Preferred Bank's (PFBC) CEO Li Yu on Q4 2015 Results - Earnings Call Transcript

| About: Preferred Bank (PFBC)

Preferred Bank (NASDAQ:PFBC)

Q4 2015 Results Earnings Conference Call

January 22, 2016, 02:00 PM ET

Executives

Kristen Papke - IR

Li Yu - Chairman and CEO

Ed Czajka - CFO

Wellington Chen - President and COO

Analysts

Aaron Deer - Sandler O'Neill

Gary Tenner - D.A. Davidson

Tim Coffey - FIG Partners

Don Worthington - Raymond James

Operator

Good day. And welcome to the Preferred Bank Fourth Quarter 2015 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]

Please note this event is being recorded. I would now like to turn the conference over to Kristen Papke, Investor Relations. Please go ahead.

Kristen Papke

Hello everyone. And thank you for joining us to discuss Preferred Bank’s financial results for the fourth quarter and year ended December 31, 2015. With me today from Management are Chairman and CEO, Li Yu; President and Chief Operating Officer, Wellington Chen and Chief Financial Officer, Edward Czajka. Management will provide a brief summary of the results [audio gap] 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 would like to turn the call over to Mr. Li Yu. Please go ahead.

Li Yu

Thank you. Good morning, ladies and gentlemen. Thank you for joining our conference call.

2015 has been a good year for Preferred Bank. Our total net income increased little over 20%, largely due to the growth in loans and deposits.

For the year loan and deposit grew a significant amount. However this amount included the balances of United International Bank, which we completed acquisition on November 20. The acquisition has given us $154 million in deposits and $149 million in loans.

Ignoring that or excluding that, our annual organic growth in loan was 19.1% and was 19.9% for deposits. Likewise if we ignore that, the balance of United International, the fourth quarter linked quarter growth in loans was 4% and deposits was 7.2%.

Annual net income is $2.14 and quarterly net income was $0.54 also on per share basis. However, these numbers included a acquisition cost of roughly $800,000 related to the United International of New York acquisition.

Without that our efficiency ratio would have been just in line with the annual number of just over 40%. The New York acquisition has given us a vital new market, especially for loans.

We're highly hopeful the market will be bringing us good vibrant results in the future and in fact will bring the profitability of New York region into about the same as our California region.

With the recent stock market correction activities or meltdown activities, we're keeping our eyes wide open. Previously we're well aware of the Chinese stock market meltdown and we have went through internal review of our portfolios.

Luckily more than 75% of businesses was mainstream community who have negligible activity with the Chinese market related activities. We have in the process of reviewing our portfolio in New York region and early indication is that because of their size, because of their locality, the involvement there is also negligible.

Although our markets are good, we still believe the majority of economic forecast that our economy will continue to grow on a steadier basis and is more than likely that Federal Reserve will increase interest rate.

If so then we are one of the biggest beneficiary of the increase. 90% of our loan portfolio is asset sensitive or fully floating. 80% or 90% is fully floating was [primarily] [ph] on a daily basis. 10% of the 90% was fully floating on a LIBOR basis, which is little longer but relatively short okay.

With that and with the various activities we're seeing, with our loan pipeline, we're highly confident and hopeful of our 2016 year.

Thank you and I’m opening for questions.

Question-and-Answer Session

Operator

We'll now begin the question-and-answer session. [Operator Instructions] The first question comes from Aaron Deer of Sandler O'Neill. Please go ahead.

Aaron Deer

Hey, good morning guys.

Li Yu

Hi, Aaron.

Aaron Deer

Congratulations on getting the deal completed and on a very strong organic quarter as well.

Wellington Chen

Thank you.

Aaron Deer

The -- with respect to UIB, can you talk a little bit about the timing of the systems integration there and what kind of activities you're taking in terms of any additional hiring in New York or training and how you would expect to see that impact the growth in that market?

Li Yu

Okay, I will let Ed start with the integration.

Ed Czajka

Hi Aaron, we are currently set to convert their systems on the weekend of February 5. So the integration activity, we closed on November 20. We expect to be more or less fully integrated by the end of that weekend.

