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Executives

Lasse Glassen - IR, Financial Relations Board

Li Yu - Chairman, President & CEO

Ed Czajka - CFO

Louie Couto - EVP

Analysts

Joe Gladue - B. Riley

Aaron Deer - Sandler O’Neill & Partners

Joe Morford - RBC Capital Markets

Julianna Balicka - KBW

John Deysher - Pinnacle

Preferred Bank (PFBC) Q3 2010 Earnings Call October 28, 2010 5:00 PM ET

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Preferred Bank third quarter 2010 conference call. During today’s presentation all participants will be in a listen-only mode.

Following the presentation the conference will be opened for questions. (Operator Instructions). This conference is being recorded today, Thursday, October 28, 2010. And at this time, I would now like to turn the conference over to Lasse Glassen with Financial Relations Board. Please go ahead, sir.

Lasse Glassen

Thank you. Good day, everyone, and thanks for joining us to discuss Preferred Bank’s results for the third quarter ended September 30, 2010. With us today from management are Mr. Li Yu, Chairman, President and Chief Executive Officer; Ed Czajka, Chief Financial Officer; and Louie Couto, Executive Vice President.

Management will provide a brief summary of the quarter and then we’ll open the call up 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 detailed descriptions of these risks and uncertainties, please refer to the documents that company files with the Federal Deposit Insurance Corporation, or FDIC. If any of these uncertainties materialized 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 would now like to turn the call over to Mr. Li Yu. Mr. Yu?

Li Yu

Good afternoon. For the third quarter 2010, we reported a gigantic amount of losses. However of which $25.5 million really is not a loss by our own definition. It is related to the conversion of preferred stock into a common stock with the conversion rate is difference between conversion, price and the market value. The difference is treated as dividends to the preferred stock shareholders and therefore created a loss to the common shares.

It did not change the total capital amount that we raised. It did not change the capital ratio, it did not change PCE and it is not operating loss nor it is a cash flow item, having said that the remaining amount is relating to operations. And I state in the press release in the third quarter we have received a Shared National Credit report and in that there are many items that we previously was identified as impaired loan and classified loan was further downgraded to non-accrual and also that required reserve was recommended to be increased and recommended to be written off. And we still do accordingly according to this recommendation of the report.

Although that as I also said many of the loans are currently [still] current and in our humble opinion our visibility in this time that we probably collect all interest and principal at maturity, but having said that we are making this reserve. Now the third quarter has been a very, very disappointing quarter for me personally because I was really thinking about we have a whole lot of loans being resolved or being solved or being correct, okay and that are (inaudible) it has a number of different things as quarter for the negotiation table and resolved only a limited amount of improvement of the PMA even though its roughly 20 some remaining dollars we put to over 14% of the inferior amount.

We were thinking lot bigger amount. However, the 14% improvement also taking into consideration about $17 million that was recommended to be non-accrual for the quarter. But having said that our product ways is continuing and stay on target as we internally measuring it and also that we hope with every dollar of the improvement in non-performing assets will be corresponding improvement in net interest margin, and also the operating cost of the bank.

So with that I am opening up for questions you may have.

Question-and-Answer Session

Operator

Thank you, sir and ladies and gentlemen we will begin the question and answer session at this time. (Operator Instructions). Our first question comes from the line of Joe Gladue with B. Riley. Please go ahead.

Joe Gladue - B. Riley

Let me start with I guess non-performers, can you give us what the balance of TDRs were may be you break it out between both accruing and non-accruing?

Ed Czajka

One of the things, we will give you the number rather away but our TDRs are accruing. If it is non-accruing what have been the improvement of non-performing category. Lu Yi you want to answer the question.

Lu Yi

Yes. At this point we have about $29.8 million in TDRs that are accruing are non-accrual loans actually it’s about 50% or actually not 90 days past due of that actual non-accruals either because they either been restructured or because of the customer continues to pay under the original terms.

Joe Gladue - B. Riley

So you had I guess pretty big increase in non-interest bearing deposits during the quarter just wondering anything particular driving that or just?

Ed Czajka

We obviously that the in-house that we are working very hard as our goal to increase our core deposits and namely mostly the DTA accounts and we have seen that A) we have added several new accounts to our books and also B) some of our customers the operation is improving therefore the cash flow is also improving. Louie Couto do you have anything to add just to it?

Louie Couto

No. that’s right. While the other thing too is Joe in light of the fact that we have raised the capital whatever our officers are going out and doing is going out and getting back some deposit that may have been lost over the last year and half when our capital ratios were depleted.

