Q3 2023 Preferred Bank Earnings Call

Participants

Edward J. Czajka; Executive VP & CFO; Preferred Bank

Li Yu; Chairman, CEO & Corporate Secretary; Preferred Bank

Nick Pi; Executive VP & Chief Credit Officer; Preferred Bank

Eric Spector

Gary Peter Tenner; MD & Senior Research Analyst; D.A. Davidson & Co., Research Division

Matthew Timothy Clark; MD & Senior Research Analyst; Piper Sandler & Co., Research Division

Robert Andrew Terrell; Analyst; Stephens Inc., Research Division

Timothy Norton Coffey; MD & Associate Director of Depository Research; Janney Montgomery Scott LLC, Research Division

Jeffrey Haas

Presentation

Operator

Good afternoon, everyone, and welcome to the Preferred Bank Third Quarter 2023 Earnings Conference Call. (Operator Instructions) Please also note, today's event is being recorded.
At this time, I'd like to turn the floor over to Jeff Haas of Financial Profiles. Please go ahead.

Jeffrey Haas

Thank you, Jamie. Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the third quarter ended September 30, 2023. 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. Good morning, ladies and gentlemen. I'm very pleased to report another quarter of record income. For the third quarter, Preferred Bank earned a net income of $38 million or $2.71 a share. Compared to the second quarter, net income and net interest income both increased and our expenses decreased.
For the quarter, with this -- we have very -- a little bit of loan growth. Loan demand continues to be low as our customers seems to be much more cautious these days and our underwriting standards remain elevated.
On the deposit side, the increase was $94 million for the quarter. We have seen deposit costs slowdown. And looking forward to fourth quarter, we think the trend will continue.
Credit quality remained generally stable. We had a small increase in total criticized assets, but we have a bigger increase in the nonperforming loans. The nonperforming loan increase is basically the migration of 2 loans from a lower classification to the nonaccrual category. Loan number 1 is a $16.1 million loan that was borrowed by one of our very good borrower for many, many years. Unfortunately, the gentleman passed away recently and the large and complex estate has caused the delay of resolution of this loan. And we notify -- we just notified that the property is in escrow. And the borrower should have -- should be closing it in later part of October and pay Preferred Bank off.
There's another $2.2 million loan is in the same category, is the discussion between the beneficiaries for a large and complex estate. This loan was secured by a property loan-to-value ratio is less than 20%. And I'm happy to report we have received full payment yesterday.
And we're also scheduled to have another large loans, which is classified -- which is include in the criticized category, large loan of $23.5 million should be paid off today. We've confirmed that with the lending bank that took over this loan. So we will obviously update you later when all these things happens.
For the quarter, we have made a provision of $3.5 million. The charge-off for the quarter is $80,000. Last quarter, there's no charge-off. Therefore, our allowance total has increased to 1.46%. We believe that one of the -- we believe that's one of the top-level allowance number among our West Coast peer group.
Our operating costs remain under control. Efficiency ratio was 25% for the quarter. Since the second quarter of 2023, we have been actively buying back of our own stock. As of today, a total of 720,000 shares has been repurchased with a total consideration of approximately $42 million. The buyback is highly beneficial or accretive to the EPS for our remaining outstanding shares. And we plan to continue the activity under the current program.
I also like to report with the large amount of buyback and with the dividends Preferred Bank's tangible capital ratio actually increased to 10.1%.
The bank has been -- in the last several years, has been reporting earnings quarter-by-quarter beating consensus estimates. Quarter after quarter, we see the future estimates going up. And we are very pleased with that. We will continue to hedge ourselves to operate a bank efficiently and prudently.
Thank you very much. I'm ready for your questions.

Question and Answer Session

Operator

(Operator Instructions) Our first question today comes from Matthew Clark from Piper Sandler.

Matthew Timothy Clark

Just starting on the margin, do you have the spot rate on deposits, either total or interest-bearing at the end of September? And then the average NIM in September and any expectations for the fourth quarter, looks like you're pretty much in line with your prior guidance of 4.40%.

