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Preferred Bank (NASDAQ:PFBC)

Q2 2011 Earnings Call

July 20, 2011 5:00 PM ET

Executives

Lasse Glassen – SVP, Financial Relations Board

Li Yu – Chairman, President and CEO

Edward Czajka – SVP and CFO

Analysts

Aaron Deer – Sandler O’Neill & Partners

Joe Gladue – B. Riley & Company

Julianna Balicka – KBW

Joe Stieven – Stieven Capital Advisors

Operator

Good day ladies and gentlemen, thank you for standing by. Welcome to the Preferred Bank 2011 Second Quarter Conference Call. During today’s presentation all parties 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 Wednesday July 20, 2011.

I would now like to turn the conference over to Lasse Glassen, Senior Vice President of Financial Relations Board. Please go ahead sir.

Lasse Glassen

Thank you, good day everyone. And thanks for joining us to discuss Preferred Bank’s preliminary results for the second quarter ended June 30, 2011. 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 a detailed description of these risks and uncertainties, please refer to the documents the company files with the Federal Deposit Insurance Corporation, or FDIC. If any of these uncertainties materializes 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 now like to turn the call over to Mr. Li Yu. Mr. Yu?

Li Yu

Thank you Lasse Glassen. Good afternoon ladies and gentlemen. I’m pleased to report the second quarter 2011 we are reporting a net profit of $1.7 million of $0.13 a share. This is a good improvement on the first quarter. Despite the facts, the credit cost is still at very large at this point in time.

Our credit cost includes $1.8 million of long loss provision. An $900,000 value adjustment or write-down of OREO yields. And also we during the quarter we also have a $700,000 recovery of loan losses on the loans that sold that mostly on the loan that were sold above book value. So, for our practice for personal purposes, the total credit costs is about $3.4 million, and we’re reporting $1.7 million after these costs.

During the quarter, we’ll continue to show improvements in overhead control and also we stabilized our net interest margin. Our core deposits as increased and we also are very encouraged by the activities in loan origination.

Let me give you a little bit color about the loan originations. For the quarter, we originated $92 million of new loans of which a little bit over little over 50% is C&I loans. And roughly 35% are owner occupied commercial real estate loans. Now real estate you’ll aware these loans are very highly competitive to get in the marketplace and we’re very pleased with the year, was our ability to generate that much, I mean in these two categories.

Looking over the pipeline, we see the second quarter to be hopefully to be at least as good as the first quarter say although I mean, second half as good as the first half, okay. Although per quarter, that it may not be evenly distributed in the third or first quarter, okay. But we are highly encouraged by the pipelines currently that we’re seeing. On the deposit side you notice that we have good increases in non-interest bearing deposits. We also have good increases in interest-bearing transaction accounts and small deposits to multi-CDs, all of them are considered core deposits.

Early indication July for the first 19 days these increases trend as to continue. We are hopeful for the second quarter, after the second quarter for the second half of the year we’d continue to have good increases in DDAs and other core deposits.

You all have been reporting the past by us that we’re working hard on NPA disposition or resolution. And we think there is some good activities in the third quarter, second quarter we would also think that the third quarter and fourth quarter of activity should continue. And although some kind of holiday season may delay a little bit in the first quarter, but overall we think the second half of the year we still – we show some good results in this particular area.

With the continued deduction, reduction in our – in the non-performing assets, we are seeing our credit cost begin to subsidizing okay. And subsided, we think the total credit cost frame is very encouraging this point of time. This is especially true that we have just received a shared national credit report that shows no adjustment needed by our bank. So if you remember the last quarter I have reported to you that there is – out there for our third quarter profitability is that snick our shared national credit. Well not where we is in long longer exist. So with all of the above, we collect the fare that at the outlook of the second half of 2011 is positive.

Thank you very much we’re ready for your questions.

Question-And-Answer Session

Operator

Thank you ladies and gentlemen. (Operator Instructions) Our first question is from the line of Aaron Deer with Sandler O’Neill & Partners. Please go ahead.

Aaron Deer – Sandler O’Neill & Partners

Hi good afternoon everyone.

Lasse Glassen

Hi Aaron.

Li Yu

Hi.

Aaron Deer – Sandler O’Neill & Partners

Li, congratulations and it sounds some good numbers this quarter and it was kind of tough couple of years for you guys, it’s very encouraging to few things move in so strongly in the right direction this quarter?

Lasse Glassen

Thank you very much for the kind word.

Aaron Deer – Sandler O’Neill & Partners

I guess on the credit front, it sounds like you are confident again the things will continue in the right direction. Obviously it’s doesn’t seem likely or it’s see the kind of improvements on the second quarter. But do you have any plan of loan sales or anything here in the back half of the year that would help sustain that the pace of the improvement that you’ve been showing more recently?

