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spk06: and welcome to the Preferred Bank third quarter 2020 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. Please note this event is being recorded. I would now like to turn the conference over to Jeff Haas of Financial Profiles.
spk00: Please go ahead. Thank you, Jason. Hello everyone, and thank you for joining us to discuss preferred banks financial results for the third quarter ended September 30 2020. With me today from management our Chairman and CEO Li Yu, President and Chief Operating Officer Wellington Chen, Chief Financial Officer Edward Chayka, 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 banks' operations and business environment, all of which are difficult to predict and many of which are beyond the control of preferred banks. For a detailed description of these risks and uncertainties, please refer to the SEC required documents that 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. Liu. Please go ahead.
spk03: Thank you very much, ladies and gentlemen. Thank you for joining our earnings conference phone call. I am very pleased to report Preferred Bank third quarter net income was $17.1 million, or $1.15 per share. These numbers compare favorably with the prior two quarters. In fact, on the pre-provision pre-tax basis, third quarter net income and a nine-month net income was a record high for our bank. The quarter's improvement is largely the significant reduction in deposit costs and continued overhead control. people have always considered Preferred Bank is an asset sensitive bank. But if you recall, about two quarters ago, I have already reported to you in our press release that we have became a liability sensitive bank. I'm just very pleased that we have something to show you in this quarter. Deposit costs will continue to decline in the fourth quarter, but not at the same magnitude and the same pace as the third quarter. For the quarter, our net interest margin was 3.54 percent, a three basis points reduction from previous quarter, mainly due to a larger balance sheet and much increased excess cash on hand. However, on the XPPP basis, our net interest margin actually improved to 3.61% from 3.59%. Quarter-quarter deposits continue to grow 1.5% or $64 million. However, our loan has declined $14 million. I guess the prolonged shutdown or lockdown in our main trade area, which is Los Angeles, New York, and San Francisco, and finally affected the deal flow pipeline. And new opportunities of loans also seems to be less attractive under the current environment. Much of our attention and focus is on credit matters. As of June 30th, we have some non-performing loans, total a little less than 50 basis points. We have decided to charge off a portion of them. And we have also decided to reserve whatever exposure we can see the full amount on the very conservative basis. Meanwhile, for the quarter, because of, for the quarter, our loan loss provision was a larger number of $9 million. So, as a result, our credit bill continues. Total reserve to loans It now stands at 1.58 percent. On the deferment side, total loan that received modification under the CALS Act was $610 million. Balance at June 30th was $467 million, and balance at September 30th was $199 million. In the third quarter, we had a 53% reduction. We've also reached out to practically all of our borrowers inquiring about their plans. And we're very encouraged to learn a great majority of them indicated that they are planning to resume their scheduled payment very soon. Therefore, deferment balance at December 31st could be a very modest amount. For the third quarter, our return on equity was 13.7 percent. We at Preferred Bank is elated about this, not because the number represents after the significant loan loss provision, not because it represents the culmination of all the one year's work to restructure and reposition our loan portfolio and our balance sheet, but rather We believe bigger earnings will give us bigger muscles to fight the uncertainties ahead. Thank you so much, and I'm ready for your questions.
spk06: Okay, we will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. The first question comes from Nick Couturel from Piper Sandler. Please go ahead.
spk07: Hi, guys. How are you doing today? Hello, Nick. Thank you. So you mentioned the increase in capitalized origination costs due to higher loan production versus the second quarter. Can you quantify that impact in bigger picture? Can you share your outlook for operating expenses?
spk01: Hi, Nick. This is Ed. I'll take that one on. Loan originations were relatively flat on a quarter-to-quarter basis when we look at Q2 versus Q3. But what we really saw was the PPP loan fees that came in, and that's why we had the outsized capitalized credit costs under salary expense, and also that had a benefit, slight benefit, under loan fee income as well. In terms of going forward, non-interest expense-wise, you know, we really don't make it a rule to give any kind of forward guidance, but obviously I think we did an excellent job with respect to expense control in the current quarter. I would look for that to continue. As you know, that's what we're all about. And we actually breached 30% efficiency ratio in this quarter. So I thought that was pretty impressive. But in terms of going forward, I think it's going to be fairly similar, probably up a little bit from Q3.
