Preferred Bank (PFBC) Earnings

Management highlights

- Net income of $31.3 million reported for the first quarter, negatively impacted by placement of a large relationship on non-performing status. - Loan growth was moderate 1.1% sequentially and deposit growth was 1.2% sequentially. - Net interest margin was 3.47%, down from 3.57% prior quarter due to reversal of interest income, but hopeful for rebound in ensuing quarters. - Operating overhead on interest expense has been stable and will continue to be. - Bank repurchased roughly 400,000 shares of its own common stock. - A large relationship with nine loans was placed on non-accrual, with some loans sold, and progress to continue in resolving the situation.

Guidance

- Hopeful that net interest margin will rebound in ensuing quarters as the reversal of interest income is non-recurring and no imminent rate movements. - Loan growth and deposit growth were moderate sequentially, but internal expectations for growth were affected by factors like the war in the Middle East, with expectations bouncing backwards and forwards but still hoping for a growth year.

Segment performance

First quarter net income was $31.3 million, or $2.53 per share. Net interest margin was 3.47%, down from 3.57% in the previous quarter. Loan growth was moderate 1.1% sequentially, deposit growth was moderate 1.2% sequentially. The bank repurchased roughly 400,000 shares of its own common stock for a total consideration of roughly $89 - $90 per share. A large relationship was placed on non-performing status, consisting of two C&I loans of $2 million and commercial real estate loans totaling $77 million non-accrued, with some loans sold later.

Risks & headwinds

- Forward-looking statements are based on specific assumptions that may not prove correct. - Subject to known and unknown risks, uncertainties, and other factors relating to the bank's operations and business environment, which are difficult to predict and many beyond the bank's control. For a detailed description, refer to SEC required documents the bank files with the FDIC.

Analyst Q&A

• Q: Just on the loans held for sale, the move there, I'm assuming 48 and a half of that is the two loans that you sold on April 1st at par, but just want to confirm that and also what else is in there?

  A: Yes, you're correct. Part of that 76 million, 48 and a half is the two notes sold at par on April 1st. There's two other notes in there that we are actively marketing at this point as well to sell the notes. That's why they're placed in held for sale.

• Q: And any pricing thoughts there on the other two?

  A: Well, we feel that they would like to get as much as close to the pot as possible. And we have been getting down some of the loans. So this is our goal there.

• Q: And then on deposit costs, I want to get a sense for where your deposit costs were either at the end of March or in March and your thoughts on the competition going forward along those lines. Just remind us how much you have in CDs coming due and 2Q and the rate it's rolling off on and the renewal rate that you expect to come on on.

  A: Well, that's a lot of questions in one, Matthew, but I'll take a stab at it. The deposit costs are coming down, but not in the same velocity they were in Q4. So that is starting to slow in terms of the lowering of deposit costs as we go forward. For your record, March deposit cost was $310,000 overall. In terms of maturities, we have $1.35 billion maturing in the quarter at a 389 rate. Those will likely be put on at similar rates, maybe a little bit lower, but we're getting close to the point where we're reaching stagnation in terms of the rolling off of CDs to newer, you know, lower-priced CDs.

• Q: And last one for me, just on the expense run rate going forward. How should we think about non-interest expenses?

  A: So we're at roughly 23 and a half for the quarter. Over a million of that was heightened levels of payroll tax related to bonus payout and related to stock vesting, which both occurred in the first quarter. So as we go forward in the Q2, I'm looking for something in the high 22s to low 23s.

• Q: I just wanted to ask on loan growth. I mean, the production, I think, must have been pretty decent this quarter just to have kind of the fine growth of LHI and loans all for sale. So could you talk about production, competition, and pricing in terms of the loan book?

