Kristen Papke - Investor Relations Li Yu - Chairman and Chief Executive Officer Wellington Chen - President and Chief Operating Officer Edward Czajka - Executive Vice President and Chief Financial Officer.

Bob Ramsey - FBR Capital Markets Aaron Deer - Sandler O'Neill & Partners Gary Tenner - D.A. Davidson & Co. Tim Coffey - FIG Partners, LLC Don Worthington - Raymond James & Associates, Inc..

Good day and welcome to the Preferred Bank Third Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Kristen Papke, Financial Profiles, Investor Relations. Please go ahead..

Hello everyone and thank you for joining us to discuss Preferred Bank’s financial results for the third quarter ended September 30, 2016. With me today from Management are Chairman and CEO, Li Yu; President and Chief Operating Officer, Wellington Chen; and Chief Financial Officer, Edward Czajka.

Management will provide a brief summary of the results, and then we will open 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 if 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 would like to turn the call over to Mr. Li Yu. Please go ahead..

Thank you. Good day, ladies and gentlemen. I am very pleased to report Preferred Bank’s record third quarter earnings of $9.9 million, or $0.69 a share, which is a great improvement on the prior quarter and prior year. During the quarter we have raised an additional $14 million of subordinated debt.

With this newfound liquidity, we have used it to purchase home mortgage loan pools in the amount of $70 million. These events has greatly invented our reported net interest margin. The home loan mortgage yields roughly 4.2%, but the subordinated interest costs is 6%.

Together with a change in leverage, which affected our net interest margin to reduce it to 3.59%. We have made some rough calculations and we believe that if it wasn't for these factors, we would be reporting at a level closer to previous quarters and there are no material change in the yields of loan yield rate that we reported before.

Third quarter loan growth totaled $117 million, excluding the $70 million home loan mortgage purchased. The organic loan growth was $19 million, or 4% on a linked-quarter basis. More importantly, deposits have increased $144 million, or 5.7%. We are rather pleased with that. There are only four factors that will affect our future loan growth.

The first of all is our ability to continue to originate, which we are confident with that. The second factor is our capital ratio, which we have enough capital. Third factor is the concentration, CIE concentration ratio which now stands below 300%. Fourth factor is liquidity.

Now we have $400 million plus in cash and a $200 million plus security portfolio. The efficiency ratio further improved to 37.7%. This is largely the result of continuous good increases in net interest income. Our bank size now exceeded $3.1 billion, the first time we are over $3 billion.

We are fully aware that to continue our growth path, we need to and we will and we have been making further investments in our human and system resources. On the drawing board were some initiative for a new full-service mortgage department and several bank new branch locations to be considered.

With that, I would like to answer your questions at this time..

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question will come from Bob Ramsey of FBR. Please go ahead..

Hey, good afternoon..

Hi, Bob..

I was wondering if you could talk a little bit about the margin outlook.

And I guess specifically what I'm asking is whether the timing of the sub debt that you guys raised most recently, if there's some sort of carryover in terms of a full quarter impact next quarter and how we should think about the margin in the fourth quarter?.

Thank you for asking that. I neglected in not including in my remarks. Actually, $12.5 million of the sub debt was issued on the first date of this quarter and $27.5 million [indiscernible] was issued on the last day of the quarter.

Notably the interest cost, interest effect on the last issuance is not currently in this quarter and likely will be having some effect to the fourth quarter. We will try to mitigate that further but likely it will reduce our net interest margin a few basis points, not significant, but it will have a reducing effect..

Got it. That is helpful.

If I think about net interest income rather than net interest margin, even though I think you typically have got a negative spread on that incremental piece of business, is it fair to expect net interest income in total to grow from the third to the fourth?.

Yes. That would be our conviction..

Okay. Great. And then sort of looking forward, could you talk about your appetite for more sub debt? Obviously, I know you guys are doing this to manage commercial real estate concentration.

Is this something that we can anticipate more of as the portfolio grows? How are you thinking about the future?.

A couple things. Number one situation is that other than commercial real estate concentration, we also are seeing our total risk capital base getting close to the marks we like to keep.

In the previous, that is one area we find it's headed a little bit more closer to the well-capitalized [indiscernible] guideline as compared to our tier one capital ratio. Having said that, capital plan is ever-changing. It really depends on what the loan growth in the future will be or total assets growth in the future will be.

Hypothetically speaking, if we have increased our deposits quite a bit even though it doesn't change anything but it does change the capital ratio and common stock situation, common capital ratio on a tier one leverage capital ratio. So likely, we have to think about other than sub debt.

But all these things are being monitored quarterly and it's strongly managed between myself and Ed..

Okay. Great. And then maybe circling back to margin, I know you talked about the impact of the sub debt in the fourth quarter.

If hypothetically the Fed were to raise rates 25 basis points in December, could you talk about what the impact would be on your margin there? I think last year when they raised the impact was probably a little bit masked by the acquisitions. So I'm just kind of curious if you could talk about what we could expect..

Okay. I will let Ed answer that, but they if likely increase in late December, it's not going to be significant. Probably, [full quarter] will be in the first quarter, right..

