Good day, and welcome to the Preferred Bank Third Quarter 2021 Earnings 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 Jeff Haas of Financial Profiles. Please go ahead.

Thanks, Jason. Hello, everyone, and thank you for joining us to discuss Preferred Bank's financial results for the third quarter ended September 30, 2021. With me today from management are Chairman and CEO, Li Yu; President and Chief Operating Officer, Wellington Chen; Chief Financial Officer, Edward Czajka; Chief Credit Officer, Nick Pi; and Deputy Chief Operating Officer, Johnny Hsu. 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 that 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 very much. Good morning, ladies and gentlemen. I am very pleased to report our third quarter net income of $26 million or $1.77 a share. Both are new records for our Preferred Bank. Likewise, the return on average assets of 1.8% and return on equity of 18% are also the recent years’ highs. This quarter, we have experienced significant deposit increases. Quarterly deposits increased nearly $400 million, on an annualized basis, a little over 33%. Important thing is that the quality of the deposit growth is good. 70% of the deposit growth are in the area of non-interest bearing demand deposits. Another 20% is in the area of interest bearing demand deposits and money market. Deposits costs improved moderately from the previous quarter. And I do expect that the trend will continue -- that moderately improve in the fourth quarter. Loan for the quarter increased $77 million or 7.1% annualized. This is lower than our previous quarters. And when looking to our pipelines, we found that this quarter we originated $260 million of new loans. However, with the $260 million on new loan is in line with previous quarters, slightly better. However, the payoff for the quarter increased to $210 million, which is roughly is about compared to average of $150 million in the previous quarters, okay? Loan yield moderated a little bit and likely to continue to moderate, I mean, compression -- moderately compressed in the coming quarter. The net interest margin came in 3.36%, which is lower than previous quarter, but that was the result of oversized deposit growth. This quarter's bright line is in the noninterest income. We had $1.1 million increase for the quarter, largely due to the increased LC fees. Looking ahead, LC fee likely to be satisfactory in the fourth quarter, but probably it will be slightly less than the third quarter. Our operating expense, to my personal surprise, came in at 30.4%. We started to feel the inflation wage -- inflation and wage increase pressure. And I guess the full effect of inflation will gradually show up in the later quarters. Our credit quality is stable. There are no deferred payment loans under the CARES Act at this time. PPP loans have been reduced to $65 million. And the nonperforming loans were steady. Altogether, we had only 7 nonperforming loans, 2 of them -- including 2 of them are the mortgage product. We are highly encouraged by the third quarter operating results under the intensive loan competition environment, which we now get used to and also amid a slow progress in controlling the Delta virus, and under the inflationary, although it's called transitional, but we don't know how long this transition is going to be, okay? But I do see all these facts will gradually improve in the coming days. And we here in Preferred Bank are quite optimistic about our 2022 year. Thank you very much. I'm ready for your questions.

[Operator Instructions]. Our first question comes from Matthew Clark from Piper Sandler.

Maybe just on the loan growth outlook and the pipeline. Sounds like the production is still very strong. The payoffs are obviously a little disappointing in some respects. What are your thoughts on payoffs going forward? And how would you describe the pipeline? I think last quarter, you mentioned it was satisfactory, but any other kind of additional color as to what you might mean by that, would be helpful?

At this point in time, it's early October, I think our pipeline is probably equally, if not slightly better than the third quarter, which -- as I indicated, third quarter actual pipeline was better than previous quarters, okay? But there are elevated, I think, payoff activities. And this low-interest environment is very prolonged, and many people are doing loans at the yield rate less than our net interest margin but fixed for 10 -- 5 or 10 years, which we think will be detrimental to the future, okay, given the fact the Fed is about to taper and maybe to lift off to somewhere -- sometimes close -- from a closing side. So maybe the situation, we choose not to compete because of these reasons, okay? So we just want to maintain going forward that our portfolio is not shortsighted.

Okay. So maybe that elevated payoff activity continues, maybe you do a little bit better in production. So maybe the growth rate is somewhere in between this quarter and your prior expectations of kind of low double digit or teens, mid-teens?

As you probably can guess, it's very hard to predict at this point in time. But we certainly -- that -- I mean our cash experiences, we always have growth, okay? We certainly would try to reach the level of previous quarter. We'll try very hard, okay? We'll continue hiring people, I mean, adding staffs. We will continue to move forward looking for new loan opportunities and -- but somehow the market has to cooperate too. The activity of -- I mean the slowness of the -- Delta control certainly will be a factor affecting the transaction level now.

Okay. Great. And then...