Edward J. Czajka

Yes. That's always good to see, Matthew. Thank you. In terms of the spot rate, the margin for September was 4.34%, so kind of in line with the entire quarter. And then the total cost of deposits was 3.42% -- excuse me, 3.62% for the month of September.
In terms of the margin going forward, I think you can probably extrapolate what's been happening over the last quarter or so and project that going on into Q4 and Q1 of next year. I would estimate somewhere in the neighborhood of 4.15% to 4.25% for Q4 and somewhere between 3.90% and 4% for Q1 of '24 notwithstanding any actions by the Fed.

Matthew Timothy Clark

Okay. Got it. And then just shifting gears to expenses. Good to see no additional OREO-related costs or very minor costs this quarter. What's kind of run rate expectations for the fourth quarter? And then should we assume some seasonal increase in 1Q.

Edward J. Czajka

In answer to your second question, yes, you'll see the seasonal increase in Q1 of next year. My expectations for Q4 would be somewhere in the root of $19.5 million to $19.8 million.

Matthew Timothy Clark

Great. Okay. And then just on credit, could this -- good to hear some of those isolated issues are resolving themselves as it relates to nonperformers and criticized. But can you remind us of your SNC exposure? And what might be criticized within that portfolio? It sounds like one of them that's resolving itself the $23-or-so million is within that SNC book. And just the overall status of that portfolio?

Li Yu

Nick, do you want to answer that?

Nick Pi

Yes. For SNC loans, they have submitted to the bank but there are second semiannual review in around September, and there's only one small loan. It's around over $2 million in exposure has been downgraded. Other than that is -- the rest of the SNC loans are stable without any credit issues at this time.

Edward J. Czajka

The total SNC relative to total loans is about, I believe, 11%.

Nick Pi

It's 11%, correct.

Matthew Timothy Clark

Okay. And then just on office commercial real estate, thanks for the additional color in the release on that. But can you -- I think one of the more popular questions these days seems to be around the reserve associated with that portfolio. And I would assume there's only some portion of that portfolio that you're more concerned about? Maybe it's the pure office or maybe not, maybe it's just the central business district, which is pretty nominal.

Li Yu

Well, we have, obviously, the business has shifted, with a little amount we have in that. And basically, they are very small properties, a very small office is being well occupied. I don't think we have any classified assets in office property, right?

Nick Pi

No, not at this time.

Li Yu

We have not. That's about the best I can answer you. (inaudible) stay good, I cannot answer any more than that.

Nick Pi

And also give you a little bit more color Matthew, on our office products. We have recently conducted the stress test, unbelievably on the office side that these are -- all those ratios are pretty good come up in this meantime. So we do not expect any immediate issues about our office project at this time.
And some of the loans are below, we think a handful of those credits with a little bit weak DCR ratio. However, we do have a very strong individual guarantors behind it. So global cash flow, I cannot cover, these are no issues whatsoever at this time.

Operator

Our next question comes from Tim Coffey from Janney.

Timothy Norton Coffey

Just a question on the nonaccrual loans. If you were to account for payoffs that you anticipate getting this week, what would that nonaccrual number be? Because I'm assuming it would be less than $19 million.

Li Yu

The $19 million plus $2.2 million.

Edward J. Czajka

$17 million...

Nick Pi

Minus $2.2 million...

Edward J. Czajka

Yes, it would be...

Li Yu

Yes. Right. Yes.

Edward J. Czajka

A little under $17 million, a little under $17 million.

Timothy Norton Coffey

Okay. Great. And then if we kind of -- we think about loan growth over the next 12 months, where are some of the biggest headwinds that you're seeing right now?

Li Yu

Well, I think the interest is still the biggest headwinds -- headwind, okay? Because based on what we see our borrowers seems to be they're all stable and affluent to get. But I mean, they just -- I guess, like everybody else, I mean they just don't want to commit into some actions that the -- when interest rate picture is not clear.