Joe Gladue - B. Riley

Okay. And I guess while I am on the subject of deposits, is there I guess appreciable amount of deposits re-priced down that could benefit net interest margin in the next quarter?

Ed Czajka

We would answer your question differently now at the end of September we have over $190 million of cash. Which is certainly excess deposit based on our own general assets and liability management. While in the one end that we will be working on deploying these excess cash we have on the hand. Also that some of the PCD that will mature in the first quarter include some of the local deposits we amend it too not renewed.

Some of deposits will be maturing in the first quarter, we will not be renewed. Okay, also which in a way reduces interest cost as deposits cost is much higher PCD cost much higher than we are earning as a difference in the (inaudible) system.

Operator

Our next question is from the line of (inaudible). Please go ahead.

Unidentified Analyst

I got two questions, one can you breakout for us the non-performing loans and non-assets for the construction lend category and also do you have any OREO or things like OREO that are basically in contract that just didn’t close this quarter? Thanks.

Ed Czajka

I will have Li answer the question.

Lu Yi

Actually on page five it has the asset quality table. We have our OREO and our non-accrual by land residential which is about $9 million in non-accrual, $24 million OREO land commercial was about $2 million in non-accrual and $11 million of OREO and in our construction we have worked with $31 million on non-accrual combined between residential and commercial and then about $10 million of OREOs in the construction.

And then getting your second question yes we continue to experience what we have experienced for a year and half which is protracted negotiations in dealing with various parties and we have a lot of interested folks that coming on our OREO and unfortunately its still something that we are seeing in the marketplace where folks want to negotiate even after deals have been signed and that we are seeing that [dissipated] a little bit. I think because of the stabilization of real estate values but we are still seeing that. So, yes we do have various transactions and stages of resolution and we expect them to finalize.

Unidentified Analyst

You expect the net interest margin continuing going up what do you think the roll down in CD rates is going to be offset by pressure on the asset yields?

Lu Yi

No actually our assets yield is improving and Ed you want to answer the question, later on answer your question on the singles falling out of contract a bit later.

Ed Czajka

Hi, Matt. We continue to believe that there is a lot of upward pressure on the margin going forward simply because of the things Mr. Yu talked about namely the deployment of all the excess cash we have on the balance sheet which we are working to deploy but as you can imagine, this rate environment is very difficult to find short duration, decent yield and good credit so that’s a difficult one. The other thing is that Mr. Yu alluded to there is broker deposits that are going to be running off which are going to be renewed those got paid down with cash so that’s a net bump to the margin as well.

What we would have seen with the net interest margin in the Q3 would have been about a 320 margin which would have been a decent improvement but with these $70 million in SNC loans that we required to place on non-accrual again put that the downward pressure on the margin. But again borrowing obviously is not going to be a [SNC] report for another year and the fact it really have $5 million of loan in 30 to 89 day past due at this point.

We are hopeful going forward in the Q4 and certainly into the first couple of quarters of 2011 that will see I don’t want to say significant margin increase but we will certainly see some up to between probably 325 and 340.

Li Yu

Matt to answer the earlier question about things I asked this is from just purely operator’s point of view. We have in May, June, July I am so optimistic about many of the loans and (inaudible) was in contract, it’s going to go through simply because the market momentum is there and frankly speaking was to (inaudible) again slowed down in the months of July, August and September. Many people have decided to either wait or renegotiate or recreate that’s in the most cautious way. So, a number of things (inaudible).

Previously I for one was hoping that now we are reporting a significant improvement in our troubled assets liquidation.

Operator

(Operator Instructions). Next question comes from the line of Aaron Deer with Sandler O’Neill & Partners. Please go ahead.

Aaron Deer - Sandler O’Neill & Partners

I haven’t had a chance to until we got through the release. So forgive me if you said this but in there, did I hear correctly you said without the [SNC] your margin would have been 323 is that right?

Ed Czajka

About 320. and the full effect of all the non-accruals would have put without the full effect of all the non-accruals, the legacy ones would have been about 350 net interest margin.

Aaron Deer - Sandler O’Neill & Partners

Are you speaking of interest reversals in the quarter, you are talking about just the pressure on the margin because of the lack of forward payment?

Ed Czajka

Well, in the 320 margin was just the effect of the interest reversals. The 350 margin is the effect of the reversals plus the legacy non-accruals, loans that are still continued to be calculated in the denominator but we don’t get interest though.

