Preferred Bank
Q1 2010 Earnings Call Transcript

Published: 4 May 2010

[Operator:]

Welcome to the Preferred Bank’s first quarter 2010 conference call. (Operator Instructions) At this time, I would like to turn the conference over to Lasse Glassen with Financial Relations Board.

[Lasse Glassen:]

Good day everyone and thanks for joining us to discuss Preferred Bank’s preliminary results for the first quarter ended March 31, 2010. With us today from managements are Mr. Li Yu, Chairman, President and Chief Executive Officer, Ed Czajka, Chief Financial Officer and Louie Couto, Acting Chief Credit Officer. Management will provide a brief summary of the quarter and then we’ll 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 documents the company files with the Federal Deposit Insurance Corporation or FDIC. If any of the 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’d now like to turn the call over to Mr. Li Yu.

[Li Yu:]

Good afternoon. I’m pleased to report that 2010 first quarter net earnings were $3.1 million or $0.20 per share. Actually, the results exceeded our own expectation. This is really good news to us after a very storm 2009. Looking at the future a little bit and really depending on the pace of the recovery of the Los Angeles economy, let me emphasize Los Angeles economy, and also our speed of resolution of our special assets OREO and may not be as good as the first quarter. This quarter we reduced our non-performing assets 14%. We thought we were doing better than that, until the last minute of March 31. As usual, they always drop out of escrow. But having said that, there’s a whole lot of activity going on and we can answer the activity level to you a little bit later. We’re very encouraged by the activities of the pace of resolution. Our bank had a concentration in construction and land loans. That is really the source of all our major losses in the past. Let me give you some pieces of information. For all the credit cards which included charge offs and full IBO losses, meaning the write-downs and total loss, all together roughly 75% of all the credit costs are from construction and land loans. And out of the 75%, almost 90% of that are from construction and land loans in other areas, and it was in this group close to three-quarters really related to participation loans with other banks. After today, within the participation land loans overall, we only have $39 million left with $14 million performing and constantly measured against current market value and the remaining $24 million all in non-accrual and always written down to fully provided to match the current valuation reports. With that, looking forward, is not so much trouble left and therefore the pressures of significant additional loan loss provision is really abating. Within our commercial real estate loans, we think are performing as we expected and we identify as much as we can identify at this point in time and provide a reserve whenever possible. In many cases, the reserve was made; a provision was made on loans still performing but with a temporary value erosion. The value could be temporary as the market recovers or the value worsens in a case later on, additional provisions will be needed. So all in all, we feel more confident at this point in time than ever before so we’re ready to face resolving all the credit issue over the next year and it is my best judgment that we continuously decline nonperforming assets over the year and move forward. Aside from that, I guess everybody knows that we’ve been ordered to raise additional capital by FDIC and CDFI and we are fully confident that such effort will be consummated within a short period of time. Thank you. Now we’re open for questions.

[Operator:]

(Operator Instructions) Your first question comes from Joe Gladue – B. Riley & Company.

[Joe Gladue:]

The press release gave us some update on some of the parts of the consent order related to capital levels, but I guess there was another part of that related to bringing down the classified loans, the sub-standard loans to below 50% of Tier-One capital. I was wondering if you could update us on your progress in regards to that.

[Li Yu:]

We have made substantial progress in that particular area and with the support; we will be close to meeting that requirement by the end of the year. So I think Louie can give you more insight right now.

[Louie Couto:]

Again, this is kind of a tricky provision item because what it calls for is the reduction of assets classified sub standard in the September report. So it would not include anything downgraded or grade change subsequent to that. So it’s a finite pool. And as you know, the reports are confidential so therefore we can kind of talk in broad sentences. The 100% to capital requirement given in September, it’s not 50% until year-end. We obviously internally know which assets they classify sub standard and given that it is a finite pool, you see the reductions we have in loans and non-accrual loans and in our construction and land portfolio, you could probably gather from that that we are having reductions in those assets as well. Internally we have our projections and we are confident we will be at or near the 50% level of capital by year-end as the present order calls for.

[Joe Gladue:]

Could you give us what the, it’s not entirely related to that same question, but what the classified assets are and how they’ve changed since year end?

[Louie Couto:]

We really again can’t get into, because it is FDIC report and anything coming from that is subject to FDIC Part 309 of confidential, but if you can understand that there’s probably a high degree of correlation and NPA’s given our reduction in PA’s you could probably gather from that that our sub standard levels are actually coming down as well.

[Li Yu:]

The word substandard classify is really a very judgmental type of opinion. You have three different groups of people coming to review the thing, all of them so called FDIC examiners. They may come up with three different answers on the same loans. Many of the loans that they’ve seen, some of them, they may come up with different ideas in that, and so there’s also the situation on September 30, a number of loans were rated sub standard that subsequently got paid off or subsequently got brought up to date. So this is one situation that’s happening that we cannot go into detail on that. Another situation, you’ve got people in the quest in so-called matching a certain number often give up unnecessary economic value. Let’s assume there’s a loan that is classified, but is performing. We know it’s going to be paid off by 2011, so why in order to make the December 31 cut, to take a $2 million to $4 million hit on the capital in loss by selling the note. That is also an economic situation that we have to deal with, and what we hope is that by that time there is enough substance of the loan where that we can reclassify them to a performing, to a so called classified assets, upgraded. So I know it’s long winded to get into things that you’re not used to, but we’re facing that every day.

