Q2 2017 Preferred Bank Earnings Call
Jul 19, 2017 AM EDT
PFBC - Preferred Bank
Q2 2017 Preferred Bank Earnings Call
Jul 19, 2017 / 06:00PM GMT
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Corporate Participants
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* Edward J. Czajka
Preferred Bank - CFO and EVP
* Kristen Papke
* Li Yu
Preferred Bank - Chairman, CEO and Company Secretary
* Nick Pi
Preferred Bank - Chief Credit Officer and EVP
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Conference Call Participants
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* Aaron James Deer
Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst
* Donald Allen Worthington
Raymond James & Associates, Inc., Research Division - Research Analyst
* Gary Peter Tenner
D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst
* Stephen M. Moss
FBR Capital Markets & Co., Research Division - SVP
* Timothy Norton Coffey
FIG Partners, LLC, Research Division - VP & Research Analyst
* Tyler Stafford
Stephens Inc., Research Division - MD
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Presentation
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Operator [1]
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Good day, and welcome to the Preferred Bank second quarter 2017 Earnings Conference Call. (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.
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Kristen Papke, [2]
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Thank you. Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the second quarter ended June 30, 2017. 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 up 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 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'd like to turn the call over to Mr. Li Yu. Please go ahead.
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [3]
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Thank you. Good morning, ladies and gentlemen. Thank you for attending our earnings conference phone call. I am very pleased to report we had a good second quarter 2017, in which the bank earned $11.7 million of net income, which equals to $0.80 per shares of earnings per share. Both of these numbers are substantially better than last year. Our bank continued to grow.
During the quarter, loan increased $104 million and deposits, which is the bright light, increased $170 million. The continued large deposit increases has eroded our capital ratio, our return on assets and our net interest margin. While it is the franchise builder and it will provide much more muscle for the long-term growth and profitability of the bank.
Net interest margin for the quarter was 3.75%, an 8 basis point expansion from the first quarter. This is less than what we had expected, largely due to the fact that the large deposit growth has changed the leverage ratio. Also contributing to that is continued market competition in pricing. I want to emphasize -- at this time, I want to emphasize that the large deposit increases had no or very, very little effect to the net income and earnings per share of the bank.
For the first time since 2009, our capital ratio has been reduced to less than 9%. We must plan for the bank to continue to grow. And, therefore, went to the state of California and obtained a Negotiation Permit to add $50 million of new capital in the form of ATM offerings. We chose this ATM methods largely because it were more accurately matching our needs with the capital amount.
Let me use a far out and hypothetical example at this time. Assuming, hypothetically, in the next 12 months, there will be no growth in deposits and assets. However, our earnings will continue to grow. We will add roughly $40 million or more in capital through earnings in the next 12 months. In which case, our capital will be closer to 10% capital ratios.
But in the most likely case, we'll be raising all the $50 million before the year. So perhaps that in our calculation of the outstanding shares by year-end should reflect the additional shares to be issued.
In June, our bank -- our Board of Directors have declared a dividend of $0.20 per share, which is an 11% increase from the $0.18 of dividend previously declared. This is our reflection of our bank's performances -- earnings performances and also our confidence in the bank's future.
Thank you so very much. I'm ready for your answers -- for your questions.
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Questions and Answers
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Operator [1]
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(Operator Instructions) First question comes from Aaron Deer with Sandler O'Neill + Partners.
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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [2]
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So Li, following up on the very impressive deposit growth that you had in the quarter. I was just curious if you could maybe give us some insight in terms of the sourcing of those inflows and what you are seeing in terms of deposit pricing pressure? Obviously, you're still -- management post some pretty impressive margin expansion. And just wondering what kind of feedback you're getting from customers on deposit pricing and if you sense any need to be tweaking those upward as we go forward?