Lasse Glassen

In the future, in the second cab we’re looking for some really good OREO yield sales okay. And we also are actively looking so for some loan sales too okay, opportunity for loan sales. Together with some to credit there may be so could upgrade it’s from an nonaccrual status or this factory factors still in play right now okay? And, lot of them is depending on the economy continues to hold, which we think it should okay, now Li Yu you have anything to add on?

Li Yu

Yeah again just of the words that misuse. But out – we’ve seen increased activity in interest in our OREO properties as you could tell there mostly land at this point. And we've seen you have multiple bids coming in and focus willing to put deposit down and entering into under contract on those. Obviously, as you pointed out the law of diminishing returns it will be difficult to post its high reductions as we reduce the overall number. But at this point we’ll see the headwinds against this in the future that we had in ‘09 or 2010 as far the nearly to consummate the transactions that we have underway.

Aaron Deer – Sandler O’Neill & Partners

Okay. And then in terms of just kind of stabilizing enough, turning around the franchise, I know you’ve made a very strong hire that you announced recently to take on the COO role. I’m wondering if there is other hires plan that can help boost production and refill that pipeline.

Lasse Glassen

Number one is that obviously the COO that we’d just we’d just add on that he currently on vacation, otherwise he will be here to give you some insight of his plan. But based on the things that I – we have collectively working on, we are looking at several of our regions there to add more power to our production staff. For instance in Orange County the region we’re traditionally very weak in the lending side, and the deposit side it is nothing as vibrant as other region and our COO has resources, human resource over in that area, and he had the plan to add more people over there.

On the other regions I have already committed to couple of new staff and very qualified, very good staff in the deposit side that was scheduled to come in – in the second half of the year.

Aaron Deer – Sandler O’Neill & Partners

That’s great. And then lastly from me, any kind of update on the potential recovery of the DTAs later down the road once you demonstrate several quarters profit away, I know it’s still long time in office, I’m just wondering if, – if you’ve gotten any update from your account in terms of...

Lasse Glassen

Ed would answer the question.

Edward Czajka

Hi Aaron that’s a – that’s great question as we talked about before, we certainly look forward to recovering at least a good portion at least about 50% of the valuation allowance on the deferred tax asset.

As its stands right now, we had been looking toward the fourth quarter of this year for our ability to take some of that back in, in my recent discussions with our External Independent Accountants, it looks as though if trends continue that we see in Quarters 1 and 2 if that continues on into Quarter 3, we may have the ability as early as next quarter to take some of that back in and start to do it ratably over the next few quarters. So, the outlook there is actually turned a little more positive than previously it was.

Aaron Deer – Sandler O’Neill & Partners

Oh that’s great news. Okay, thanks guys.

Lasse Glassen

Thanks, Aaron.

Edward Czajka

Thanks.

Operator

Thank you. The next question is from the line of Joe Gladue with B. Riley & Company. Please go ahead.

Joe Gladue – B. Riley & Company

Yeah hi and I’ll add my congratulations as well.

Edward Czajka

Thank you.

Lasse Glassen

Thanks, Joe.

Joe Gladue – B. Riley & Company

Let me start with that I guess personnel expenses there you had a good decrease in personnel expenses and compensation expenses sequentially. Was there anything non-recurring contributing to that or is that’s a sustainable level?

Lasse Glassen

Good question. I know the answer, but rather had Ed answer that. Ed?

Edward Czajka

A couple of things. we did have a little bit of a higher costs in Quarter 1 related to FAS 123R Joe as I’m sure you probably know that relates to the expense we have to book related to restricted share awards as well as the stock option expense. So that did decline a little bit in Q2.

However the bigger was really a function of loan production in terms of our capitalized loan origination costs obviously as you know, as the origination volume picks up we get to capitalize more those origination costs going forward, majority of those origination costs are human-related human resource-related.

So, as product picks up we get to see a better capitalized loan origination cost, which of course is a credit to personal expense.

Joe Gladue – B. Riley & Company

Okay, all right. I guess just wondering if you could give us a little color there, I guess there was a small amount of loan to migrating to nonaccrual just wonder if you could, what type of loans where they and is that indicate any particular industry or anything?

Lasse Glassen

Li Yu, want to color that?

Li Yu

Yeah, it was predominantly the majority that was one loan actually it’s commercial real estate and it was reported as past due 30 to 89 the quarter before, the customer had been struggling and we’ve been working with them. But at this point, because we do not believe that they are going to be able to pay all the accrued interest and principal, we put the loan on nonaccrual. It’s not an overall trends and isolated case generally without particular loan.

