Preferred Bank's (PFBC) CEO Li Yu on Q2 2016 Results - Earnings Call Transcript

| About: Preferred Bank (PFBC)
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Preferred Bank (NASDAQ:PFBC) Q2 2016 Earnings Conference Call July 21, 2016 2:00 PM ET

Executives

Kristen Papke – Investor Relations-Financial Profiles

Li Yu – Chairman and Chief Executive Officer

Wellington Chen – President and Chief Operating Officer

Edward Czajka – Executive Vice President and Chief Financial Officer

Nick Pi – Executive Vice President and Chief Credit Officer

Analysts

Kyle Peterson – FBR

Aaron Deer – Sandler O’Neill

Gary Tenner – D.A. Davidson

Tim Coffey – FIG Partners

Operator

Good afternoon and welcome to the Second Quarter 2016 Earnings 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, Financial Profiles. Please go ahead.

Kristen Papke

Hello everyone. And thank you for joining us to discuss Preferred Bank’s financial results for the second quarter ended June 30, 2016. With me today from Management are Chairman and CEO, Li Yu; President and Chief Operating Officer, Wellington Chen; Chief Financial Officer, Edward Czajka; and Chief Credit Officer, Nick Pi.

Management will provide a brief summary of the results, and then we will open 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 risks – 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

Good morning or good afternoon. I am very pleased to report our second-quarter results as there are many positive events in this quarter.

First of all, the bank raised $72 million capital in the form of subordinated debt. Although we have input primary capital but our recent Tier 2 capital began to show a limit a lesser amount than the level we would like to have. More importantly, our CIE concentration ratio has entered into the area that we begin to feel less comfortable. And those are the primary reasons for raising this fund.

We have deployed $34 million of this fund on July 1 to purchase a home mortgage portfolio and we most probably will purchase another home loan portfolio to fully utilize this fund. After that, the net interest in effect, back to the fund, to this setback is probably in approximately about $250,000 a quarter. With this new capital, it does allow Preferred Bank to continue to grow at a respectable rate.

For the second quarter, our total loan increased $114 million or 21% plus on an annualized basis, the $121 million maybe a – $114 million maybe a record for the bank. Early indication in the third quarter which is up to now the pipeline seems to be quite similar to the pipeline of second quarter, and we are very please with the second quarter loan result.

Our deposits in the second quarter has increased $157 million or annualized at 27% or 28%. The $157 million is a Bank record. We tried to find out the reason why for this pleasant surprise other than perhaps our effort, other than that it is perhaps the reason that we began to be recognized by more customers. Nearly every rating agency in the country has put us in the top edge loangroup. And most recently a core rating has rated our deposit to be eight minus.

In the early part of third quarter our deposits continue to grow. As of yesterday evening, we were just a tad below total assets of $3 billion level. Especially when considering the interest effect on the sub debt, we had a slight improvement in our NIM, together with a larger average outstanding loan balances. We produced larger net income increases which in turn has brought our efficiency ratio down to 39.4%.

Despite a very large loan-loss provision when considering that we have a large recovery in the quarter also, despite a very large provision, we earned $0.61 per quarter which is a great improvement from the prior quarter. The large loan-loss provision stemmed from a SNiC loan being downgraded to non-accrual status and we have immediately charge-off 50% of the loan amount in accordance with recommended accounting practice. We’re pleased with the second quarter result. And the staff and myself also feel pretty good with the remainder of the year.

Thank you very much. I’m ready for your questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Bob Ramsey with FBR. Please go ahead.

Kyle Peterson

Hi, guys this is actually Kyle Peterson speaking for Bob today. Just a couple of questions here. First on the in the purchased mortgage portfolios, I was wondering could you guys give anymore background on that? Just kind of with regards to things like structure, yields, geography, really just any additional detail you guys can provide would be great.

Li Yu

Okay. That is a July event, but Wellington would like to answer that?

Wellington Chen

Sure, we’re looking at really the geography of California local. We purchased about $30 million worth and we go through the due diligence and we review each individual mortgage in detail, getting the update. Now we are taking a look at the value, and return, and the location and everything, and the duration really is adjustable 5.1, 7.1 and 10.1.

