Kristen Papke - IR, Financial Profiles Li Yu - Chairman & CEO Edward Czajka - EVP & CFO Wellington Chen - President & COO.

Aaron Deer - Sandler O’Neill Steve Moss - B. Riley FBR. Gordon Maguire - Stephens Inc. Gary Tenner - D. A. Davidson & Co. Tim Coffey - FIG Partners Don Worthington - Raymond James.

Good day and welcome to the Preferred Bank Second Quarter 2018 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, Investor Relations for Financial Profiles. Please go ahead..

Hello, everyone, and thank you for joining us to discuss Preferred Bank’s financial results for the second quarter ended June 30, 2018. 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 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 its 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..

Thank you. Good morning. I am pleased to report that our second quarter net income was $17.4 million on a $1.14 per share. Net income was 48.5% better than the year before.

Earnings per share was 41% better than the year before because these numbers include the positive tax effect resulting from the tax cut, but on a pretax earnings basis, this year is 27.5% better than the same quarter last year.

This quarter we had a reversal of interest about $800,000 related to the New York loans and which has reduced our net interest income. Deposits seem to have resumed its gross capital. For the quarter deposit increased 4.6% on a linked quarter basis.

We updated our interest-paying rate all of our deposit product this quarter and is part of the reason for the increase of deposit totals. Loan increased roughly $90 million or 2.9% on a linked quarter basis. The loan pipeline still looks reasonably steady. We still are subject to heavy payoff pressure as the earlier quarters.

We still find many of our fellow banks are financing long term loan on a fixed rate basis and the latest being a loan that was paid off in July, the hotel loan was paid off by another bank at the rate of mid 4% for a 10-year fixed rate. We've decided, we're not competitive and didn't try to retain the credit.

During the quarter, like some previous quarter, we have been working pretty hard on converting our core processing system. As such there are some key conversion cost as you recall it right that related to the conversion of our old system that was expended throughout the first three quarter.

We expect the conversion effort will be completed in this quarter. In fact, we're pretty close to conversion -- completion right now then and but the expense will not be repeating in the first quarter, but as such, we are able to maintain efficiency ratio at the 35% basis. Our net interest margin was 4.07%.

Although there seems to be a little compression from 4.14% reported in the last quarter, but I like to remind you that I reported to you in last year, last quarter's earnings phone call that next quarter will have a -- it was pretty extraordinary as deposit didn’t grow and resulted in the leverage fetching, which may have affected over $0.10 of the net interest margin.

So actually, we're quite pleased with net interest margin that represent in our mind a small goal from last quarter even without increasing the deposit to the market rate, cost to the market rate. We have for this quarter delivered ROA of 1.83% and ROE of 18.8%.

We have been delivering this kind of top of the peer group earnings during the past number of quarters. We hope to work -- continue to -- dedicated to do the same thing. Thank you very much. Ready for your question..

We will now begin the question-and-answer session. [Operator Instructions] The first question today comes from Aaron Deer with Sandler O’Neill. Please go ahead..

Hi. Good morning, everyone..

Hi..

I guess let's start with the nonaccruals are moved to held for sale.

I am just curious there is no write-down required on the transfer and I understand that the credit themselves have no real loss risk from given where the LTVs were with the underwriting, but if you're looking to sell the loan, is it reasonable to expect that you are going to get face value or better and what's currently due to the conclusion?.

Number one, if we are selling it, it is pretty hard to predict now what the sales value it is. We will do what it would end up and while in a current economy it requires to value this assets based on what are the most recent valuation report that we have received and we have done and other people have done many different valuation report.

We took the lowest possible use of the property and the lowest possible valuation from all this report and still did not come up with any in turn write down necessary and we cannot under the current accounting rules to make any provision of right down to that. Now that we don't want to..

Okay. I understand. Okay. And then on the eye Ed is you're kind of looking at your expected CDs that are maturing over the next -- this month to next or this quarter and next along with your anticipated funding needs and where current market rates are on deposit prices.

Is it your expectation that we should see the margin and I should maybe clarify the core margin if you back out the interest reversals that you had in the prior quarter, but is it your expectation that the margin should now continuing upward trajectory..

Well first off, it probably would've been around 422, 423 this quarter excluding the reversal of interest.