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [3]
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Okay. First we needed to be source of deposit increases. They're really many -- many, many reasons for that. I guess the one -- the first and foremost is that our customers are getting richer because the increase in real estate prices, increase in stock prices, an increase in the earnings profitability in the company. So generally, it is growth of our existing customer. And although -- also that we fear that as we go along with our performance that our reputation also gets better. Our customer's confidence in us getting higher. So that add to the deposit, the momentum. And along with that, we have some new product, which compared to our peer group was probably okay. For instance, we grew our mobile banking both in personal and business mobile banking, and which some of our larger competitors, they don't have that yet, okay? So all in all, finally, I think that I'd like to brag a little bit and say, maybe our people work smarter now, okay? So this is the reason for the sauce. And pricing pressures that we see, a little bit increase in pricing pressure. We have not witnessed the competition pressure to be very high. And although, we have no problem attracting deposits at our current posted rates. We realize as we go along the thing will probably go along with the Fed rate increases of 10-year or 2-year, whatever these things will move. I guess we'll have to move along with that. But so far we haven't seen much.
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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [4]
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Okay, that's great. And then just curious, the -- given the growth that you're seeing, obviously, your credit trends are quite favorable but I was wondering if you could just give us a sense of, in terms of new originations, what kind of provision or reserve is being set aside for those? Just trying to gauge if we should anticipate the reserve ratio continuing to drift lower or if it's likely to maybe stabilize here around this current level?
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [5]
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Well, one of the things I like to emphasize is that making a reserve today is a nearly a science rather than a art, okay? And with the insistence of the PCOAB (sic) [PCAOB], which is accounting governing body, they are demanding all the accounting firm to be more, I should say, systematic and methodical in calculating the reserve, okay? There's a very little room for the bank to discretionally provide more reserves if we wanted to. I, personally, have previously wanted to add a so-called a cushion on allocated reserves to our [ALLL], but wasn't successful. We were not allowed by our accounting firm to do that, okay? So having said that, the reserve going forward, assuming the mix of our loan portfolio doesn't change and the product type mix doesn't change, we'll be right around in the $0.98 to $1.01 area, okay? For the new loans to be generated. That assumes there's no charge offs that will require to be replenished.
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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [6]
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Okay, that's great. Appreciate that. And then just one confirmation on your comment. It sounded like you anticipate using the full -- the $50 million of the ATM that's authorized by year-end, did I hear that correctly?
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [7]
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Well yes, obviously, that we wrote 9% right now and we'd like to bring the ratio up again and even the first 18 days of the month, which is up to yesterday, we grew another $70 million around deposits. So it looks like it's continued growing in, okay? And these are all relationship type of deposits. So with that, we -- in our planning, we must assume that some degree of further accumulation of deposits and therefore, the capital will be needed.
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Operator [8]
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Your next question comes from Tyler Stafford with Stephens.
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Tyler Stafford, Stephens Inc., Research Division - MD [9]
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I just wanted to start maybe on the margin and Ed, get your thoughts on -- that the margin for next quarter after the June rate hike that we had and any commentary you could share in terms of what -- how loan yields progressed throughout the quarter?
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Edward J. Czajka, Preferred Bank - CFO and EVP [10]
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Well, we did see, as you would expect, and as we would expect, we saw a nice spike in loan yields from the May to June months. And obviously, that bore itself out in the 8-basis-point expansion on a quarter-over-quarter basis. Looking forward, Tyler, as we've discussed before, the challenge really becomes what the leverage looks like during the quarter. What average deposits are versus average total loans. To the extent, we have that continuous steady growth in deposits that Mr. Yu just talked about. We can still be looking at a situation where we don't get much expansion in Q3 relative to the net interest margin. However, we will see a significant increase in net interest income. It just may not bear itself out in that mathematical equation.
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Tyler Stafford, Stephens Inc., Research Division - MD [11]
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Okay. Are we to the point yet where you could remix some of the earning assets and liquidity that you got into securities and loans yet? Or are we still not there yet in terms of the rate outlook?
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [12]
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We do not know what you mean by mixing the leasing. What we do is that, as far as the loan is concerned, that we just have to do our loans in the normal method and as if independent of the deposit. Not because with more deposits, we'll just have to do more loans, okay? We just have to do these things, two things, separately. As far as security is concerned, I don't know what magic that Ed has in his pocket. But I haven't seen anything that actually -- you can buy right now that would lead us not to a sleepless night of a [single value eroding] in the immediate future. So -- and I guess, just really conservative maybe we should bite the bullet and not be too short-term-pocket motivated.