So it’s fairly quick timeline. Everything is a go right now and everything looks really good. As a matter of fact, we just completed our mock testing and everything look great. So we’re on track and I'll let Wellington discuss the personnel question?

Wellington Chen

Hi Aaron, we have a group of experienced bankers out there. I think that I was just out there last week and working with them. So working with their existing customer and going after the customer that they couldn’t bank previously due to the bank size, I think that there is a -- we’re very bullish in getting our share of business.

Now in terms of additional talents, that's always our focus. We’re always looking for good talent out there where it's West Coast or the East Coast.

Li Yu

Aaron I would like to add little bit color on the New York. To me the New York -- one of the biggest attraction of New York is the people. Granted because they were previously under a difficult situation and that they have [indiscernible] per employees low.

But given time we will make these people create more activities, which in my opinion they’re fully capable of, we're also looking for branching out in the Greater New York area so to make the total region more economically -- size of economy look better.

Aaron Deer

That’s great. I appreciate that. I was also curious if you could touch on the commercial real estate guidance that the regulators had just reiterated at year end and what are your thoughts on that and how that might affect your appetite for various loan types in the year ahead.

Li Yu

Okay. We previous to the acquisition as based on September 30 number, we had a total so called investment CRE number. By the way, I like to reiterate that government’s guideline is that investment commercial real estate guideline is roughly 300% of risk based -- total risk based capital. It is a guideline.

Over that number, they're expecting the banks to intensify their underwriting procedure or monitoring procedure, and from top to bottom in the hierarchy you ask someone, they say well, as long as you do the right job, we're okay with it.

Having said that, we're very mindful of keeping the number a little lower. September 30, we have a number of roughly 350% without UIB. With UIB, it goes to a little over 380%.

Now, since October 1, we'll be working on a very hard -- various situation whereby not matching some of the maturing CRE loans was the rates that other people is offering by concentrating or generating -- originating other type of loan by selling off some of the loans to participation, we have managed to bring down this number to 338% estimated end of December 31, 2015.

And also including in the 338% number was 58% in multi-family, which mean apartments. So the real non-residential type of a CRE is about 280% and our underwriting procedure is that we think we are keeping our underwriting procedure without relaxing on it.

And for instance none of the new origination in the fourth quarter was over 70% effective, maybe one of 70% that was related to a long time, long time customer has a proven record as substantial [indiscernible].

Our average all that -- original CRE loans in the fourth quarter is LTVs right around 60% and we’re very, very conscientious about the location of the property. We generally do all our CRE including apartments in the highly populated infield areas. So this my summary report to you.

Aaron Deer

That’s great. Thank you very much. Mr. Yu, I’ll step back.

Operator

The next question comes from Gary Tenner of D.A. Davidson. Please go ahead.

Gary Tenner

Thanks. Good morning. Just a couple of questions. On the margin -- the core margin in the third quarter was around 380% I believe. So nice expansion in this quarter.

Could you attribute for us how much of that expansion was the impact of the Fed move in mid December and talk about it, there would be any competitive dynamics on the pricing side that may limit some of that follow through coming to the first quarter?

Li Yu

Ed, do you want to talk about the first?

Ed Czajka

Sure. Hi Gary. In terms of the core net interest margin expansion, I would say probably only maybe a couple of basis points at most attributed to that. Obviously, we only got a half a month of benefit there. We expect to -- the loans that we set as well Fed funds.

In terms of going forward and in terms of pricing, what we’re seeing in deposits is as you know the middle end and the long end of the curve have actually moved down since the Fed tightening in middle of December.

So what we’re seeing in the market on deposits is really not a lot of movement upward. We're seeing some -- a lot of CD promotions, but in terms of the core deposit pricing, money market and those types of things, we’re really not seeing a lot of movement there at all. So I think that could potentially benefit us in the upcoming year if it remains that way.

Gary Tenner

Okay. So it sounds like a full quarter of higher yields without a lot of upward pressure on funding cost. Is that accurate?

