Preferred Bank (NASDAQ:PFBC) is Los Angeles CA-based $6 billion community bank. Preferred has a history of organic growth except for one small acquisition in Flushing NY. The bank’s current management team owns ~8% of the shares and is one of the most efficient banks in the U.S., with an efficiency ratio of ~30%.
From a loan perspective, the bank is mostly a real estate lender, with 50%+ in commercial real estate loans by YE 2021. Approximately 70% of the total loan book is lent towards real estate, including single-family residential and multifamily construction. On average, the real estate loan has a weighted average LTV of 55% and DSCR of 1.55x, showing very conservative underwriting criteria. C&I only represents less than 30% of the total loan book. In terms of C&I lending, the bank specializes in business banking and letter of credit financing.
From a deposit perspective, the bank has a significant percentage of high-cost funding, the time deposit. Despite the percentage of time deposits has been declining over time, money-savvy customers are shopping for higher rates which causes the significant reliance on high-cost time deposits as a funding source. FY21 the bank has made some improvement but is still a much weaker deposit franchise.
Preferred Bank reported net income of $95.2 million for the fiscal year 2021 as compared to $69.5 million for the prior year. Earnings per share were $6.41 versus $4.65 for the prior year. Revenues for the year increased to $194.6 million from $148.6 million for the fiscal year 2020. During Q4, Preferred Bank reported ROA and ROE of 1.8% and 18.4%, respectively. The efficiency ratio is 28.8% and Net interest income/Revenue is 94.5%. NIM is 3.28% and Tier 1 Capital Ratio is 11.21%
From a profitability perspective, reported ROA has been consistently above 1% during the past few years, even in FY20 when provisioning increased significantly. That being said, the performance is impressive during FY20, the bank delivered 142 basis points of ROA. The negative provisioning in FY21 indicates a reversal of credit losses in FY20, which is a good sign as the actual loan loss is not as severe.
Credit quality is robust for the bank. Even during the worst year in the pandemic, NPL increased to 51 basis points, which is significantly higher than historical averages. This is largely a reflection of the portfolio composition and the conservative underwriting, with a 55% average LTV on real estate, the risk of NPL is significantly reduced.
The hallmark of Preferred Bank is the ~30% efficiency ratio. Only 1% of the U.S. banks can achieve such a level of efficiency. Even though the bank has limited income from fees, the highly efficient operations show investors the upper range band that a bank can achieve from an ROA perspective.
Stock is attractively priced at 12.5x P/E and 2.0x P/TBV. The bank’s relatively expensive book value is a reflection of the extremely efficient execution of the bank.
From a risk perspective, the relatively large exposure to high-cost deposits means that a high number of customers will shop for rates and that CD will reprice over time. Inflation is another risk that can drive an increase in cost structure, but it is an industry-wide phenomenon.
From a reward perspective, the bank is efficiently operated. For every dollar of revenue generated in a rising rate environment, more dollars will flow to the bottom line to shareholders. The management team is aligned with shareholders, collectively owning ~8% of the stock.
To sum up, the bank is attractively priced and extremely well run. Preferred hit 1.7% in ROA with very limited reliance on fee income. The bank has been able to grow double-digits over the past five years. We like the risk/reward dynamics and believe that the management team can manage inflation well.
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