Tony Rossi - Investor Relations, Senior Vice President at Financial Profiles, Inc. Li Yu - Chairman and Chief Executive Officer Edward Czajka - Executive Vice President and Chief Financial Officer Wellington Chen - President and Chief Operating Officer Nick Pi - Executive Vice President and Chief Credit Officer.

Tim Coffey - FIG Partners Steve Moss - B. Riley FBR Tyler Stafford - Stephens Inc. Aaron Deer - Sandler O'Neill Don Worthington - Raymond James Christopher Hillary - Roubaix.

Good day and welcome to the Preferred Bank third quarter 2018 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 Tony Rossi, Investor Relations for Preferred Bank. Please go ahead..

Thanks Michelle. Hello everyone and thank you for joining us to discuss Preferred Bank's financial results for the third quarter ended September 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 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 would like to turn the call over to Mr. Li Yu. Please go ahead..

Thank you. Good morning ladies and gentlemen. I am pleased to report for the third quarter ended September 30, 2018, we had a record quarter in total assets, loan, deposits, net interest income, net income and earnings per share. For the quarter, we earned $18.3 million total net income or $0.20 a share.

Among all the good news above is a very competitive marketplace. For the quarter, we continued to face strong payoff activities in loans. We lost loans to other banks and nonblank financial institutions rates on loan terms that we cannot meet.

For instance, the most recent several loans of commercial retail properties that people are offering to our borrowers prime minus 0.25% or a 4.6% interest only fixed rate for 10 years. These are the terms that we cannot possibly beat. However, we manage to increase our total loan portfolio by nearly $90 million or 2.8% on a linked quarter basis.

Deposits is equally competitive. For me, personally I have never seen the scope and the frequency of deposit rate adjustment that happened recently. Especially, many of the rate adjustment or rate parade was lead by major banks or moneycenter banks which is quite unusual. Nationwide, there is a trend of money moving to time deposits.

Nevertheless, our staff has managed to increase the bank's total deposits by $108 million or 3.2%. Our net interest margin has moderately reduced three basis points to 4.04% because of the above. But our net interest income increased 5.9% between quarters. Net interest income, it is our main focus.

We like to think that the upcoming deposit rate adjustments in the future will largely be absorbed by or well covered by any rate increases as Preferred Bank continue to have one of the most asset sensitive balance sheet. We have been and we will continue to manage our overhead. Thank you very much. I am ready for your questions..

[Operator Instructions]. The first question comes from Tim Coffey of FIG Partners. Please go ahead..

Thank you. Good morning gentlemen..

Hi Tim..

The last two quarters, Preferred has increased deposits faster than loans.

Is that a trend that you see continuing going forward?.

Don't know. I have always been saying that there is no pipeline for deposits. All we know is continue to work on it, okay. And the deposit product what we are offering is a very generic product as with everybody else. So there is no new programs for that. We just continue to work and we just continue to turn over any relationship that we find..

Okay. It makes a lot of sense to be growing deposits faster than loans right now but it also corresponded with an increase in your deposit cost.

Would you see the deposit costs continue at the same growth rate?.

We largely, because of the size of our institution, it is a small institution in the sea of banks, okay, we really more so than reacting to the market deposit rate increases. And most of the time, it's defensive movement rather than offensive movement.

So I like to think, in the upcoming one or two quarters, deposit may continue to increase at the same speed as it has in the past. But that's assuming everybody is still doing the same thing as before..

Fair.

And the CDs that you added this quarter, what were the rates on those?.

Ed, you want to answer that?.

Yes. Well, obviously it depends on the term, Tim, but anywhere from 1% to probably 2.5%, depending on the term. What we are seeing out there is, as Mr. Yu alluded to, a lot of larger banks at the very top of some of these rate risks. So it's very interesting to see but yes, depending on the term.

Like, for instance, year-and-a-half we are looking at 2.2%. One year, we are looking at 2%, somewhere in there..

Okay..

By the way, just giving you a benchmark, okay, about what the rate in the marketplace is. A major $78 billion California bank is posting 14 months at 2.5%. And another $60 billion conservatively managed California bank is posting one year at 2.5%. So it's all over the place..

No, absolutely.

Do you feel that the pressure or the competition for deposits is stronger in Southern California versus your East Coast footprint?.

I don't know, Wellington, how you feel. I feel East Coast is so small, okay..

East Coast is small, but the time that I spend over there and our people over there is just as competitive. And understanding that all branch facility on the East Coast on the street there is about 50 banks, large and small. So the answer, Tim, is pretty much the same, if not more actually..

Okay. Thanks. I will take a step back. Thank you..

The next question comes from Steve Moss at B. Riley FBR. Please go ahead..