Hi, Bob..

Hey..

The last time we've run – we run it quarterly. The effect on the net interest income on an annual basis for a 25 basis point move up is somewhere in the neighborhood of about $2 million worth of net interest income increase on an annual basis. So if we were to look at December rate hike, as Mr.

Yu said, the impact would be negligible for Q4, but certainly going into the first quarter, provided there is no other noise associated with that, we would be looking at margin increase in the neighborhood of probably 8 to 10 basis points and about $2 million in extra net interest income..

Got it. Perfect. I'll hop out and give someone else a chance. That's helpful. Thank you..

The next question will come from Aaron Deer of Sandler O'Neill. Please go ahead..

Hey. Good morning, everyone..

Hi..

Li, you were commenting on the strength of deposits inflows this quarter.

I was wondering if you could have a breakout in terms of what percentage of those were commercial versus retail?.

Actually, the second quarter deposits, I mean third quarter deposit was made up of a lot of different factors. Part of it is the State of California deposits with Preferred Bank. And for the first time the State of California in many years, they make a deposit, $35 million in-house pay. Likely, it will continue to go in the future.

And the retail deposits, I think mostly, I would say at least 70% was in the commercial area..

I'm sorry, 70% were commercial?.

Yes..

Okay. I guess kind of sticking with that same theme, you mentioned some of the potential initiatives in terms of developing your own in-house mortgage origination platform and potentially looking at some new branches.

Any plans in terms of more advanced cash management tools or things that could attract more of those corporate operating accounts that could continue to improve the quality and cost of the deposit base?.

We're continually doing that. I'd like to – on answer I'd like Wellington and Ed to answer that in that sequence..

Hi, Aaron. I think on the cash management side we have a pretty good array of products and services in place already and that's how we are able to continue to capture and grow our commercial deposit. Anything going forward, we have to look at it. We're not going to put in the product unless we have a target and we have the business in line for it..

Sure..

Sorry, Aaron. I was going to add that we have just recently rolled out business mobility, which is a mobile banking platform for businesses and then coming early next year, we will be rolling out personal mobility, which is mobile banking for retail clients..

That’s great..

So we certainly are – we continue to move in that direction, for sure..

Sure. Okay. And then lastly, just going back to kind of the outlook, I guess, for growth.

How does the pipeline shape up today versus three months ago, six months ago and kind of as you start looking ahead to next year with your planning committees, what are your expectations for growth, if you're willing to share some of that?.

Well, I'd like to make two separate comparisons, comparing the beginning of the third quarter versus the beginning of the fourth quarter. I would say the pipeline is consistent. Pretty much the same situation. But the actual closing of it is hard to tell. Sometimes fourth quarter, people [indiscernible] holidays gets in the way of closing schedules.

Sometimes holidays hastens, advance the closing schedule. So this is one area that we can not control that, other than the flow of it is still there. Our visibility of the pipeline is generally speaking only three to four months period of time, but we can feel the marketplace.

We have constant meetings with our [indiscernible] people in terms of their so called human activity and how they feel what the marketplace is. So far, we're seeing no deterioration..

Okay. That's great. Thank you for taking my questions..

Our next question will come from Gary Tenner of D.A. Davidson. Please go ahead..

Thanks, good morning. A lot of my questions were asked, but I wanted to get a sense of the expense outlook given your commentary on the need to invest in personnel systems, the potential for a mortgage platform, et cetera.

With the efficiency ratio around 38% where it is right now, is this effectively a bottom given those initiatives or could it stay here or do you think it reverses at least while you are building some of this stuff out?.

Well, I will let Ed go into more detail but from my point of view, I hope it is, we can get closer to the level realizing 37.7% is a pretty low number. I like to think that the expenses we made along with the net interest income increases.

So with that I hope that our revenue producing capability will be equally as vibrant as our expense increases, our increase leading investments.

Ed, do you have any idea for that?.

Yes, Gary we ran at a pace of about $10.5 million this quarter and we had talked previously of running just under $11 million and so I'm going to stick to that commentary, if you will. I think going forward we will be looking at probably just under $11 million in terms of run rate, somewhere in that neighborhood.

Obviously, as you said, 37.7% is a great efficiency ratio. I think from a long-term standpoint we still are targeting 40%, low, low 40%s. We were certainly very pleased that this number came in where it's at but I think going forward to expect that would be difficult..

Okay.

And then just on the legal cost recovery, was that netted against other expenses this quarter?.

It was netted against professional services, yes..

Professional services, okay.

Which were flat sequentially even with that?.

Yes, sir..

Was there anything else in there that would have artificially increased it or is that higher-level than extra recovery [indiscernible]?.

Some of the fees that we recovered were actually incurred in that quarter as well. Some of those were basically a wash. I think going forward, we're probably looking at the level that we saw in the third quarter but probably down a little bit from that..

Okay. Thank you..

And the next question will come from Tim Coffey of FIG Partners. Please go ahead..

Thanks. Afternoon, or morning, gentlemen..

Hi, Tim..

As we look at some of the expansion of the business, branch additions, new business lines, how far out is that from actually moving forward on it?.