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Edward J. Czajka, Preferred Bank - CFO and EVP [13]
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Tyler, to add on to that, we're still seeing, I'm sure you followed it, the 10 year, and that's kind of -- I watch most closely relative to the bond portfolio. And obviously, after the election, we got a nice spike and then it's trended down pretty -- unfortunately, really since then. So until we have, I think, real clear direction and that 10 year really hits a sustained higher-level, I think we'll be reluctant to put any more work -- money to work on the bond portfolio.
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Tyler Stafford, Stephens Inc., Research Division - MD [14]
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Okay. That's fair. On expenses, I was a little bit surprised that the compensation line item was up this quarter after the fallout from the deferred comp last quarter. Is there anything I'm missing there? And then maybe just a similar question on the other expense line item. Was there anything noisy in that line item that should fallout?
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Edward J. Czajka, Preferred Bank - CFO and EVP [15]
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With respect to other expense line item, we had a FDIC assessment catch up essentially. With respect to the employee salaries and compensation, most of that was in the compensation expense as well as bonus expense. And we also had some variation relative to about 91 deferred loan -- capitalized loan costs. So that would have accounted for that. But essentially $800,000 in additional -- in higher salary.
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Tyler Stafford, Stephens Inc., Research Division - MD [16]
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So with the fallout from the legal expense that you guys had last quarter, is this a fair run rate for expenses?
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Edward J. Czajka, Preferred Bank - CFO and EVP [17]
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I would think it'd be slightly below, where we hit Q2, Tyler. I would say closer to 12 as opposed to the 12.4.
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Operator [18]
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The next question comes from Steve Moss with FBR.
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Stephen M. Moss, FBR Capital Markets & Co., Research Division - SVP [19]
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I was wondering if you just discuss where the loan pipeline stands and where you're seeing the strongest growth these days?
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [20]
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Okay. One of you can take on that and then maybe I can add a little bit to that.
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Unidentified Company Representative, [21]
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Well, the loan pipeline, it looks pretty healthy right now. And it's all cylinders kicking in from our Southern California, Northern California, SOS New York. In terms of product, we are very selective in terms of what kind of CRE we want to tackle, more like a owner/user type of product. At C&I, we recruited couple of C&I lenders late last year. And so it's been about 6 to 7 months (inaudible) production to continue to kick in.
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [22]
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Well, it seems to be a little bit [what some light to] the product types and so on. The product types, although, generally still the same. But we are conscientious about the CI concentration of ratio. In the back of my mind, it -- although, we are choosing on new loans and revolvers preference so on, certain other type rather than the thing that would create a concentration issue, okay? And so that's really related to another situation. Obviously that there's a lot of publicity these days regarding e-commerce and expect to reinstate the retail properties. So I will say that we have tightened up the underwriting standards and we have tightened up substantially the -- how should I -- should have said tightened, I would have, investigation. Quite substantially, the more effort was put onto any of the request that was sent to us and being very, very choosy.
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Stephen M. Moss, FBR Capital Markets & Co., Research Division - SVP [23]
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Okay, that is helpful. And then I was wondering with regard to capital, I hear you in terms of the ATM. Kind of where are you thinking for a long-term target on capital ratios?
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [24]
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Well we have, obviously, internally always believed that we should be operating between 8% and 9% as the lowest level of possible capital. That is based on the so-called -- the all the capital ratio levels previously published via the regulator, was on the BASEL and all those things that goes along. I think there's a whole lot of change in this environment and we'd like to wait and see to what their conclusion is or what the market conclusion before we come to a -- revise any of the -- our internal goal. Before that I think, between 8% and 9%, it will be the lowest level that we want to operate at right now.
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Operator [25]
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The next question comes from Tim Coffey with FIG Partners.
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Timothy Norton Coffey, FIG Partners, LLC, Research Division - VP & Research Analyst [26]
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Looking at the NIM this quarter with the kind of the additional deposits, you didn't have that kind of deposit growth and say, the loan and deposit ratio had been somewhat similar to the previous 2 quarters. How much more basis points of NIM would you have gained?
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [27]
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Well to answer your question, I've done a very, very personal (inaudible) computer assisted, having scratch paper type of post. After the loan-to-deposit ratio in -- on December 31 was 92%. And it's down to 88% right now, okay? And that is June 30. And I guess that 4% change is caused by anywhere between $0.07 to $0.09 of erosion in net interest in margins, okay? That would've happened. But please remember that you're talking to a person who is not a (inaudible). So I don't take any of these responsibilities.