Good morning.

I guess for folks on the other side of the balance sheet, just kind of wondering where loan yields are these days and kind of what's wearing off and what are you able to book loans on these today?.

Well, with the most recent several increases that Fed Reserve has done, well, the marketplace used to be, well, let's say, we were able to book certain type of loan at prime plus 1%, okay Now, generally speaking, we are getting is prime plus 0.5% to prime plus 0.75% fore this segment type of a loan.

There is all different segment of loans that commands a different type of price. Even in the commercial real estate when you are, so called, the autonomous usually come in at much lower rate and many times it's fixed rate. So it is all over the place.

But it is safe to say that the margin over prime are margin over whatever the index is, has been gradually reducing..

With that said, Steve, the average yield this quarter on the loan portfolio is 5.75%..

Okay. That's helpful.

And then wondering on expenses here, what are your expense expectations for the fourth quarter and the conversion related stuff as well?.

Well, obviously, we are a little bit light in Q3 at $13.6 million, which was nice to see. So we will definitely see some increase. We will probably likely be in the low $14 million for noninterest expense for Q4 would be my guess. As our day two items for our system conversion start to go into effect in terms of the people and the project..

Okay.

And kind of how do we think about the conversion expense beyond that and into 2019?.

Well, beyond that, there shouldn't be much at all. We will probably have a little bit in Q1 of 2019 as the last of the day two items are implemented and then we shouldn't see anything in terms of impact from conversion beyond that..

Okay. That's helpful.

And then my third question, with regard to the increase in the reserve ratio and the provision, just wondering if any of that was related to the transfer of the New York loans back to held for investment or if there is anything just underlying that you are adding reserves for?.

That's the main reason..

Okay. Well, thank you very much..

Thanks Steve..

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

Hi. Good afternoon guys..

Hi Tyler..

So I just wanted to follow-up on the last question regarding the New York credits. I am just trying to understand, I guess, better what happened this quarter. So last quarter, you decided to market the notes, move them to HFS. This quarter, you moved it back into HFI.

So are we to assume there is basically no market for the notes at a price that you have found acceptable?.

Tyler, this is Nick Pi speaking. The reason is that currently we work with bankruptcy trustee, try to solve the issue as rapidly as possible. So trustee we signed a stipulation was to let half option sell in the bankruptcy which will speed up the process of selling these two New York loans..

Okay. So you think you can recover on these or move past these quicker by going this route rather than just selling the note, as you had planned last quarter? That's okay. Got it..

Yes. That is true, you know..

Okay.

When was the last time you received a payment from those borrowers or borrower?.

I believe it should be back in February of this year..

Okay. All right. Maybe just going back to the earlier comments, just about loan competition, Mr. Yu, as you mentioned earlier, the pressure to overall growth this quarter. As you point out, the growth was still actually quite strong this quarter.

So I was just wondering if you could give us an idea of the magnitude of that impact that the competition had on the overall growth this quarter?.

Well, we could have grown similar to last year, okay, which is in the mid-teens, a bit over mid-teens in the growth rate. But this quarter, as I have spoken, some of the loans that's being offered to our customers, in my personal opinion, is unimaginable in the rate they are being offered.

We can only congratulate our customer and encourage them to just go ahead and take the deal. How can you not take a shopping center loans when one year ago it was dark, okay. By everybody's opinion, shopping center is bad, okay. Well, people are offering prime plus 1.25% now, okay..

Sure. Okay..

So it's something that you love the customer, hopefully they still like us. You just have to give up..

Yes. Understood. And then I just wanted to clarify one more comment, just around the deposit pricing expectations. So if competition stays status quo as it is today, then you would expect a similar deposit cost increase next quarter.

Was that the comment you said earlier?.

Well, it is just a larger type of comment, okay. If deposits cost marketplace increase at average of, let's say, 30 basis point, well, next quarter probably it's 30 basis point too. But I hope it is not that much because everybody is questioning their deposit costs pretty much to decide in excess of loan rate increases.

You want to add here some numbers, right?.

Yes. So, Tyler, just to give you a little, some math behind it, our total cost of deposits in the second quarter went up 19 basis points, okay. And if you will recall, that's when you kind of jump back in the market for deposits. We kind of just took first quarter off. The increase in cost of deposits in this quarter moderated down to 16 basis points.

So if we can see that as a trend, that's great. But as Mr. Yu said, we will certainly still be looking for certainly an increase in cost of deposits. But what we don't have yet baked in, is the 25 basis points we got at the end of September on the loan side..

Yes. Okay. Well, let me just ask one more.

So if you don't have the September hike, I guess obviously not in the quarter but well, just from a trajectory standpoint, if those deposit cost do hopefully plateau or migrate modestly lower and you get the benefit from September, say, would you expect the margin to expand from this level over the near term?.