Aaron Deer - Sandler O’Neill & Partners

And then what is the volume of CDs that are maturing in the fourth quarter?

Ed Czajka

It’s about $30 million.

Aaron Deer - Sandler O’Neill & Partners

And lastly obviously there has been a fair bit of balance sheet shrinkage over the past several quarters, with your capital levels back I would imagine that you have got your lenders reengage I am wondering if you are starting to get any traction on new originations and when we might see an inflection point on loan down?

Li Yu

Actually loan balance would probably be the increasing depend on timing of booking the books, the trend is willing be increasing but that would other than utilization of the excess cash, I mean cash balance we have. So, whereas the total assets may not change all will be reduced by not only the renewal of broker deposits, other deposits where the loan battles could actually increase.

Aaron Deer - Sandler O’Neill & Partners

Right. So may be you can give a number what the new originations were in the quarter and what your outlook is the fourth quarter?

Louie Couto

This is Lou Couto. For the quarter we had $47.5 million of new loans originated, $35 million was roughly in CRE and about $12 C&I loans. Generally again our [CRE] credits was giving anywhere between 6% and 6.5%, [NLR] and C&I are little bit less obviously because of the substantial deposit balance as they come but generally we are having floors five and a quarter to 513 quarters in the C&I credit.

Operator

Our next question from the line of Joe Morford with RBC Capital Markets. Please go ahead.

Joe Morford - RBC Capital Markets

I guess first to say can you remind us the size of the portfolio participations that would have been reviewed by the Shared National Credit Exam and was that attributable for most if not all of the provision in the quarter?

Li Yu

Yes, Louie you want to answer the question.

Louie Couto

Sure, as of September 30 we have $88.2 million in Shared National Credit of which about $48.7 million are C&I and $39.5 million are real estate related and that’s general what the SNC report reviewed of that $88.2 million about $24.3 million is actually impaired. Mr. Yu made a comment before regarding the actual payment standards and in fact of the $17.7 million that report recommended we put on non-accrual, he had indicated most were infected all of them are current and to this day they are still current. And so I believe that something an important that needs to made and those are cash based from the company.

Next question is how much reserve is on this SNC report. The additional provision in the third for the Shared National Credits was $6.1 million.

Joe Morford - RBC Capital Markets

6.1, okay so the three balance would have been for the legacy or the remaining portfolio?

Louie Couto

That’s correct.

Joe Morford - RBC Capital Markets

Okay and then the separate question just on OREO cost in the quarter, fairly modest and it looks like a small piece of that or I guess most of it was valuation charges but still overall pretty modest amount. In general with the OREO assisted that you are moving out, it seems that it’s pretty close to where you have them written down on the books and what’s your expectation there?

Li Yu

I don’t know we are not updated with the current quarter yet but up to June our liquidation has been almost $0.91 to $1. So that was the old numbers that we have. Now, going forward a lot depends on what the market trend is going to be. Because in some assets we have on the book, actually we are lower much lower than the appraisal value but yet again in actual negotiations things especially we have other banks involved in multi-party negotiations. It may or may not resolve in a month that’s equal to or better than the appraisal value.

It is hard to tell but only its kind of going forward would dictate what the final results value we have. But having said that let me confirm again, in the past up to June our average liquidation price is $0.91 to a $1.

Operator

Our next question is followed from the line of Joe Gladue with B. Riley. Please go ahead.

Joe Gladue - B. Riley

Just one thing I forgot to ask you last time. Could you give us the level of 90 day as to accruing months?

Li Yu

That would be zero.

Operator

Our next question is from the line of Julianna Balicka with KBW. Please go ahead.

Julianna Balicka - KBW

I have a few follow-up questions a lot of them have already been asked. On the originations in terms of the $35 million theory that you referenced, is that owner occupied or how do you stand on the 300% threshold of theory to capital? Although with your new capital rise that might be non-issues so that’s why?

Ed Czajka

No. we have to answer. Most of those actually were not owner occupied. Our 930 numbers after owner occupied its going to be slightly above the 300% guidance that regulars have in order to have more robust stress testing of the portfolio that’s actually for my reading what the guideline is that if you are over a 100% construction and 300% in CRE non-owner occupied this supposed to have more robust monitoring of the CRE and stress testing both of which we actually do here internally.

The numbers (inaudible) is not available yet because we haven’t filed our report we will be doing it on Friday as required. But I again project its going to be slightly over the 300 but clearly as you pointed out because of our capital substantially below what it was in years and substantially inline with the ratios the regulators are looking for.