  A: Pricing is all over the place. We're still facing a lot of people in pricing below six on the fixed rate basis. We can't afford to do that, okay? So, and especially when the movement of the interest, when the movement of our interest rate is unclear at this point in time. We have not been getting the rate cuts that we previously for Canada, okay? So, most people have been having let's say, frankly speaking, they're doing rates a little bit less than I expected. Okay, so yeah, so they're doing long-term fixed rate loans lower than you want to do them. In terms of just the activity levels and quality of credit that you're seeing come through, how does that look today? A: Well, we see the quality pretty much the same situation. And I don't think the industry has been losing on the quality. Based on our colleague has been very much controlling themselves in that aspect. And likewise, obviously, we try to do that too.

• Q: Hey, I wanted to start on just the margin, the 3.4 million interest reversal. It seems like that's, you know, 19, 20 basis points of margin or so. Just, you know, as that normalizes in 2Q, I guess if we add that back in, it gets, you know, closer to like a 375 type margin. So similar to your fourth quarter, just wanted to, you know, verify that's how you're kind of thinking about margin for 2Q or how else should we think about trends of the NEM going into 2Q and then kind of throughout the year?

  A: Yeah, I think directionally you're correct, but probably about five basis points high there. So the margin for March came in at 371, just so you know that. And so we're looking for something in that area as we go forward. Now with the sale of the note on April 1st, we are going to recoup some interest that we reversed out. So that's going to be a little bit of a tailwind for Q2. So it might be a little higher than that, but right around the 370 number, I think, uh, is probably good for us.

• Q: Should we expect that, you know, when you talk about resolution of some of the remainder of these credits by kind of third quarter time frame, is note sales the primary avenue in which you're seeking to remediate or any other planned kind of actions on the non-performers?

  A: It's obviously that note sales is the quickest, best for us if we can get the price that we want to get, okay? And that is really also like pricing. issue for us. And actually, each loan has its different nature. The most clear situation is the loan-to-value ratio based on appraisal. Normally speaking, obviously, when the situation is narrow, you don't get as good a pricing as the loan with a bigger margin in the situation. So in the meantime, the other resolution process, which is foreclosure process, still going on. And right now, most of the loan has been filed, bankruptcy starting, so we have to go through dealing with the bankruptcy too. And it depends on what the bankruptcy judge is awarding. They might award in certain cases, they have more time to selling it, to operate it to reorganize it okay that's something out of our care okay but to the extent we can get them immediately again then we will resell them so therefore each each property is is heaven as a different you know resolution nature not that it's very necessary predictable you know yeah understand

• Q: If I add back in kind of the HFS loans this quarter, it looks like you were kind of tracking mid-single digits. Do you feel like in this competitive backdrop, that's a decent cadence through the year for loan growth, or are we more likely to see some compression?

  A: Yeah. Just given the competitive environment. Yeah, I think about three months ago in the press conference, I was saying internally we're guiding ourselves doing high single digits. But however, internally we didn't know there's a war in Iran. So how much the change on that issue alone, we do not know. And plus, we seem to have administration that is presenting more changes in every aspect of the situation that usually bank gets related to in any of the changes they want to make. So our situation right now is that we're bouncing backwards and forwards in terms of our own internal expectations. We have to be realistic. when there's wars going on, when there's no petroleum, when the price goes to the roof, you're not going to see the same long demand as you are in a peacetime situation. So I guess all these kind of situations, all we can do is stay alert, but we still hope that this will be a growth year for PreferBank.

• Q: I was hoping you could maybe help break down a bit of the dynamics behind this lower growth that we're seeing. It sounds like, to your point, that we may be seeing somewhat of a slowdown in demand. Is that a fair characterization if I'm reading between the lines? And then just any commentary on that? on how payoffs and paydowns have been playing into this and where you're seeing the most opportunity within the pipeline and to grow loans right now?

  A: I think demand slowdown is a foregone conclusion. Just think about when the petroleum price is going to, I mean, $100 per barrel, not petroleum oil. When the products are related, all the various products are related, And the long-term, short-term and long-term, in fact, is hard to measure. And the supply nature also makes it immeasurable. So definitely that will affect. It's just we may not see it all yet, and it's for the time, reflected in our economy. So that is what we are pretty much convinced in-house at home.

