Good day and welcome to the Preferred Bank Second Quarter 2017 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. Please note this event is being recorded. I would now like to turn the conference over to Kristen Papke, Investor Relations. Please go ahead.

Thank you. Hello everyone and thank you for joining us to discuss Preferred Bank’s financial results for the second quarter ended June 30, 2017. 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’d like to turn the call over to Mr. Li Yu. Please go ahead.

Thank you. Good morning, ladies and gentlemen. Thank you for attending our earnings conference phone call. I'm very pleased to report, we had a good second quarter 2017. In which the Bank earned $11.7 million in net income which equals to $0.80 per share of earnings per share. Both these numbers are substantially better than last year. Our bank continues to grow. During the quarter, loans increased $104 million and deposits which is the bright light increased $170 million. The continuous large deposit increases has eroded our capital ratio, our return on assets and our net interest margin, but it is the franchise builder and it will provide much more muscle for the long-term growth and profitability of the Bank. Net interest margin for the quarter was 3.75%, an 8 basis-point expansion from the first quarter. This is less than what we had expected, largely due to the fact that large deposit growth has changed the leverage ratio. Also contributing to that is continued market competition in pricing. I want to emphasize -- at this time I want to emphasize that the largely deposit increases have no or very, very little effect to the net income and earnings per share of the Bank. For the first time since 2009, our capital ratio has been reduced to less than 9%. We must transfer the Bank to continue to grow, and therefore went to the state of California and obtained a negotiation permit to add $50 million of new capital in the form of ATM offerings. We chose this ATM method largely because it will more accurately match in our needs with the capital amount. Let me use a far out and hypothetical example at this time. Assuming, hypothetically, in the next 12 months, there will be no growth in deposits and assets, however, our earnings continue to grow. We will add roughly $40 million or more new capital through earnings in the next 12 months in which case our capital would be close to 10% capital ratio. But in the most likely case, we will be raising other $50 million before the year, so perhaps that in our calculation of the outstanding shares by year-end to reflect the additional shares to be issued. In June, our Bank Board of Directors has declared the dividends of $0.20 per share, which is an 11% increase from the $0.18 of dividend previously declared. This is our reflection of our Bank’s performances, earnings performances, and also our confidence in the Bank’s future. Thank you so very much. I'm ready for your questions.

We will now begin the question-and-answer Session. [Operator Instructions] First question comes from Aaron Deer with Sandler O’Neill & Partners. Please go ahead.

Li, following up on the very impressive deposit growth that you had in the quarter, I was just curious if you could maybe give us some insight in terms of the sourcing of those inflows and what you're seeing in terms of deposit pricing pressure because obviously you're still managing to post some pretty impressive margin expansion. And I'm just wondering what kind of feedback you're getting from customers on deposit pricing and if you sense any need to be tweaking those upward as we go forward.

First, related to the source of deposit increases. There are really many, many reasons for that. I guess, the one, the first and foremost is that our customers are getting richer because the increase in real estate prices, increasing stock prices and increase in the earnings profitability in the Company. So generally, it is growth of our existing customer. And also we feel that as we go along with our performance, the reputation gets better. Our customers’ confident in us is getting higher. So that adds to the deposit momentum. And along with that, now we have some new products which compared to our peer group probably ahead. For instance, we rolled out the mobile banking both in personal and in business mobile banking and which somewhat larger competitors, they don’t have that yet. So, all in all, primarily, I think that -- I like to drag a little bit and let’s say maybe our people work smarter now. So, this is the reason for the source. And pricing pressure is that we a little bit increase in pricing pressure. We haven’t witnessed the competition pressure to be very high; we have no problem attracting deposits at current posted rates. We realize as we go along, the thing will probably go along would be fed rate increases or ten-year or two-year whatever these things will move, I guess we have to move along with that. So, far we haven’t seen much.

Okay. That’s great. And I'm just curious, given the growth that you're seeing; obviously your credit trends are quite favorable. But, I just wonder if you could just give us a sense of in terms of new originations, what kind of provision or reserve has been set aside for those? Just trying to gauge if we should anticipate the reserve ratio continuing to drift lower or if it’s likely to maybe stabilize here around current level?

