Preferred Bank (NASDAQ:PFBC) Q4 2022 Earnings Call Transcript

Preferred Bank (NASDAQ:PFBC) Q4 2022 Earnings Call Transcript January 19, 2023

Operator: Good day, and welcome to the Preferred Bank Fourth Quarter 2022 Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Jeff Haas of Financial Profiles. Please go ahead.

Jeffrey Haas: Hello, everyone, and thank you for joining us to discuss Preferred Bank’s financial results for the fourth quarter ended December 31, 2022. With me today from management are Chairman and CEO, Li Yu; President and Chief Operating Officer, Wellington Chen; Chief Financial Officer, Edward Czajka; Chief Credit Officer, Nick Pi; and Deputy Chief Operating Officer, Johnny Hsu. 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.

Li Yu: Thank you very much. Thank you, ladies and gentlemen, for attending our earnings conference. I am very pleased to report that we have another record quarter of earnings. Fourth quarter 2022 net income was $39.6million or $2.71 a share, which compares very favorably with prior quarter and prior year. Because of this increased earning power, our Board has announced a 28% increase in dividend in December and to be –start to be payable in January. Growth in interest income has outpaced the growth in deposit costs. Consequently, our net interest margin expanded to 4.75% for the quarter. However, towards the latter part of the quarter, we have seen that the deposit cost increase has accelerated. We believe the catching up and this process will continue into first quarter of 2023 at least.

Many of our customers are continuing to manage their money by moving their deposits from lower cost to higher costs. And then we see the market continues to offer higher deposits nearly every day — deposit cost every day. Going forward, to grow deposits at a reasonable cost will be a challenge and will be the thing that we must do. Sequentially, this quarter has net loan increase of 1.3% and a deposit increase of 1.9%. Deposit — I mean, loan demand has tapered down or moderated since third quarter of 2022, and we believe it will be carry-over well into the first quarter at least. Our customers generally find it just more prudent in their operations. And then in terms of — especially in terms of new transactions or new initiative committed.

Because of our high earning capabilities, liquidity and capital ratio both improved from the previous quarter. And we believe our current liquidity level and capital level can easily handle our gross — foreseeable gross need in the year 2023. Benefited by the net interest income increase, our efficiency ratio coming at 26%. Even when we consider included a $1.8 million of OREO items. Going forward, in 2023, expenses is expected to increase. General wage inflation is the main thing. The increase includes FDIC premium — new premium assessment, two new –at least two new planned bank branches, some planned addition to SAF and also a fully operatable SBA department that will be fully operative in 2023. Our attention since early 2022, but I’m sure that you can see on my previous earnings release report, since2022, we’ve been very focused on credit matters.

I’m also pleased to report that both NPAs and NPL has improved from the third quarter. At December 31, they are at a lower level than September 30. In fact, in early January, we have resolved another $5.3 million of fully collected — another $5.3 million of nonperforming loans. Effectively, as of today, our December 31, nonperforming loans is only $200,000. In a very good early indicator of credit quality is our 30 to 89 days past due loans. I’m also pleased to report at December 31, the amount totaled only approximately $4 million. Based upon are port published by Bank of America, our third quarter return on tangible common equity is 23.6% which ranked us the second among all California public traded banks over $2 billion. We believe our fourth quarter performance will lend us apart from the same situation at least.

Because of our business spa model and because we are a business bank serving business and private clients, our motto does not that allow us to necessarily become a very low cost — deposit cost operator. But however, if you add noninterest expense to the deposit costs, which will give us the total cost of operation. For years, we have been the lowest among our peer group. We believe or I believe, okay, the high earning power and the low effective total cost will be the best defense facing a recessionary economy. We are optimistic about 2023, but we’ll be very careful. Thank you. I’m ready for your questions.

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Q&A Session

Operator: Our first question comes from Matthew Clark with Piper Sandler. Please go ahead with your question.

Matthew Clark: Wanted to start on noninterest expense and clarify some of your guidance around the growth this year. I assume it excludes the OREO-related costs in ’22, roughly, I think, $2.9 million. Maybe you can speak to the run rate going forward and how you think that run rate might progress throughout the year?

Li Yu: Well, this must answered by Ed which is in the budgeting process.

Edward Czajka: Yes. Matthew. Yes. So if we pull out the OREO costs in Q4, we were just under $18 million on a run rate. Going forward, at least for Q1, which is always a little bit of an aberration for us because of certain costs inQ1, we’re looking at probably the low end at about $18.6 million in high end, just under $20 million in terms of noninterest expense. Going forward from there, it will probably be somewhat similar, although you’ll have a slow ramp rate in terms of the growth in noninterest expense.