• Q: Do you think we're at or near an inflection here? Are you seeing continued migration, or is some of this broader macro side, like do you think credit is not at that point yet and it's just still pretty uncertain?

  A: Number one issue is that I don't know in the past who has been this busy on credit or not. It seems to be this transaction is really the inflection point on our current attention and so on. And even with that, it has been a long group of loans that was performing pretty well until some irregular return was found by Western Alliance Bank. Western Alliance Bank published an announcement, and the whole thing just started to get sour from that point on. In the next several months to the point, we have to call it a and none accrued, and we had to resolve that immediately. Other than that, our total credit picture has been remaining generally stable, and I can send you the FDIC statistics about our 10-year charge-off ratio. We're probably lower than the average of the banking group. So I do not know that we have been struggling about credit in the past but we are struggling about this credit this group of credit right now okay

• Q: You're still sitting on a lot of excess capital you've been more active with with the buyback i'm just kind of curious how you think about capital priorities today you know the stocks moved a bit higher from where you've repurchased uh more recently but just kind of curious how you think about um capital priorities today

  A: There are two group of pictures, two group of thoughts. One group representing the demoralized or the active trader investor type, okay? And their idea is that you have enough capital, you just go do the buyback, whatever you can, immediately, as much as you can. Okay, so that's one group. And then we have another group of long-term investors, probably... Their position of banks hardly moves at all in the past 10 years. And plus, we have also rating agencies. Both seem to say, well, you need to play it safe on your capital. What you need to do is look at the future economy, look at your earning forecast, and determine on a flexible basis what you can do year from year. So I guess our board decided... The security is above all situations. So we're leaning a little bit toward a long-term shareholder viewpoint.

• Q: With the rate backdrop today, you're obviously naturally asset-sensitive, but given the markets kind of looking at this as the Fed on pause today, maybe for now at least, has your thoughts on managing rate sensitivity shifted at all?

  A: I will say something. Ed and I have joined this panel all the time. My feeling is that within the next peer group of races, for Preferred Bank particularly, we are sort of like near neutral in assets sensitivity, particularly because of a large I mean, not TCD portfolio. And under the current status where the rate is not moving, actually our TCD rate we're paying is improving in each quarter. And that's out of a very slow late nowadays because of the market competition. So we just are not clear about our economy yet. Again, likewise, it was all the things that were happening to us. I mean, obviously, we can always name the war as one of them. Well, was that due to our economy? Would it create, would you be able to tell me whether we're going to have a recession ahead of us or we have low growths ahead of us or high growths ahead of us? Okay. And this question is puzzling generally almost everyone at this point in time. Because a lot of uncertainty we're facing. So this year, the challenge is, in my opinion, is stay flexible. Stay alert, flexible. I don't know, Ed, how you feel. A: Yeah, well, no, I think similarly, you know, we haven't really changed much in terms of the balance sheet profile in probably the last 12 months since we, you know, at the height of rates in 23 started doing more fixed rate loans. That percentage between fixed and variable on the book is about the same as it's been, about 75-25 variable to fixed. Along with that, we try to get more and more of our large corporate deposit accounts, interest-bearing checking and money market, tied directly to Fed funds, the large corporate accounts. To the extent we can tie them to Fed funds, it makes our asset liability matching, as Mr. Yu said, more closer to neutral than the asset sensitivity we had, say, going into 2021, 2022, when we were highly asset sensitive and took advantage of all the rate hikes. So I think we're kind of on a pause mode in terms of changing the balance sheet and want to kind of keep it where it is right now. As Mr. Hughes said, flexibility. I mean, if this war continues and we get into a point where inflation creeps up, we may not be looking at rate cuts as the next rate change from the FOMC. So I think we want to stay flexible. And, you know, what we've always done is keep both sides of the balance sheet short, and that way we can react to anything.