Well, one of the things I would like to emphasize is that making a reserve today is nearly a science rather than art. And we the insistence of a PCOAB, which is accounting governing body, they are demanding all the accounting firms to be more, I should say, systematic and methodical in calculating the reserve. There is a very little room for the Bank to discretionary provide more reserve, if we wanted to. I personally have previously wanted to add a so called a cushion on allocated reserve to our AL, [ph] but wasn’t successful; we weren’t allowed by our accounting from to do that. So, having said that, the reserve going forward, assuming the mix of our loan portfolio doesn’t change, but the product type mix doesn’t change, we’ll be right around in the $0.98 to $1.01 area for the new loans to be generated. But assume there is no charge-offs that are required to be replenished.

And then just one confirmation on your comment. It sounded like you anticipate using this, the full $50 million of the ATM that’s authorized, by year-end. Did I hear that correctly?

Yes. Obviously we’re blow 9% right now and we would like to bring the ratio up a bit. And even the first 18 days of the month, which is upto yesterday, we grew over $70 million around deposits. So, it looks like it continues growing in. And these are all relationship type of deposits. So, with that, in our planning, we must assume to some degree a further accumulation of deposits and therefore the capital will be needed.

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

I just wanted to start maybe on the margin and get your thoughts on the margin for next quarter, after the June rate hike that we had and any commentary you could share on in terms of what -- how loan yields progressed throughout the quarter?

Well, we did see as you would expect and Li would expect, we saw a nice spike in loan yields from the May to June month and obviously that bore itself out the 80 basis-point expansion on a quarter-over-quarter basis. Looking forward, Tyler, as we have discussed before that the challenge really becomes what the leverage looks like during the quarter, what average deposits are versus average total loans. To the extent we have that continuous steady growth in deposits that Mr. Yu just talked about, we could still be looking at a situation where we don’t get much expansion in Q3 relative to the net interest margin. However, we will see significant increase in net interest income. It’s just may not bear itself out in that mathematical equation.

Are we to the point yet where you could remix some of the earnings assets and liquidity as you got into securities and loans yet, or are we still not there yet in terms of the rate outlook?

We do not know what you mean by mixing. So, what we do is that as far as the loan is concerned that we just have to grow a loans in normal method and independent of deposits, not because we have more deposit, we just have to do more loans. We just have to do these things separately. As far as security is concerned, I don’t know what magic Ed has in his pockets, but I haven’t seen anything that we can buy right now that lead us not to a sleepless night of seeing value eroding in immediate future. I guess just to be conservative, maybe we should bite the bullet [ph] and not being too short-term profit motivated.

Yes. Tyler, to add on to that, we are still seeing, I'm sure you follow us, the tenure and that’s what’s kind of I watch most closely relative to the bond portfolio. And obviously after the election we have got a nice spike and then it’s trended down pretty unfortunately really since then. So, until we have I think real clear direction and that tenure has to sustain a higher level, I think we'll be reluctant to put in any more money to work in the bond portfolio.

Okay, that's fair. On expenses, I was a little bit surprised that the compensation line item was up this quarter after the fallout from the deferred comp last quarter. Is there anything I'm missing there? And maybe just a similar question on the other expense line item, was there anything noisy in that line item that should fall off?

With respect to the other expense line item, we had a FDIC assessment catch up essentially. With respect to the employee salaries and compensation, most of that was in the compensation expense as well as bonus expense and we also had some variation relative to FAS 91 deferred loan capitalized loan cost. So that would have accounted for that, but essentially 800,000 in additional and higher salary.

So with the fallout from the legal expense that you guys had last quarter, is this a fair run rate for expenses?

I would think it'd be slightly below where we hit Q2, Tyler; I would say closer to 12 as opposed to the 12.4.

The next question comes from Steve Moss with FBR. Please go ahead.