Kyle Peterson

Okay, great. Alright, great, yes that’s helpful, thank you. And then I guess a little bit as switching gears here, a little bit. Notice you guys had good trends fee income side with both the trade finance and then just on the OpEx side, as well. Are those kind of results for the income and expenses? Are those good run rates to use to going forward or where there any kind of one-off items in there that we should be aware of?

Wellington Chen

Well, I would have Edward Czajka to answer that.

Edward Czajka

Hi Kyle, in terms of fee income, yes it was a very solid quarter from the standpoint and certainly the trade finance line item is really more so focused on standby LC fee and income is really what’s driving that line item. It was a little bit up sized in the quarter so I would say the run rate is probably a little high this quarter going forward. But in terms of non-interest expense, I think, we feel pretty good about the overall non-interest expenses. Obviously we had some OREO cost in there which going forward in future quarters we’ll begin to evade [ph] and eventually be gone.

Obviously in the salaries and benefits expense continues to rise as we continue to grow in accordance with that. But I think on the whole, the non-interest expense run rate is – should be fairly indicative going forward with some growth built-in.

Kyle Peterson

Okay, great thank you. I guess just one last quick one, and then I’ll kind of hop out. So if any more information you guys could give on that SNiC credit, and I just want to make sure I heard it ready right. Did you say 50% of it was charged off this quarter?

Edward Czajka

Correct.

Kyle Peterson

Alright, yes, thank you. And yes I guess any other background you guys might be able to provide about the borrower, anything else about the kind of state of the credit now would be helpful?

Edward Czajka

We probably cannot mention the borrower and too much detail because lenders liability and other things. We can give you some color about that and Nick will answer that, okay.

Nick Pi

High, Kyle. For this customer, they are actually a film related company with DVD distribution business. And right after we recognized some of the trouble with this loan, then I did go back to review the credit file because at the time of approval, I was not the Chief Credit Officer at that time. So I went back to review the file and I didn't find out any kind of wrongdoing about underwriting and didn't find out any division from our standard policies. So I don't think this is kind of a loan exposed to any kind of risk to other loans that would have on our portfolio. So this is purely an isolated case we believe at this time. And since lenders, councils involved with some sort of credibility issues on the borrow side, so I’m now in position to release too much of detailed information on this credit.

Kyle Peterson

Alright, yes that is very helpful. Thank you very much. I think that’s all from me. Thank you.

Operator

The next question comes from Aaron Deer with Sandler O’Neill. Please go ahead.

Aaron Deer

Hi, good morning everyone.

Li Yu

Hi.

Wellington Chen

Hi Aaron.

Aaron Deer

May be just following up on that, I understand you can’t talk too much about the borrower, but maybe if you could just give the total loans, it sounds like your piece of this is around $4 million. I was just curious what the total size of the credit was?

Li Yu

$5.2 million.

Aaron Deer

What industry the borrowers were in?

Li Yu

$5.2 million.

Aaron Deer

$5.2 million, okay. And what’s the total size of the credit and what industry?

Li Yu

I think the total size about $70 million, okay. And industry is entertainment industry.

Aaron Deer

Okay. And then, Ed, you were kind of touching on expense outlook. It does not sound like you are anticipating too much increase in expenses although, you did highlight in the press release some of the cost related to just compliance and such. Can you give maybe some more color on this since you’ve highlighted that I’m just wondering if there – are there some specific costs that you have in mind that you anticipate incurring over the next couple of quarters.

Li Yu

Well, one thing Aaron in business when you go out, when the company gets bigger, you need more people. I guess one of them with natural growth was the people. And number two is that whenever a typical banker comes up, we have to do the opportunistic hiring. So it is sometimes when it happens, it happens. Now given that in total is that there will be some degree of personal cost increases. And I like to think we are going to make more money in the remainder of years. Therefore, we have a bonus formula related to the earnings so the personnel costs, really the bonus side, will also increase. The exact amount cannot be estimated right now because it is [indiscernible] when it happens. But there will be some increases as going forward. But we like to think that the increase will be in line with the earnings increases, okay.

So for that matter, okay, for that matter I would say that the efficiency ratio going forward will not change to 45% or 50%.