Li Yu

We like to think if there is any pressure at all it would be very limited. However I’m constantly contemplating is it a time to get a longer term deposit such as three-year deposits, three-year deposits will prove to be long term very profitable for us. So this is something that we’re contemplating. Certainly those are strategic moves rather than pressure or anything like that.

Gary Tenner

Okay. Great and then just on the credit side, obviously you guys are really had a greater run in terms of consistently lowering non-accruals right now just one small non-accrual loan and OREO property led us out to pretty small provision again this quarter.

With your reserve now down closer to 1%, can you talk about kind of your expectations for the provision levels maybe for 2016 given expectations for strong loan growth?

Li Yu

Okay. There is two types of situations I want to talk about. Number one, the reserve is -- one of them is related to the mark on the UIB loans, which they don't carry reserve, for what really was marked with the [fair] [ph] value.

Another situation is the portion of the -- very small portion of the mortgage loan portfolio has traditionally supported the carrier very low reserve number. The other CRE portion and the C&I portion of the reserve is approximately same as before and we are under heavy, heavy advises from our CPAs with their newly acquired information how to properly do a reserve.

And we're also facing the immediate release of the CECLs. So a big story about it is that we're not so sure, but I just want to tell you is that whatever we're doing right now is leading what is the current accounting standard.

Now looking in the first quarter, probably if we have the same amount of production, our provision will be little bit elevated, but I just don't know how much.

Gary Tenner

Okay. And what is the credit discount on UIB portfolio at your end?

Ed Czajka

Right now it's not finalized Gary. Still working through it, but the current draft right now is about 1.3% was the mark on the whole loan portfolio.

Gary Tenner

Okay. Great. Thanks guys.

Li Yu

Okay.

Operator

The next question comes from Tim Coffey of FIG Partners. Please go ahead.

Tim Coffey

Thank you. Good morning, gentlemen.

Li Yu

Good morning, Tim. Good morning.

Tim Coffey

As we look out to loan yields the next or six quarters, how confident are you guys holding about 5%?

Ed Czajka

Point, Mr. Coffey.

Tim Coffey

Just hold the crystal ball.

Ed Czajka

Mr. Coffey, that's a million dollar question. Put it this way that certainly that we will be -- we try very hard to hold over that okay. But being that if in the next six months if we have another way to increases okay, which are 25 basis points, some of our floating rate loan would be -- will be floating upwards.

So the likelihood of keeping it over 5% with that particular increase looks let's say 50.1% okay. So certainly if there's and interest as our corporate history has always been tried to manage our net interest margin in a level that is probably higher than our peer group.

Tim Coffey

Okay. And then have you built any prepayment penalties in -- sorry, were there any prepayment penalties in the net interest or in the interest income line item this quarter?

Li Yu

In the market phase, if you have a floating rate loan, fully floating rate loan, any prepayment penalty is unusual. Whenever possible we'll build it in. However our customer, basically our customer will be putting, well experienced customer, they certainly were fight back.

So we have very little free loans that have a prepayment penalty related to that okay. So short answer is not much.

Tim Coffey

Okay. And then given kind of the levers that were seen in the Chinese stock market as you mentioned earlier, is that having any kind of an impact on customer liquidity whether it be in your core market in Southern California or in the EB-5 program?

Li Yu

The EB-5 we're able to do till already approved, is already in the needs of the BSA requirement okay. So, so far we haven't seen anything and based on our discussion with our customer and it seems to be what are the projects already going on -- will continue to go on, okay.

As far as the other type of loans okay, we just don't have many loans so called that are China related. To certainly there maybe some distributors or maybe some related people of the Chinese factory having operation in United State, but basically a locally capitalized and we’re lending to them based on local operations and the number is very, very small, okay.

Tim Coffey

Right, yeah and there -- speaking about the EB-5 program there is a significant backlog on or applications and I’m sure on projects there coming forward. So are we talking about if the problems in China extended a year, would that start to pose a problem for you on EB-5 business side?