This is our top priority to loan growth.

Yes. Okay. Great. And then just the other one for me was on the letters of credit fees and the sustainability of that activity. Is that something you think you can replicate going forward? Do you feel like it was a little outsized?

I think third quarter is a little outsized, but the fourth quarter will be better than the second quarter but probably lower than the third quarter a little bit.

The next question comes from Gary Tenner from D.A. Davidson.

A quick follow-up on the letter of credit fee question. Li, based on kind of your comments, does the fourth quarter represent sort of a baseline that you might think about letter credit fees going kind of a seasonal impact that would diminish going to the first quarter of '22?

The nature of letter credit is we open it on a fee, okay? So actually, it is a certain degree of volatility baked in, okay? But looking at the situation, to the best we can tell, third quarter will be slightly less than the -- fourth quarter will be slightly than third quarter. And then I hope in the first quarter, so far, it looks like we'll be closer to fourth quarter at this time. But obviously, we hope to pick a few more deals and we call more fee income.

Okay. And last quarter, I think, Ed, you kind of highlighted payoffs as one of the risks of being an offset to the production as more of a transactionally oriented bank. And I think this quarter, obviously, we saw that. Is there any room production side? I think you talked about some new hires a few quarters ago. Just thoughts on the ability to kind of try to outrun some of the payoffs?

Let me put it this way. The -- it's like talking to our shareholders, we did our best, okay? And the only thing I can say is that looking at our past experiences, we always will be -- was trying to put production as one of our top priority. But anything at this point in time -- the crystal ball is kind of murky at this point in time. Payoff doesn't come in with a lot of it, I mean, notice ahead, it just happen. I mean they just -- certainly, you receive a demand. It is a payoff, okay? So sometimes it's quite surprising to us that the payoffs happen. We do our best in the weekly basis, try to update our list of payoffs. And we do a weekly basis try to update our pipeline, and that is a bank top event every week.

Okay. And then finally for me, it looks like you put a couple of hundred million dollars to work in the service portfolio during the quarter. But with the deposit flows you mentioned, the cash balances increased by a similar amount. So just anything that's about -- maybe thinking about putting more of that to work at some shorter-term yields that might be not as attractive as loan yields but won't lock in the rate for that period of time we're talking about that other banks are doing?

Yes. It's a difficult challenge, Gary, as you can imagine in this this rate environment to try to go after yields. So we'll -- we're not going to necessarily do that. But yes, we put about $200 million to work, and it's very short monthly Ginnie floaters. So we're not taking interest rate risk there. We'll -- we may do a little bit more of that. But at this point, we don't want to go long in the bond portfolio. So we'd like to lend it out as our first option. And to add on to your previous question regarding hires and production, I think you have already seen within the third quarter production numbers, some of the effect of new hires that we have taken on this year. So we certainly look forward to increasing that as we go forward. But as Mr. Yu said, it's -- we're -- it's top priority. We're doing our best.

Next question comes from Steve Moss from B. Riley.

Maybe just on loan pricing here, kind of curious as to what are -- where new money yields are these days? And also loan yields ticked up quarter-over-quarter. I know there's a little bit of an uptick in fees, but that doesn't seem to account for the increasing yield quarter-over-quarter.

You had the number right in front of you, Ed.

Yes. So the -- if you recall, Steve, last quarter, we had an interest adjustment downward about -- almost $2.3 million. So that was really...

I remember that now, yes.

Yes, that was the driver. But overall, loan yields are -- excluding that, just looking at that a few minutes ago, overall loan yields are holding up fairly well. The challenge with the margin is the rest of the earning assets and the cash that we have.

Okay. And then in terms of the yield on the Ginnie Mae you guys put on, just kind of curious what's the rate there?

Didn’t think you're going to ask that question in public. 45 basis points.

Okay. And what's the appetite? I mean you're sitting on, call it, over $1 billion in cash in terms of adding more in the upcoming quarter, just how do we -- how are you thinking about that in the short term?

We would obviously try to deploy that, but we have to weigh in the interest rate, I mean, trends going forward on the whole situation, okay? And also we, as the operator, must be cognizant about once the tapering happens and once the sort of like -- I wouldn't say tightening or normalization happening, would the high liquidity that every bank is having will be holding on or some of them will be going away. So we just have to be careful about these items. Some of the items is precautionary. And so -- I mean some of the situation we're doing is really preventive medicine. So it's not going to be -- we're not going to be chasing the last dollars in risk of this kind of nature, okay?