Well, I can only hope for it. That will certainly enhance our earnings..

It's a possibility..

Understood. Thank you guys..

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

Am I coming through?.

Yes. Now you are..

Sorry. Okay. Just kind of following through on the margin discussion. I know you guys book mostly verbal rate loans.

Can you remind me, is that still north of 90% of the total portfolio that's variable rate and I think also predominantly tied to prime? Is that correct?.

Yes..

Okay. And then maybe give us a sense of what the -- it sounds like paydowns are challenges there for a lot of banks.

What was the magnitude of the paydowns this quarter and how does that compare to recent quarters?.

Well, paydowns in the last three quarters is probably -- yes, about consistently at the $150 million level. So last quarter, I mean September quarter is slightly less than that, but that kind of paydown is early. We saw that some of the loans that are really good quality loan on it as we were explaining a bit early..

Okay. And then you have continued to see some pretty good growth in the C&I category.

Is that all homegrown stuff? Or is any of the participations or what kind of industries are you seeing the best growth in?.

So, for this quarter, I think all the C&I loan is homegrown, right..

Yes..

Okay..

Okay.

Any particular industries where you are seeing particular success on that front?.

No. It's across the board..

Okay. And then lastly on fees. You guys have been making some good progress in growing your trade finance fees.

Do you expect that to continue? Or is there any sort of seasonal impact we should look for in the fourth quarter that might bring that down or up?.

We are not hoping any increases in fourth quarter, okay..

Yes. I would look for that to be fairly flattish, Aaron, from herein..

Okay. Good stuff. Thanks for taking my questions..

The next question comes from Don Worthington of Raymond James. Please go ahead..

Thank you. Good morning..

Hi..

A couple of questions in the expense area. It looks like salaries and benefits were down linked quarter.

Anything in particular driving that?.

Well, a few things, Don. One was, the bonus accrual was slightly less in Q3 than it was Q2. As interest rates go us, our hurdle rate goes up in terms of our formula for adding to the bonus pool in terms of our pretax earnings. So that was one factor. The other was, as loan production increases so does the capitalized personnel costs.

So that also increased in Q3 over Q2. And as you know, that's a credit to personnel expenses. We capitalize those cost and amortize over the life of loan..

Okay. Great. Thanks Ed. And then OREO expense was up as well.

Was that just related to that one property that's been there for a while, the $4.1 million?.

Yes. As you know, we do pay some HOA fees on the units that we own. I think we also had an additional legal bill this quarter, which drove that up a little bit..

Okay. Great. Thank you. That's all I had..

The next question comes from Christopher Hillary of Roubaix. Please go ahead..

Thank you. Good afternoon or good morning. You shared some color just on what was changing in the marketplace during the quarter.

Would you care to share with us some thoughts on how you think the competitive dynamics around loans and deposits will play out for the rest of the year or the rest of this cycle?.

You mean for the cycle and for overall, in my personal opinion, for Preferred Bank?.

Well, just you commented how those aggressive loan terms and you have never seen deposit rates move in the way they moved during the quarter.

So you know, to what extent do you think that's an unusual? To what extent? And how do you think it's going to play out from here, given, it's so unusual?.

First of all, there is no history to follow up on that. Logic tells me these things like that couldn't last very long, okay. People cannot be making the loans, you know, at basically that kind of rate with the cost of fund. I hope everybody has pretty close cost of fund.

So how does these particular institutions were able to compete that way, we are at a loss. But I don't think it's going to last very long. As an operator of the bank, you just have to stay conservative, thinking it might happen..

Okay.

And then are there certain areas of loan demand that you think stand out where there is still opportunities without the unusual degree of competitive rates and terms?.

Well, there are loan demands outstanding. There is lot of demand over there. There are certain segment of the loan that people cannot do. For instance, California is short of housing, okay.

And that's one of the reasons of the short of housing is that housing is that banks generally are keeping their total construction loan portfolio to a certain level, okay, which conformed to current credit environment and government policy, okay. So result of that, not enough people are making loan in this particular segment, okay.

And there is opportunity there, but nobody is really, I should say, be very aggressive about chasing loans there. So there are few segments of that..

Okay. Great. Thank you. Good luck with the rest of the year..

Yes..

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

Well, thank you very much, okay. So, obviously, everybody's questions seem to be lot of how the competitive future will be, okay. Sitting over here, we certainly like to be less competitive. It will make our job a little bit easier, make our shareholders a little bit more happier, okay.

But we have to be well prepared for that and we have keep up operation as if this situation will be a long-term situation. And we are ready to do that, okay. Thank you so very much..

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