Timothy Norton Coffey

Okay. You said your underwriting was remaining stable. I'm wondering, is there any places that you're starting to tighten your underwriting?

Li Yu

We have tightened it before. When I used the word is actually elevated because we are more picky on the location. We're very more -- much picky on the guarantor. And I guess the other mathematics is LTVs, I mean you can lower it down a little bit. I mean, requirement. But that's what we're staying elevated is these two categories now.

Timothy Norton Coffey

Okay. Also on cap rates in your footprint, are you starting to see commercial real estate cap rates starting to move our budge at all?

Nick Pi

Yes. Based on the most recent appraisals, the cap rate has gone up a little bit because of the current CRE market situation, but has not yet that out of control at this time. So valuations still maintains pretty good for our bank because normally, we maintain our loan-to-value ratio around -- 55% around. So even with a little bit high cap rate, I believe our cushion is still there and our credit should be performing well.

Operator

Our next question comes from Andrew Terrell from Stephens.

Robert Andrew Terrell

If I could start maybe on the nonaccruals this quarter. I appreciate all the commentary you gave there. I think you gave the LTV for the second smaller loan, sub-20%. For the $16.1 million loan that you referenced, do you have the LTV for that specific credit?

Nick Pi

Yes. That credit is the most recent appraisal. That is around under 50%.

Edward J. Czajka

And Andrew, just to clarify, that's a classified, not a nonaccrual loan.

Nick Pi

That's a classified.

Edward J. Czajka

Yes. That's not part of the nonaccrual. So.

Robert Andrew Terrell

All right. Okay. Okay. Got it. And then if I can move over maybe to deposit growth. You guys had some good deposit growth this quarter. It's good to see. I hear some of the commentary around the loan growth and the challenges there right now. But could you maybe talk about the pipeline for incremental deposit growth? What you're seeing there? And then more specifically on the pricing front, where new time deposits are being priced at today?

Li Yu

Well, so far, what we see is for us. And even in the immediate marketplace we're dealing with, deposit rate offering has been stable. And I don't see -- think the much -- there's much bank change basically their deposit rates that offering to their customers. Therefore, the fluidity of the interbank, I mean, deposit transfer and so on, is much limited in this quarter compared to previous quarter. I guess it's a matter of opening up new accounts in our offices, meeting new people and opening new account that cost, the $94 million increase. So we do not see -- if the Fed does nothing. We do not foresee the big deposit rate changes in the next quarter -- meaning fourth quarter.

Robert Andrew Terrell

Okay. And what's the kind of level that new CD deposits are being priced at today?

Li Yu

We have priced at the 5.03%, after CD amount. That's the highest rate we have. But there's different categories that's lowest in case. So it's ranging from 4% to that, okay?

Operator

Our next question comes from Eric Spector from Raymond James.

Eric Spector

This is Eric on the line for David Feaster. Probably on the CD front. I'm just curious if you could provide some color just on the maturity schedule.

Edward J. Czajka

Generally speaking, they -- most of the CD maturities are a year. So we have basically a constantly rotating maturity schedule of the entire portfolio. For the fourth quarter, I think we have about $400 million to $500 million, I believe, maturing for the fourth quarter.

Eric Spector

Okay. And then that's laddered out kind of similarly quarter by quarter?

Edward J. Czajka

Yes.

Eric Spector

Okay. And then just curious on the demand front, it looks like growth was primarily from resi mortgage and resi construction. Just curious your appetite for resi growth at this point? And what's driving the growth there?

Li Yu

On the demand side?

Edward J. Czajka

Yes.

Eric Spector

Yes, on the demand side.