spk07: Sounds great, and I agree with your assessment. So this was the second quarter we saw CNI paydowns dampen the growth you achieved in the real estate book. You had the big draw on commercial lines in the first quarter. Now we're back towards the end of the 2019 level with respect to balances. Is your sense that commercial paydowns are in the final ending?
spk03: Well, I didn't quite really get the question. I mean, you're asking really based on whether the C&I balance is continuing to reduce. Actually, C&I balance in this quarter has reduced about $67 million, okay, mostly in the customers' paydowns. Okay, so net production. Actually, we have a little bit of net production. Well, our new production versus the payoffs kind of shows a balance of about $40 million, but because of the CMI, existing customers less usage of our loan amount, so the quarterly total loan balance reduced by $14 million. Okay.
spk07: Your total capital ratio is up nearly 80 basis points from the end of the year. You continue to have strong internal capital generation, as you pointed out, even in spite of the big reserve builds. Can you help us think about your capital priorities, and specifically if and when you may revisit a buyback?
spk03: Believe it or not, compared to our peer group, we're the lower half of our capital ratio. We have a designated peer group among our people. And at this point in time, our attention really is focused upon the uncertainties ahead of us. We just want to be well prepared for any kind of things that can affect us. We will revisit that, providing that our loan growth did not restart. When we start the loan growth, there's no need to buy back stock. We can create more income for our shareholders by growing the bank. Okay.
spk07: And then lastly, the tax rate came down quite a bit this quarter. It seems to be more a matter of timing rather than a structural change. How are you thinking about the tax rate going forward?
spk01: Nick, I'll take that one. This is Ed. Yeah, the tax rate came down in Q3, and that was a true up to the 2019 tax returns. So we would look for a somewhat similar tax rate in Q4, albeit up probably just a little bit. And then for 2021, Excluding what happens with respect to the upcoming election, we would expect to head back to the right around 29, 29 and a half ETR. That's great. Thanks so much for taking my questions.
spk06: The next question comes from Gary Tanner from DA Davidson. Please go ahead. Hello, Gary. Is your line on mute? Sorry about that. Good morning.
spk11: A couple of questions for me. I just wonder if you could provide any details on the charge-offs in the quarter. I didn't quite catch any detail, Lee, that you may have provided.
spk03: Yeah, we have two loans, two larger loans. There was a bunch of little, you know, little incidents to come. We have two larger loans that was placed on a crew in a second floor, okay? And these homes are currently in the prolonged collection process, although indication is that the latest appraisal value, which is a while ago, is still well covered alone. But we believe the market value has slid down a bit. And because of the uncertainty of the collection process, the length of it, we decided to go actively and touch up on our amount and reserve. whatever exposure we can find. So I hope it's sort of like a proactive move in preparing for 2021. Okay, great.
spk11: And on the previous question in terms of comp, I think you said that you had the benefit this quarter that drove count lower because the PPP fees came in this quarter, but wouldn't the deferred count have been a benefit in the second quarter from the PPP production?
spk01: Well, actually a majority of it was a lot of the fees received and the bookings took place in Q3. So it was after the end of June when a lot of that took place. In addition to that, Gary, with respect to comp expense. Bonus expense was also lowered this quarter as well. And as you know, bonus expense, incentive comp expense is a component of the bank's overall profitability.
spk06: Thank you. The next question comes from David Feaster from Raymond James. Please go ahead.
spk09: Hey, good morning, everybody. Hi. Mr. Liu, I just wanted to follow up on your comments at the start where you had kind of made it sound like that new loan opportunities might be a bit less attractive in the current environment. Did I understand that correctly? And maybe just why is that? Is it structure? Is it just pricing? Is it just uncertainty in the market? Just curious your thoughts on loan demand and your appetite for new credit.
