Good day and welcome to the Preferred Bank Third Quarter 2019 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 of Financial Profiles. Please go ahead..

Thank you, operator. Hello everyone and thank you for joining us to discuss Preferred Bank's financial results for the third quarter ended September 30, 2019. With me today from management, our Chairman and CEO, Li Yu; President, 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 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 proven correct, 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. You please go ahead..

Thank you. Good day ladies and gentleman, my name is Li Yu. I'm pleased to report our third quarter net income of $20 million or $1.32 a share. Although this is only slightly better than the second quarter, but we have had two fed rate cuts in the quarter. We have a very strong quarter in loan production.

Although the final results of loan only increased $89 million or roughly 10% annualized to-date. But, this was tarnished by the last quarter's activities.

If you recall that as of June 30 earnings conference call, I reported to you that there had been a large usage right at the quarter end our of the C&I credit line, which was paid-off immediately in early July. That has benefited production results of the second quarter, but hurt the third quarter.

As a matter of fact, we had one of the largest loan production in the quarter in our corporate history. During the quarter, we have originated $511 million in new commitments, which had an outstanding balance of $349 million of new loans for this quarter. The real highlight is our deposits production.

Our deposits increased $192 million or 20% on an annual basis. We have had a number of quarters that our deposits was trailing the growth rate of the loan. We are so pleased to see this increase in deposits that have added additional liquidity to fund our future growth.

At quarter end, we had $465 million cash on hand although this large increase in deposits, it changed somewhat the leverage which affected the net interest margin, which reduced 23 basis points from last quarter. The decrease was largely -- I mean related to the fed rate cuts. We had some interest cost reduction.

Our transactional accounts interest cost as reduced, we mean reasonably but our PCD deposit interest did not reduce by much. This is remarkably because the maturity schedule and market competition. We'll continue focus on our deposit cost. Loan quality alone, I mean the credit pasture is stable.

We had $435 million loan charge-off in the quarter, but that was related to -- that was previously fully reserved non-accrual loans. Year-to-date, we had a $216,000 of net recovery. We have today on September 30, we've brought back 209,000 shares of our common stock and the buyback activity is ongoing.

The bank has always been trying to maintain a low operating expense and a higher profitability and we're certainly continued to do so. Thank you. I'm ready for your question..

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Aaron Deer of Sandler O'Neill & Partners. Please go ahead..

Hi. Good morning everyone. I was impressed by the deposit inflows this quarter and was hoping to understand maybe the dynamics behind that a little better. Can you talk about, where those were coming from and if it was through the branches or through some of your deposit gathering team specifically and what kind of costs those new deposits came on out.

I'm curious to know, if you were lagging others in the market who are dropping the cost and so that helped to bring some more in flows your way or what were the dynamics there?.

We were getting our deposits in several different sources, but the big increases and obviously number one is the -- we are gaining certain customers. As I reported earlier, we had originally $511 million of new loans, many new loan customers were over a very meaningful deposit.

Second is that, actually relate to our customers, last quarter had heavy usage of their own fund is that always reported -- also reported last quarter. This has reversed the normal situation. So, their bank account has increased with us. Other than that, our gathering team over the bank is having their normal growth.

So this three factors adding to an increase in our deposits..

So, have you tested the market in terms of where do your deposit cost stand today versus three months ago and how do you -- do you expect to be able to continue reducing deposit costs if you're moving them in that direction? And how do you expect your deposit flows to react?.

We would -- I would handle and reply to you, but we have a -- on the general deposit reduction basis to lead is that the transaction accounts will be priced based along the set movement and certainly market competition.

But the fact that, that the TCD we will continue pricing, I mean, pricing the lower in our costs, but it depends on maturity schedule. It's not all TCD can change cost overnight. It's over, I mean, as an average do reduce [indiscernible] each month.

And Ed, do you want to add to it?.

Yes. In terms of looking at month-over-month and this is nothing that's public, but since we're on a public speaker, the average cost of deposits has come down 14 basis points in just the last two months alone. So, we are starting to see some traction.

We just did not see a lot of traction from a quarter-over-quarter basis, when you look at the average cost.

As we look at the CD maturity schedule out six months, there's going to be a pretty decent deferential between what's maturing and what's coming on and renewing and that's only going to get more noticeable as we get toward the end of the year and the beginning part of '20, the differentials are going to be very large if we remain in this current interest rate environment..

So Ed, if we'd see, let's presume that we get no additional rate cuts just for simplicity sake. But the rate environment and the curve stays as it is today.

Obviously, with those initial rate cuts, it hit the margin pretty hard with the secondary effect of deposit costs now coming down as a result with that setup, where would you expect the margin to trend from here?.

That's the $64,000 question, Aaron. Given the fact that rates are going to -- if we're assuming rates are going to stay the same, I would expect to see a little more compression in the current margin. And then, I would expect to see margin expansion. We currently have nearly half the floating rate book protected in terms of -- to further rate cuts.