Good morning. I was wondering to just discuss where the loan pipeline stands and where you're seeing the strongest growth these days.

One of you can take on that and maybe I can add a little bit to that.

Well, the loan pipeline looks pretty healthy right now and it's all of sudden kicking in from our Southern California, Northern California as well as New York. In terms of product, we are very selective in terms of what kind of CRE we want to tackle, more like a owner user type of product. And C&I are -- we recruited a couple of C&I lenders late last year. And so it's been about six or seven months, their production should continue to kick in.

To put some light here to the product types and so on. The products are although generally still the same but we are conscious about the C&I concentration and ratio. In the back of my mind, when we were choosing on the new loans and revolvers performance, certain other type rather than the things that would create a concentration issue. And so, that's really related. Another situation is obviously that there's a lot of publicity these days regarding e-commerce and expect to restate retail properties. I would say that we have tightened up the underwriting standards and we're tightening up substantially the -- how should I -- I should have said [ph] tightened, we have the investigation, quite substantially the more effort was put on to any of the request that was sent to us and being very, very choosy.

Okay. That is helpful. And then I was wondering with regard to capital, I hear you in terms of the ATM, kind of where are you thinking for a long term target on capital ratios?

Well, we have obviously internally always believed that we should be operating between 8 and up to 9% as lowest level possible capital. That is based on the so called all the capital ratio that was previously published by the regulator with Basel, all of those things along. I think there’s a whole lot of change in this environment and we’d like to wait and see to what their conclusion is what the market conclusion before we come to a revised any of our internal growth. Before that I think 8 and 9%, it will be the lowest level they want to operate at.

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

Looking at the NIM this quarter with the addition of deposits, can you have that kind of deposit growth and say the loan to deposit ratio has been somewhat similar to the previous two quarters. How much more basis points of NIM would you have gained?

To answer your question, I've done a very, very personal, on computer assist, [ph] I mean scratch paper type of approach. The loan to deposit ratio on December 31st was 92%, and it’s down to 88% right now on June 30th and this 4% changes is caused by anywhere between $0.07 to $0.09 of erosion in net interest margin that would have happened. But please remember that you are talking to a person who’s not a checker. [Ph] So, I don’t think any responsibility.

So that's all folks. I remember from the last call, you talked about how you are seeing good margin expansion just in March. So, that’s kind of what my question was. And then the deposit growth, going back to the beginning part of the Q&A, that was mainly from existing clients or did you create new products that brought in new business on the deposit side?

Not new products, the clients; did we have new products?

No new products. I think some of our -- again, we brought in couple of deposit officers. So, we actually expand this on the new clients as well. So, we build this on retention. While we try to bring in new deposit, we want to make sure we maintain and hold on to our existing deposit.

Okay. That's great and an exceptional growth from existing clients.

We consider our Bank does not have special products, which is bankruptcy deposits or I mean large amount of escrow deposits other couple of small accounts. So, we are -- basically very such a normal type of business.

And I'm not that familiar and the processes that you are going through with the state of California to execute on the ATM. But is this something conceivably that could be done in third quarter?

Do you want to answer that in terms of starting?

Yes, absolutely. We still have one more -- another permit to get before we can actually start executing on it but the first one was the biggest hurdle, Tim, in terms of getting the negotiating permit. In terms of getting the documentation in place, getting the work from the accountants in place, comfort letters and so forth, that should be fairly quick to do. And we should be able to start executing on the ATM and before the end of the third quarter.

I just want to explain to you this, it is certainly -- will not be any regulators, let alone state of California’s intention of limiting the capital growth, capital increase of any financial institution. But I think in our particular case, this ATM method is a first case the state of California has ever faced under their system. There is lot of things between the legal side, the lawyer side and us to work out, and they’ll pay cost to have a so called -- sort of that unusual type of -- how should I – disclosure to you...

Right.

It would be done. From now on, it’s. Okay?

That’s kind of what I was asking, I wanted find out how long it would take to get the stock permit. So, it sounds like the hardest parts are already been -- hurdles are crossed.

Yes. All the heavy lifting is done.