Joe Gladue – B. Riley & Company

Okay. And I guess well I am on the subject to that the quality, looks like there was some decline in TDRs, some of them return to accruing status?

Li Yu

Generally yes, it was some of that some also are paying down a bit.

Joe Gladue – B. Riley & Company

All right. On the, I guess, balance sheet still some contraction in both fits overall asset balances it looks like both securities and loans are still declining. Obviously still a bad environment for loan growth, but do you expect fair continue to contract the balance sheet in the second half of the year?

Lasse Glassen

Well you have to realized that the much of the decline is really a so-called a positive diachronic, is the reduction of the non-performing loans. And also the payoff of some of the avenue at the sales of some of the OREO.

So, actually we have not quite made up with the new loan origination yet okay. But obviously, our plan in the second half of the year that we will grow the loan portfolio to hopefully to the standard of by the year in 2010 about the same standard in the bank.

This is a leading in fact, if we do that you will see that really the difference is that change of whatever huge amount of non-performing loan into performing and therefore what you intend are profitability, okay.

Another situation is that, there is something that we did not tell you before. Traditionally Preferred Bank being in the Chinese-based bank, we do a lot of cash secured loans in the neighborhood of about $50 million to $70 million. And we have conscientiously reduced the cash secured loan okay. The reason is that, we’ll make a very little dollar amount of that and for the accommodation of the customer. And, we’ll barely make our cost in doing those kind of thing.

But the net result of having those loans meaning, having the cash as secured which will be the deposit as affording and so that like reduce our capital ratio which is something that we have done in the past try to reduce. So, these are the two factors that really we didn’t get, but the real essence of total earning assets loan has been on the increased trend, okay.

Edward Czajka

Joe, I also want to point out that you mentioned loans going down; they did go down when looking at compared to year end 2010. However, when you looked on the linked quarter basis we are up about $10 million over March 31. So, wanted to point that out as well. So, it’s a different trend.

Joe Gladue – B. Riley & Company

Okay that’s fair, all right. I guess lastly I’ll ask about the net interest margin. You’re getting a better mix of deposits and I guess getting little out of the non-performing loans and originating a lot more there. Now what is the outlook for improving the net interest margin some more?

Li Yu

Well it’s going to be a function of a couple of things. First off, on a linked quarter basis it’s down about 6 basis points from 363 to 357, Q1 as you recall Joe was positively impact by an interest recovery of about 263,000. So if we strip that out, down about 6 basis points.

Couple of things were interesting during the quarter, as DDAs continue to grow which obviously is the best one of the best trends we can see, our cost of funds went down about 11 basis points on a linked quarter basis. So that was very positive.

However, what we’re seeing in terms of average loan balances is still a bit of a challenge for us, some of that a lot of that loan growth that we talked about in the second quarter in that production came towards the end of the quarter. So we didn’t have the full benefit of having those loans on the books for the entire quarter. So, asset yields were down about 15 basis points, because cash balances were up little bit.

The other thing we did and I mentioned in the press release, as we sold about little over $6 million in municipal securities during the quarter, obviously a lot of call has been made on municipalities that had been in the immediate or lately so we wanted to try to reduce our exposure there. So those, that contribute as well to a little bit of a decline in the assets yields.

But, going forward given what we see in the pipeline and what we saw in terms of production in Q2 and what we see going forward, I would certainly look where assets yields to come up. I would continue to look for the cost of funds to come down, but very, very slowly. And so we’d like to think there is going to be some expansion in the margin maybe to the tune of about three and three quarters’ percent by the fourth quarter of this year.

Joe Gladue – B. Riley & Company

All right that’s all I had. Thank you.

Operator

Thank you. The next question is from the line of Julianna Balicka with KBW. Please go ahead.

Julianna Balicka – KBW

Good afternoon.

Lasse Glassen

Hello.

Julianna Balicka – KBW

Hello, how are you?

Lasse Glassen

Good.

Edward Czajka

Hi, Julianna.

Julianna Balicka – KBW

Hi. I have a couple of follow-up questions if I may.

Lasse Glassen

Surely.

Julianna Balicka – KBW

One thing I’d like to start thinking about with you guys given the positive trends that you’re seeing in credit and resolution is looking at your allowance and kind of your charge-offs are saying consistent you’re working down on nonaccruals. How can we start proactively thinking about the level of reserves that you’ll have say by year-end and also by the year-end of 2012, I know regulators are not likely to be very happy with banks are releasing reserves too quickly and you guys are not one of them, but other are. So currently, if you can just talk us through the logic of how that is going to work?