spk03: Actually, you mentioned just about every possibility, but let me clarify it. New opportunity for a hotel loan, you don't want to do it. New opportunity for a retail loan, the chances you want to do it is less than 50%. Even in the old days, it seems to be fine. And new opportunity for some specialized product, so our office and so on, then it becomes it's You know, it's less attractive, especially in some of the areas that we're operating at. And today, with the prolonged interest rate situation, people are also looking for loans at the price to the unreasonable level. Would you believe the loan pricing is less than our net interest margin? So that makes it eliminate a lot of the opportunities that we looked at.
spk01: David, I'm going to add to that, to what Mr. Yu said. You know, a lot of the economic activity going on in the United States is very regionalized right now and very localized. If you look at what's going on in the South and economic activity there, the Midwest, far more than what's taking place in California. I mean, LA County is still in one of the strictest lockdowns in the entire country still. As well as New York. And so as we look at lending opportunities, we have to look at our local economy and what's going on there as opposed to, you know, what may be more of a macro thing to look at.
spk09: That's a good point. So probably, I mean, you guys are still, like you said, originations have been flattish. So probably some exclusive of PPP, which is obviously going to decline, probably some flattish to maybe modest contraction in loan balances in the short run?
spk03: Well, actually, you know, because we are a sort of like one-off type of loan company, it depends on the special loans that come to us. Early indication in the fourth quarter, we maybe have some production, but it is... You know, we don't know the payoff situation was coming along in the later of the quarter and so on. So, if you look at it, we try our best, but right now is the key situation is for us to manage our credit and to keep our profitability up.
spk09: Yeah. And kind of along those same lines, you guys have done a tremendous job defending the margin. you know, tremendous job reducing deposit costs. And ex-PPP was actually up quarter of a quarter like you alluded to. You know, but you had mentioned that the, you know, the incremental reduction in deposit costs is probably going to be less in near term. Do you think that you can continue to support loan yields and outpace the deposit costs or outpace the decline in loan yields and we could see, you know, margin flat to up or... Would you maybe expect some further NIM compression just given the pricing challenges that you had mentioned?
spk03: Okay. Long yield reduction in the third quarter, okay, is in the neighborhood where the actual yield is in the single-digit situation. So I like to think in the fourth quarter that probably that the reduction in interest costs will be offsetting the loan year reduction at least. Okay. Okay. That's helpful.
spk09: And then the last one for me, you guys have done a terrific job on the deferral front. Deferrals, you know, they're down significantly. But I guess how have deferrals trended since that 930 level? Like where are they today? how much of the balances are second deferrals versus those that are still on first deferrals? And kind of does that $27 million deferral target that you guys put out in your presentation, is that still holding true?
spk03: Well, what I'm telling you, Johnny, you want to take on that question and then I'll add on to it.
spk02: I think, hi, David. This is Wellington. I think that the furloughs is all on the second, already on the second. That's included. Okay. So this is it. Okay.
spk05: Okay.
spk09: So like after your conversation, nothing has really changed in that $27 million kind of target that you laid out after all the conversations with your borrowers? You're still thinking minimal at the end of December? Absolutely.
spk03: Actually, David, if you read the text of our press release, they indicate there are still $4 million in new requests for deferrals, okay, as of September 30th, okay? So the question is deferrals sometimes are coming, but the number is very mild. You see, many of our customers have been paying out of their pocket for a period of time, but since the lockdown is lasting more than you and I were originally expecting, originally anticipated, okay? So the question of some of them is finding, I mean, starting to have difficulty. In many cases, the new deferral we're granting is only principal only or partial interest, okay? So if you look at our deferral composites, 40% of our deferral is partial deferrals, okay? So we look at everything, study everyone, and try to see the you know, under the good underwriting principles in granting our deferrals. Okay.
spk09: That's helpful. Appreciate all the color guides. Thank you.
spk06: The next question comes from Tim Coffey from Janney. Please go ahead.
spk10: Thanks, Jordan, everybody, and thanks for hosting the call today. Thank you. Yeah, I want to follow up a little bit on the loan demand from your clients. So if the restrictions were lifted tomorrow, would you expect to see a resurgent in demand for credit from your borrowers, or is it more that your borrowers are just kind of hesitant right now to make new investments and things of that nature?