Going forward we did have a pretty significant increase in cost of funds over the quarter, but we had a good increase in our loan yields as well so as you know, as we've talked about deposit betas in the first part of the cycle, were very, very, very low and those have continued to increases as we go forward so were to walk the line of continuing to be competitive and to grow deposits, but at the same time, not getting too crazy because we're still sitting on nearly $500 million in cash.

And so we can afford to be a little more selective in terms of our deposit growth. The other thing I wanted to point out also with respect to deposit growth, even though we went up 147 for the quarter. our net amount of rate listing service department broker deposits net debt down $19 million for this quarter.

So we actually shed some of those while we were growing core deposits but going forward on the margin Aaron, I would venture to say from 407 it will probably pick up a little from here for sure..

Okay. From 407 or from the 422, 423 just mentioned..

Almost 407..

Okay.

So I guess why not the 422 423 if that's where the -- where I was asked the interest reversal?.

Well because we still have a lot of you headwinds as Mr. Li was talking about on prior calls and perhaps on this one as well. The new loan production that we're putting on is not going on at the higher yields one would expect given the increasing rate environment. So there's headwind. Rising deposit costs are also a headwind.

We still have a number of CDs still on the books and Aaron as I'm sure you can imagine, six mature in the next few months that are far below market rates. Those will renew at market rates. And so we'll have that pressure as well..

Okay. No that's exactly what I was, Li was trying to get out is kind of what your anticipated funding is or the impact of it has. So there is going to be some more pull through and just the higher cost of funds. Okay. And then just any sense of the it sounds like the pipeline is still you said reasonably steady.

So should we expect loan growth for the back half to be something similar to what we saw in the first half? Is that a reasonable conclusion?.

I can only tell you that from what I can see Ms. Wellington [ph] is seeing differently. I can only tell you that we can only see three months. Okay, long time plan because what we see is a reasonably steady as compared to the second quarter. Wellington, you have any other information..

No. I totally agree..

Okay. All right. Thanks guys. Appreciate it..

Your next question comes from Steve Moss with B Riley FBR. Please go ahead..

Good morning. I was wondering if you can drill then a little bit on expenses here in particular I know you mentioned the de-conversion expense in the release. I was wondering did that include consulting or how much additional expenses are tied to consulting fees..

We'll have at least a few hundred thousand more Steve. But in the context and the grand scheme of things, it's not going to be felt. We've already -- there's a few things related to that conversion. The capitalized cost of the new system that gets capitalized in and that gets amortized over the life of the contract we know that.

The interesting part about this as Mr. Li Yu alluded to de-conversion fees from your old system have to be expensed. And so, that's what we have been expensing throughout, first, second and partially in the third quarter. Those de-conversion fees were slated to be about 1.1 million to-date through Q2. We've expensed $900,000 of that.

So we'll only have a little bit left in Q3 as well as a little bit left in consulting cost..

Okay.

And then I guess in terms of you know drilling down on the margin perhaps a little further, where are your fee rates these days that are bringing in the new deposits?.

Well there -- it depends on obviously the maturity bucket. I think for one year we're right around 2%. I think for three year we are around 250 and then obviously you extrapolate in between those. But those are the one year and the two year are really more special rates if you will..

Okay.

And I guess my last question here, in terms of the problem New York loans, do you have any expectations around the possible timing of the sale of those loans?.

No. But it has been stated as one of the top priority item for us. But in the meantime you can always sell it under huge discount and there are a lot of vultures flying around trying to pick up on this thing. And we have many, many offer coming to us lower than we want to sell level.

But obviously we have to walk the fine line about picking the price in the timing..

All right. Well thank you very much..

Thank you..

The next question comes from Tyler Stafford with Stephens. Please go ahead..

Hey guys this is actually Gordon Maguire on for Tyler today.

How are you’ll doing?.

Good, how are you Gordon?.

Still pretty good. I'd like to just piggy back on the problem loan discussion. I'm wondering if you could just go into a little bit more detail on the borrower and the property use.

And just provide a little bit clarity that gets us a little bit more comfortable on the underwriting just like LTV, debt service coverage what kind of occupancy you're seeing out of those properties?.

Gordon I'd like you to refer you to a press release that was issued earlier this quarter. It has all that information continuing there, including the address of the property, the type of the property, the original valuation, the loan to value ratio of the property and then with other information sitting over there.