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Timothy Norton Coffey, FIG Partners, LLC, Research Division - VP & Research Analyst [28]
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That's helpful. Because I remember the last call, you talked about how you're seeing good margin expansion just in March. So that's kind of what my -- the gist of my question was. And then the deposit growth, going back to the beginning part of the Q&A, that was mainly from existing clients or did you create any new products that brought in new business on the deposit side?
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [29]
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Not new product, the new clients. Do you have new products?
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Unidentified Company Representative, [30]
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No new products. I think some of our -- again, we've brought in a couple of deposit officers. So we actually expanded the new clients as well. While we built this on retention, while we try to bring in new deposit, we want to make sure we maintain and hold onto our existing deposit.
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Timothy Norton Coffey, FIG Partners, LLC, Research Division - VP & Research Analyst [31]
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Okay, that's great. That's an exceptional growth from existing clients.
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [32]
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Expected to reconsider, our bank does not have special products such as bankruptcy deposits or, I mean large amount of escrow deposits other than couple of small comps. So we -- our basically very such a normal type of business.
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Timothy Norton Coffey, FIG Partners, LLC, Research Division - VP & Research Analyst [33]
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Okay, thank you. That's very good color. And I'm not that familiar in the processes that you're going through with the state of California to execute on the ATM. But is this something conceivably that could be done in third quarter?
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [34]
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You want to answer that?
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Edward J. Czajka, Preferred Bank - CFO and EVP [35]
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In terms of starting it, yes, absolutely. We still have one more -- another permit to get before we can actually start executing on it. But the first one was the biggest hurdle, Tim, in terms of getting the Negotiating Permit. As long -- in terms of getting the documentation in place, getting the work from the accountants in place, comfort letters and so forth, that should be fairly quick to do. And we should be able to start executing on the ATM before the end of the third quarter.
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [36]
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Tim, I just want to explain to you this. It is certainly, we're not the [any] regulators, let alone state of California intentional of limiting the capital growth -- capital increase of any financial institution, okay? But I think in our particular case, this ATM method, okay? Is a first case the state of California had ever faced under their system. And there is a lot of other things between the legal side, the lawyer side and us that will work out. And they'll hopefully cause the kind of -- have a so called, the sort of that unusual type of a -- how should I say -- disclosure to you. It would be done. From now on it's easy, okay?
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Timothy Norton Coffey, FIG Partners, LLC, Research Division - VP & Research Analyst [37]
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Yes, that was kind of what I was asking. Yes, I wanted to find out, how long it would take to get the Stock Permit? So it sounds like that the hardest part's already been -- that hurdle has already been crossed.
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [38]
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Yes, all the heavy lifting is done.
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Timothy Norton Coffey, FIG Partners, LLC, Research Division - VP & Research Analyst [39]
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Okay. And then just one last question, could you remind me again what the charge-off related to in the quarter?
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [40]
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Well, charge-offs related to -- Nick, you want to explain that and then I'll do it, okay?
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Nick Pi, Preferred Bank - Chief Credit Officer and EVP [41]
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This is really related to one of our nonperforming loan on our book for almost over a year and (inaudible) bankruptcy in the second quarter 2016. During the previous quarters, we don't -- we didn't have [really good] indications from bankruptcy trustee about the reserve or about the solution. So that's what we periodically made the reserve on this credit. And the most recently, we received some sort of good indication from bankruptcy trustee regarding the deterioration of the credit. That's why we, the management, made the decision to charge-off.
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [42]
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Let me just add on related to that. The credit was previously having above 85% of reserve based on that. So it's nearly fully reserved. And although, we believe there'll definitely be recovery coming in the future. But we fear that it is more comfortable just charging off the whole thing in this quarter. So the loan has been nearly fully reserved in the past.
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Operator [43]
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The next question comes from Gary Tenner with D.A. Davidson.
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Gary Peter Tenner, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [44]
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Just a couple of questions. One, to revisit on the deposit side. Do I understand correctly that you're going to continue to work to build deposits regardless kind of the pace of loan growth and it doesn't sound like you're going to invest in the securities portfolio? So we should assume there could be some incremental build of just excess liquidity over the next couple of quarters?