First of all, on the mortgage banking department, we already recruited the top two people for that. Throughout the next quarter or so, we will be developing the system procedures and policy system procedures. We want to be very much comfortable with our internal compliance activity before we roll out the product and try to attract new businesses.

So this is the – property we're beginning to have some locating some loan applications in the first quarter some time and hopefully gradually increase through the quarters. Now with the branch locations concerned, our philosophy is always we have several location possibilities, but we then to go out and hunt for the talent.

When the talent is found, then we decide which location that we want to start first. Happily, our report is that we have long had our eyes on a northern California, South of San Francisco, between South San Francisco and Silicon Valley.

That region is our preferred next location and we already found the talent, so likely that we start seeking for the location. The process is sometimes tedious. First when you find a location, then you negotiate a lease. All of this takes some time.

Then, we live in our days if you want to do some TIs, it takes a long time between the government and the contractors. It looks like it's at earliest mid year next year that we could have that location..

Get back to the mortgage piece.

Are those two people based in your Southern California footprint?.

Yes..

What are your goals in terms of the origination? Will this be originate to sell or originate to hold?.

We think in our present capacity situation it would be to hold. [indiscernible] Home mortgage business will always be a so called diversification line for us. Preferred Bank has, since its inception, has been a business bank. We really know well in the past hopefully that C&I and CIE. Now we enter the new area go we like to go slow.

We like to learn to crawl first..

Understandable. Thank you. The rest of my questions have been answered..

Thank you..

Your next question will come from Don Worthington of Raymond James. Please go ahead..

Thank you. Good morning, everyone..

Hi, Don..

Getting back to the deposit growth in the quarter.

Besides the public funds deposit, was there anything else that you would consider a large deposit or anything that might be temporary in nature?.

Each quarter end there seems to be some $20 million movements in term of some of our customers have tried to put money in and then start to pay off in the next quarter for various reasons, many of them for tax payments. There is some increases.

The largest I have seen is between the first day and earnings phone call days in the past three quarters has been maybe $20 million, $25 million. Certainly, I would not call that very significant..

Okay. Thanks. In terms of the New York branch, just curious as to the contribution to growth that's occurring out of that location..

New York bank, when we purchased the deposits $150 million. Now at this time it is $205 million as of today. The loan has been grown too close to $700 million, $780 million and has a healthy, healthy pipeline on the New York side.

New York actually has a very good future outlook because previously it was a very small bank under regulatory, how should I say, CMV audit. Now [indiscernible] certainly opened up for them and from a small lending limit to a very large lending limit.

So we've gradually, gradually changing them from a – like a slow-moving retail bank into a business bank..

Okay. Great. Thank you..

And the next question will be from Bob Ramsey of FBR. Please go ahead..

Hey. Thanks for taking the follow-up. Just wanted to cover a little bit more on the mortgage origination business.

I'm curious, one, how soon do you think they actually will be ready to start originating loans? Two, is this – sort of is the right way to think about this, you guys have been buying some resi mortgage pool and this would take the place of that; you would be able to generate them internally rather than buy them? And then three, what sort of substructure are you guys looking at? Will these be ARMs, will they be fixed rate mortgages, will they be in California, will they be national? I'm just kind of curious, a little color on what you guys are looking to do..

Okay. Ed, if you want to add on, Wellington.

Because from what I understand at this point in time from all the directions discussions we have talked about, that we have primarily decided that number one, it's going to be really servicing our current market and be an additional service to our customer base that hopefully was in the market that we're serving.

So likely what we're going to be doing is Southern California and in New York only. And number two is that it will serve as a – also a thing to hopefully attracting new deposits, too. And third of the situation is as I probably reported earlier, it will be a so-called portfolio balancing or portfolio diversification for Preferred Bank.

I don't think in the next year it will grow into a very significant operation in Preferred Bank. But when two or three years later, we just have to wait and see.

And the likelihood of when it will be starting to take application would be sometime in the first quarter when we are comfortable with all of our operation, our policies and the compliance activity..

Okay..

Bob. Let me chime in a little bit on the mortgage. We will keep it with the ARM type of mortgage between in the one to five years ARM. And as Mr. Yu mentioned, we will move slowly because we want to make sure our friendly regulators are comfortable with our set up in the operations and policy..

Okay. Perfect. Thank you. End of Q&A.

And ladies and gentlemen, that will conclude the question-and-answer session. I would like to hand the conference back to Mr. Yu for his closing comments..

Thank you so very much. One of the situation is that I didn’t mention is for all the loans that was originated by us in the third quarter, substantially all of them is floating-rate loan. Most of them is floating based on prime rate. So we're still keeping our active portfolio as sensitive as possibly can.

So we believe if the all-elusive interest rate increases will ever come, we will be have good benefits from that. With that, I'm very happy that with the performance of our third quarter and I'm very happy with the progress of the Bank at this point in time. And I am also very thankful for all of your support. Thank you..

Thank you, Mr. Yu. Ladies and gentlemen, the conference has concluded. Thank you for attending today's presentation. You may now disconnect..