Louie Couto

Julianna as just a reference point, with most of the people have been covered after we take a look at it and we are the second lowest. There is only one banker lower than us in the CI concentration.

Julianna Balicka - KBW

That is true.

Louie Couto

So you might see we are 1%, 2%, 3% over the regulators guideline but we are 100 basis points lower than some of the people you covered.

Julianna Balicka - KBW

Very good and then talking about the originations, can you kind of little bit about declining your C&I advances, is that flex seasonality or what’s the line utilization of your [powers] or can you just talk a little bit more about your C&I.

Ed Czajka

Same answer as we have as of June 30. its most of our borrower is tend to be much more conservative than they used to be. The draw down on the line I mean is lot than in previous year. We do not have any defection of our customer in C&I sector. In fact, as you see we added $12 million to our C&I commitment. But it is the utilization has been done.

Louie Couto

As brought it before we actually there also depositing more into their DTA. So its having a positive effect on our balances as a result of their cash.

Julianna Balicka - KBW

And one final question if I may. What is of your total loan balances of 934 which can you refresh your memory what the participation going is?

Ed Czajka

It’s slightly over a $100 million, $88 million of which is the Shared National Credit.

Operator

Our next question comes from the line of John Deysher with Pinnacle. Please go ahead.

John Deysher - Pinnacle

Couple of questions on the OREO sales of $17.8 million what percentage of that if any was financed by the bank?

Li Yu

A large percentage of that whether it was a CRE loan.

John Deysher - Pinnacle

So a large percentage of the 17.8 was embedded in the $35 million of CRE?

Li Yu

Yes that’s correct.

John Deysher - Pinnacle

Okay what kind of loan to value per share was there?

Li Yu

We received in excess of about 25% in cash down payments. So its been 70% to 73% loan to value. Probably we want to use the appraisal value as the guidance to loan the value will be than 70% because the transaction price is lower than the appraisal value.

John Deysher - Pinnacle

And the $12 million increase in C&I loans roughly speaking what kind of credits are those that are actually increasing their loans?

Li Yu

As far as the industries?

John Deysher - Pinnacle

Yes, the industries.

Li Yu

Again some of that is trade finance, I don’t have all that information but service, trade finance type loan.

John Deysher - Pinnacle

And then on the deposit side, I think you said about $30 million of broker deposits are going to roll over in fourth quarter. How much do you expect to roll over in 2011 and could you give us if you have a rough breakdown in terms of how the quarter is unfold?

Ed Czajka

Its about, I think its just slightly under $50 million for all of 2011 John. It is the like (inaudible), most of it in the first and second quarter. I think there is almost nothing in the third quarter and then there is a little bit in the fourth. So, the finance of the $50 million from the first two quarters in 211.

John Deysher - Pinnacle

Okay and then would you say that would be approximately even or its more skewed towards the first quarter?

Louie Couto

I think it about even. I think its about even.

Operator

Thank you. Once ladies and gentlemen (Operator Instructions). Next question is a follow-up from the line of Matthew (inaudible). Please go ahead.

Unidentified Analyst

I can’t get enough. I need if you got at the tier one capital in dollars at the end of the quarter and also if you have the current balances of the DTA and the associated reserve?

Ed Czajka

Matthew I am going to have to get back to you that offline.

Li Yu

The net value is nothing.

Ed Czajka

Yes, the net DTA or closed to zero. I help you to give the gross.

Unidentified Analyst

Okay and the (inaudible) capital?

Ed Czajka

I think I have to give you that offline itself, have those members right now.

Operator

Thank you and gentlemen I am sure there are no further questions at this time. Please continue.

Li Yu

I guess there are no further question. The first one let me thank you for your interest in year questions and I of the things I would like to add on to (inaudible), we are experiencing a greater property increase also which allow us to have better liquidity. In the last three months and going forward as we think and with that its more than enough to with our current cash model enough to meet the need of (inaudible) deposit from the brokerage deposit and also the deployment into the new loans. Okay. So with that I would like to close our meeting and then thank you very much for all your interest.

Operator

Thank you, sir. Ladies and gentlemen, if you would like to listen to a replay of today’s conference please dial 1800-406-7325 or 303-590-3030 using the access code of 4376121 followed by the pound. This does conclude the Preferred Bank third quarter 2010 results conference call. Thank you very much for your participation and you may now disconnect.

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