Lasse Glassen

One of the things that I can say is that let’s assume we’re lucky enough, let’s say as we lucky enough. We have a lot of resolution between now and a year and which resulted a lot of release up to reserve of reduction in non-performing assets. We may have over reserve situation happening in that case.

And if so that as long as our content doesn’t make us do that, we probably won’t release any of the reserve picking on that.

Julianna Balicka – KBW

So you will be more conservative in keep your reserves as much as you possibly can until?

Lasse Glassen

Yeah.

Julianna Balicka – KBW

Everything is just completely out of the woods?

Lasse Glassen

Yes. And also you have to notice that our conference may take a different view point at the year end and make us force us to do something and then we are helpless.

Julianna Balicka – KBW

But that’s how is greatly you have accountants versus regulators?

Lasse Glassen

Yeah.

Julianna Balicka – KBW

Yeah.

Lasse Glassen

Well, and I think also Julianna, looking at that going forward there is certainly the ability to grow into the reserve the level that we have in terms of growth going forward, probably in 2012. And maybe not taking provisions that would otherwise, we otherwise would take on a normalized basis.

Julianna Balicka – KBW

That make sense and in terms of the loan growth that you are kind of looking at how should we be thinking about the increase to reserves that will – not reserve excuse me, the increase to expenses that will arise out of just the investments you’re going to have to make in the infrastructure and in the talent that you’re going to be hiring versus when the commitments of these far – these lenders are going to be also obtained will translate into outstanding some things like that?

Lasse Glassen

I like to think the hiring of the talents is not as significant as we revitalizing our current talents. Most of the internal office are being handed the duty of resolving trouble loans. And as these seems reducing they would now have the free time to go out chase for new credit, and which is something in the essence is like a drypowder situation. But we do strategically would be adding on several area of people, as I previously answered to – that in certain area we feel inadequate.

Julianna Balicka – KBW

Okay that makes sense. And then final question in the different topic, Ed what kind of securities are you buying right now?

Edward Czajka

I haven’t bought anything in gosh probably four, five months. What I would like to think is going to happen Julianna over the next 12 to 18 months is we’ll as a slow shift in the asset mix in the balance sheet, potentially away from the securities.

I think the securities portfolio as peaked out in terms of balances, obviously to the extent we’ve got a strong pipeline and we’ve got a lot of cash on the balance sheet. We can use the cash and then perhaps eventually use some security sales to fund the additional asset growth, as well obviously as continue the deposit growth. So, haven’t bought anything.

Julianna Balicka – KBW

Okay very good, excellent. Thank you very much for taking my questions. Excellent.

Lasse Glassen

Thanks Julianna.

Edward Czajka

Thanks Julianna.

Julianna Balicka – KBW

Thank you.

Operator

(Operator Instructions) The next question is from the line of Joe Stieven with Stieven Capital Advisors. Please go ahead.

Joe Stieven – Stieven Capital Advisors

First of all, good afternoon and again very good quarter. Most my question had been answered, but I’ll ask this one now. You guys obviously still have the consent order, but you are substantially ahead of a consent order requirements, can you give us the timeframe when the regulators are going to come back and look at this because, that’s sort of – that’s it?

Lasse Glassen

I will defer the question to the person that you must have the most familiar with regulate to action which is Louie Couto okay, Louie, do you want to answer that?

Li Yu

Yeah, generally the regulators will require the completion of full scope examination before they make any determination on the termination of an enforcement action. We’re not scheduled for another full scope examination until the first quarter of 2012. And so, at the earliest it would have to be a short period after that.

Joe Stieven – Stieven Capital Advisors

Now, didn’t he head of the FDIC recently say that, in companies that made significant progress raising capital etcetera that they would actually do things prior to the schedule of the full scope exam?

Li Yu

They did, but of course every, these decisions tend to be made in a local manner. Certainly we will have open communications with our field office and regional office about the situation.

Joe Stieven – Stieven Capital Advisors

I would encourage you, because what’s for a company is under consent already your numbers are way too good. So, congratulations again. Thanks.

Lasse Glassen

Thanks Joe.

Li Yu

Thank you Joe.

Operator

There are no further questions at this time. I will turn it back over to Mr. Yu for any closing remarks.

Li Yu

Okay. Well we are we feel are very encouraged by these results. The second quarter but we’re more encouraged by the sign we’re seeing at this point in time. We’re here hoping that the commonly worked what continue to hoard at least okay. And, we’re looking forward to also reporting some positive results in the future quarters. Thank you very much.

Operator

Ladies and gentlemen, this does conclude the Preferred Bank second quarter 2011 conference call. If you would like to listen to the replay of today’s conference please dial 1800-406-7325 or 303-590-3030, and entering the access code of 445-8043. Thank you for your participation. You may now disconnect.

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