Matthew Clark: Yes. Got it. Okay. And then shifting to the margin. Do you have the spot rate on interest-bearing deposits at the end of the year?

Edward Czajka: Total interest-bearing deposits, not at the end of the year, but for the month of December were 247 — 2.47%.

Matthew Clark: Okay. And do you happen to have the — since you have the average for the month of December, you have the average margin in December?

Edward Czajka: Yes. The margin for December was 4.83%.

Matthew Clark: Okay. Thank you. And then just on the overall outlook on interest-bearing deposit costs. We heard your comments earlier, Mr. Yu about things accelerating toward the end of the quarter. How are — what are your thoughts on — where your beta might settle out through the cycle, assuming we get another 50 basis points from the Fed here and were done relative to last cycle, I think you were in the mid-50s.

Li Yu: Yes. Well, my thoughts is that — from my experience is that we will continue to see the market competitors paying more interest. And we, as a small fish in the big pond, we just have to follow the trend and do our part in the same thing and hopefully that try to manage it more closely. Now actually, you’d be surprised some of the largest institutions back in November before the December rate, they’re already offering one year, I mean, like a certificate deposit at 5%, okay, and I can list — a whole list for you. We have gathered that. So going forward, is these big institutions, what the market rate they set, what market they prepare. We just try to catch up. And we have no idea what they would do so on. But based on my experiences, I think the first quarter, the deposit costs are further accelerating increases as compared to fourth quarter.

And then our margin — in my opinion, it’s not at or near top, okay, in the cycle. And obviously, margin itself has to do with the leverage too, depending on how much it grows in loans, how much gross deposits you have, in general, the spread, I think, is among the top that it’s starting in fourth quarter. Which not to say in this — in the first quarter, we’re not be able to earn a very handsome margin, you know.

Operator: Our next question comes from Andrew Terrell with Stephens. Please go ahead with your question.

Andrew Terrell: I wanted to start on just deposits, specifically noninterest-bearing — if I look, I think your mix is around 21%,22% noninterest-bearing deposits as a percentage of total. I’m just trying to get a sense of, I guess, what you’re seeing so far in 1Q in terms of noninterest-bearing deposit flows. And then what your sense is on where we could see noninterest-bearing deposits bottom out?

Li Yu: The answer is we don’t know. That’s one of the reasons why we say we have no control of our margin going forward because we see customers continue to manage their money. They either pay off their loans or they just reduce their loans, save interest cost or in many cases, where customers using the excess cash to payoff their real estate loan because they consider 8% or 7.5% unbearable, okay? So this trend will continue. And this is also that more people will recognize that their money can earn over 4%. Now, they want to move to TCDs and other things, okay? So this kind of movement and I try to look at other press even as big as JPMorgan, they’ve no idea, okay? What this migration process would be. So this is one sector situation.

Another one situation, I can never tell how the big banks set their price situation and become the main competitor for deposits because they’ve huge market share. So we just have to follow and lot to do with their funding condition or the overall tightness about the fund. So this is really the very important wire card going into 2023.

Andrew Terrell: Yes. Understood. I appreciate the color there. Maybe if I could move over to just outlook on provision and reserve moving forward? I guess, how are you thinking about allowance levels moving through 2023?

Li Yu: Well, our general philosophy is we have been building up our reserve at the year-end. We will take every quarter, take a look and generally stay conservative. Take a look and to see whether that number is going to be increased or needed or stayed approximately the same. Of course, we have to subject to CECL methodology and so some of the situation is to go through a calculation process. So in generally speaking, if we based on the credit metrics as of now, I have to say we’re over reserved, but we don’t know what the coming economy will be. So we stay at the level. I understand some of our direct competitors has reserved less than maybe basis points, okay, that they have the same type of business as we do, but we believe that we need to be stay at this level for now.

Andrew Terrell: Yes. Okay. Maybe sticking on credit. I’m just looking at loan yields, call it, near 7% — just south of 7% in the fourth quarter. Obviously, really good for the margin. But I guess, any color on how debt service coverage profiles have changed at your borrowers, just given the increase in loan yields and any loans that you’ve had to restructure as a result of rising rates or any that you foresee having to restructure? Just any kind of incremental color there would be helpful.

Li Yu: Well, I have Nick answer that first and then I’ll add on to it.