spk03: Well, my impression is that there's a lot of money on the sidelines, okay, and the people are just waiting. to jump into it, okay? I mean, one of you want to add on that?
spk02: Oh, I mean, I agree. I think that there are a lot of money on the sideline. They are waiting for opportunities. And is it going to spike up overnight? Probably not, because we're going to also be cautious, too, and, you know, ramp it up gradually. But I think that there's definitely, if pandemic's done tomorrow, then we have to look at our competitor as well, too, how the market react. And we have to look at what's the, again, as Mr. Yu mentioned earlier, the pricing of the loan.
spk10: Sure. Okay. All right. That's helpful. Thank you. And just, you know, circling back on the deferrals, you know, with the positive trajectory of the deferrals, are you done reserving or is it a little too early to make that call?
spk03: Well, we have no, I mean, 12-color reserve is over all, okay, and it's for the future, okay? Let me answer you by saying this, okay? You know, I have reached out to several of our shareholders. I said, well, given our situation, our deferral doesn't look that bad, okay? In fact, you could say it looks reasonably good. But what do you want me to do? Okay. Under the uncertainty, because there may be a second wave on the vaccine. And today, I mean, uh, the, the, the, the government officer come out saying that, Oh, maybe six months before everything was happening. And so on. What about if New York is locked down for another six months and won't let anything happen? So the majority of my, shareholder and tells me, says, Lee, you're in the long game. You should manage the bank in the safest and most conservative basis under the current environment. So I guess, I mean, we will make some additional further, further reserve of credit, okay? But again, we will open our eye to COT. I know we are anti-climate. Most of the bank is reporting reduced provision and so on and so forth. But it seems to be the mandate of my shareholder is that they want us to play it safe. Especially by playing it safe, we still have a 13% return on investment. And it seems to be they're happy with that.
spk10: Okay. No, that's helpful. And then, Ed, just if I could, on CDs that might be repricing this quarter, if you know what the yield on those are or the cost of those are and where the market rate is right now?
spk03: I know the number. There's a $434 million CD that would be renewed in the fourth quarter, okay? Okay. The rate on that is $116 million, okay? Okay. And currently, our CD rate is in a 60 to 70 basis points rate. So there will be some savings. But mind you, the $434 million is not really evenly renewed during the first quarter. I guess a bigger portion will be in December.
spk10: Okay. All right. Well, that's very helpful. Thank you very much.
spk06: The next question comes from Steve Moss from B. Riley FBR. Please go ahead.
spk12: Good morning. I guess just starting with going back to credit here for a moment, with regard to, you know, the provisions court, I'm just kind of curious how much was the specific reserve for the two larger credits here?
spk03: I think we reserve additional $6 million or so, approximately $6 million. Okay, other than when we're about to charge you off.
spk12: Right, okay, so then absent that specific reserve, your provision for the quarter would have been closer to $3 million, just as we kind of think about economic impacts. Is that kind of a fair way to think about it?
spk03: I think the charge of really as no economic impact reserve is the amount that has really put impact. In other words, in a getting everything even basis, if we make a reserve of $5 million, provision will be $5 million. And the next quarter charge off is just a reduction of the reserve that was previously made on it.
spk12: Right. Just trying to think about just the driver of the provision going forward. If economic forecasts remain relatively stable, the biggest driver going forward will be whatever you may have in terms of specific reserves.
spk03: Could you be a little bit more specific about that case? So, I mean, okay.
spk01: So, I guess, hang on. I'm sorry. Let me, Steve, I'm sorry. I want to correct what Mr. Yu said earlier. Apologies. But the specific reserve assigned to those two specific credits was 3.3 million. when we're looking at the overall provision of $9 million. So, the specific was 3.3, and then the charge-off on the two was 3.5.
spk03: Male Speaker 3.0 Charge-off is already done. Male Speaker 3.0 Yeah. Male Speaker 3.0 Okay. So, it's already taken up. So, additional $3 million.
spk01: Male Speaker 3.0 Right. Male Speaker 3.0 Right. Male Speaker 3.0 I just want to clarify that. Yeah. And so, back to your question.