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [45]
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Well, put it this way, we'll let the natural things happen, wouldn't go out to buy deposits. If deposits come in as it currently is coming, we will open our arm and welcome them. But we will not go out and fight for deposits by competing with other people, with high rates and (inaudible) , or have special promotion. But as of today, these deposits has been coming in and that's due multiple reasons. And I guess in the past, we've always said it's the hardest thing for us to predict the deposit growth because there's no pipeline, okay? A customer suddenly, I mean, sold a piece of property, he has about $30 million, $40 million that I want to keep them in the bank for one year, so they place it with us. And we didn't know that until 3 days ago. Okay, so that is like this.
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Gary Peter Tenner, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [46]
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Okay. Okay, and then just a question on the loan front. Good loan growth but the for-sale housing construction balances declined, looks like they kind of peaked in the March quarter down about 15% sequentially. Could you talk about that portfolio and your thoughts there going forward?
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Nick Pi, Preferred Bank - Chief Credit Officer and EVP [47]
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Hi, Gary. Well, still home construction is down and that's by design because of what we tried to do in the, again, as Mr. Yu mentioned earlier, to manage our CRE concentration as well as construction lending.
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Edward J. Czajka, Preferred Bank - CFO and EVP [48]
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You'll also notice, Gary, that the other construction actually increased over that same period. So from a concentration standpoint, what we want to do is manage the overall construction to the total loan book as well as total capital.
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Operator [49]
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The next question comes from Don Worthington with Raymond James.
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Donald Allen Worthington, Raymond James & Associates, Inc., Research Division - Research Analyst [50]
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In terms of REO, you've had that one property on the books for a while. Any change in the status there at $4.1 million?
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [51]
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That $4.1 million was a (inaudible) condo in the entire complex. The homeowner association and us is joining right now and wants to market this entire property together. And they are, you know, in the process of obtaining 3 different appraisals, we'll cooperate with them. So not to selling our portion of the property separately. So that they can get a better value on the whole situation. The value based on our information in the marketplace is substantially higher than the $4.1 million we carry on the book. We hope that the property there will be some action later in the first quarter this year -- first quarter next year.
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Donald Allen Worthington, Raymond James & Associates, Inc., Research Division - Research Analyst [52]
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Great, thank you. And then in terms of CRE and C&I, have you experienced any weakness related to retail customers or borrowers?
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [53]
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Well, first of all, please understand all signs of [them does] not have the privilege of doing a mole, okay? So because this is generally higher than our type of customer. What we are generally doing is so-called a very nice neighborhood centers in the retail or the special retail service center retail property was in the city or such as special credit line type of a retail, such as a Taco Bell or a McDonald franchise, the property (inaudible). These are the retail things we're doing. What we have seen is that obviously that some of the centers having a limited pressure on the some of the retail customer more so the [department store guide] -- how should I say -- the merchandise type has (inaudible) . But by and large, most of our customer was able to quickly retailing it into different, more service type of customer. It's amazing, the speed of these (inaudible) upon. So far that we see the trend, we're scared all the time and we're scared about the development incomers, what it'll do to us? And what we think we can do is keep a watchful eye.
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Operator [54]
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(Operator Instructions) We have a follow-up question from Tyler Stafford with Stephens.
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Tyler Stafford, Stephens Inc., Research Division - MD [55]
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Just one more follow-up question from me, just on the margin [model in] question. Do you have what the security yields were in the second quarter? I've got them as $3.60 last quarter?
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Edward J. Czajka, Preferred Bank - CFO and EVP [56]
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It was about $3.65.
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Operator [57]
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This concludes our question-and-answer session. I'd like to turn the conference back over to Li Yu for any closing remarks.
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Li Yu, Preferred Bank - Chairman, CEO and Company Secretary [58]
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Well, thank you, I'm sorry. There's somebody intruding in the meeting. But thank you so much for your attending the earnings conference again. And the people here, including management and some of the staff involved in this conference room, is dedicated to continue to bring good results to our shareholders, okay? So -- and we hope to have your continued support in the future. Thank you.
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Operator [59]
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This conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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