So and then probably no need to repeat over here. But I do like to go over the underwriting procedure. And because when this thing happens, since our loan process require, loan of this type require Board approval.

So the Board including myself is highly concerned about whether we are offering any under-price writing practices that was in the bank or whether it was sticking to our guideline and have on information fetching.

So we have run through the heavy review and gone through every step of the document to see whether this document is pertinent document is bonafide document, true document, it was being done on the basis, it should be should be underwritten, so any misrepresentation among other things.

So after all the review, our Board has concluded that they didn't see anything that was why to further criticize on these things. Then internally we went through another matter of it. In this single event or isolated event relating to one borrower or is it across the board Preferred Bank, we have a lot of other credit that needs to be concerned with.

In fact in the second quarter, we see improving credit trend overall in terms of the quantity of most of our loans and 30 to 90 days has been reduced. Then another crew has reduced. So we have concluded this is probably isolated event.

Then now including you I have to answer at least three or four very senior shareholder of us and as they all are on half along go through every step of the way, okay, including why and who and how and want and when, all this and the philosophical thing that and go over this transaction.

And so far, I don't think that there's any follow up questions from these people. Many of these people you would know..

All right. Just, so I guess move into the deposits. So you move the rates in March.

I was wondering if you could discuss your relative positioning as far as your marketed rates versus the competitors and how long or how much time you think the move up in March might give you before you might have another fall?.

It seems to be -- my feeling is that what I can see is that first of all in late -- in February and January and February we start to see people making moves on the interest rate and this time the move was like a steel case to have a move, seems to be people moving and moving $0.50 or more on each of the product in one shop type of situation.

So some banks started to move and then gradually everybody started do it. So we are one of the last one to do it among our community banking group in the Los Angeles area and follow up on that as few other people then re-move their rates again.

So I can tell you right now be sitting right in the middle of the range of interest rate compared to our peer group or competitors. We cannot compare them with the major bank. We still don’t want to pay anything serious, but they are getting deposits anyway. Next move when it's going to come, don't know.

It just our situation, but likely to be associated with another rating gives them maybe another next move in this quarter and which it just a guess..

Okay. I guess as far as how we're thinking about deposit growth.

I know Ed I think you mentioned the liquidity levels you have on the balance sheet, do you think those will think deposit growth maybe close from the 2Q number and you have to move those cash balances down from here?.

Well I think Gordon as Mr. Yu alluded to regarding the loan pipeline, he's got three months of visibility. We pretty much have zero months of visibility with respect to any kind of deposit pipeline. But suffice to say, our goal has always been to grow deposits first.

Philosophically we believe that's where the value of the franchise truly lies and so that will always be our number one goal. However as you mentioned, we do have a lot of cash as we talked about in Q1 we had a lot of cash, so we didn't have to do a lot of chasing with respect to deposits.

But I think you can expect deposit growth rate similar maybe a little less than what you saw in Q2 going forward for the next few quarters. That would be my best educated guess at this point..

Thanks. That's helpful. I'll step out now. Thank you..

The next question comes from Gary Tenner with D.A. Davidson. Please go ahead..

Thanks. Good morning, everybody.

Ed, I was hoping you could give us the interest-bearing deposit rate for the second quarter as well as your average loan your second quarter? I don't think you include that in your release?.

Yeah average loan yield Gary was 557 for Q2. Average rates on interest bearing deposits including money market were about 102..

Okay. And that 557 is after the interest reversal.

Correct?.

Correct. Add another approximately nine basis points to that to get more accurate read..

Okay. Great.

And then on the loan growth this quarter in terms of the C&I growth, was that general C&I or was that more weighted towards trade finance in the quarter?.

You want to answer that?.

Sure. Gary this is Wellington. It’s general C&I. We don't have that much of trade finance transaction and so it's really working -- local working capital to various local institutions..

So were you guys seeing increased new production in that C&I bucket or was it increased utilization of your existing commitments?.

It's both, but we did have some quite a bit new relationship that we brought in that we've been working on since earlier this year. So and then that couple with few existing customer that they haven't been drawing much on their line of credit and seasonal situation. So they started to wind down..

All right, thank you..

Thank you..

The next question comes from Tim Coffey with FIG Partners. Please go ahead..