spk03: Male Speaker 3.0 in charge of the three.
spk01: Male Speaker 3.0 Yeah.
spk12: Male Speaker 3.0 Okay. So, then, just as I think about the drivers of your provision forecast of the provision going forward, If, you know, economic forecasts continue to generally improve, you know, barring some exceptional specific reserves, you know, probably should see a meaningful reduction in the loan loss provision going forward. Well, yes, sir.
spk03: If economic forecast is showing the improvement, we would definitely reduce the provision, okay? And if the deferment works out to be like we project it to be, and there are no new surprises in the whole situation, maybe somewhere in 2021 we can release the reserve, okay? Giving the situation as of today, I don't think any economist has given a definite answer to how the economy is doing that well. And as I stated earlier is that the majority of the constituents of us is expecting us to play it safe. Right. So, okay, the short term, we were probably will still continue, but we will still be large. But we were definitely making the adjustment. I mean, I mean, whenever, whenever is, I mean, is indicating so.
spk12: Okay. That's helpful. I just wanted to try to dig down a little further into that. The rest of my questions have been asked and answered. I appreciate that. Thank you. Thank you.
spk06: The next question comes from Andrew Terrell from Stevens. Please go ahead.
spk08: Hey, good morning, everyone.
spk06: Hi, Andrew.
spk08: Hey, so most of my questions have been asked and answered already. Do you guys have the balance of classified and criticized loans this quarter?
spk01: We do. I do. Hang on. Got a lot of paper here. Hang on. There it is. Classified is 59. And then overall criticized would be the special mention plus the criticized about 139 added together.
spk08: That's helpful. Thank you. So I'm looking at the table you guys provide in the release that breaks down the loan portfolio by bucket and gives the loan to value and then debt service coverage. This is an extremely helpful breakdown, by the way. If I compare this quarter versus kind of last quarter, most of the real estate buckets saw an uptick in loan to value by about 3% on average and I'm curious, is this more just an ebb and flow of the portfolios, or are you getting updated appraisals on properties right now? And if so, how are those valuations comparing to the previous ones in place?
spk03: You want to answer that first?
spk01: Yeah, I would say at this point, Andrew, it's really a combination of both. There is certainly churn through there, even though the portfolio only moved $14 million. There's a fairly decent amount of activity that goes in there with respect to payoffs, new originations, as well as renewals. So on the renewals, depending on the length and size, appraisals are updated. Other than that, it's as you said, it's the ebb and flow.
spk08: All right, thank you. Just last one from me. Have you guys started submitting applications for the PPP forgiveness? And do you have any kind of just ballpark estimate on when you anticipate recognizing the fees?
spk05: Johnny, you want to answer that? Yeah, we did submit forgiveness applications already, and a few have come in in early October. So we expect that to be continuing throughout the fourth quarter.
spk01: The fees are currently being amortized over the life of these loans right now. So the fee recognition at the end of this won't be that significant because we'll also have deferred costs to recognize.
spk03: And also our total PPP is only $74 million. Yeah. Out of the $4 billion loan portfolio. So in relative sense, it's, you know, it will not affect things that much.
spk08: Got it. Okay. Thank you for taking my questions.
spk06: Next question is a follow-up from Nick Couturelle from Piper Sandler. Please go ahead.
spk07: Hey, guys, just a quick follow-up on the NIM. So point to point, you had a big increase in cash balances at September 30th relative to June 30th. We're only a few weeks into the fourth quarter here, but has that excess liquidity started to come down materially at this point?
spk03: No, even slightly. Hopefully it's not much. Nowadays, you know, when the cash inflows, unless it's DDA, we're kind of sitting there, you know, happy but not happy about it.
spk01: Upside down. That's very helpful.
spk06: This concludes our question and answer session. I would like to turn the conference back over to Lee Yu for any closing remarks.
spk03: Well, thank you so very much for your attending the conference, and we hope we can continue our operation under the current metrics that give us the kind of possibility and situation we'd like to have. Thank you so much.
spk06: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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