So, the floors are certainly kicking in and we'll start to make a difference if we get any more..

Okay. That actually goes to my next question. It was in the nature of the floors.

Can you talk about kind of where those floors were layered in as rates were going up and what that means for your loan yields as we come back down again?.

Well, as they were going up, obviously they weren't as much of a concern, although we kept them in place as rates were going up. But as you can imagine, the difference between what we're actually getting yields versus the floors and enough rate environment is fairly meaningless because it's so wide.

Those things start to narrow as rates start to come down. And what our goal has been has to try to -- as each loan renews is to try to pick up the floor a little bit on these prime-based loans if we can, if we have the leverage to. Right now we have roughly over $900 million of floating rate prime-based loans that are already at their floors..

That's exactly what I was looking for is, what -- Ed, can you break out of the 3.5 billion of loans or so how much of that is protected by floors and kind of at what rates below where the prevailing rate is today?.

Before Ed reply to you on that, okay, was actually mathematically is one thing. There's few other dynamics in the real life that we have to account for it. For our bank, I think is for many other bank there will be continuously new loan being made and all loan being paid off.

All loan usually carry a floor is much lower, so the so called the layer would change on a monthly basis. Second things, many new old loans gets renewed and when they're renewed, they generally updated to a higher level floor if not the current floor.

All these factors is depending on -- also the movement of the proportion also as how much being paid off, how much is the new loans that's being originated, right. So these are some changing, we have seen as very encouraging curve of the moving up the floors pay to the situation.

So, even I, with all these information, I cannot estimate what the results is..

Okay. I appreciate that. Thank you..

Yes. So, I guess just to add to that, as I said, we have about roughly 940 million of floating rate prime-based loans that are at their floor. They will not move. In addition to that in the portfolio, we have over 500 million of fixed rate loans, which will not move obviously. So, we're protected on those components of loans. And that as Mr.

Yu says this number, in terms of our fully index rates that are at the floor or below the floor is really a dynamic number and to give you an example, the dollar amount of loans that were at or below floor doubled from August to September.

Some of that is result of the rate cut, but also a lot of that is a result of what our officers are doing in terms of these loan renewals..

Sure. Okay. Well good. I appreciate the color. Thank you..

Our next question comes from Steve Moss of B. Riley FBR. Please go ahead..

Good morning. Wanted to follow-up on the loan floor question.

If we get another rate cut here, whether it's October or December, how many additional loans will be at the floor with one more rate cut all else equal?.

Let's see..

You want a rough estimate? Well, I would say probably 20% of our loans, okay, will be upgraded to the floor, to the protected level. That was between the dynamics I was talking about. And then, the current rate that is only 25 basis points below the floor, not below whatever -- below those index, okay..

Okay. That's helpful. And then, also, one that I've had maybe a little bit further on the spread between the roll off on a new CD money dynamic.

Ed, what is the spread now between the CD rates you're putting on today versus what's maturing?.

Today, Steve, it is around 30 basis points..

Okay..

However, as I was telling Aaron, as we get closer to the end of this year and into the beginning of next year, that spread widens significantly upwards of 60 basis points plus..

And that's before any additional rate cuts?.

Yes, sir. And that's before any additional rate cuts. If we get more rate cuts, that's obviously going to get bigger..

Right. Okay, that's helpful. And then, just wondering on the loan pipeline, obviously, Metro was a good quarter for originations.

How was customer activity and what's the outlook on that front?.

Well, the third quarter is historically one of our better quarters in a situation. The fourth quarter is historically one of the unpredictable quarter for our history. We have seen that was a rate reduction. Many buyer that become a little more active on the marketplace, on the real estate and many more new projects wanted to be started.

So, I would say the general environment of loan production is trending toward a little bit in term of real estate activity CIE is concern. On the C&I side, we see a little bit more usage of our credit line mainly because of the cost reduction. But, the real thing is that, Wellington will give you more color in the whole situation..

Well, I think that the real color is that Steve as Mr. Yu mentioned that it looks like the pipeline is exactly -- it's hard to predict. I think the bogey is the payoff because the payoff is always lingering out here. So, while our loan pipeline is pretty robust right now. We have -- we do have some loans that carried over upon third quarter as well.

So, as I mentioned again, the payoff is the bogey..

Okay. That's helpful. And then, one last question for me. Just obviously a more challenging rate environment, but the floors going forward definitely help.

How do we think about expenses going forward? I know you guys want to maintain a low efficiency ratio, but is there possibly that expenses could come down? I mean, there was obviously very good cost control this quarter..

Well, one thing is that, certainly, we all want to control deposits. But, we have been controlling costs to the level is probably one of the lowest in the industry. So, going forward, I think that the cost as a percentage wise speaking will maintain the current level because our total assets will be growing.