Li Yu

I’m going to be purely speculating and to give you one man’s opinion okay, the net effect is going to be reducing, but not by much because while there is a lot of people having getting the fund out or their fund destroyed up, there is also many other people have a bigger propendency or bigger desire to get their money out to diversify themselves.

Just like the recent -- our stock market -- the United States stock market correction, that some of my customers talking about stopping their other investment projects in real estate, but yet there are some people saying they need to switch to real estate because that seems to be safer for the long term. So it’s a two way kind of thing.

Tim Coffey

Okay. And then just one final question, as you look how to build up the operations on the East Coast, does M&A factor into that?

Li Yu

We are right now, we have been relaxed with people started bringing us with more -- lot more opportunity not that we've done the first one and we're looking at basically that like I said, we’re kind of a tricky price we create and also the market opportunity that was relatively given to us.

So, we are continuously looking but when we'll be doing what we think is absolutely beneficial to us. We're not looking just for -- looking for adding the balance sheet numbers.

Tim Coffey

Okay. Understood. All right. Well thank you very much. Those were my questions.

Li Yu

Okay.

Operator

The next question comes from Don Worthington of Raymond James. Please go ahead.

Don Worthington

Good morning, everyone.

Li Yu

Hi. Good morning.

Don Worthington

Do you expect any more in the way of merger cost in the first quarter that would be non-recurring?

Li Yu

Ed.

Ed Czajka

To the extent, we could help it melt Don, we think everything is pretty much in the fourth quarter at this point. There maybe a few things, but they’ll be relatively small.

Don Worthington

Okay. And then in terms of I guess getting back to the interest rate risk issue, how much do you have in the way of loans that are on how floors where you need another move or two by the Fed in order to adjust the yield on the loans?

Ed Czajka

Don, I don’t -- I will present the answer to you in a different form about that.

Don Worthington

Okay.

Ed Czajka

When we do our IRR analytics, we take into account -- it’s on an account level basis. So we take into account every floor and every loan and where it fits that relative to the index. So that’s all factored in.

What I can tell you is that right around 75 basis points of the Fed hike and 25 of which has already taken place now, at about 75 basis points is where almost the entire portfolio starts to lift off the floors. At 25 basis points, last I recall, a 25 basis point move we generate about $2 million more in additional net interest income annually.

Li Yu

We estimate…

Ed Czajka

We estimate and that starts to accelerate as we go higher and higher.

Don Worthington

Okay. Great, that’s good color. And then in terms of the OREO property, any prognosis on how long that will take to resolve?

Li Yu

It probably takes little bit longer than normal other OREO because we still involve with the, we carry with the borrowers lawsuit with -- probably the people. So we're still probably being named in it okay.

So it probably is another six months to a year before we can stop marketing a property and not being hurt by the value. We think we're already looking down to whatever the current day market value is, but would like to think -- we would like to resolve those issues before we market them.

Don Worthington

Okay. Great. Thank you, Mr. Yu.

Li Yu

Thank you.

Operator

And we have a follow-up from Gary Tenner of D.A. Davidson. Please go ahead.

Gary Tenner

Thanks. I just had one more question on trade finance. We had heard from one of the other banks that there was pressure on the trade finance in the fourth quarter with some paydowns and loan and finance availability in China.

Your fee income was up in the fourth quarter and trade finance, but wondering if you're seeing any of that.

Li Yu

Our trade finance portfolio is very limited. We have total about $50 million -- less than $50 million total pre-financed loans in the California operation. I've not really tried to see finalized what the New York trade finance loans with their total portfolio of $150 million in total loan, it is very small okay.

So we have not noticed any pressure in that yet, okay in term of the pay down activities on that okay.

Gary Tenner

All right. Thanks again.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Li Yu, Chairman and CEO, for any closing remarks.

Li Yu

Well, thank you very much for attending the conference. We are pleased with the year and certainly that -- hopefully that we can do equally if not better in 2016. And with that Happy New Year and hope everything is health and happiness for everybody who is this conference phone call. Thank you.

Operator

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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