[Joe Gladue:]

I’d like to talk about the provisioning or the lack of provisioning this quarter. Obviously, you did have a good decrease in non-accruals and eliminated the past due 90 days, but you still have some increase in early stage delinquencies. I was just wondering if you could touch on what’s going on.

[Li Yu:]

I going to cover the overall situation and Louie can add on to some of the details of the whole situation. We have at quarter end, and don’t forget we’ve just come through a full opinion audit by PMG, where are quarter end we have searched left, right and all sides to put everything that we can identify so far and bring it to valuation report that we have received. Although there’s no assurance that the future valuation report will not be as good as the last one received, but with the market stabilized right now, the changes of that is not as dangerous as used to be. But we’ve done all that, but we still have a little bit unallocated left. We cannot risk the situation of arbitrarily putting additional loan loss provisions because that would be non-GAAP, and also on the borderline of income managing being criticized for that. But we did try to do as much as we can in looking at the whole loan loss reserve situation. Part of it is because whenever you go through an audit process at the year end, your auditors have tried to see every valuation report they can and sort of like taking at December 31, there may be a small portion of the losses already counted but our guess is very little. But it probably, all the situations resolved is we think we’re over reserved as of September 30 anyway. But, different opinion of the situation. But there are a lot of loans that later got paid off when the reserve is released, upgraded, reserve is released. All construction loan where they’re selling down the price is much better than estimated and the reserve number is being revised downward.

[Louie Couto:]

Again, when we do our allowance analysis, we obviously follow GAAP procedures where we’re under FAS 114 looking at recent appraisals and we have the discipline here that we get properties reappraised every six months or impaired in classified loans. One of the things we’ve noticed is that the items that were getting reappraised in the first quarter would have been the ones that we had appraised in the third quarter of ’09 and on average, we’re seeing a very slight decline if not in some of our properties, we’re actually seeing value holding steady or going up. And what was happening in ’08 and ’09 each quarter when we were ordering as many other banks were ordering new appraisals to do their FAS 114, they were determining 20% to 30% declines which would significantly increasing the reserves and/or charge offs of impaired and/or classified loans, and so that is very much a change in the first quarter of 2010. Certainly, there is, we hope that would continue, but there’s no certainty that will. The other item too is, again we follow FAS5 to do on our past loans and again that is a mathematical calculation based on historical loss percentages and as the appraisals and the charge offs begin to moderate, that is also going to have positive effects in that portfolio and that analysis as well.

[Joe Gladue:]

The non-performing asset migration table you put in the press release is nice, but looking at the line with sales and payoffs of loans, I guess particularly wondering sales of nonaccrual loans in OREO, are you seeing much additional charge off on those sales or are they generally coming in where you’ve got the properties marked down to.

[Louie Couto:]

Mr. Yu kind of brought this up before where we, our non accruing loans, we have several projects that are now in the sales phase and one of the decisions we have to make internally is, do we wait for the natural sales of the units where we’ve got it marked to or do we for expediency purposes, perhaps take a further slight liquidation discount to move them more quickly off the books. And that’s kind of what Mr. Yu was referring to earlier and economically, in many cases that doesn’t make sense to move those for expediency purposes since the units now, the project is in sales stage and they’ve gotten some units in escrow already, whereas in the past, we could not have said and were more inclined to do so. In 2010 we’re beginning to see that our borrowers are getting units in escrow and even on loans that we have in the past put on nonaccrual, it might make less sense for expediency sake to move those out in a note sale and take a liquidity discount if you will.

[Operator:]

You're next question comes from Julianna Balicka – Keefe, Bruyette & Woods.

[Julianna Balicka:]

I wanted to talk a little bit about deposits. You had some pretty good growth this quarter, $31 million, 6%. Can you talk about where those deposits came from? Also in the context of your 10-K, it looks like you had $793 million of CD’s that were maturing in the first quarter so with the deposit growth this quarter that kind of implies some pretty good inflow so maybe you can elaborate on that.

[Li Yu:]

First of all, let me give you the overall deposit increases. I guess you’ve seen year end and first quarter was about $70 million increases is I remember correctly, but if you noticed that we do have about $30 million increase, a fairly good increase on the DBA. And also, we’re showing additional increases on the MMA and other interest bearing deposits. So it’s across the board increases. And also, we try to build up more deposits in the PCV end, because as you know, within our consent order that we have to get rid of the broker deposits, so what we have done is we TVC also in anticipation of these broker deposits run off on whole situation. Now stepping aside trying to find the information for the detail you mentioned later, so you start with the next question and give you answer on the earlier one you just asked about $700 million.