Okay. That's fair and obviously consistent with what you guys have done in the past. And I guess maybe just in terms of expenses here. I understand, you talked a little bit about inflationary pressure. Just kind of curious as to how you guys are thinking about expenses for the fourth quarter and maybe a little bit into 2022.

Well, my guess is a bit higher, but Ed has a different flavor, maybe you know...

No. I agree with you this time, sir. They will likely be higher. The sub 15.4 this quarter, I think, was pretty good given the environment that we're in. But clearly, as we go forward, wage pressure will continue to weigh on expenses. So they will likely increase incrementally going forward.

Steve, wage pressure is that when people start to take your people away with a high -- I mean offer and then the new highs coming in at the level higher, you -- we are forced to somewhere along the line making adjustment for all the staff, okay? So these things, as we go forward, we'll make rational adjustment. It only reflects on the expense level obviously going forward. And I think every bank would face that kind of pressure.

[Operator Instructions]. The next question is from Andrew Terrell from Stephens.

I was hoping maybe we could get an update on how business is trending over in Texas with your Houston office. Are things still on track to kind of hit the -- I think it was $150 million of outstandings by the middle of next year? And then outside of that, any thoughts on maybe kind of new market expansion opportunities at this point?

Wellington, unless you want to add, I answer that first, okay?

Please.

Okay. We have some turnover in Houston, okay? I mean the leader of the team, which not a producer, more or less a visionary person has chosen to take another position with another bank, okay? So -- and following him is 1 or 2 of the producers, okay? Right now, we have 3 loan staff at this point in time in Houston. They have continued producing, okay? The total level of expectation in the next 6 months has moderated down but still will be very much in line with the expenses, the payroll related to that. We are currently hiring and looking for new staff to beef up the Houston operation, okay? So when the new staff coming along, it will be reaccelerated okay? So Wellington, anything to add?

No. I think you covered basically, and just to mention that the loan pipeline for Houston is -- still looks pretty robust, still have a pretty good inventory going. And people over there are holding the fort and holding the production.

Okay. And any thoughts on kind of potential kind of new market expansion?

We are working on it, but we cannot say anything until we're successful letting some team of people.

Okay. I think the valuation of shares has kind of improved a bit relative to where you were repurchasing at during the third quarter. Any kind of change in appetite for buybacks moving forward? Or should we still expect share repurchases?

Well, Ed, do you want to report on that?

Sure. Andrew, we have in place with the repurchase plan is a hard cap, a hard ceiling of $65 a share. And so we ran into that around mid to late September. And so we -- not terminated, but we have not been active in the market since that time.

Obviously, that -- if our share continues to improve, we will go to the Board and seeking for their approval to increase the limit on the whole situation. But given that -- the ability to generate earnings and beef up our capital level and additional -- the fund should be returned to capital account use.

Understood. Okay. Mr. Yu, how are you feeling about the reserve at around 1.4% today? Do you think there's kind of further room to work this down? Or are you comfortable with where it's at today?

I can only answer in -- this thing, and then I have Nick answer that a little bit later. First of all is that if you remember the pre-pandemic level, okay, the CECL -- day after CECL conversion, our level is at [150], okay? So last year, I think the banking industry has been very prudent in putting a whole lot of reserve on our kind of situation. So many of the factors that depend on each bank's viewpoint has -- is different, but everybody started to recognize improved economic conditions, okay? So everybody's model -- CECL model as -- they depend on economic condition. So when it would return back to the pre-CECL -- I mean day after CECL level, we do not know. But I think it's quite a quality hold steady. If the economy does not deteriorate, one day, we get to that level. Nick, anything to add?

I totally echo Mr. Yu's comment. With the improvement of economic conditions related to our CECL forecast as well as on the qualitative side, we tentatively believe that there will be somewhat less stress on the reserve requirement in the future quarters. However, definitely, as Mr. Yu mentioned, you will definitely -- also depending on lots of moving factors such as loan growth, migration of credit quality and also GDP, unemployment rates, all those, et cetera, et cetera.

Uncertainty of pandemic.

Right. So definitely, this is our best guesstimate. For the long run, our reserves should be gradually reduced to around 1.3% level, plus/minus, depends on all those moving factors. So we're -- hard to see how we're going to handle this during the next few quarters. It eventually will be in that range.

There are no more questions in the queue. This concludes our question-and-answer session. I'd like to turn the conference back over to Li Yu for any closing remarks.

Well, thank you very much for your interest in our bank, and we appreciate your support. And we are not looking -- we are back now looking for a home running every segment of our operations, but we do look for overall, I mean, above average in -- put us in the high-performing category, okay? So we'll continue our effort toward that direction. Thank you.

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