Li Yu

Well, we're highly dependent on our customers that on a daily basis, meaning the commercial customers, business customers who are dealing with us. So you see after last scale that we had in March with the meltdowns, I guess, so on actually, everybody is putting so much attention in uninsured deposits so on. We are a business bank, and we're dealing with business. And business their deposit is basically uninsured. And they don't want to be cutting up in two pieces into ICS and so on, I think they cannot operate that way.
So we have a couple of very -- several very large customers, their deposits, they sign up all the conversion to ICS, but then not being break down. They don't want to actually use it, but they want to have the activity to turn into ICS when they -- if they need it. But the fact is that for the community banks, there may be regional banks, too. I mean if that issue doesn't get resolved, everybody will have to worry about the large DDA they are getting from our customers and changing the nature of liquidity and coverage.
So I don't know that issues still out there. We don't have an answer to you. But as the pure dollar amount of DDA, we're just like everybody else seeing that small migration into the higher cost area but we hope the pace has slowed down. In fact, I hope pace almost will end in this quarter, but time is to tell that.

Eric Spector

Okay. I just wanted to touch on more on the loan demand side. Like growth this quarter was driven by resi mortgage and resi construction. Just curious what drove the growth there?

Li Yu

Yes. We -- obviously, I mean, our commercial -- real estate market, which is our biggest loan and biggest category. And it depends on the maturity schedule of pay downs and so on and also that we have a number of full construction loans being paid down. So these are the things that the changes on quarter-to-quarter is, we have never treated the mortgage as the main cause of our new generation. In fact, we had -- you may not know that, but we have previously disclosed that our internal goal is to keep our mortgage product to less than 10%.

Eric Spector

Okay. I appreciate the color. And just wanted to get an update on the SBA department expansion in the Houston LPO. Are you looking at additional expansion opportunities? And just kind of any color there would be helpful.

Li Yu

Can I bring in another level, in changing from a more macro basis. To me, at this point in time, doing a new loan is a lot less profitable than buying back the stock. But new loan will give us long-term growth. But since the loan demand is not there, we'd like to concentrate our efforts in managing our liquidity, managing our profitability and managing our return to our investors. Opening new locations is not an immediate endeavor at this point in time.

Operator

Our next question comes from Gary Tenner from D.A. Davidson.

Gary Peter Tenner

Bunch of my questions have been answered, but just wanted to ask in terms of kind of balance sheet management. You've continued to allow the AFS portfolio to run off, paid down the FHLB debt this quarter. So as you think of the liquidity on the balance sheet, which is ample, any thoughts in terms of putting any of that to work in the securities portfolio in anticipation of locking in some yield potentially for the longer term.

Li Yu

We -- this is something and is continuously looking into it. And we continue to talk to each other about that. It seems to be every time we did something we were wrong, that's because 3 months ago, we were talking about a lot of -- do some treasury paper. I'm glad we didn't do that.

Edward J. Czajka

They will come at time.

Li Yu

Yes, some time it was just a [standoff], I guess for us, that's not the major income of us. It's small diversification. So we like to believe we care for, a little bit more cautious so that it wouldn't allow a lot of adjustment, the write-down of our portfolio.

Edward J. Czajka

And Gary, the profitability of the overall bank is really one of the main drivers behind having such a large cash position that we've had over the last 10 years. We have not had to go after that last dollar of income and put that money at risk. And so we find ourselves in a very good position right now with our liquidity because we haven't done that and with respect to our tangible capital levels as well.

Gary Peter Tenner

Yes. I mean, certainly, it's been a huge advantage to have a small portfolio in this environment and not thinking so much about current profitability, but down the road profitability. But I appreciate the thoughts on that. And then just I missed some of the numbers are on the buyback. I have the total shares purchased in the last couple of quarters. But what was the average price per share?

Edward J. Czajka

The average price per share through the total buyback is just a hair over $58 a share.

Operator

And ladies and gentlemen, at this time, we'll be concluding today's question-and-answer session. I'd like to turn the floor back over to Mr. Yu for any closing remarks.

Li Yu

Well, thank you very much that we -- everything that -- in this quarter seems to be more stable than the previous quarter. And from my side, I'm just got to see some of the legacy. When you said the legacy loans is getting resolved gradually. These things do take time. But I'm also happy to see the new migration into the category is very, very limited. So with that, I hope that we can continue to be this way. Thank you.

Operator

And ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for joining. You may now disconnect your lines.