Aaron Deer

Okay. Thank you, Li. And then another question with respect to the sub debt offering. Can you maybe give where – I guess it was in June, 30 numbers, where your commercial real estate is as a percentage of total risk-based capital and I don't know if you can do that pro forma for the last kind of stub of the – of the sub debt that was added.

Li Yu

Pro forma real estate – non-owner occupied real estate concentration ratio is right below 300%, probably 295% but we have not finalized any final calculation yet, but right below 300% for the quarter end.

Aaron Deer

Okay.

Li Yu

Pro forma [ph] including, $15 million.

Aaron Deer

Very good, thanks for the help.

Li Yu

Thank you.

Operator

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

Gary Tenner

Thanks good morning. Just couple of questions, on the mortgage portfolio purchase of $30 million. What was the yield on that portfolio?

Li Yu

It’s about high four’s.

Edward Czajka

Gary…

Gary Tenner

I’m sorry say again.

Li Yu

High four.

Gary Tenner

High four, okay.

Li Yu

Yes.

Gary Tenner

And I don’t know if I heard Li’s comments accurately, were you saying that presuming another similarly sized purchase quarterly…

Li Yu

Yes, we have…

Gary Tenner

Quarterly headwind will be about $250,000 from the sub debt?

Li Yu

Well with another purchase of the – was in home mortgage portfolio. The net interest differences of the debt and the income from the mortgage portfolio will be roughly $250,000 per quarter. It depends on what the rate we get in the next [indiscernible] (0:17:28)* quarter, it could be less than $250,000 it could be more than $250,000.

Gary Tenner

Okay.

Li Yu

I’m not sure.

Gary Tenner

So that $250,000 assumes another similarly sized portfolio though?

Li Yu

Yes.

Gary Tenner

Is that right? Okay.

Li Yu

Yes.

Gary Tenner

All right fair enough. And then regarding the personnel line which you talked about a moment ago, $1 million sequential decline, part of it seasonal payroll stuff, but you also highlighted in the press release that there was a higher level of capitalized loan origination cost, is that just simply related to the new hires that became productive during the quarter and that’s why you were able to start capitalizing their cost?

Edward Czajka

No. that’s really, Gary, hi, this is Ed. That’s really goes along with our loan production levels as new loans come on and loans are renewed, we capitalize and have to defer those loan costs. So as production increases, we get to capitalize a greater deal of those salary expenses and when you capitalize them of course you credit salary expense and debit deferred loan costs.

Gary Tenner

Right, okay, all right. So it’s not new – it’s not new producers, it’s just increased production.

Li Yu

Yes, increase number of loan. This is in line with FASB 91. We have to do almost nearly scientific calculation quarter-by-quarter depending on the number of loan and the type of loan we produce.

Gary Tenner

Right, okay, that’s fine. Thank you very much.

Li Yu

Thank you.

Operator

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

Tim Coffey

Thanks, good morning gentlemen.

Li Yu

Hi.

Edward Czajka

Hi, Tim.

Tim Coffey

So you’ve had a pretty good tale on recoveries in the – within the loan portfolio, especially commercial land. Is that nearing an end or do you see a little bit more going forward?

Li Yu

There is a little bit more going forward because we know this because we will charge-off the entire thing. The thing is based on the payment schedules coming down. The next payment will be next spring probably with a complete payoff, okay. If that is to occur, we probably will have additional $2 million or more recovery, as some of them will be interest income because interest could be recovered last.

Tim Coffey

Okay. And what is the timeframe on that you said?

Li Yu

Next spring, April.

Tim Coffey

Okay, okay. And how does that affect, if at all, your provision expenses going forward on, if you exclude the SNiC from this quarter?

Li Yu

Well, that probably will create a increase in reserve situation. And then again for that quarter, maybe we have a beneficial provision situation meaning less provision or no provision possible, okay. But all has to be measured depend on how loan growth in the second quarter of 2017.

Tim Coffey

Right. Okay, all right. Thank you. The rest of my questions have been answered.

Li Yu

Okay.

Operator

[Operator Instructions] We have no further questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Yu for any closing remarks.

Li Yu

Well, thank you so much for your continuous interest and continued support of the Bank to date. And as we always will be dedicated to the best interests of our shareholders. Thank you.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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