Great. Thank you and good morning to everybody. As you get to looking at kind of the growth in deposits, it is likely that you'll start driving down that cash because our load is it's more than you've had in a while.

So then could we see that create somewhat of a slowdown on the growth and deposit costs?.

Well, actually Tim to correct, your cash levels have actually been close to 500 million for about the last five quarters now. It was really only kind of Q1 where we drew down a little bit. But again like I said, cost of deposits will keep going up simply because of how the cities will be maturing and rolling over. That's just a given.

What we need to do is control and weigh the cost versus the growth. Given the backdrop of almost $500 million in cash and wanting to maximize EPS. So that's really kind of the balancing act we have to do here is managing all those components..

Gary, I guess that really -- I guess I have to answer you from an operating point of view not really a mathematical point of view okay. We want to continue to operate and continue to grow. One of the situation we do is that whenever you can have to stable long term deposit at a reasonable cost, you take it.

Got as you currently median, is somebody walks in that says, Li he is about to $0.5 million, billing dollar deposit I am going to stay for a year to year. We take it right away. It will hurt a NIM to no end. You have heard the ROA. You heard many different things. how many healthy ROE and net income.

But regardless – with the deposit we can conduct to loans. I guess this is survival of the institution. So with that is it as long as we have that big, I mean even though we have the big cash on camp, if I can I'd like to maintain even more cash on game..

Thank you for that clarification. Yeah. I guess the visibility you are seeing in your loan portfolio, there is no reason to get cute on the funding. So that makes sense. And then I just had a couple of other cleanup questions.

Beyond the de-conversion and switching core systems, do you have any other big IT projects planned or back office projects planned..

Not big Tim, but we do have what we call Day 2 projects post convergence. There's going to be some new products and services. The biggest of which we will be implementing will be online account opening and actually be able to go to our website and open a new deposit account.

So you can imagine the processes are around that and implementing that are considerable. So those are what we call day two projects. Those will be rolled out over Q3 and Q4 of this year..

Okay. All right.

Those things we should start looking to budget for in non-restrictive senses?.

Well a lot of that stuff is already baked in. So what you're really going to be seeing will be the consulting and the people cost surrounding that, but it won't be considerable..

Okay.

And then just sort of clarification, the discussions that we had about loans in the pipeline for 3Q, is that inclusive of this hotel loan paying down?.

Sure. When we look at the pipeline, we also look at payoffs, loan payoffs, the net number is what we're talking about..

Great. Okay. Great. Thank you. Those were all my questions..

Okay..

[Operator Instructions] The next question comes from Don Worthington with Raymond James. Please go ahead..

Thank you. Good morning, everyone..

Hello Don..

I just wanted to make sure I was through there. Any outlook for the tax rate in the second half, I know was up a bit this quarter versus last..

Yeah, that's a great question Don. I am glad you brought that up. I think it will be consistent with this most recent quarter. That's my best visibility and I think that's right around 28%..

Okay. Great.

And then what was the nature or what generating the securities gain in the quarter versus some restructuring or anything along that line?.

It was actually a couple of things. Believe it or not, it was a little bit of a blessing in disguise. We owned a corporate note, which was a former subsidiary of Bank of America, which actually had a below investment grade rating on it if you can believe that. That was call at par. We owned it at a discount. So that was the gain.

Offsetting that $130,000 gain was a loss of about $18,000 on the sale of a pool of MBS, which under the new accounting standards in Q1 required us to mark that pool to market through the P&L on a quarterly basis.

I think you saw one of our two big brothers have a challenge without this quarter and so in order for us not to have to market the market on a quarterly basis to the P&L we sold. It about $18,000..

Okay. Great. Thanks for the color. And then you mentioned at least that one competitive deal where you had a pay off.

Where's the competition coming from primarily? Is it other community banks or large banks or all the above?.

It's other community bank also that Preferred Bank is reading the sources roll out. Seems to be their funding structure is way different than ours. They're not so -- also bank larger than necessary, so called Omega Bank, but banks are in $100 billion range now..

Okay. All right. Thank you. That's all I had..

This concludes our question-and-answer session. I'd now like to turn the conference back over to Mr. Yu for any closing remarks..

Well so thank you so much for you joining us in the earnings call. As we said we hope we will continue to deliver favorable financial results to our shareholders. Thank you..

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect..