another record quarter of earnings. Fourth quarter 2022 net income was $39.6 million or $2.71 a share, which compares very favorably with prior quarter and prior year. This increased earning power, our board has announced a 28% increase in dividend in December and start to be payable in January. Growth in interest income has outpaced the growth in deposit cost. Our net interest margin expanded to 4.75% for the quarter came. Toward the latter part of the quarter, we have seen that the deposit cost increase has accelerated. We believe it's catching up and this process will continue into first quarter of 2023 at least.
Many of our customers are continuing to manage their money by moving their deposits from lower cost to higher cost. We see the market continues to offer higher deposits nearly every day, deposit costs every day. Going forward, to grow deposits at a reasonable cost will be a challenge and will be a thing that we must do. Sequentially, this quarter has a net loan increase of 1.3%, and a deposit increase of 1.9%. I mean, loan demand has tapering down or moderated since third quarter of 2022. We believe it will be carry over well into the first quarter at least. Our customer generally are finally just more prudent in their operations, especially in term of new transaction or new initiative committed.
Because of our high earning capability, liquidity and capital ratio both improved from the previous quarter, and we believe our current liquidity level and capital level can easily handle our growth, foreseeable growth need in the year 2023. Benefited by the net interest income increase, our efficiency ratio come in at 26%, even when we consider included a $1.8 million of OREO items. Going forward, in 2023, expenses is expected to increase. General wage inflation is the main thing. The increase include FDIC premium, new premium assessment, at least two new planned branches. Some planned addition to staff and also a fully operative SBA department that will be fully operative in 2023.
Our attention since early 2022, that I'm sure that you can see on my previous earnings release report. Since 2022, we've been very focused on credit matters, okay? I'm also pleased to report that both MPAs and MPL has improved from the third quarter. At December 31st, they are at a lower level than September 30th. In fact, in early January, we have resolved another $5.3 million or fully collected another $5.3 million of non-performing loans. Effectively, as of today, our December 31st non-performing loans is only $200,000. A very good early indicator of credit quality is our 30 to 89 days past due loans, okay? I'm also pleased to report at December 31st, the amount totaled only approximately $1 million.
Based upon a report published by Bank of America, our third quarter return on tangible common equity is 23.6%, which ranked us the second among all California public traded banks over $2 billion. We believe our fourth quarter performance will land us at approximately the same situation, at least. Because of our business SBA model and because we are a business bank serving business and private clients, our model does not allow us to necessarily become a very low cost, deposit cost operator. However, if you add non-interest expense to the deposit cost, which will give us the total cost of operation, for years, we have been the lowest among our peer group. We believe or I believe, okay, the high earning power and the low effective total cost will be the best defense facing a recessionary economy.
We are optimistic about 2023, but we'll be very careful. Thank you. 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 touch tone phone. If you are using a speaker phone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press Star, then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Matthew Clark with Piper Sandler. Please go ahead with your question.
Good morning, gentlemen. Wanted to start on non-interest expense and clarify some of your guidance around the growth this year. I assume it excludes the OREO related costs in 2022, roughly, I think $2.9 million. Maybe you can speak to the run rate going forward and how you think that run rate might progress throughout the year.
Well, I just best answer by Ed, okay? He's just in the budgeting process.
Hey, Matthew. If we, you know, if we pull out the OREO costs in Q4, we were just under $18 million on a run rate. Going forward, at least for Q1, which is always a little bit of a aberration for us because of certain costs in Q1. We're looking at probably the low end, about $18.6 million, high end, just under $20 million in terms of non-interest expense. Going forward from there, it'll probably be somewhat similar, although you'll have a slow ramp rate in terms of the growth of non-interest expense.
Yep, got it. Okay. Shifting to the margin, do you have the spot rate on interest-bearing deposits at the end of the year?
Total interest-bearing deposits, not at the end of the year, but for just the month of December were $2.47.
Okay. Okay. Do you happen to have the since you have the average for the month of December, you have the average margin in December?
Yeah, the margin for December was 4.83%.
Okay, thank you. Just on the overall outlook on interest-bearing deposit costs. We heard your comments earlier, Mr. Yu, about things accelerating toward the end of the quarter. What are your thoughts on, where your beta might settle out through the cycle, assuming we get a, you know, another 50 basis points from the Fed here and we're done, relative to last cycle, I think we were in the mid-fifties?
Yeah, well, my thoughts is that experience is that we will continue to see the market competitors paying more interest. We as a small fish in a big pond, we just have to follow the trend and do approximately the same thing and hopefully that try to manage it more closely. Now, actually, you'd be surprised some of the largest institutions back in November before the December rate raise, they already offering one year, I mean, like, certificate deposit 5%. I can list a whole list for you. We have gathered that. Going forward, as these big institutions, what the market rate they set, what market they prepare, we just try to catch up. We have no idea what they would do and so on.
Based on my experiences, I think the first quarter, the deposit costs are further accelerating increases as compared to fourth quarter. Then our margin, you know, would, in my opinion, is, if not at or near top, okay, in a cycle. Obviously, margin itself has to do with the leverage too, depending on how much you growth in loans, how much growth deposit you have. In general, the spread, I think, is among the top. It's top in fourth quarter.
Okay, thank you.
Which not to say in first quarter, we not be able to earn a very handsome margin, you know.
Our next question comes from Andrew Terrell with Stephens. Please go ahead with your question.
Hey, good morning.
Morning.
Good morning.
I wanted to start on just deposits, specifically non-interest bearing. If I look, I think your mix is around 21%, 22% non-interest bearing deposits as a percentage of total. Just trying to get a sense of, I guess, what you're seeing so far in 1 Q in terms of non-interest bearing deposit flows, and then what your sense is on where we could see non-interest bearing deposits, bottom out.
The answer is we don't know. That's one of the reason we would say we have no control of the margin going forward. We see customers continue to manage their money. They either pay off their lines or they just reduce their loans, okay, save interest costs, or in many cases, where customer using their excess cash to pay off their real estate loan because they consider, you know, 8%, 7.5% unbearable, okay? This trend will continue. This is also that more people will recognize that their money can earn, you know, over 4% now. They want to move to TCDs or other things, okay?
This kind of movement, I try to look at it, the other press release, even as big as JPMorgan, they have no idea, okay, what this migration process will be. This is one sector situation. Another one situation, I can never tell how the big banks set their price situation and become the main competitor for deposit because they have huge market share. We just have to follow. A lot to do with their funding condition or the overall tightness about the firm. This is really the very important wild card going into 2023.
Yeah. Understood. I appreciate the color there. Maybe if I could move over to just um outlook on um provision and reserve moving forward, I guess, how are you thinking about uh allowance levels um moving through 2023?
Well uhhh our general philosophy is we have been building up our reserve at the bank. We would take every quarter, take a look and generally stay conservative, to see whether that number is to be increased or needed or stayed approximately the same. Has to subject to the CECL methodology and so on. Some of the situation, they have to go through a calculation process. In generally speaking, if we base on the credit metrics as of now, I have to say we're over-reserved, but we don't know what the coming economy will be. We stay at the level. I understand some of our direct competitor has reserved less than 90 basis points. That they have to do the same type of business as we do.
We believe that we need to be stay at this level now.
Yeah. Yeah. Okay. Maybe sticking on credit. I'm just looking at loan yields, call it near 7%, just south of 7% in the fourth quarter. Obviously, really good for the margin. I guess any color on how debt service coverage profiles have changed at your borrowers, just given the increase in uhh loan yields? Any loans that you've had to restructure as a result of rising rates or any that you foresee having to restructure? Just any kind of incremental color there would be helpful.
I have Nick answer that first, and I add on to it.
Sure.
Andrew, uh this is Nick speaking. For our TDR, we only have two small loans on our TDR list, combined with only a $1.5 million, is belonging to one relationship, and they are paying. Everything is seems okay. And uh definitely for Fed's uh rapid re-increases and our borrower, I believe that they do have some pressures on that service coverage ratio side. However, most of our loans, we have a very financially strong sponsorship behind it and y ou can see from our past due report, we don't have that many past due uh uh under 30-90 days. Also, non-performing loan, we only have one mortgage loan as Mr. Yu mentioned previously, it's only a $280,000 around. That's it.
So basically uh uh our credit quality is still, uh, quite stable comparing to our, uh, previous quarters, and we expect that to be the situation. And definitely, there are still, uh, many, many, uh, economy uncertainties ahead of us in, uh, 2023, such as, uh, uh, you know, honorable energy of food supplies, inflation costs, uh, weakening, uh, the purchase powers and the rapid rate increase and Fed's, uh, QT side. All, all those kind of things really, uh, uh, you know, give us, uh, uncertainties for this market. And the management continues to maintain a kind of a moderate risk posture for, uh, factoring, uh, the reserve requirements at this time.
Again, this is pretty much that uh I've said. At this time, if based on metric-matrix to date, we are over-reserved. Okay, that's my personal opinion. But however, in general, we have been trying to consider the recessionary economy, what the effect will be. Okay.
Okay. That's all very helpful. I appreciate y'all taking the questions.
Our next question comes from Gary Tenner with D.A. Davidson. Please go ahead with your question.
Thanks, everybody. Good morning.
Hi.
Had two questions. First on the commercial construction segment, relatively small, but had a couple of quarters of decline before uh increasing this quarter on an end of period basis. Just wondering if you could talk about kind of the, you know, committed pipeline that might fund over the course of the next year and if there's, you know, does the period-end number continue to trend down? Was the fourth quarter a bit of an aberration there, or anything else to think about?
Nick will give you more color on that. Some of the fluctuation here then is because in the past, we had pandemic slowed down many of the projects, okay? Many of these is restarted, and obviously, the summertime has been the greatest time to increase the construction. Okay. Nick with that.
Our construction portfolio, we try to manage this portfolio under uh 10%. During the past quarters, I believe this is around 8%, and this quarter dropped a little bit to below 8%. Just give a little bit more color on our construction loans, 'cause we don't do many uh uh construction loans, which is not a desirable product. Most of our construction loans actually uh is from the existing loans, and we try to slow down a little bit, especially for those uh condo project and those kind of things, because of uh there's a lot of uh uncertainties in the economy. We try to uh slow down a little bit.
all of our construction loans at the origination, we try to based on, increase projections to, have interest reserve. We are doing construction very conservatively, compared to our peer groups.
Okay, thanks. Then a question for Ed. You know, there's obviously a lot of conjecture out there in terms of what happens to rates, how long they stay at elevated levels when the Fed does stop tightening. Just wondering, given, you know, the amount of progress you've made in terms of asset yields, you know, year to date or in 2022, you know, any updated thoughts on how you might kind of manage the balance sheet to lock in some of those benefits, you know, looking forward to a timeframe where the Fed does start to cut rate?
I'm not gonna speak for the production side, but, I know we have had a lot of discussions around, as you know, Gary, about 80% of the book is a floating rate. There have been a lot of discussions around and, you know, making headway into doing some more fixed rate lending at this time, given the overall level of interest rates, this would kind of be the opportunity time to start doing more fixed rate lending. That still presents a challenge. Obviously, as we've talked about already, the activity has slowed down, economic activity has slowed down. I can let, you know, Mr. Yu, do you wanna speak to more on that?
Well, I think in overall fund management situation, we have a most of floating rate loans. In fact, substantially all our floating rate loan has a floor. The floor sort of protects us from the fluctuation, okay, that can caused by the rate situation. Obviously that during this high interest rate time, it will be sometime advantage to do selectively few fixed rate loans, so on. The floor really puts us in a situation that, I mean, that we can have time to adjust, okay, along with the interest cost rate decreases. Going forward that we just have played every step of the way, just like when it's going up, we build up the sensitive balance sheet.
Just as a follow-up to that, to the degree that, you know, you've got new loans in, working through the pipeline, which as you pointed out, I mean, that's slowed down dramatically, are your customers more interested in variable rate loans because the customer has a sense that rates are gonna fall quickly? You know, is that kind of the general view of your customer base that they think that that'll pivot quickly to the downside?
Customers are probably more interested in this day as a floating rate loans, you know. We do like, presumably are talking about real estate, we're not talking about C&I, okay? They forecast, they listen to forecast by all the economists who is indicating that rate will come down latter part this year or early next year, okay? To them, it's just a short-term situation.
All right. Thank you.
Our next question comes from David Feaster with Raymond James. Please go ahead with your question.
Hey, good afternoon, everybody.
Hi.
I wanted to touch on some of the expansionary plans that you touched on early, in the call. Maybe specifically starting with the SBA department. Just curious the plans for that, whether your plans are to retain production or sell it, maybe the timeline for the build-out and maybe where you're gonna be focused from a regional perspective.
SBA department was started latter part of 2022 with a skeleton crew. We are going through to be getting our PLP position. We've never been a preferred lender before. We expect the PLP position will be granted early part of this year. As far as the plan of a way return, retain something like that, Ronald, you wanna answer that?
thank you, Mr. Yu. David, our plan is to, as we fund the SBA loan, we will, just sell it to a secondary market.
Okay. Do you have any early expectations in terms of production, or is it kind and see?
It's a wait and see, especially with current economy, current situation. You know, the SBA, with the recessionary economy, SBA tends to slow down. A lot of people actually, you know, the market has slowed down. But,
Okay.
I know. We're just looking at to go about methodically and, you know, just very, very careful since it's a new product that we have, although we have experienced team and the team leader.
Got a tailwind on the fee income side, but wouldn't expect a huge contribution this year.
Yes, sir.
Okay. Then maybe just touching on the branch expansion side. Just curious, are the branches a part of the Texas expansion, and those LPOs? Maybe if you could just give us an update on where we are in Texas, how growth and demand and, pipelines are trending there.
Texas is going to be converted into a branch from LPO to a branch in about 2 months, okay? Right now, we're all busy in working on the, this things, okay? Pipeline does not change that much from last year to this year, the loan outstanding and so on. In fact, we currently are in a situation, the entire bank is looking at things very carefully. Another branch we have signed a lease. I think we need to sign a new committed, okay?
Mm-hmm.
We think it will be in the Southern California in a very good location. We're working very close on that. We have budgeted already. That's what I mean. Yeah. Going forward, in the remainder of the years, if new opportunities come up, we just grab it. If there's a new personnel that to be hired, we're not gonna be worried about its budget. We're just gonna hire them, you know.
Yeah. That's music to Ed's ears. I guess the other thing is I wanted to touch on is you guys have been very good stewards of capital, and you have a very strong capital position ahead of a potential credit cycle. You know, if we step back and think about a potentially slower pace of loan growth and your incredibly high levels of profitability, you're gonna be accreting capital at a really rapid pace. You know, we talked about a couple growth initiatives. Just curious about your capital priorities here. We've seen some dividend growth. You know, again, carrying significant levels of excess capital into a credit cycle is not a bad thing, but just was curious whether there's any appetite to increase capital return or other capital priorities.
Thank you for asking the question, recognizing all that, okay? Because we are state-chartered bank, okay, reporting, I mean, without a holding company, any capital raising is requiring a capital buyback, capital transaction was required shareholder approval, which is required by the state regulator. Every time we want to buy back some stock, if we wanna go through the whole process, that's nine months process. This year, what we're gonna do is we just got the board approval to submit for shareholder approval during our proxy season for pre-approving a total amount of stock buyback. We'll go to the state whenever we're ready to act on that.
Generally speaking is that the majority opinion of the board that at the beginning of the year, we need to be a little bit more careful in watching the economy and have the capital ready if the economy, for some strange reason, turns out. Once it is clear, then we expect to return things to our shareholders.
Okay. That makes complete sense. Terrific, guys. I appreciate it.
Sure.
Our next question comes from Tim Coffey with Janney. Please go ahead with your question.
Great. Thank you. Morning, everybody.
Hey, Tim.
Yeah, I had a question about the cash on balance sheet. It still remains at elevated levels, and I'm wondering, does the uncertainty about customer liquidity behavior outweigh the opportunity to reinvest that in securities?
Well, that's a very good question. As you know, Tim, we have kept an inordinately large amount of cash on the balance sheet actually since the financial crisis. We've always had a fairly large cash position. One thing we actually did do during the fourth quarter is we did invest some of that excess cash in the treasury market at where what I consider to be extremely attractive yields. I think we may do some here in the near future in order to lock in some of those, some of that additional yield rather than have cash float along with the Fed's interest rate decisions.
Okay. Okay. That's helpful. Just curious about what you're seeing from competitors. Clearly, you know, your customers have started to express some cautiousness in terms of their lending behavior. I'm wondering, are you seeing them pull back from the market or otherwise tighten their credit boxes?
First of all, strangely enough, they are like us. They're looking for opportunities, but they be very prudent, okay. There are competitors doing things at this point in time which requires to research into it, okay. There's one of the largest bank in California is still offering customers a seven years fixed rate, okay, C&I loans at low 6%, very low 6%, and without prepayment penalty. They are willing to grab business by forgiving the interest income. We're looking that. We lost a number of accounts to them, but we're still looking at that and to see how we can compete with this kind of situation. I guess there's always gonna be low, how should I say, people that you cannot compete with.
We lost another loan to a credit union, 5.25%, five years, okay, which fixed rate. We just can't compete.
Okay. All right. Okay, yeah.
We don't see that with things every day, you know?
Right. Okay. Okay. You're still seeing irrational activity. Okay. All right. Great. Those are my questions. Thank you very much.
This concludes our question and answer session. I would like to turn the conference over to Li Yu for any closing remarks.
Well uh actually the question asked is all pointing at the things we want further clarified so I thank you very much for your, for your time and uh as I said, we're optimistic and we'll be careful. Thank you.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.