Our loan portfolio and deposits will be growing. But, the pure number expenses, it always increases. I'm not going to go tell my staff, you guys are going to take a cut next year, right? So, the labor market, it is right now. Recruiting people is, I never had such a difficult period in recruiting staff.

Actually, I mean, human cost is two-thirds off -- maybe over two-thirds of our total cost structure. So, that's the biggest element. And rent has a speeding increase, right? And, all other costs seems to be all picked up a little bit. We don't see any decrease in the same. Lawyer's always charge you more by the day.

So, our hope is that -- our practice has been that to grow our bank to keep our costs in control..

All right. Thank you very much. I appreciate that..

Thank you..

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

Thanks. Good morning.

I was just wondering Ed, if you could tell us what the average loan yields were in the quarter versus the second quarter?.

Average loan yield for third quarter, Gary was 593 versus an average of 614 for Q2?.

Thank you.

And just to clarify, in Li's prepared remarks, the production and new loans were those year-to-date numbers?.

No. Those were for the quarter. It was a very robust quarter for loan production over 500 million..

Okay.

Would you run us through both those numbers again, just really quick?.

Well, we had a net loan -- [indiscernible] that's a commitment. The outstanding amount of new loan that was originated in the third quarter is $349 million..

So the differential would be the payoff..

Yes. Okay. Thank you..

[Operator Instructions] Our next question comes from Tim Coffey of Janney. Please go ahead..

Thank you. Good morning everybody. Hey, Ed, we looked at the reg data for preferred as of the second quarter.

It indicated that 70% of the CD book would mature by the middle of next year -- quarters since that data has things have -- has that percentage materially changed?.

I wouldn't say so, no. That sounds about right.

70% in nine months is that the timeframe you're talking about Tim?.

Yes..

Okay. Then, it sounds about right..

Okay.

And where are you on the buyback authorization? How much more -- do you have the ability to buy back?.

We have spent as of September 30 is roughly one-third of our money. So, we are intending that it continues..

Okay. All right. Well, thank you. The rest of my questions have been answered..

Thank you..

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

Hey, good afternoon guys. Just one more follow-up for me. I apologize if you've touched on this already. I just curious it, what if you can speak to what initial tariff impacts you've seen across the portfolio, if at all yet. And if you guys have completed any kind of review on potential impacts. Thanks..

Tariff in fact in general that only affects a very small portion of our total portfolio, okay. And we haven't seen anything affecting us at this point in time. We have completed review in two different times during the year on the tariff effect, account by account analysis, in term of the tariff situation.

And in fact, roughly, maybe 40, 50, investor during the conferences have been discussing in detail with Ed, everyone of these accounts and how they happen. We have spent a substantial management time in doing so..

Hello..

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

Hey guys, just a quick follow-up. Ed on the 400,000 FDIC assessments credit, I'm guessing there's probably a similar amount that you'll benefit from in the fourth quarter and then maybe some more in the first quarter.

Is that -- am I thinking about that, right or is it going extend for a longer period?.

You might be thinking about that, correct? Yes, Aaron..

Okay. Thank you..

Not necessarily the same amount though..

Right..

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

Thank you.

Just had one question in terms of credit; credit is still pretty benign, but just curious as to what you might be thinking in terms of provisioning going forward?.

Well, are the two things, on the next quarter, we'll be providing breakdown of current methodology. But in January, we'll be providing, I mean in the first quarter, we will be providing based on the new CISO. The early indication is that the increase is not there, okay. We are happy with that, the hit to our capital is going to be very, very little.

But, when we providing nowadays, I have to make this very clear, people think that we have certain liberty in providing our loan loss reserve.

Actually, the loan loss reserve is based on rigid formula, okay? That was really by our accountants, okay? That going through the historical factor and the so called the historical loss estimate, all those model they have build up. So, right now, every quarter, we're doing it based on whatever is needed.

Having said that, we have 40 and well reserve at this point in time, which is indicated in our -- I mean, reporting over the place, including other external people's report.

But, going forward, the provision will be based on new loan production unless there is new weaknesses, okay or if there is some changes and upgrading that will be affecting our loan loss provision on the positive side. So having said that, I don't know whether you want more color from Ed, Nick or Don..

I'd be happy to take it if he has some..

Just like Mr. Yu mentioned earlier that we have conducted a very detailed loan review with each team lending unit to go through their CRA and C&I loan portfolios. And at this moment, we still consider that our loan portfolio is pretty -- obviously, without any severe concern at this time..

Okay, great. Thank you..

Thank you..

This concludes our question-and-answer session. I would like to turn the conference right over to the management team for any closing remarks..

Okay. I guess there's no further question. Thank you very much. Thank you for your attention today. And although that in a very down low market, but we feel pretty good result with our production. We see a pretty good profitability and we feel pretty good about our return for our shareholders. Thank you so much..

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