And then just one last question. Could you remind me again what the charge-off related to in the quarter?

Charge-offs related to -- Nick do you want to explain that?

This is really related to one of our non-performing loan or book for almost over a year and followed [ph] bankruptcy in second quarter 2016. And during the previous quarters -- we didn’t have really good indications from bankruptcy trustee about the result or about the solution. So that’s why we periodically made the reserve on this credit. Then most recently we received some sort of good indication from bankruptcy trustee regarding deterioration of the credit that’s why we -- the management made the decision to charge off.

Let me just add on little bit to that, credit, previously having above 85% reserve based on that history. It’s nearly fully reserved. And although we believe there will defiantly be recovery coming in the future, but we see that as more comfortable just charging off the whole thing in this quarter. So, the loan has been nearly fully reserved in the past.

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

Just a couple of questions, one to revisit on the deposit side. Do I understand correctly that you're going to continue to work to build deposits regardless kind of the pace of the loan growth and doesn’t sound like you're going to invest in the securities portfolio, so we should assume there could be some incremental build of just excess liquidity over next couple of quarters?

Put it this way. We would like to natural things happen, wouldn’t go out to buy deposits. If deposits come in as it currently is coming, we will open our arms and welcome that. But we will not go out and file for deposits by competing with other people with high rates and [indiscernible] special promotion. But as of today, this deposit has been coming in, as I said to multiple reasons. And I guess in the past, I always say, hardest thing for us to predict the deposit growth, because there is no pipeline. A customer certainly -- I mean sold a piece of property, he has about $30 million, $40 million that I want to keep in the Bank for one year, so they place it with us. And we didn’t know that until three days ago, so that was like this.

Okay. And then just a question on the loan front, good loan growth but the for sale housing construction balances declined, that was like they kind of peaked in the March quarter, down about 15% sequentially. Could you talk about that portfolio and your thoughts going forward?

For sale housing construction is down and that’s by design, because what we tried to do and again as Mr. Yu mentioned earlier, to manage our CRE concentration as well as construction lending.

You will also notice, Gary, that the other construction actually increased over that same period. So, from a concentration standpoint, what we want to do is manage the overall construction to the total loan book as well as total capital.

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

In terms of REO, you had one property on the books from a while, any change in the status there, that $4.1 million?

That $4.1 million was a -- condo in the entire complex. The Homeowner Association and us are joining right now and they want to market this entire property together. And they are in the process of obtaining three different appraisals, we’ll cooperate with them. So, not to selling our portion of the property separately, so that they can get a better value on the whole situation. The value based on our information in the marketplace is substantially higher than the $4.1 million we carry on the book. We hope that the property, there will be some action later at the fourth quarter this year, first quarter next year.

And then in terms of CRE and C&I, have you experienced any weakness related to retail customers or borrowers?

Well, first of all, please understand, all signs are there. I do not have the privilege of doing more, [Ph] so, because this is generally higher than our type of a customer. But what we generally are doing is so called, the very nice neighborhood centers in the retail or the special retail service center, a retail property within a city or such as special credit line type of retail such as a Taco Bell or a McDonald franchise, the property. [Ph] These are the retail things we are doing. What we have seen is obviously that some of the centers having a little bit pressure on some of the retail customer, more so department store type or more so merchandise type has finally [indiscernible]. But by and large, most of our customer was able to quickly retailing it into different more service type of customer. It's amazing, the speed of these deals being returned. So far that we see the trend, we’re scared all the time, we’re scared about the development in e-commerce what can do to us. And only thing we can do is keep watchful eyes.

[Operator Instructions] We have a follow-up question from Tyler Stafford with Stephens. Please go ahead.

Hey, just one more follow-up question from me just on the margin question. Do you have what the security yields were in the second quarter? I’ve got them as 3.60 last quarter.

It was about 3.65.

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

Thank you so much for your attending the earnings conference. And people here including management as well staff, all in this conference room is dedicated to continue to deliver results to our shareholders. And we hope to have your continued support in the future. Thank you.

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