[Edward Czajka:]

$793 million is the total amount of CD’s at the end of the year not the amount that’s maturing over the course of 2010.

[Julianna Balicka:]

In that case, how much of your CD’s and brokered deposits matured in the first quarter that did not renew and what kind of balances are going to be maturing in the next quarter for which you’re going to have to reserve your liquidity.

[Edward Czajka:]

We had $42 million of brokered mature during the first quarter that went out and obviously not to be renewed. I’m sorry, what was the second part of the question?

[Julianna Balicka:]

What’s going to go out in the second quarter?

[Edward Czajka:]

I don’t have the exact number. I do know for the course of 2010 there’s a total of about I think it’s $111 million maturing during the year, so a substantial piece of that is already out of the way in Q1.

[Julianna Balicka:]

And new deposits, where did they come from? What kind of customers; internet, branches?

[Li Yu:]

All sorts. Internet is part of it. Branch is part of it. And also that our CNI customer also added some deposit to it. We were able also to gain a few new customers that gave us a substantial deposits.

[Louie Couto:]

I think what’s happening is there’s a lot of deposit diversification that customers are doing as well and so perhaps because of the mergers and acquisitions of east, west and other banks, they may be diversifying out of some of those other banks into our and we’ve noticed that there’s been some diversification that our customers are doing so there is some flow of deposits in the community.

[Julianna Balicka:]

In your 10-K you discussed substantial loan portfolio pay downs to fund your deposits and I was wondering, and seeing the decrease in your loan portfolio this quarter I was wondering if you have a target loan portfolio size for year end, maybe target by portfolio category or how are you thinking about your future balance sheet?

[Louie Couto:]

Again, I think the biggest thing that we’re really focused on is reducing our concentration in construction and land loans. That has been the most problematic portfolio for us especially participations purchased and participations purchased outside the LA/Orange County area. So that is our primary focus, is to allow that to continue to run off and decline. We’re also going to be opportunistic to the extent that there are prudently underwritten good customers that bring deposit balances to us whether it be either very low loan to value COE or CNI; but again, it has to be a relationship type program. But certainly, our focus at this point is in reducing the construction and land portfolio.

[Li Yu:]

From a total asset and liability asset point of view, total loan balance at year-end is not expected to be too much different from currently level, just move slightly downward and maybe upward. The reason is that some of the sales of OREO, we will be facilitating with some financing. That will increase it. There’s also some unfunded, although not much, unfunded construction loans that will be funded throughout the year that will increase the balance a little bit. These are offset by the payoffs on the loans in the situation. As we go forward, we have to maintain our reasonable earnings situation as balancing out total asset size, so we’re not stopping making new loans. We just want to do sensible new loans.

[Operator:]

You're next question comes from Donald Worthington – Howe Barnes Hoefer & Arnett.

[Donald Worthington:]

In terms of the margin, were there any interest recoveries that helped the margin this quarter?

[Li Yu:]

We don’t have any interest recoveries but we do have recoveries from guarantee which is resulted in other income increases. Edward Czajka We did have some loans that went back to accrual status, but in terms of overall recovery from previous charged off, we didn’t have any and to add a little more color to your net interest margin question, the margin was compressed about a full point in Q1 due to the effect of nonaccrual loans. It would have been about 402 on a pro forma basis versus the 307 we posted during the quarter.

[Donald Worthington:]

You mean as a result of reversal.

[Edward Czajka:]

And all the ongoing non-accruals.

[Donald Worthington:]

Any ballpark figure in terms of how much capital you think you need to raise?

[Li Yu:]

At this point in time, we will not venture saying at that this point in time, but also the Board is constantly monitoring trying to decide what is optimum situation about capital raising. But one thing we know that will be sufficient to handle the requirement that is put out by our regulators.

[Operator:]

You're next question comes from [Jeff Marr – Taylor Funds]

[[Jeff Marr:]

I’d like to congratulate you for a nice quarter. Going back to the question earlier as far as the capital raise, with the performance that you guys have done, it’s fantastic, just kind of throwing it out there; does it make sense to raise capital at all at this point in time?

[Li Yu:]

We have to. When I’m answering that, I’m answering without a guilty feeling. I myself am on record as being the largest shareholder of the bank, and raising the capital certainly would be dilutive to my own interests. But with the regulators security putting on the table, there’s no way we can escape that.

[[Jeff Marr:]

Are you anticipating as far as a portion of that new capital coming from China?

[Li Yu:]

I don’t know. China, one thing I know. Any Chinese banking institution with capital is not so far pooled by Federal Reserve at this point in time. My intention is that the money is borrowed in China in Federal Reserve Bank, trying to come up with MOU. Before that was signed, they cannot make investment. Individual citizens I don’t see any of our interested parties is people from China directly. They may be one or two, a minor amount.

[Operator:]

There are no further question.

[Li Yu:]

If there are no other questions, thank you very much. We know we still have a long hard road ahead of us, but we feel so much better than we ever felt before and we hope that the next quarter we can be equally as positive as reporting our earnings results to you. Thank you very much.